Many Numbers Still Don't Add Up at Tyco

Also Monday, the ailing conglomerate released its annual report for its fiscal year ended Sept. 30, 2002. The annual revealed that the Internal Revenue Service and other tax authorities have "raised issues and proposed tax deficiences." TheStreet.com reported earlier this month that Tyco, which has an extremely low tax rate compared with other corporations, was in discussions with the IRS to reach a settlement on back taxes that could result in Tyco paying out as much as $1.7 billion. The company denied the report at the time and the annual report says that it has provided in its income tax provision for any deficiencies and believes they will not have a "material adverse effect" on its results or financial position.

Marginal

The key consideration for investors at this point is what Tyco can really make. In fiscal 2002, when many acquisitions were done and Kozlowski was still in charge, the company made earnings before interest, taxes and charges of $4.5 billion on revenue of $35.6 billion. That works out at an operating margin of 12.6%. In 2000, Tyco reported a margin close to 20%.

Assuming the accounting games disappear and the acquisitions peter out, Tyco's margins could easily slip below 10%. That would mean Tyco does not deserve to have a capitalization (market worth plus debt minus cash) of more than one times sales, the level at which an average manufacturing company trades. Tyco has debt minus cash of $18 billion and sales of $36 billion. That means market worth has to be around $18 billion to get to a capitalization of one times sales.

The problem is that Tyco currently has a market worth of more than $30 billion. As a result, the stock would have to fall over 40%, to around $9, to get close to a reasonable valuation. This method is kind to Tyco because it leaves out off balance sheet debt and assumes 2002 sales were real and repeatable.