Tyco fights back

January 21, 2002: 5:42 p.m. ET

The conglomerate will meet with analysts on Tuesday to try and reassure investors that it isn�t the next Enron.
By Staff Writer Paul R. La Monica

NEW YORK (CNN/Money) - Pssst. Did you hear the latest rumor about Tyco?

"Sources" say that CEO Dennis Kozlowski, purportedly a big Patriots fan, paid the referees to make that questionable incomplete pass call in Saturday's New England-Oakland playoff game.

Ok. That's absolutely untrue. But given all the other gossip that's been circulating about the embattled conglomerate during the past few weeks, allegations of rigging football games wouldn't be that much of a shock.

Of course, these rumors -- which center on accounting irregularities and other business problems at Tyco -- could very well turn out to be true. But the company announced late Friday that it would hold an analyst meeting� Tuesday morning to address the "continuing stream of baseless rumors" that have weighed on Tyco -- shares are down 21.1 percent so far this year.

Strange rumors brewing
Market gossip hounds have been working overtime since a relatively small research firm in Plymouth, Minn. called SEC Insight put out a report on Jan. 2 saying that the SEC had denied its request for certain Tyco documents. The newsletter speculated that a reason for not releasing documents could be due to an ongoing investigation into Tyco's numbers. The SEC did not comment. And Tyco (TYC: up $1.38 to $46.45, Research, Estimates) denied that it was the subject of a probe.

Since then, Tyco has become the topic of all kinds of scuttlebutt faster than you could say Enron.

Tyco's name was bandied about in newswire reports and on investor message boards. Rumors ranged from the slightly plausible (that the acquisitive company was about to issue a large convertible bond offering in order to raise cash for more deals) to the highly unlikely (that Tyco was considering an acquisition of Dow component Honeywell or United Technologies.)

And in the strangest twist of all, headline-driven speculation ran rampant on message boards last Thursday that Tyco CFO Mark Swartz was resigning -- if true, that would have been an ominous sign indeed. But it turns out the departing executive in question was Mark Schwartz -- the president of Kmart.

Valid concerns about acquisition strategy
Truth be told, Tyco has been dogged for years by concerns about its accounting. That's because the company is a voracious acquirer, buying several big companies each year to fuel growth -- high-profile acquisitions in recent years range from medical-supplies company U.S. Surgical to electronic-security company Sensormatic.

Critics argue that all the acquisitions make it nearly impossible to look at the company without using the controversial pro-forma method of accounting. Pro forma numbers, which back out one-time charges such as merger expenses, have come under fire because they are often misleading to investors.

In October 1999, renowned short seller David Tice issued a report that questioned Tyco's accounting practices. Two months later, the SEC began an inquiry into Tyco's merger-related accounting. It ended the investigation in July 2000 without taking any action.

Electronics business is struggling
Still, even if accusations of accounting shenanigans prove untrue, concerns about Tyco's ability to keep growing at a healthy pace if it halted or slowed its aggressive acquisition strategy are valid.

Tyco has posted, on average, an annual earnings gain of 36.2 percent over the past five years. Analysts are now predicting a growth rate of 20 percent over the next three to five years. But that projection assumes Tyco makes acquisitions, since none of its existing business could provide that kind of growth.

Worries about how Tyco will continue to post solid earnings gains are even more relevant now given Tyco's exposure to the struggling telecom business. Revenues for Tyco's electronics unit, which accounted for 31 percent of total sales in Tyco's latest quarter, slipped 19 percent from the same period a year ago. Profits plunged 34 percent.

And Tyco announced last week that earnings for its second quarter (ending in March) would be lower than expected due to soft demand for its electronics products.

Tyco is also highly leveraged, with $42.5 billion in long-term debt and just $3.2 billion in cash, although the company's bonds are rated investment grade by the major credit rating agencies.

If this wasn't enough, investors also need to keep in mind that Tyco sports a huge amount of goodwill on its balance sheet due to acquisitions, $39 billion in fact. AOL Time Warner, owner of this Web site, announced earlier this month that it would take a charge up to $60 billion in order to account for the decline in value of its goodwill, which are intangible assets related to purchases that an acquiring company includes on its balance sheets. Given the market meltdown over the past two years, it would not be a major surprise if Tyco had to write down goodwill as well.