Tyco Regime Changes but Vague's Still in Vogue

There's a new CEO, but the company's reluctance to share key data continues unabated.
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Tyco's

(TYC)

new CEO, Ed Breen, must have caught something from Dennis Kozlowski's coffee cup.

Breen's performance on Thursday's earnings call eerily recalled the bluster, denial and obfuscating vagueness that Kozlowski, the scandal-ridden conglomerate's now-disgraced CEO, exhibited in his waning months at the company. With Tyco anxiously waiting for its lenders to push back the maturity on a fearsome-looking slug of debt, his penchant for vagueness should be deeply disturbing to investors.

Yet even though results for the fiscal fourth quarter were hit by huge restructuring charges and a lackluster operating performance, Wall Street continues to deal the company a free pass, evidenced by Tyco's 11% jump Thursday. Clearly investors were

reassured by statements from a lawyer employed by Tyco that an unfinished internal accounting probe had not yet turned up evidence of large-scale fraud -- and was unlikely to.

Even so, there's no avoiding the harsh reality that Tyco will be restating past earnings as the result of a change in the way it books fees from dealers who are used to gain contracts for its alarm business. And the company's comments on the accounting probe don't make it as clear as Wall Street might wish that a clean bill of health awaits the end of the inquiry. Tyco didn't reply to a request for comment.

Close-Mouthed

Investors didn't seem to care that fourth-quarter operating earnings of 30 cents a share were 2 cents below the Wall Street consensus, or that the company's guidance for the first quarter of fiscal 2003 falls way short of expectations.

Tough Year
Tyco talks turnaround

While the company issued projections for full-year 2003 earnings and cash flows that didn't stray far from the consensus numbers, Breen and his new CFO, David FitzPatrick, failed to explain in even the coarsest detail how each of Tyco's businesses would perform over the next year.

Failure to flesh out the basics suggests that Breen is trying to paint a picture of a solid recovery while he attempts to drastically improve Tyco's burdensome capital structure. One way of doing that is to lighten the amount of debt that matures over the next year or so.

Tyco is talking to its bank creditors about ways to ensure that the coming maturities can be met by cash flows. The company said Thursday that it had over $11 billion of obligations maturing over the next 14 months. It identified $3.9 billion of that sum, coming due in fiscal second quarter, as bank debt.

Another method is to raise capital through an equity offering. The higher Tyco's stock price is, the easier it gets to raise large sums through an offering. Even after its recent rally, Tyco remains 75% off its 52-week high.

Thursday, Breen did not rule out a stock issue when asked if one were necessary. On the debt, if the banks play hard and demand collateral in return for extending their loans, the market would react negatively. That's because it would be a sign that they are nervous about Tyco's prospects and thus want to be ahead of bond holders in the creditor queue. The company expects bank negotiations to be over by the late fall.

However, there is no way bankers will allow Tyco executives to be as blurry as Breen was about 2003 outlook during the call. When asked to explain exactly how so-called free cash flows will reach the company forecast $2.5 billion to $3 billion in 2003, Breen declined to answer. The same response met a questioner asking for profitability projections for Tyco's main segments. Tyco has forecast per-share operating earnings of $1.50 to $1.75 in 2003, compared with $1.79 in 2002.

Getting Hungry?

The sluggish economy is one reason for Tyco's anemic results, but another factor could be the lack of acquisitions in recent quarters. Tyco, once a voracious acquirer, has faced allegations that it fiddled with acquisition accounting to give false boost to profits in a practice known as spring-loading.

David Boies, the big-name lawyer Tyco has employed to oversee its accounting probe, said Thursday that the investigation was reviewing large acquisitions. If Tyco's earnings were heavily dependent on spring-loading, posting growth will be difficult without new purchases. That remains the case even if the probe happens to turn up no wrongdoing.

The company did not offer up any comment Thursday on a

Wall Street Journal

report from September that the

Securities and Exchange Commission

and the Manhattan district attorney are looking into whether an allegedly secret payment made by Tyco represented a payoff to hide possible accounting improprieties.

One area that law enforcers may be probing is Tyco's taxes. The company's tax rate is moving up and Breen said it could rise into the high 20s, presumably above 25%, in 2003. The effective rate in 2002 was 22%. Breen says this is because company debt levels are coming down, reducing interest payments, which are tax deductible.

However, the rising rate could signal a move to appease the tax authorities. Tyco's tax rate benefits from its offshore domicile and it may have come under scrutiny after charges that Kozlowski evaded taxes. The nightmare scenario for Tyco is that it ends up paying large amounts of back taxes and fines.

Breen may be hoping that the banks will come up with a debt package after the internal accounting probe is completed. But the company cannot control the timing of any SEC or DA probe, which may persuade the banks to demand a tougher deal.

More Murkiness

The change in the way fees from dealers are booked resulted in a $135 million adjustment to 2002 results. But the thinking behind the company's new policy went unexplained. Instead of booking all the fee in the income statement as it is received, half of it will be deferred onto the balance sheet and bled into earnings over 10 years. But why isn't more of it being deferred? Only Tyco knows.

Finally, the company's confident-sounding pronouncements about the accounting probe deserve scrutiny. The company said the inquiry was only 60% complete, but Boies felt he was in a position to say, "I would be very, very surprised if we uncovered a very large fraud at this stage." He also said that the company is obligated to disclose any notable findings by the probe as they are discovered.

Before that, however, Breen said "it is likely that some disclosures will be made in addition to" to one made about the dealer accounts Thursday. So if he expects some more, why weren't they discussed on the call? The reason may be that Breen believes them to be nonmaterial -- but that is for investors to decide.