Credit analyst: Tyco's abandoned breakup plan like putting Humpty Dumpty together again

By Ronda Fears

Nashville, Tenn., April 26 - There's too much risk and uncertainty surrounding Tyco International, said Carol Levenson, director of research at Gimme Credit, likening the company's abandoned breakup plan to putting Humpty Dumpty together again.

"Even if Tyco can pull off the CIT deal and remove some of the liquidity pressure, we would not recommend this paper, given the need to boost the stock price and the uncertainty about future financial policies," Levenson said in a report Friday.

Most of the rumors surrounding Tyco International (Baa2/BBB) came true - no split-up of the industrial companies, no sale of the plastics business, the separation of CIT via a 100% IPO instead of a spin-off and a dramatically a lowered earnings and cash flow outlook.

"Unfortunately, our fear of a new shareholder enhancement scheme also came true, as Tyco now intends to use its free cash flow and an indeterminate amount of the proceeds from the CIT IPO to buy back its undervalued stock," Levenson said.

After the series of bombshells, said stock fell another 20%, she noted.

"We don't want to belabor the obvious, but we're getting a little punchy with all the strategic zig-zags going on here. All of a sudden, Tyco will no longer be focused on growth, but return on capital instead," the analyst said in the report.

"And, not surprisingly, bondholders are still pretty much in the dark about their future."

Tyco Industrial had $6.7 billion in short-term debt on its balance sheet at the end March and this does not include another $2.3 billion in convertibles putable next February, she noted. The company had $4 billion in cash, she added, and management now projects free cash flow over the next four quarters of around $4 billion.

"We think you'll agree Tyco won't be able to tap the public debt markets until it gets its act together and even if had a fighting chance before (Thursday), the Moody's downgrade and continuing review has probably nixed it," Levenson said, adding, "it's maxed out on its bank lines. This places Tyco in the by-now familiar position of a fallen angel that needs to sell assets to meet its maturities."

In this case, although one would think a conglomerate such as Tyco would have lots of salable assets, Levenson said, the units it has chosen to get rid of seem to be awfully difficult to sell. This has given rise, she said, to what could be called a "Hail Mary pass, the almost unheard of scheme to do a 100% IPO of CIT."

While nobody would be very specific about anything Thursday, citing fear of the SEC's wrath regarding the IPO, the hoped-for proceeds to Tyco from the CIT IPO are in the $6.5 billion range. Timing is uncertain, she added, but speed is of the essence.

"Assuming Tyco raises this amount - a huge leap of faith given management's recent track record of capital markets execution - we're betting at least half of the proceeds will be used for stock buybacks, as well as most of the free cash flow in the future," Levenson said in the report.

Without the finance company Tyco has little incentive to burnish its credit quality, she said, and in fact, after the Moody's action, it has even less to lose. Moody's on Thursday downgraded the long-term debt ratings of Tyco to Baa2, and the Tyco 0% convertibles to Baa2 from Baa1.

"Naturally management's revised forecast shows Tyco meeting all its maturities without asset sales, but only with the help of $3.25 billion in refinancing sometime in the next nine months. By the way, if any stockholders are listening, this forecast does not include any share buybacks," Levenson said.

"Meanwhile, as Tyco awaits the proceeds from the CIT IPO, there seems to be little sense of urgency about conserving cash. Although the company generated over $1 billion in free cash flow in the March quarter, net debt actually increased by $200 million. The free cash flow and more was consumed by acquisitions, and additional acquisitions remain in the forecast. And how is management going to resist buying back stock at current levels?"

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