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Tyco Throws Wall Street a Bone

Some observers think the cash flow number is meant to placate investors ahead of Wednesday's earnings call.



has served up two pricey appetizers to investors hungry for information.

The company announced a $1.2 billion accounting charge -- and an equally staggering cash flow number -- ahead of an early earnings report due out later today. The market choked on the first item, pushing Tyco shares down 12% to $14.34 in the pre-market session. But investors quickly digested the accounting charges, pulling the stock back above $15 in heavy afternoon trading, after Tyco threw them something better to chew on.

The company said it had generated $1.1 billion in free cash flow during the second quarter. To some, that number -- the most important measure of Tyco's strength -- looked twice as big as it should have.

New Glasses

Based on its own guidance, Tyco was set to deliver free cash flow of $450 million in the quarter. But the smaller figure, Wall Street experts say, was based on Tyco's newly conservative definition of free cash flow. The $1.1 billion figure thrown about by Tyco -- as the company readily admitted -- is based upon a more generous calculation, excluding certain expenses, that Tyco is in the process of abandoning.

"They put out that one big number as a nugget for people to latch onto," said a Wall Street expert with no position in the stock. "But when you finish looking at how good that number is, you realize they didn't really double their target."

Instead, he said, the $1.1 billion appears to translate into $600 million or $650 million in free cash flow under the new definition. Still, he called the number a solid one that "meaningfully exceeded" what the Street was expecting. But he also questioned where that extra cash flow came from.

He laid out a variety of scenarios that may have boosted the crucial figure. First, Tyco probably continued to collect on bad accounts in its troubled security unit, which -- after this quarter's big charges -- may be poised for some nice, clean quarters and headed off for sale. Second, the company may have already sold some assets that brought cash in the door. And third, it may have applied a lower tax rate than it adopted before shareholders voted against relocating the company away from tax-friendly Bermuda.

Coming Home

But cash boosts from the latter two, particular the last, are unsustainable, the expert said. Indeed, Tyco is on the verge of paying bigger -- not smaller -- bills to the Internal Revenue service, he said.

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This summer, Congress is expected to introduce a bill that severely punishes corporations that choose to locate in offshore tax havens. So in the end, Tyco may have little choice but to change its foreign address.

"Everybody will be coming home by Jan. 1," one expert predicted. "It's going to become extremely imprudent not to be here."

In the meantime, Tyco is already battling with the IRS. The company is currently undergoing one of the most extensive corporate tax audits ever conducted -- and is expected to pay dearly in the end.



Peter Eavis has previously reported, Tyco could soon be forking over a 10-figure check to settle its IRS account.

Former CFO Mark Swartz is "supposed to sing like a canary about all the tax issues," one outside expert said. "The tax bill with the IRS is very real."

Suit and Tie

Shareholder lawsuits are similarly pressing. Some observers expect Tyco to settle the cases -- which one watcher calls "many and deep" -- by giving investors a free piece of the company's future through options and warrants. The strategy would allow Tyco to preserve much-needed cash but, in the end, could dilute current shareholders by 20% to 40%.

With everything from taxes to dilution to the overall economy pressing down on Tyco, the company could see its annual earnings plunge from an expected $1.40 a share this year to as little as 80 cents a share in 2004. Still, most believe, Tyco would rather see investors eyeing the company's future -- however challenging it may be -- instead of dwelling on its past.

Indeed, some people are convinced that Tyco purposely leaked news of the charges so that investors could digest the past and get it out of their systems ahead of the conference call.

"They want the venting to go on now," one expert said. "When they host the call, they don't want people throwing tomatoes at them."