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Riddle me this: What is worse for a stock than when the company reports earnings that wildly miss estimates? Answer: when the two worst words in the English language get used in conjunction with the company -- "financial scandal." These words were uttered too frequently by business-news talking heads in the late '90s and early 2000s. You remember the names: Cendant, Enron, WorldCom, Adelphia, and Tyco International (NYSE: TYC ) .
But which of these things is not like the other? Note how there's only one surviving ticker symbol. So why did Tyco survive and the others fold?
Investors tend to lump Tyco in with all those other names, when in fact, the scandal was tiny in comparison. Former CEO Dennis Kozlowski was basically convicted of being piggish via unjust enrichment, to the tune of several hundred million dollars. While that'll buy someone a lot of $15,000 dog umbrella stands, Tyco as a business was totally viable. Meanwhile, the aforementioned companies essentially fabricated earnings on a wide basis. Billions upon billions of dollars simply didn't exist. They all went bankrupt, destroying thousands of pensions, jobs, and lives along the way.
Because the stink has been off the company for many years, it's high time investors resurrected Tyco in their consciousness, if they haven't already. It's easy to write off a company forever after it has been hit with a scandal, but in this case, why treat dandruff with decapitation? Like most every other business, Tyco has been struggling in this economy, but a close look at its assets and financials yields a company in solid shape for the future.
The most recognizable name in the Tyco portfolio is probably the home security company ADT. Beyond that, Tyco is loaded with assets with industrial themes, including electrical and metal products, flow-control products, safety products, and fire protection services. It sells to the entire world. One of my favorite mutual fund companies, Dodge & Cox, owns 5% of the shares. I'm disappointed that insider ownership is practically non-existent, but the company has been profitable over the trailing 12 months to the tune of $1.1 billion, with free cash flow in the neighborhood of $2 billion. It carries $4.5 billion in total debt, but easily met its debt service.
When it comes to conglomerates, I'm not wild about using traditional metrics to come up with a valuation. Tyco has made so many acquisitions and dispositions that organic growth is not a great way to value it.
Fortunately, I chose a method in an earlier article about Liberty Starz (Nasdaq: LSTZA ) and Liberty Interactive (Nasdaq: LINTA ) . These tracking stocks, and Liberty Interactive in particular, are composed of acquisitions made by the parent holding company. As noted in that article, on a price-to-free cash flow basis, Tyco is similarly valued to Liberty Starz and another of my favorite conglomerates, Leucadia National (NYSE: LUK ) . In fact, it probably most resembles Leucadia. While this metric doesn't necessarily offer an absolute valuation, it tells us that Tyco is being valued relatively closely to its peers, so at least on that basis it's not overvalued.
There are other ways to play Tyco. Those interested in the health-care side of Tyco should note that the company spun off Covidien (NYSE: COV ) in 2007. That company is worth checking out, because its earnings and cash flow are strong, and its five-year PEG ratio of 0.84 is under its industry average. I'm not as wild about the other spinoff from 2007, Tyco Electronics (NYSE: TEL ) . While cash flow is good and earnings are recovering, it isn't as attractive to me as a health-care play.
The bottom line is that one shouldn't throw out the baby with the bathwater when a big scandal hits a company. Tyco took its time, but it did the right things to emerge from the nightmare pretty much as it had been before -- a functioning company with real assets that is worth a look.
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