Credit analyst sees reaction to Tyco news muted, looks for more downside

By Ronda Fears

Nashville, Tenn., June 4 - The reaction to Tyco's embarrassment surrounding its ousted CEO was muted, especially in the credit markets, said Carol Levenson, director of research at Gimme Credit, in a report Tuesday. She sees Tyco's future "up for grabs" and further downside in the credit.

Tyco shares regained 72c to close at $16.77 on Tuesday. The 0% convertibles also firmed a bit with the 2020 issue quoted at 63 bid, 63.25 offered and the 2021 issue quoted at 71 bid, 71.5 offered.

Dennis Kozlowski, Tyco's chief executive, was forced to resign over the weekend amid a tax probe into his personal affairs, and was indicted Tuesday for alleged tax evasion related to fine art purchases.

As if Tyco (Baa2/BBB) didn't already have enough troubles, the Kozlowski news was a humiliation, the analyst said.

"As for the issue we're all obsessed with - the speedy "monetization" of CIT - the interim CEO said there was no change in plans," Levenson said.

"He also mouthed the right platitudes about sticking to Tyco's strategy du jour, organic growth and healthy returns on capital. But this was all done with a press release, leaving investors with plenty of unanswered questions. Clearly Tyco's future direction is up for grabs, especially after its stock fell by as much as 30% during the day."

It's unseemly to extrapolate from the CEO's alleged tax evasion to Tyco's complicated and disparaged accounting practices, she said, but added that the SEC might be tempted to use this as an excuse to launch an investigation.

"Moreover, these events are bound to increase investor wariness, not to mention possibly spooking potential buyers of CIT, either as a whole or in an IPO," Levenson said.

"What with the now-you-see-it-now-you-don't $5 billion Lehman bid for CIT and this latest evidence of turmoil at Tyco, it seems the cash amount likely to be realized from this monetization is becoming progressively smaller. "

This could mean a bigger loss on the disposal and higher book leverage for Tyco, which needs to monitor this measure carefully to avoid bumping up against its bank covenant, the analyst added.

Tyco's bankers are no doubt itching for an excuse to force Tyco to renegotiate its fully-drawn bank lines, which are cheap, unsecured and relatively unrestrictive, she also noted.

There are already concerns about CIT's asset quality, especially its telecom portfolio, even if the company can be safely insulated from its floundering parent, Levenson pointed out.

"Although Tyco management has steadfastly maintained they don't need the cash from the CIT sale - well, at least not until next February - we believe they do, and we think the bidders for CIT have been handed a negotiating gift with yesterday's news," Levenson said.

"Apart from the CIT issue, bondholders must now reckon with the unknown financial policies of a new management team. As we've pointed out before, if Tyco manages to get rid of CIT it has little incentive to preserve its ratings or even to maintain investment grade ratings."

After yesterday's loss of $12 billion in market value, Levenson fears stock buybacks will be back on the table for consideration once again. And, she noted that while Tyco is not an energy trader, customer and supplier confidence is important.

"Didn't Tyco itself blame some $600 million of its second quarter loss on 'distraction costs'? Surely these costs are likely to intensify now," Levenson said.

"It's only fair to note Tyco is not in dire straits, although its capital markets access is impaired to the point of being dysfunctional. "

As long as it continues to throw off plentiful free cash flow it retains some measure of financial flexibility, she said, but maturities over the next 12 to 18 months are considerable and the bankers are likely to be miffed about credit line drawdowns.

"Due to its September fiscal year, the company has not yet produced one of those newfangled 10-Ks that outlines all its contractual cash commitments, guarantees, ratings triggers and debt covenants," Levenson said.

"So, things could be lurking of which we're unaware, although management has said a downgrade to junk would affect Tyco only minimally. We thought the bond market underreacted yesterday and we see additional downside."

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