The ghost of Cendant (CD Quote) past appeared on Wall Street Thursday, dragging the stock of manufacturing conglomerate Tyco (TYC Quote) behind it.
Tyco: Join the discussion on TSC Message Boards. The sharp drop in Tyco shares Wednesday and Thursday, triggered by allegations of accounting irregularities and countered by strongly supportive comments from analysts, suggests that investors remain deeply scarred by the fall of highfliers such as Cendant and
Sunbeam (SOC Quote). Both companies benefited from hyperbolic growth that fed fat stock-price gains before they disclosed accounting problems that slashed their stock prices.
The specter of Cendant, the high-profile accounting scandal of 1998, began haunting Tyco Wednesday afternoon. Rumors of accounting irregularities whooshed through the market, knocking 6% off Tyco shares before the stock was halted on the
New York Stock Exchange. The notion of an accounting problem at the fast-growing conglomerate was raised Monday in a report by David Tice, who manages the
(BEARX Quote)Prudent Bear fund, and a jittery market picked up on the cue following an offhand comment by
CNBC reporter David Faber.
On Wednesday evening, the company vigorously denied that it had accounting problems or that its earnings would take a hit. Thursday morning it reassured analysts in a premarket conference call. Sell-siders duly rallied to Tyco's defense.
Tyco stock gave up another 10% Thursday nonetheless. Supportive analysts blamed the stock's fall on a hair-trigger response from investors wary of being caught in the middle of another accounting blowup like those at Cendant or
Waste Management (WMI Quote).
The Ups and Downs
Tyco shares hit the skids following a strong 1999 run-up |
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| Source: BigCharts |
"The subject the report touches on -- how much integrity do their accounting standards have -- is at the forefront of people's minds," says Quint Nufer, an analyst with
Warburg Dillon Read who rates Tyco shares a strong buy. (His firm hasn't done recent underwriting for the company.) "At first sniff, people decided to sell." He says he's confident in Tyco's management and the company's explanations of its accounting practices.
Of course, sell-siders leaping to defend a Wall Street darling -- Tyco's shares had surged 41% this year before this week -- isn't exactly some newfangled market trend. There were a lot of stalwart Sunbeam supporters, too, Tice says, even after he issued bearish reports on its shares. Tice, who has no position in Tyco and wouldn't release a copy of his report, says he is concerned about Tyco's quality of earnings, particularly its cash flow, the large charges it takes when making acquisitions and its use of "pooling" accounting.
And make no mistake: Tyco's been on a tear lately, making acquisitions including electronic connector maker
AMP and
U.S. Surgical, then wringing cost savings out of them. Sales rose 25% in fiscal 1998 as net income rose 63%. Sell-side analysts shower the company with strong buys, while some of the nation's biggest funds, including
Janus and
Fidelity, were listed as holders of the stock as of the second quarter's end. In a flattering April
Barron's story, Chairman and CEO Dennis Kozlowski earned a comparison with legendary
General Electric (GE Quote) poobah Jack Welch. Even after the recent setbacks, the stock is still up some 25% this year.
Analysts were particularly vehement in their defense of Tyco and its management. "It's one of the cleaner companies I cover from an accounting standpoint," says Nufer. (For its part, the company in its Wednesday night press release denounced the rumors as "false, unfounded and malicious," saying fourth-quarter results would likely exceed analysts' consensus expectations. Tyco officials weren't available for comment Thursday.)
"They use extremely conservative accounting," says Harriet Baldwin, analyst with
Deutsche Banc Alex. Brown, who rates Tyco shares a strong buy (her firm hasn't done recent underwriting for the company).
Tice disagrees. He says the company's string of charges related to acquisitions and its use of pooling accounting make it hard to figure out whether the businesses' underlying performance is really improving dramatically. He also says he's concerned about Tyco's alleged practice of overreserving for certain transactions, which Tice says could allow Tyco to use unneeded reserves to boost earnings. And he notes that Tyco is predicting dramatic increases in free cash flow this year and wonders how it'll achieve that through operating performance alone. While not alleging any deviance from generally accepted accounting principles, he says, "there's smoke there."
Analysts pooh-poohed Tice's specific concerns. Baldwin says Tyco's free cash flow is strong. "That measure tells you what's really going on," she says. "Any flimflam in accounting would get washed out."
Warburg's Nufer adds that the company addressed all of Tice's concerns on the conference call. "They went into painstaking detail about how they determine what restructuring costs will be, how those reserves are utilized, and how they're reversed," Nufer says. "If indeed it happens that they've overreserved, they haven't used operating expenses to offset that."
Salomon Smith Barney analyst Jeffrey Sprague, in a research note, called Tice's cash flow analysis "flawed." (He rates Tyco shares a buy, and his firm has done underwriting for the company.)
Now, sell-side analysts are saying the plunge in Tyco's shares represents, you guessed it, a great buying opportunity. "You're looking at a company with 40-50% earnings growth this year, the same next year, and, assuming no more acquisitions, another 35% in 2001," says Nufer. At a price-to-earnings ratio of about 22, based on
First Call/Thomson Financial's fiscal 2000 earnings estimates of $4.13 per share, before charges, Tyco shares do indeed look inexpensive.
But in the near term, Tyco's share price will hinge on whether investors' love of a good bargain outweighs their terror -- however far-fetched -- of being caught in a Cendant-esque debacle.
