The issues stock investors face in today's tough market may well be summarized in one simple question: Should you buy Tyco International Ltd. or not?
Tyco, roiled by news that its former top executive Dennis Kozlowski was indicted on charges of evading state sales tax, is dogged by questions about how it accounted for a huge number of acquisitions it made in the 1990s and the amount of debt it carries. Tyco stock has lost more than 80% of its value since the beginning of the year.
"The real issue - and why the stock's been in free-fall - is fear of the unknown," said Christopher J. Grant, president of Nackers & Grant in Brookfield.
Grant has conquered his fear and is buying Tyco. So is John C. Thompson, portfolio manager at Thompson Plumb & Associates Inc. in Madison and co-manager of the Thompson Plumb Growth Fund.
Other professional investors say they're not willing to venture out on that high-wire act.
"I see the warts on this one," says Terence V. Pavlic, president of Pavlic Investment Advisors Inc., Brookfield. "There are 5,000 stocks in America - why go there?"
"We've seen this happen with a host of other companies in the last two years. We think caution is the better course to pursue in this case," agrees Christopher P. Shea, research director and portfolio manager at Intrinsic Investors LLC in Wauwatosa.
Shea has small Tyco positions in some customer accounts but isn't buying more.
Pavlic says he's uncomfortable with all the questions about the legitimacy of Tyco's balance sheet and earnings, and how the company will work its way out of the $14 billion of debt that's due by the end of 2003.
Plus, he says, even with Kozlowski gone, investors have to question management's credibility as Tyco keeps changing strategies as to how many divisions it intends to divest.
Investors who wait for all those questions to be answered are missing "the opportunity of the century," Grant counters.
Sure, Tyco may have been aggressive in its accounting, but Grant doesn't buy the idea the company ever faked revenue.
Tyco has real cash flows, and it passed an SEC investigation into its accounting practices in July 2000, Grant and Thompson say.
Still, Tyco has $14 billion of debt coming due by the end of 2003, and its CIT Group, likely wouldn't fetch more than $5 billion in the initial public offering for the finance subsidiary the SEC finally approved Wednesday, Pavlic says.
"A CIT IPO would give them a little cash flow, but in the end the balance sheet erodes," he says. "I can't believe with their credit rating being downgraded regularly that they'll have access to credit markets at any reasonable price."
Thompson compares the expectation that Tyco should pay back all its debt at the end of 2003 to demanding an individual pay back half their mortgage in a year.
He and Grant say Tyco's strong cash flow and the proceeds from the CIT IPO will be enough to take care of all the company's near-term liquidity issues.
Tyco's chief financial officer said in a conference call last week that the company plans to pay off $10 billion in debt over the next six months, dropping its total debt to $17 billion by the end of the year, Grant said. Even if Tyco didn't have the cash, it could pay back much of the debt coming due in 2003 with stock - or sell more operating companies to raise cash, they say.
Thompson estimates Tyco's pieces are worth $60 billion to potential buyers. He says a good quality company such as its ADT Security division is likely worth $20 billion, and even a small environmental engineering firm it owns, Earthtech, is worth $2 billion.
Thompson puts the value of all of Tyco's operating companies at about $60 billion - a number that far exceeds its debt and quells his fears of a bankruptcy. "The reason companies go bankrupt is their assets are less than their liabilities," he says.
"My homework says on all the known pieces I'm aware of, I think the value of the company is meaningfully higher than where it's trading now," Grant agrees.
Still, Shea says Tyco's break-up value has been dropping dramatically in recent months, making a decision to buy these shares a bit like catching a falling knife. And Pavlic worries that investigators might uncover more hidden accounting gimmickry.
"While it's true their businesses certainly have value," he says, "you have to look at this and say, 'How many other games are being played, and how does this end?' "
Shea would want to see Tyco's balance sheet and earnings estimates improve before he bought more.
Pavlic doesn't think he'd ever buy the stock again, given the allegations against Kowolski, the discovery of a company-owned house in Florida whose existence was hidden from shareholders, and board member Frank Walsh's profits related to the CIT acquisition.
Tyco paid Walsh $10 million for helping orchestrate the purchase, and contributed $10 million to a foundation Walsh is a trustee of, plus Walsh pulled in nearly $2 million worth of Tyco stock for his 50,000 CIT shares.
"That's on top of $75,000 a year for being a director and 10,000 Tyco stock options in 2001," Pavlic says.
It was Walsh's deal that triggered Pavlic's sale of Tyco shares in January. "It really wasn't an investment decision, it was something more basic," he says. "It was ethics."
Maybe there are ethics concerns, but the resulting excesses are immaterial to Tyco's financial results, Thompson says.
In his view, the lack of "real, material negative news may help explain why a "who's who" of the investment business - portfolio managers at the American Funds, Bill Miller at Legg Mason, Jim Gibson at the Clipper Fund, and David Dreman at Scudder Dreman - is buying Tyco shares.
In many ways, the Tyco decision boils down to how much fear you want to handle and how willing you are to look past ethical issues. Thompson, for one, doesn't have any trouble looking past either.
"It's capitalism," he says. "Our job is not to judge; it's to try and make money."
Appeared in the Milwaukee Journal Sentinel on June 16, 2002.