Even after recent hits, credit analyst sees more downside for Tyco

By Ronda Fears

Nashville, Tenn., June 7 - Even though Tyco has been hit hard recently, Carol Levenson, director of research at Gimme Credit, sees more downside in the credit. Moreover, she said Tyco needs a new turnaround plan.

"Counting Tyco International's (Baa3/BBB-) serial acquisitions over the last few years as Plan A, the split-up scheme announced in January as Plan B and April's abandonment of the split-up scheme and a new plan to 'monetize' CIT as Plan C, we figure Tyco is badly in need of a Plan D," Levenson said in a report Monday.

"Last week, although we were reluctant to jump to conclusions about the alleged skullduggery of Tyco's ex-CEO, we were concerned about the impact of management turmoil on the company's financial flexibility."

Friday, when it appeared the company itself may have been implicated in some of its management's questionable transactions, the stock fell by as much as 35%, and both major rating agencies downgraded the company within moments of each other.

"The company finally held a conference call, but we did not come away with a warm feeling," Levenson said.

"As we observed last week, TYC has not exactly been forthcoming with details about the impact of rating downgrades. But Friday, when presented with a fait accompli in the form of a Moody's downgrade of the holding company's ratings to junk, management finally got specific."

Tyco management believes this downgrade only affects Tyco's accounts receivable securitization program, which means the company will have to find cash over the next three months to pay off $535 million of this debt.

"But in the name of conservatism, and perhaps in recognition of the near-inevitability of further downgrades, Tyco recalculated its cash needs assuming another $225 million in debt will have to be repaid," she noted.

Tyco also said a ratings sensitive swap will be unwound at a gain, making the net cash impact of the downgrade $655 million.

"This increases the amount of refinancing Tyco must execute by next February to nearly $4 billion, without asset sales," the analyst said.

"Note there's also an estimated 100 basis point increase in Tyco's bank loan rates, which may not represent a huge cash outlay but it ought to affect the company's earnings."

Nevertheless, this year's earnings guidance was affirmed.

As for rumors of an SEC-related delay of the CIT IPO, management claimed the only unresolved issues have to do with CIT's goodwill, not with "recent events."

"Still, even if the SEC allows the IPO to proceed, we couldn't imagine a worse environment in which to try to issue stock," Levenson said.

"Let's all hope a private sale of CIT is still an option, although an IPO would likely bring in cash much sooner. Meanwhile, a Plan D should definitely be moved to the front burner."

The longer Tyco owns CIT, the more difficult life will be for the finance company, as evidenced by S&P's downgrade of CIT on Friday, directly linked to Tyco's downgrade.

At the same time, with all its "monetization" eggs in the CIT basket, Levenson estimates Tyco faces a staggering $14 billion in maturities, including putable convertibles, between now and the end of next year.

"With essentially no access to the capital markets and securitization no longer available, this leaves free cash flow and other asset sales as Tyco's only hope, short of renegotiating its bank lines," she said.

"Naturally, asset sales executed under duress are not the most optimal solution, and Tyco may have to part with some of its more valuable and stable lines of business."

To the extent that capital spending and planned acquisitions are discretionary, the analyst said now would be a heck of a good time to cut back on both, although management claims the company is not in a "crisis mode."

The quarterly dividend could be eliminated as well, she said.

"We continue to see additional downside here," Levenson said.

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