Do Tyco’s Parts Add Up to a Winner?

07/18/2007 12:00 am EST

Focus:

Bill Martin

, FindProfit

Bill Martin, editor of FindProfit, looks at the three remaining pieces from the breakup of Tyco International and tried to determine where the value is.

Tyco International (NYSE: TYC) has completed the long-planned spin-off of its Tyco Electronics (NYSE: TEL) and Covidien (NYSE: COV) units. As a result, shareholders now own one share of TYC, one share of TEL, and one share of COV for every four TYC shares that they originally owned.

TYC was a huge conglomerate with a wide variety of global operations spanning numerous industries. By splitting up [the company], management believes that it can make its units more cohesive, focused, and well run.

Let's look at each of the underlying components to better understand where we think the levers of value creation lie.

Run by CEO Ed Breen, who previously ran the entire conglomerate, Tyco International is primarily made up of the company's security, fire, and engineered products businesses. The fire and security operations are wonderful subscription-based businesses with high-margin recurring revenue models.

With net debt of just $1 billion against total earnings before interest, taxes, depreciation, and amortization (EBITDA) of over $3 billion, we would look for TYC to buy in stock and add additional leverage. Further, we would expect Breen to continue to invest heavily in growth and new products.

With a market capitalization of around $26 billion and trading at around 16.5x Wall Street's 2008 earnings estimates, TYC holders stand to benefit from modestly improved operating results and financial engineering that drives shareholder returns. (It closed below $50 Tuesday—Editor.)

Tyco Electronics has the greatest cyclical exposure to the global economy, specifically the automotive industry. While many of TEL's components are dominant in their categories, we believe that management will seek to further optimize its product line-up by making acquisitions and investing in research & development while divesting lower-margin product lines.

Cost cutting by consolidating global manufacturing operations should also continue in earnest. TEL is poised to generate around $2.3 billion in EBITDA, which suggests that the company's $3 billion in debt could be modestly increased to better improve shareholder returns.

With a market cap of around $20 billion and trading at around 17x Wall Street's 2008 earnings estimates, we believe that TEL is fairly valued at current levels. (It closed just below $38 Tuesday—Editor.)

Widely regarded as Tyco's crown jewel, Covidien is an important player in medical device, imaging, and supply markets. COV has the best long-term growth prospects of all three companies and should command the highest multiple.

However, recent operating results have been mixed, as COV has worked to hike R&D and acquisition spending after years of underinvestment. With $4.45 billion in debt against $2.2 billion in EBITDA, we don't expect COV to be an aggressive buyer of its stock.

With a market cap of around $22 billion and trading at around 18x Wall Street's 2008 earnings estimates, we believe that COV could be the real winner in 2008-2010 as growth accelerates and the market rewards the company with a higher earnings multiple. 

At this point, we would be buyers of TYC below $48, TEL below $38, and COV up to $44, [where it closed Tuesday—Editor].

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