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Tyco: Street forgives and forgets
Nevermind the $6,000 shower curtain. Wall Street likes the prospects for a scandal-free Tyco.
May 2, 2005: 12:55 PM EDT
By Paul R. La Monica, CNN/Money senior writer
Former Tyco CEO Dennis Kozlowski, seen here at a birthday party for his wife, has become a poster child for corporate scandals. Tyco took up part of the tab for the bash, held on the Italian island of Sardinia.
Former Tyco CEO Dennis Kozlowski, seen here at a birthday party for his wife, has become a poster child for corporate scandals. Tyco took up part of the tab for the bash, held on the Italian island of Sardinia.
Shares of Tyco are still well below their highs but they've bounced back sharply since Ed Breen took the helm in late 2002.
Shares of Tyco are still well below their highs but they've bounced back sharply since Ed Breen took the helm in late 2002.

NEW YORK (CNN/Money) It's good to see that Wall Street doesn't hold a grudge.

Tyco International was market darling in the 1990s thanks to an aggressive acquisition strategy that fueled impressive earnings growth. But investors were burned three years ago after questionable accounting practices came to light and the stock took a big nosedive.

What's more, former Tyco (Research) CEO Dennis Kozlowski and former chief financial officer Mark Swartz have been accused of treating the company's coffers as their own personal bank. A larceny trial for Kozlowski and Swartz ended in a mistrial last year and a second trial is now in the process of wrapping up.

Still, it hasn't taken long for Wall Street to forgive and forget. Fifteen of the 17 analysts who follow Tyco have it rated at least a buy, according to Thomson/First Call. And nine have it rated a strong buy.

And though shares are trading at nearly 50 percent below where they were before the scandal broke nearly three years ago, the stock has bounced back sharply under the leadership of CEO Ed Breen. Shares shot up 56 percent in 2003 and 35 percent last year.

So is Tyco still a "buy"-co?

Expectations are rising...

It might get tougher for the company to impress investors since much of the turnaround is factored into the price. Under Breen, Tyco already has sold several non-core assets to cut costs and lower its debt load.

At some point, the market will want to see healthier levels of sales growth.

Tyco will report its fiscal second quarter results on Tuesday and analysts are forecasting a solid increase in profits of 15 percent from a year ago. Revenues, however, are expected to increase only 4 percent.

"Breen has done a marvelous job. But going down the road we have to wait and see," said Jeff Pittsburg, an analyst with independent research firm Pittsburg Research.

The stock's comeback under Breen raises another risk. Expectations are once again high for the company. When Tyco reported earnings for its fiscal first quarter in February that matched estimates, the stock wound up falling nearly 4.5 percent on the news.

"Investors were disappointed with in line results and were expecting a strong to blowout quarter," wrote Robert McCarthy, an analyst with CIBC World Markets, in a report following the first quarter results.

Demand in Tyco's two largest businesses -- fire and security products and electronic components -- was relatively tame during the quarter. These two units accounted for nearly 60 percent of total sales in the fiscal first quarter but revenues increased by less than two percent from the same period a year ago in each unit. So investors will be looking for improvement there.

...but demand is improving and stock is attractive

But David Bleustein, an analyst with UBS Investment Research, thinks that investors may have overreacted to the first quarter sales weakness.

In a recent preview of Tyco's second quarter, Bleustein reported that strong earnings reports from chip makers Intel (Research) and Texas Instruments (Research) could be a sign that Tyco's electronics business will have a healthy quarter. He added that solid results from Honeywell (Research) and United Technologies (Research) bode well for Tyco's fire and security division.

And Tyco's healthcare division, which makes medical equipment and represents nearly a quarter of the company's total sales, has been a bright spot with 6 percent sales growth in the first quarter.

Strength in healthcare is particularly important since the unit also has the highest profit margins of Tyco's major businesses and accounted for more than 40 percent of the company's overall operating income in the first quarter.

And fortunately for investors, Tyco's stock, despite its big run, is attractively valued. Shares trade at 16 times fiscal 2005 earnings estimates, which seems reasonable considering that profits are expected to be up 19 percent this year and 17 percent in 2006.

What's more, that's a sizable discount to fellow conglomerate General Electric (Research), which trades at 20 times 2005 earnings estimates even though its earnings are expected to increase at a slightly slower pace than Tyco's: 14 percent this year and 13 percent in 2006.

UBS' Bleustein thinks this much of a premium is unjustified.

"The strength in Tyco's operations and cash flows could enable Tyco to trade at a comparable multiple to leading multi-industry companies, including General Electric," he wrote.

So in some respects, it appears that Tyco could still be paying the price of the Kozlowski/Swartz scandal. Memories of the infamous $6,000 shower curtain and sordid tales of bacchanalian birthday parties don't die easily after all.

"Isn't it amazing that Kozlowski is still in the news?" Pittsburg said. "But the fact of the matter is the company is doing terrific. The real story should be how well Breen has managed the company. I don't understand why people don't focus on that. I guess it's not sensational enough."

But if Tyco can continue to post solid gains in earnings and start to show a meaningful increase in sales as well, then sooner or later investors will reward it for solid fundamentals instead of penalizing it for its former management's sins.

For a look at why Money's Michael Sivy likes Tyco, click here.

For more on Kozlowski, Enron, Martha and other corporate scandals, click here.

Analysts quoted in this story do not own shares of Tyco. UBS has done investment banking for Tyco but the other research firms mentioned do not have a banking relationship with the company.  Top of page


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