will be glad to bid farewell to this year. But believe it or not, 2003 could be even worse for the troubled conglomerate.
Next year, Ed Breen, the ex-
executive who recently replaced the disgraced Dennis Kozlowski as CEO, must find a way to pay back nearly $12 billion in debt and other obligations that fall due. If the size of the debt mountain weren't problem enough, Breen's task is made more arduous by a strict legal provision that could complicate any efforts by Tyco to pledge assets to secure loans from risk-averse lenders.
This potential legal thicket is important, because it's no exaggeration to say that Tyco's future now lies in the hands of its banks and bond creditors. Tyco's cash crunch was eased after it sold its commercial lender
for $4.4 billion in July, and the company has $6.5 billion of cash on its balance sheet.
Yet even with that cash on hand, the company's maturity schedule looks daunting. With its businesses performing modestly at best and a host of investigations yet to be completed, Tyco stock looks vulnerable, having more than doubled off its summer low as investors cheered the regime change.
Shares in Tyco rose 38 cents Thursday to $15.40. The company declined to comment for this piece.
The last 12 months have been trying to say the least at Tyco. The company has faced myriad accusations of accounting misdeeds, its two most senior executives -- Kozlowski and former CFO Mark Swartz -- were indicted on fraud charges, and the company is being investigated by both the
Securities and Exchange Commission
and the Manhattan district attorney.
Moreover, Tyco's main businesses have performed poorly. This could be the result of the slow economy, but another reason may be that prior profitability was overstated by questionable bookkeeping and by the large amount of acquisitions done by the company. Some Tyco skeptics continue to argue that over time the company will be unable to gloss over the poor performance of its many parts, and that eventually the numbers must reflect the company's true weaknesses.
But a look at the company's demanding debt-repayment schedule suggests Tyco's next bout of trouble may come quite a bit sooner. The company must repay nearly $3.9 billion of bank debt that comes due in February next year, the same month that investors have the right to demand that Tyco repay $2.3 billion of convertible bonds -- an obligation Tyco can meet in stock or cash.
There could be as much as $1.85 billion of bond debt coming due in the second and third quarters of 2003, though the actual sum may have been reduced by debt repurchases. Then, in the fourth quarter, holders of another convertible issue have the right to redeem their securities for $3.6 billion in cash.
At the same time, cash from operations looks anemic. All those obligations add up to $11.7 billion. In fiscal 2003 ending next September, Tyco expects $2.5 billion to $3 billion of free cash flow, which is a company-devised measure of cash flow that factors in capital spending but excludes other types of cash outflows. The company hasn't updated its guidance for the last quarter of calendar 2003, though in an August regulatory filing Tyco indicated it expected to bring in cash flow of around $700 million for that period. Previous cash flow guidance provided by Tyco has proved to be generous, however.
If Tyco were to pay its February convertible back in stock, its cash obligations would be $9.4 billion, which more or less matches cash flow plus cash in hand.
Clearly, that's too close for comfort. No surprise, then, that Tyco is talking to its banks to gain some financial breathing room. On a third-quarter earnings conference call in October, Tyco's Breen said that dealing with the financing issue "continues to be our top priority," and added that he hopes to have a deal with the banks "well in advance of our February maturities."
The market is eager to see details of a bank deal. "The clock is ticking, as far as I am concerned," says Cynthia Werneth, the analyst at the Standard & Poor's rating agency who covers Tyco. "I would hope we see something soon."
No bank deal is going to be easy on Tyco, however.
J.P. Morgan Chase
Bank of America
, the three lead banks on the February loan, have all been badly burned by corporate defaults recently and presumably won't be in much of a mood for compromise.
And there is a potential complicating factor to any deal. When a company is in distress like Tyco, bankers will normally ask for collateral for any new loans. When asked on the conference call whether Tyco was discussing secured financing, Breen did not explicitly rule it out, though there is chatter that the company hopes to do an unsecured deal.
A legal provision called a negative pledge that is contained in Tyco's bond indentures could make it hard for the company to pledge a substantial amount of hard assets just to the banks. Contained in bond indentures since mid-1998, and thus covering possibly over $10 billion of bond debt, the negative pledges are designed to prevent other creditors from getting ahead of bondholders by grabbing assets as security.
The negative pledge does that by requiring that the company also offer security to the bondholders. Lawyers think the wording of the Tyco negative pledge makes it hard to circumvent. "It's pretty strong and should give pause to any bank group that is looking to prime the bondholders with a lien," says Andrew Rahl, an attorney and corporate restructuring specialist at Anderson Kill & Olick in New York.
There may be some loopholes that would allow the banks to gain assets such as receivables and maybe inventory as collateral. That's because such assets may not qualify as the "principal property" that the indenture says bondholders have equal rights to. That said, even if the banks only manage to secure receivables, they would still push ahead of bondholders in the capital structure, and that would make future bond issues by Tyco difficult and expensive.
One possibility is that the banks will roll over only part of the $3.9 billion of bank debt and demand repayment of the rest. The banks may demand that the new, smaller loans be secured. And if that happens, the banks would probably also want to gain collateral for their $2 billion of loans that fall due in 2006, subordinating bondholders still further.
What does this mean for stockholders, who are below both banks and bondholders in the capital structure? Any moves by the bank to gain security would be received negatively because it would betray nervousness on their part and because it would effectively reduce "available" shareholders' equity.
Indeed, shareholders' equity is already of doubtful value. Tyco's tangible book value, which excludes goodwill because it is not a hard asset and may be worth a fraction of its balance sheet value, is negative to the tune of nearly $8 billion.
The other important factors in the bank negotiations are the status and findings of the SEC and Manhattan DA investigations of Tyco. These may not be completed before February. If they're not, the threat that the probes will turn up evidence of accounting fraud after February is one more argument for why the banks will be ultracautious when deciding whether to roll over their loans.
The company has itself appointed experts and lawyers to conduct its own internal accounting investigation, and it is probably hoping that if it finds no serious fraud, the banks will be placated. However, the banks might doubt the thoroughness of the probe after the third-quarter conference call, when David Boies, the outside lawyer overseeing the probe, said "we're obviously not reauditing the company and going through every single accounting issue."
Ideally, investors would expect something deeper than an audit because previous audits failed to uncover the alleged misdeeds over several years that make up many of the charges against Kozlowski and Swartz.