Tyco Split Could Find Bondholder Resistance

NEW YORK ( TheStreet) -- Bondholders may say 'not so fast' to Tyco International's ( TYC) plans to split into three companies.

The split of Tyco into three units could be held up if debt owners organize in opposition, just as they did to the company's first breakup plan in 2007.

Tyco's spinoff of its $3 billion North American ADT residential security business and $4 billion flow control division will create two new publicly traded companies, in addition to a remaining Tyco International consisting of its $10 billion commercial fire and security division.

Monday's decision to split one company into a triumvirate is similar to 2007 plans by CEO Edward D. Breen to spin off Tyco's healthcare division that earned $10 billion in annual revenue and its electronics divisions that earned $12.8 billion in revenue. The two new companies are now called Covidien Ltd. ( COV) and TE Connectivity Inc. ( TEL).

As in 2007, the key question will be whether shareholders and debt holders like the details of the plan.

Tyco's stock has rallied 3.1 percent since the announcement because company management and analysts believe shares of the conglomerate will be more valuable when channeled into three smaller companies with a focused expertise.

In a statement when the deal was announced, CEO Breen said that, "the new standalone companies will have greater flexibility to pursue their own focused strategies for growth." Independently, each company will have acquisition and growth strategies, according to the company's press release.

For share owners, the spinoff has great upside.

The plan is for current Tyco shareholders to own 100 percent of the three new companies and benefit from a more focused management and operating structure. On an analyst call about the deal, Breen said past 2007 spinoffs worked because each company, "has significantly outperform ed the market since their announced separation."

The smaller independent companies may also be takeover targets, wrote Jeff Sprague an analyst with Vertical Research Partners in a note written after Tyco's announcement. Sprague said that AT&T Inc. ( T), Comcast Corp. ( CMCSA) and Verizon Communications ( VZ) might look to buy the independent ADT business, General Electric Co. ( GE) or United Technologies Corp. ( UTX) might be interested in the flow control division and Schneider Electric, UTX or Siemens AG ( SI) could even look to buy the remaining Tyco International fire and security operations.

Less clear is whether debt holders will be so excited about the deal.

Currently, Tyco International Ltd. and Tyco International Finance S.A. have $4.1 billion in long-term debt according to quarterly filings, which are backed by the assets and earnings of the entire company. If those debts were continued as is in a smaller Tyco only containing the commercial fire and safety divisions, holders may not like the spinoff. After the deal announcement, Moody's put its A3 rating and Standard & Poor's and Fitch put their A- ratings on review because the new Tyco might not have the assets or earnings to warrant current ratings.

Tyco's initial announcement didn't specifically state how debtholders would be treated, but it set aside $700 million to complete the transaction. In a separate analyst call CEO Breen said that Tyco will reduce some remaining company debt and refinance it to spinoff businesses. Breen added, "we can accomplish that without any conflict with our bond holders."

Because all nine of Tyco's existing notes have call provisions, the company can take back debt from creditors if it chooses. After a bond market rally Tyco bonds are priced above par, meaning that outstanding debt would have to be redeemed at more than 100 cents on the dollar.

Edwin Weist a Senior Analyst at Moody's who is looking into ratings after the transaction says, "I would assume a large portion of that $700 million cost to execute the transaction would consist of these 'make whole provisions' or reducing the debt at a cost above par." Calling in all existing debt "is expensive," says Weist, but he adds, "Tyco has to offer some incentive."

How much incentive is the question?

If agencies were to lower their ratings, holders may backlash against CEO Breen's spinoff ambition as they did in 2007.

Creditors sued Tyco International after it spun off Covidien and TE Connectivity because they saw their interests diminished, when more than half of the company's revenue disappeared with Covidien. Tyco and creditors agreed to a $250 million settlement in 2008. In that spinoff, all $10 billion of outstanding bonds were refinanced. This time, $10 billion in commercial fire and security revenue stays, while only $7 billion in ADT North America and flow control revenue leaves.

In an interview with TheStreet.com a Tyco spokesman said that the company is deciding whether to refinance a portion or the entirety of its debt stock. The Tyco spokesman added, "A portion of the existing Tyco debt will have to be repaid," and added that "we've had preliminary discussions with ratings agencies." The spokesman wouldn't comment on whether discussions are ongoing with debt holders.

-- Written by Antoine Gara in New York.

More from Mergers and Acquisitions

10 Questions for PayPal Ahead of Its Big Investor Day

10 Questions for PayPal Ahead of Its Big Investor Day

Congress May Have Just Set in Motion a Huge Banking Industry Merger Wave

Congress May Have Just Set in Motion a Huge Banking Industry Merger Wave

Attention 60 Minutes: Google Isn't the Only Big-Tech Monopoly

Attention 60 Minutes: Google Isn't the Only Big-Tech Monopoly

Apple Buys Tesla? Amazon Buys Sears? 3 Dream Mergers That Just Make Sense

Apple Buys Tesla? Amazon Buys Sears? 3 Dream Mergers That Just Make Sense

Square Shares Shake Off Concerns About PayPal's Deal for iZettle

Square Shares Shake Off Concerns About PayPal's Deal for iZettle