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Finding Value Behind Tyco's Static

Value manager Robert Marcin tells why he's buying the stock but not the breakup strategy.

I just bought a position in




This is the first time I have owned Tyco shares. In the past, the shares traded at higher valuations than I am comfortable owning. Also, the company's rapid-fire acquisition strategy raised questions about earnings quality and growth rates. But recently, with the stock in the mid-$20s, I summoned some courage and placed the order.

Tyco fits my purchase discipline of buying stocks that decline significantly to low valuations with still-reasonable business fundamentals. It might represent a good opportunity for value-oriented investors. The initial purchase represents a conservative position in my portfolio, the outcome of which will not affect my lifestyle either way. In this column I wanted to explain my thinking and send a message to Tyco's CEO Dennis Kozlowski.

Tyco is a decent business at attractive valuations. My purchase, at $26 a share, represents a

price-to-earnings ratio of 8, an enterprise value/revenue ratio of 1.5, and an enterprise value/

EBITDA ratio of 7. In today's market, these are compelling valuations for a set of leading businesses that generate significant excess cash flow. Many busted large-cap tech shares trade for five to eight times revenue and 50 times normalized earnings.

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Naturally, this assumes Tyco's numbers are real. I have my concerns about the income statement and balance sheet. But at these valuations, I am willing to give Kozlowski the benefit of the doubt. Should the liquidity and earnings quality issues abate, the shares have a good trade in them. Remember, I have never been long or short Tyco in my entire investment career. I had no biases regarding this situation.

Though I bought the stock, I haven't bought the split-up concept. I didn't buy the breakup plan before Kozlowski's interview on


Thursday, and I didn't buy his feeble defense of the strategy on the show. The CEO contended that the strategic reversal was simply an attempt to create shareholder value, and that he did not need to prove his prior strategy. I am not so sure. As I see it, Tyco has three interrelated problems: management credibility, debt/liquidity concerns and earnings quality issues that have depressed the stock's valuations. All three would be addressed with one simple strategic decision.

Tyco should stop the acquisition binge in its tracks. Right here, right now! Management should operate the companies for two years without another significant purchase or "big bath" write-off. Give investors a clean profit-and-loss statement for eight quarters. Let them see the free cash flow in the form of significant debt repayment. Deliver the profits, deliver the organic growth and deliver the balance sheet! Go ahead and sell CIT and the plastics business to pay down debt and repurchase stock. This strategy would clean up the balance sheet and reveal more accurately the company's earnings quality and organic growth capabilities. It would dramatically enhance the credibility of Tyco's management. Only then will the issues that plague the stock's valuation diminish.

This strategy also would eliminate the breakup tactic. The split-up idea has been a disaster! It doesn't solve the issues; rather, it appears to be a hastily conceived attempt by management to dodge them. Note how poorly the shares have performed since the plan's announcement. Three or four smaller companies with the same issues will not create more shareholder value than operating a Tyco conglomerate more conservatively. What does the split-up generate besides another round of investment banking fees and another round of big write-offs? It makes me very suspicious of a management team that reverses a very successful long-term strategy at the drop of a valuation hat!

I have purchased Tyco stock despite my disagreement with the company's near-term breakup plan. Value investors get accustomed to purchasing stocks with disagreement embedded in a stock's price. That's why the shares are so cheap. I even expect the stock to rise short-term as the plan gets executed. However, I still believe long-term valuation creation for shareholders would be better served by sticking with the "mini GE" conglomerate strategy. If Tyco possesses the growth, profitability and cash-flow characteristics that management claims, there is one simple, effective way to create shareholder value. Prove it. Not with another deal. Operate without one. Let investors see if Kozlowski is a financial wizard or just the Wizard of Oz!

Robert Marcin is the principal of Marcin Asset Management, a private investment firm. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). At the time of publication, Marcin was long Tyco, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to