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Tyco Is Heading Back to the Well

One can easily surmise that the company is intent on raising more money in the market.



must need more money.

That conclusion appears increasingly reasonable given Tyco's recent moves, culminating in Wednesday's announcement of some $1.5 billion in pretax accounting charges. The company had already said it was going to take as much as $325 million in charges in its fiscal second quarter, ended March 31, so Tyco effectively surprised the market with around $1.2 billion in new accounting adjustments.

Tyco said it had found these latest problems through its "intensified internal audits." Alert investors shall recall that the company trumpeted an audit by external lawyer David Boies at the end of last year, just before it raised $4.5 billion in the market to prevent a life-threatening cash squeeze that was brewing. Soon after raising all that money,

Tyco sounded a lot less sure about the Boies review, saying it had "limitations." With the cash in the bag, no one cared about Tyco's newfound coolness towards the work of the superlawyer. Don't be surprised if the same pattern emerges.

Tapping the Revolver

The Boies report, which Tyco said required "15,000 lawyer hours and 50,000 accountant hours," uncovered a range of relatively inoffensive accounting issues that led to a $382 million charge. Because the report was cast as a thorough piece of work and because it resulted in only relatively minor charges, Tyco was able to raise oodles of new money.

Only four months later, these "intensified" audits have found $1.5 billion worth of issues. The company will no doubt try and spin it as the final accounting charges it will levy, clearing the way for recovery. Then, as before, the company will come to market looking for cash. After all, a $1.5 billion bank facility expires early next year and it has big bond maturities later this year.

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Ah, but doesn't the great cash flow number reported in the fiscal second quarter show that they won't need new money from the market? The company said Wednesday that it produced $1.1 billion of free cash flow (under its old definition), compared with guidance of $450 million to $750 million, which was given by CEO Ed Breen on a Jan. 22 conference call.

We shall see how Tyco arrived at the $1.1 billion after the close of regular trading when financials will be released, but there's a good chance it has been achieved by one-off improvements in working capital or reduced capital expenditures, which also aren't sustainable. Seeing as Tyco has reduced guidance for earnings, it's hard to see how net income can have been a driver behind the improved cash flow.

Indeed, if we estimate that Tyco made $1 billion in cash from operations and used $450 million on capex and $25 million on dividends, it had to find as much as $575 million from working capital and deferred taxes. That might appear impressive, but last quarter's working capital performance was, in the company's own words, "atrocious" -- so a rebound from a low level is not such a big achievement. Moreover, working capital improvements aren't normally sustainable.

Raising Some Scratch

Much will be revealed after the close. But don't be utterly surprised if Breen and his crew hint at capital raisings in the near future. They may even up the ante and raise cash flow guidance for this year. If they don't, it effectively means future quarters are going to weaker than expected. But even if they do raise it, it may not be sufficient, because Tyco may have large cash needs outside of what it needs to shell out to run its business and pay back creditors.

Any shareholder suits related to the alleged crimes committed by former top executives could be hellishly expensive and it is possible that Tyco, an offshore company that manages to pay far less in taxes than rivals, will have to pay back taxes to the Internal Revenue Service.

Detox will check back in later to comment on numbers and the conference call.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to