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Tumbling Tyco Finds a Growth Goal It Can't Manage

Some investors wonder just how bad the underlying trends must be for the conglomerate to warn.

Has

Tyco

(TYC)

lost its game of chicken at the wheel?

Tyco, a giant electronics and health care conglomerate, dropped 8.3%, or $4.35, to $48.05 Tuesday after it beat analysts' first-quarter earnings

expectations by a penny but warned second-quarter profits would fall short of the mark.

This year hasn't been very good to Tyco's stock. So far in 2002 it has slipped 19.8%, in part due to a somewhat obscure newsletter's suggestion that the

Securities and Exchange Commission

was about to take a fresh look at the company. Also contributing to the decline has been persistent chatter that a writer (let's call him Alex Berenson) at a major paper (let's call it

The New York Times

) was about to put out a story about how Tyco's accounting practices were less than pristine.

(Tyco didn't get back to us in time for publication, but in the past they've characterized their accounting as conservative.) The story was supposed to be in the paper two weekends ago and then it was supposed to be in the paper last weekend, and so far it hasn't shown up.

And maybe, now that Tyco's painted a less-than-rosy picture of its growth prospects, it doesn't even matter.

Past, Prologue

Rumors that Tyco's numbers are as much smoke as substance are hardly new. Back in October 1999 the company's stock took a big dip after a newsletter produced by David Tice, the short-seller who manages the Prudent Bear Fund, published a report that said the company's aggressive use of pooling-of-interest accounting rules had made results look a lot better than they were. In response to Tice's complaints, the SEC launched an inquiry into the company's accounting practices that December.

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In mid-2000, after asking Tyco to make some minor accounting tweaks, the SEC concluded its inquiry without taking any enforcement action. Tyco's stock more than doubled from the time Tice raised his concerns to when the SEC closed its case.

Tice remains uncowed. "It was not a full audit," he says of the SEC's action. "It was a limited review." In any case, he says that he never accused the company of misstating profits -- just that its accounting methods had led investors to believe in a growth rate that won't be there in the future. He says aggressive accounting practices have continued to artificially boost Tyco's growth rate, and while he wasn't short the stock in 1999 when he raised concerns about it, he's short some shares now and also owns puts.

Growth Will Out

Until recently, concerns such as Tice's didn't amount to much. Tyco kept on delivering, beating analyst estimates and raising guidance even as the economy began to falter. Its stock landed in the black for both 2000 and 2001 -- no mean feat.

In some ways this case harks back to the concerns that were often raised about

America Online's

accounting back in the late 1990s. A negative article would emerge, and AOL's stock would swoon for a bit -- before inevitably storming on higher. Why? Because no matter what you said about its methods, the company was still growing like the dickens. What's more, AOL ended up winning the game: In early 2000 it used its overpriced stock to buy the underpriced Time Warner, and though its stock has suffered badly over the last two years, it got hurt nothing like, say,

Yahoo!

.

But the problem for Tyco is that, unlike AOL, it isn't holding up its end of the bargain. In return for investors ignoring grumblers like Tice, the company was supposed to deliver on its promises. But when the company said this morning that second-quarter earnings would come in at 80 cents to 82 cents, instead of the 86 cents Wall Street was forecasting, the deal was off. "The recession is over and now they're telling you they've got problems?" says Seth Tobias of the hedge fund Circle T. "Stay away."

Tobias, who says he bought and quickly sold a small position in Tyco Tuesday, says investors have very little regard for any company with a spot of mold on it. After

Enron

, risk is a four-letter word. "The glass is half-empty on almost every one of these type of stories," he says.

Tice, of course, offers an even more dour assessment.

"When a company that is good at these machinations falls short," he says, "people wonder how bad it really is."