This has been a year of de-conglomeration, as a number of multi-industry colossuses from Fortune Brands Inc. to ITT Corp. have announced plans to reward shareholders by breaking up or spinning off components so that the value of the parts outweighs the whole. The market has generally rewarded the companies’ news with a nice pop in their share price.
And then there is Tyco International Ltd. , a company that thinks the plan so nice that it will be doing it twice.
After having split into three pieces in 2007, Tyco says it will trifurcate its remaining businesses some time next year. In contrast to some of the other stock-goosing split-up announcements, the Tyco plan has been greeted with a strangely cold reaction. The company’s stock closed Friday at $42.38, the same price as it was a couple of days before the mid-September announcement.
Why such pessimism? It may be uncertainty over the plan, more details of which are expected in November. It could be that the 2007 split hasn’t yielded the robust returns that were expected, as none of the three pieces have been sold to an acquirer and the market turmoil of the past few years has dampened returns. Or it could be that the perennially unloved Tyco can’t do anything to excite the market.
All of which means an opportunity for investors if things finally break Tyco’s way.
The new Tyco split-up plan, announced by chief executive Ed Breen, would create three companies: A North American residential-security company, using the well-known banner of ADT, would be one; an industrial valve and flow-control business would be another; a commercial security and fire-protection business would be a third.
The first two businesses have about $3-billion (U.S.) in revenue, while the commercial protection business books has about $10-billion in sales. (Mr. Breen said the possibility of this breakup has been considered since the 2007 transaction.)
The breakup is appealing for those who think Tyco can best maximize shareholder value by selling itself to an acquirer. At an enterprise value – equity and debt – of about $22-billion, it’s considered too large for a strategic buyer, given its disparate businesses, but each of its component businesses could be a potential target.
For instance, Tyco’s decision to separate North American residential security from the commercial business seems odd – until you learn U.S. cable companies like Comcast Corp., eager to add to their recurring revenues, might want to buy ADT.
“Given ADT’s 90-per-cent recurring revenue base and exceptional free cash flow … we would expect the stand-alone business to be a likely takeout candidate,” CitiGroup Global Markets Inc. analyst Deane M. Dray said in a client note.
But, says Mr. Dray, the larger commercial protection business could be sold as well, with Schneider Electric SA, ABB Ltd. , Johnson Controls Inc. , United Technologies Corp . and Honeywell International Inc. as potential suitors.
The flow-control business, while a global leader, is struggling because of its “late-cycle” economic exposure and may be more attractive a year from now when the split-up is complete, he says.
Mr. Dray says “take-out” multiples for each of the three business imply a $67-per-share value for Tyco, but he’s basing his target price – $50 – on the premise that each new company will be valued with a multiple similar to that of its peers.
Indeed, some analysts believe you don’t have to rely on an exit strategy to see gains in Tyco.
Nicholas Heymann of William Blair & Co. LLC believes Tyco’s stock can trade at a price-to-earnings multiple of 13.5, a 25-per-cent premium to the market, near its highest point of the last two years. That would translate to $55 a share on his fiscal-year 2012 estimate of $4.05 earnings per share. “We remain strongly convinced that the company’s fundamental prospects, growth potential, financial condition, and global footprint have never been as strong during the past decade as they are today for Tyco.”
For now, the market has disagreed, allowing investors to get into Tyco at a depressed price. Breaking up really isn’t so hard to do, and it just might yield a return its shareholders have so far been missing.
Tyco International Ltd. (TYC-N)
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