Fraud-Free Tyco Enjoys<BR/> a Relief Rally

But some investors continue to worry about the company's cash position and stock multiple.
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The surprises that batter most ordinary stocks -- earnings misses, lowered guidance, revenue restatements -- left

Tyco

(TYC)

unscathed Thursday.

Tyco investors, numbed by corporate scandals and paralyzed by accounting fears, had clearly expected worse from the troubled conglomerate. After all, the company has been in the news far more often recently stemming from the excesses of its previous management than from any company news, good or bad. So following Thursday morning's dreary earnings report, investors pushed Tyco's stock up 12% as an apparent reward for sparing them any indication of massive accounting fraud.

"I would be very, very surprised if we uncovered a large fraud at this stage," David Boies, the attorney overseeing Tyco's forensic audit, told analysts Thursday. "I don't think that's there."

Despite the lawyer's reassurances, investors continue to worry about the ongoing audit of the company's books. Others question the solidity of Tyco's cash situation, and short-sellers say that given Tyco's dimming earnings-generating power, the stock appears increasingly pricey. Nonetheless, Tyco jumped $1.58 to $15.52.

More Restatements

The worry starts as it always does at Tyco, with the state of the company's books. Short-sellers have contended for years that the company has benefited from tricky accounting on its many 1990s-era acquisitions. As a result, every press release and conference call is met with a certain amount of held breath on the part of investors.

But so far the new management at Tyco has managed to avoid dropping an accounting bomb that would shake investor confidence, such as it is. The company continued to have success on that front Thursday, advising investors that changes are coming on its books but seemingly indicating that the damage is containable.

Boies indicated that future restatements -- like those announced with Thursday's fourth-quarter results -- are probably inevitable. Tyco said Thursday that it prematurely recognized $135 million worth of income this year from security contracts in its ADT unit. The company is restating those earnings, recognizing the profits more slowly over the 10-year life of the security contracts. The accounting change will also reduce 2000 and 2001 earnings by 1%.

With Tyco's internal review only 60% complete, Boies predicted this restatement will not be Tyco's last. Considering the scars left on the company by the alleged fraud at the hands of ex-CEO Dennis Kozlowski and his minions, investors seemed to take that as something approaching good news.

"There will be instances where you find judgments that, while in accordance with

generally accepted accounting principles, should have been treated differently," Boies said. "Likely, other disclosures will be made."

Softness

In the meantime, Tyco outlined a weak fourth quarter that -- despite record sales and a spike in cash flow -- revealed plenty of disappointments. The Bermuda-based conglomerate lost $1.7 billion during the quarter, primarily due to a $2.2 billion writedown in its struggling telecom unit.

But even without extraordinary charges, the company failed to meet analysts' earnings expectations of 33 cents a share. Instead, fourth-quarter earnings came in at 30 cents, nearly two-thirds lower than earnings from a year ago.

Profits, as well as profit margins, declined across all four segments of Tyco's operations. The company's electronics division, weighted by troubled Tycom, fared the worst. There, profits tumbled 71% to $234 million, and profit margins slid from 29% to 9.1%. Profits in Tyco's three other divisions -- fire and security, health care and engineered products -- fell 31%, 16% and 11%, respectively.

Those slides came despite a 3% jump in revenue from the fourth quarter of 2001. Lifted by a surge in collected receivables, Tyco's fourth-quarter revenue of $9.36 billion set a company record. Free cash flow of $1.3 billion also exceeded expectations set less than a month ago.

Cash and the Barrel

But as expected, Tyco drastically reduced its cash-flow guidance for 2003. The company is now projecting 2003 cash flow of $2.5 billion to $3 billion, well short of previous management's guidance of $4.2 billion and surprisingly low even to some analysts braced for a cut.

"We know we have opportunity in our cash number for next year," admitted CEO Ed Breen. But "we think it's premature to commit to a different range."

Some bears, analyzing such factors as Tyco's $1.7 billion pension shortfall and rising corporate tax rate, have projected 2003 cash-flow figures as low as $2 billion, however. In the meantime, they continue to fret over a multibillion-dollar funding gap that must be closed next year.

Breen described that financing, still elusive, as the company's top priority, and expressed confidence in a favorable, near-term resolution. But he stopped short of promising that Tyco will escape the need for collateral.

"I'm not going to shut the door on any opportunity," Breen told analysts. But "you know how we should be rated and looked at."

Breen said that, so far, banks have appropriately been treating Tyco as an investment-grade company.

Fair Comparison?

Short-sellers, pointing to ongoing uncertainties and Tyco's weak fourth quarter, marveled at the market's celebration Thursday.

"There wasn't a single positive thing in Tyco's news -- other than the absence of major fraud," one short-seller said. "Maybe people were expecting the company to go bankrupt or something. But it's still our general view that this company's not worth 10 times earnings, given the quality of its balance sheet."

Tyco's assets are dominated by $27 billion in goodwill that, some observers believe, leaves the company vulnerable to massive writedowns and possible covenant violations. But other people look at Tyco's 2003 earnings projections, currently at $1.50 to $1.75 a share, and see a cheap stock.

Peter Cohan, a Massachusetts author and investment strategist, tried to rationalize the market's enthusiasm.

"If Tyco were valued the same as

General Electric

(GE) - Get Report

-- just for the sake of argument -- then it would be a $30 stock," said Cohan, who has no position in the company. "But I'm not sure that's really a fair comparison."