August 18, 2010
Analyst:
JORDAN WINTERS
330-881-3173
Winters_147@fisher.osu.edu
Price: $37.30
Rating: Buy
Price Target: $45
Projected Return: 24%
52-Week Range: $30.01-$40.61
Tyco International Ltd.
(TYC – $37.30)
Industry Group: Industrial Conglomerates
TYC – Initiate Coverage - BUY
Beta: 1.22
2010E
2011E
2012E
$2.50
14.6x
$2.50
$17.8
$3.06
11.9x
$3.07
$18.8
$3.51
10.4x
$3.54
$19.8
2Q10A
3Q10A
4Q10E
1Q11E
$0.59
$0.55
$4.17
$0.72
$0.64
$4.27
$0.65
$0.65
$4.42
$0.70
$0.70
$4.31
2Q09A
3Q09A
4Q09A
1Q10A
$0.55
$0.42
$4.15
$0.58
$0.45
$4.24
$0.54
$0.61
$4.42
$0.65
$0.60
$4.25
EPS
P/E
Consensus
Revenue (Bil)
EPS
Consensus
Revenue (Bil)
EPS
Consensus
Revenue
Debt
Cash
S/H Equity
Enterprise Value
Net Debt
Net Debt-toCapitalization
$4.17 B
$1.82 B
$14.1 B
$19.1 B
$2.34 B
Shares O/S (Mil)
Market Cap. (Bil)
Avg. Daily Vol. (6
mos. in 000s)
497.69
$18.16
Dividend
Yield
$0.84
2.30%
12.9%
6,195
TYC’s industry leading market
positions, global presence, and
financial flexibility are currently
underappreciated by the market.
Broadview acquisition provides
synergy opportunities with ADT and
increases Tyco’s recurring revenue
base.
Inclusion into the S&P 500
could prove to be a short-term catalyst.
Strong balance sheet with nearly $2
billion in cash and low debt will allow
management to pursue acquisitions
and repurchase shares.
TYC trades at 12.1x my 2011 estimate
of $3.07 against a historical range of
6x to 20x.
TYC - August 18, 2010
Table of Contents
Company Profile ........................................................................................................................................... 3
Management.................................................................................................................................................. 3
Business Structure......................................................................................................................................... 4
Market Factors .............................................................................................................................................. 8
Economics Factors ........................................................................................................................................ 8
Sector Analysis ........................................................................................................................................... 10
Industry Analysis ........................................................................................................................................ 10
Financial Statement Analysis ...................................................................................................................... 11
Relative Valuation ...................................................................................................................................... 12
Equity Valuation – Multiples ...................................................................................................................... 13
Equity Valuation – Discounted Cash Flow (DCF) Method ........................................................................ 14
Summary ..................................................................................................................................................... 16
Risks............................................................................................................................................................ 16
Sources ........................................................................................................................................................ 17
Appendix A – Selected Financial Data ....................................................................................................... 18
Appendix B – DCF Model .......................................................................................................................... 19
Initiate Coverage - Buy
Page 2
TYC - August 18, 2010
Company Profile(1)
Tyco International Ltd. is a diversified, global supplier of products and services to the security, fire
protection and detection, valves and controls, and other industrial markets. The company has a leading
position in each of its five reported business segments:
ADT Worldwide designs, sells, installs, services, and monitors electronic systems for
residential, commercial, education, governmental, and industrial customers.
Flow Control designs, manufactures, sells, and services valves, pipes, fittings, valve
automation, and heat tracing products for the oil, gas, and other energy markets along with
general process industries and the water and wastewater markets.
Fire Protection Services designs, sells, installs, and services fire detection and fire suppression
systems for commercial, industrial, and governmental customers.
Electrical and Metal Products designs, manufactures, and sells galvanized steel tubing,
armored wire and cable, and other metal products for non-residential construction, electrical,
fire and safety, and mechanical customers.
Safety Products designs, manufactures, and sells fire suppression, electronic, security, and life
safety products, including fire suppression products, breathing apparatus, intrusion security,
access control and video management systems. In addition, Safety Products manufactures
products installed and serviced by ADT Worldwide and Fire Protection Services.
Exhibit 1. Tyco’s Leading Market Share
Management(1)
Mr. Edward D. Breen, age 53, has been the Chairman and Chief Executive Officer at Tyco International
since July 2001. Prior to joining Tyco, Mr. Breen was President and Chief Operating Officer of Motorola
from January 2002 to July 2002; Executive Vice President and President of Motorola’s Networks Sector
from January 2001 to January 2002; Executive Vice President and President of Motorola’s Broadband
Communications Sector from January 2000 to January 2001; Chairman, President, and Chief Executive
Officer of General Instrument Corporation from December 1997 to January 2000; and prior to December
1997, President of General Instrument’s Broadband Networks Group. Mr. Breen also serves as a director
of Comcast Corporation and is a member of the Advisory Board of New Mountain Capital LLC, a private
equity firm.
Initiate Coverage - Buy
Page 3
TYC - August 18, 2010
Other members of senior management include:
Name
Christopher J. Coughlin
Naren K. Gursahaney
Patrick Decker
George R. Oliver
Edward C. Arditte
Carol Anthony Davidson
John E. Evard, Jr.
Arun Nayar
Age
57
48
45
49
54
54
63
59
Judith A. Reinsdorf
Laurie A. Siegel
46
53
Shelley Stewart, Jr.
56
Position
Executive Vice President and Chief Financial Officer
President of ADT Worldwide
President of Flow Control
President Tyco Safety Products
Senior Vice President, Strategy and Investor Relations
Senior Vice President, Controller and Chief Accounting Officer
Senior Vice President and Chief Tax Officer
Senior Vice President, Corporate Development and General Tax
Counsel
Executive Vice President and General Counsel
Senior Vice President, Human Resources and Internal
Communications
Senior Vice President of Operational Excellence and Chief
Procurement Officer
Mr. Breen and other members of senior management were brought on to restructure, rebrand, and rebuild
the company following the 2002 corporate scandal involving then Chief Executive Officer Dennis
Kozlowski and Chief Financial Officer Mark H. Swartz. Mr. Breen has done a wonderful job during his
tenure as CEO and finally has the company positioned to move forward and take advantage of the growth
opportunities in Tyco’s markets.
Executive compensation includes base salary (~15%), an annual cash bonus (~15%), share-based
compensation (~60%), and other compensation (~10%). Mr. Breen’s annual cash bonus is based on a
weighted average of earnings per share, adjusted free cash flow, and organic revenue growth. Similar
metric are used for other senior managers. In total, the directors and senior management at Tyco own
roughly 1.3% of the total shares outstanding, with the majority of that (0.8%) owned by Mr. Breen.
Business Structure(1)
Tyco International Ltd. was created as the result of the July 1997 acquisition of Tyco International Ltd. (a
Massachusetts corporation) by ADT Limited (a public company organized under the laws of Bermuda).
At this time, ADT Limited adopted the name Tyco International Ltd. Effective March 17th, 2009, the
company ceased to exist as a Bermuda corporation and reincorporated in Switzerland. The company still
maintains its operational headquarters in Princeton, New Jersey.
Tyco was rocked by a corporate scandal in 2002 when former Chairman and Chief Executive Officer
Dennis Kozlowski and former Chief Financial Officer Mark H. Swartz were accused of theft of more than
$150 million from the company, which they claimed was justified by the Board of Directors as
compensation. On June 17th, 2005, Kozlowski and Swartz were each convicted on twenty-nine of the
thirty counts brought against them and sentenced to no less than eight years and four months and no more
than twenty-five years in prison. Since this time, Tyco has largely fallen off the radar of many investors,
but has seemingly worked its way through all of the operational issues that the company previously faced
and now is the time for investors to take notice.
In June 2007, Tyco underwent a significant amount of restructuring in order to redefine its operating
model. The company spun-off its Electronics segment (Tyco Electronics), its Healthcare segment
(Covidien Ltd.), and its Plastics and Adhesives business was divested in 2005. This effectively removed
Initiate Coverage - Buy
Page 4
TYC - August 18, 2010
55% of Tyco’s 2006 revenue base and made the company much more manageable. Tyco now operates
under five business segments: ADT Worldwide, Flow Control, Fire Protection Services, Electrical and
Metal Products, and Safety Products.
Of the $17.2 billion in revenue Tyco generated in 2009, only 48% was derived in the United States. 27%
was derived in Europe, the Middle East, and Africa; 16% in Asia Pacific; and 9% in Other Americas.
This global revenue base will allow high growth markets, such as those in Asia Pacific, to offset any
weakness in the economies of the United States and Western Europe. Another significant feature about
Tyco’s revenue base, and a continued focus of senior management, is not simply selling a product, but
also assisting the customer after the sale and developing an annuity style revenue stream from services.
Almost 40% of Tyco’s 2009 revenue base was from these services. This greatly reduces the cyclicality of
Tyco’s revenue and should be looked at favorably by investors as this mix continues to shift towards
services.
Exhibit 2. Tyco’s Service Revenue Continues to Grow
ADT Worldwide
ADT Worldwide designs, installs, services, and monitors electronic security systems for residential,
commercial, education, governmental, and industrial customers around the world. ADT had net revenues
of $7.0 billion in 2009, or roughly 41% of Tyco’s consolidated net revenue. In addition, ~68% of ADT’s
revenue is derived from services and only ~32% is derived from product sales.
Exhibit 3. Monthly Revenue per New Residential Customer
On May 14th, 2010 Tyco completed the acquisition of
Broadview Security (also known as Brink’s Home Security)
for $2.0 billion. Broadview previously served a customer base
of over 1.3 million accounts which spanned over 90% of the
zip codes in the United States. ADT’s North American
residential and small business operations will now serve more
than six million customers and nearly seven and a half million
globally. Broadview’s fit within the Tyco business model is
perfect as the company had 2009 revenue of $565 million with
over $500 million of that recurring. The acquisition of
Broadview should provide significant opportunities to create
value for shareholders as Broadview has historically had a
lower attrition rate than the legacy ADT business. As shown
in Exhibit 7 on page ten of this report, the longer a customer
remains a subscriber to ADT services, the more profitable the
account becomes. In addition, ADT has wider range of
product offerings that should allow for a significant crossInitiate Coverage - Buy
Page 5
TYC - August 18, 2010
selling opportunity with Broadview’s current customer base and boost top line performance. Previously
ADT and Broadview held the number one and number two positions in terms of market share,
respectively, and now have over an 11% share.
As seen in Exhibit 1, the main competitors to ADT include Secom, UTC and Honeywell.
Flow Control
Flow control designs, manufactures, sells, and services valves, pipes, fittings, valve automation, and heat
tracing products for the oil, gas, and other energy markets along with general process industries and the
water and wastewater industries. Flow Control had net revenues of ~$3.9 billion in 2009, or ~22% of
Tyco’s consolidated net revenue. About 93% of Flow Control’s revenue is derived from product sales
and only ~7% is derived from services. While Flow Control may not have the high service revenue that
other segments do, it is one of the most globally diverse segments with over 80% of revenues coming
from outside of North America. With an even split between process control, energy, and water end
markets, Flow Control is not hostage to any one industry or customer and will be the biggest beneficiary
of the developing world’s infrastructure build over the next decade.
In addition, Tyco reached an agreement on July 29th, 2010 to divest of its European waterworks business.
This business manufactures and supplies equipment for commercial and residential water markets
including valves, hydrants, fittings, house connection components, and water meter boxes. This business
had been losing money and allows Flow Control to further focus on water infrastructure projects and
regions that are growing and profitable. The business was sold to private equity firm Triton for
approximately $245 million.
As seen in Exhibit 1, the main competitors to Flow Control include Emerson, Cameron, and Flowserve.
Fire Protection Services
Fire Protection Services designs, sells, installs, and services fire detection and fire suppression systems
for commercial enterprises, governmental entities, airports, commercial shipping companies, fire
departments, transportation systems, healthcare owners, petrochemical facilities, and homeowners. Fire
Protection Services had net revenues of ~$3.4 billion, or ~20% of Tyco’s consolidated net revenue.
About 49% of Fire Protection Services revenue was derived from services and ~51% was derived from
product sales. As the global economy grows over the coming years the need for fire alarms, nurse call
systems, sprinkler systems, and fire extinguishers is only going to grow with it and Tyco is well
positioned globally to take advantage of this growth.
As seen in Exhibit 1, the main competitors to Fire Protection Services include UTC, Siemens, GE, and
Honeywell.
Electrical and Metal Products
Electrical and Metal Products designs, manufactures, and sells galvanized steel tubing and pipe products,
pre-wired armored electrical cables, electrical support systems, and metal framing systems for trade
contractors in the construction and modernization of non-residential structures such as commercial office
buildings, institutional facilities, manufacturing plants and warehouses, shopping centers, and multifamily dwellings. Electrical and Metal products had 2009 revenue of ~$1.4 billion, or ~8% of Tyco’s
consolidated net revenues. Virtually 100% of Electrical and Metal Products revenue was from product
sales.
On April 27th, 2010, Tyco formally announced plans to pursue a tax-free spin-off of the Electrical and
Metal Products segment. Profitability of the Electrical and Metal Products segment depends primarily on
metal spreads, particularly steel and copper. While over a given cycle this segment does generate strong
Initiate Coverage - Buy
Page 6
TYC - August 18, 2010
operating margins and cash flow, the year to year and quarter to quarter cyclicality of the business does
not fit with the rest of the Tyco portfolio. Tyco expects the spin-off to occur in the first half of fiscal
2011 and will result in Electrical and Metal Products segment being an independent, publicly traded
business. I view this spin-off as a positive for Tyco as it makes removes the one remaining legacy
business that did not fit with the vision that Mr. Breen has for the future.
The main competitor to Electrical and Metal Products is John Maneely Steel.
Safety Products
Safety Products designs, manufactures, and sells fire suppression, electronic, security, and life safety
products, including fire suppression products, breathing apparatus, intrusion security, access control, and
video management systems. Safety Products had revenues in 2009 of ~$1.6 billion, or ~9% of Tyco’s
consolidated net revenue. Virtually 100% of Safety Products revenues were from product sales.
Main competitors to Safety products include Groeniger & Company, System Sendor, and UTC.
Initiate Coverage - Buy
Page 7
TYC - August 18, 2010
Market Factors
In December 2008, Tyco announced it would reincorporate in Switzerland and was subsequently removed
from the S&P 500. The day of the announcement, Tyco shares dropped over 10%. Since its removal
from the index, Tyco has been unable to attract the attention of investors. Despite managements attempts
to transform the business model, the average investor still would not classify Tyco as a “need to own”
stock as asset managers could ignore it and not be penalized. In May 2010, Standard & Poor’s changed
the way it defined a U.S. based company and released a list of 20 stocks that were eligible to re-enter the
index based on the new criteria. Tyco was one of those 20 stocks. Inclusion in the S&P 500 would draw
immediate investor interest and asset managers would be forced to pay attention to the stock. Another
company on the list released by Standard and Poor’s, ACE Ltd., was added back to the index on July 14 th,
and the stock traded higher by 5% that day. A historical study has shown that stocks have jumped an
average of 5% on the day they were added to the index and continued to outperform by an additional 400
basis points over the next year. Inclusion into the S&P 500 could be a significant short-term catalyst for
Tyco.(2)
Economics Factors
An estimate of Tyco’s primary end market breakdown is: residential construction (~20%), commercial
construction (~25%), industrial construction (~25%), water (~5%), energy infrastructure (~5%),
transportation (~5%), and government (~15%).(4) The assumption to be made from the end market data is
that housing and construction related economic indicators, consumer confidence, and global infrastructure
build should be fairly well correlated with Tyco’s stock price. However, given the diverse exposure to
each end market it is difficult to pin down one indicator that will help investors gauge which direction
Tyco’s stock will trend. Three of the better indicators include the consumption portion of domestic GDP
growth (with a three month lead), existing single family home sales (with a twelve month lead), and the
ISM employment index (with a one month lead). (Charts courtesy of Thomson Reuters Baseline.)
Exhibit 4. Tyco vs. Change in Real Consumption (GDP, Lead 3 Months)
Initiate Coverage - Buy
Page 8
TYC - August 18, 2010
Exhibit 5. Tyco vs. Existing Single Family Home Sales (Lead 12 Months)
Exhibit 6. Tyco vs. ISM Employment Index (Lead 1 Month)
These relationships are reasonable. The consumption expenditures portion of GDP is driven solely by
consumers. Therefore, when consumers have money and are spending it is reasonable to assume that they
will spend some of it to protect their family by purchasing home security or fire protection equipment and
services. In addition, these sales are tied to consumers actually having a home to protect and so a pick-up
in existing single family home sales will lead to purchases about one year out. Finally, to purchase a
home consumers need jobs. Job growth is the key to the consumer and the home security market. The
residential market is not Tyco’s only end market; however the stock tends to trade more closely with the
health of the consumer as opposed to the health of the commercial or industrial markets.
While many of the construction and housing market and employment statistics would seem to paint a
fairly bleak picture of Tyco’s most important end markets, there could be a potential silver lining.
Attrition rates are a key metric to judge the health of ADT’s business. In the current state of the housing
market, many homeowners are now tied to their homes. The less turnover in housing, the less the
occupants will think about the security services that they pay for and may be more willing to continue
their service. The profitability of a customer to ADT is significantly higher in the out years than at the
initial sign up date. The longer occupants stay in their current homes and do not cut their spending on
security, the better this is for ADT. In addition, I believe that there is limited downside risk to cutting
home security spending due to the fact that adults will always feel the need to protect their family and
thus will look at other discretionary items to cut first if the need arises. Exhibit 7 below shows the cash
economic model for ADT.
Initiate Coverage - Buy
Page 9
TYC - August 18, 2010
Exhibit 7. ADT’s Cash Economic Model
Sector Analysis
Year to date, the industrials sector has outperformed the S&P 500 by over eight hundred basis points.
This outperformance can be attributed to the strength of the global economy, particularly in Brazil, China,
India, and other emerging economies which have continued to build out the infrastructure necessary to
support their growing populations.
Exhibit 8 below shows that the industrials sector is currently receiving a slight premium multiple to the
S&P 500 which is justified by the global growth prospects and international exposure of the sector. In
addition, I would stress that the multiple premium in most cases is minimal and not at extreme levels.
The fundamental story behind the industrial sector and the companies that comprise it are sufficient to
offset any concern about overpaying or buying at the peak.
Exhibit 8. Industrial Sector Relative Valuation to the S&P 500
P/FE
P/S
P/B
P/EBITDA
P/CF
High
1.2 x
1.1 x
1.3 x
1.5 x
1.2 x
Low
0.8 x
0.8 x
1.0 x
0.8 x
0.8 x
Median
1.0 x
1.0 x
1.1 x
1.2 x
1.1 x
Current
1.1 x
1.0 x
1.2 x
1.2 x
1.1 x
Industry Analysis
Tyco falls into the industrial conglomerates industry within the industrials sector. Other companies that
fall into the industrial conglomerates industry include Carlisle Companies (CSL), General Electric (GE),
McDermott International (MDR), 3M Company (MMM), and Textron (TXT). Because of the diverse and
often completely different end markets served by each of the companies it is a stretch to call them
competitors, but the market generally values the companies similarly and so they will become the basis
for this analysis.
Initiate Coverage - Buy
Page 10
TYC - August 18, 2010
Among the thirteen industries that make up the industrials sector, the industrial conglomerates group has
underperformed the sector by roughly 300 basis points year-to-date. I believe that this trend will reverse
itself in the coming quarters and growth in the U.S. and Western Europe may begin to weigh on the
market as a whole and investors reward those companies with a stable, diversified revenue base.
Companies such as Tyco should be the beneficiaries of such a decision by the market as investors look to
add stability to their portfolios at the expense of cyclicality.
Industrial conglomerate stocks are currently being priced at a discount to the sector (0.8x relative P/CF)
and this could provide an opportunistic time to build a position. Exhibit 9 below shows the current
absolute valuation metrics for the industrial conglomerates industry. Of the six companies presented,
CSL, MDR, and TYC appear to be relatively inexpensive when compared to GE, MMM, and TXT.
Given Tyco’s restructured business model and recurring revenue base, I would expect the market to
rethink the multiple granted to the company over time and bring it up to a level more consistent with the
latter group. Potential inclusion in the S&P 500 as mentioned before would be a significant catalyst to
put Tyco back on the trading screens of many investors.
Exhibit 9. Industrial Conglomerates Valuation Metrics
EV/Sales
EV/EBITDA
P/FE
P/CF
CSL
0.8 x
6.9 x
12.5 x
7.9 x
GE
4.0 x
27.9 x
13.1 x
7.5 x
MDR
0.4 x
3.5 x
9.5 x
5.5 x
MMM
2.4 x
8.6 x
13.9 x
11.6 x
TXT
1.2 x
16.2 x
21.5 x
8.7 x
TYC
1.2 x
6.9 x
12.5 x
7.5 x
Financial Statement Analysis
As a byproduct of its continued focus to restructure its operations around recurring revenue streams, Tyco
generates strong free cash flow and currently has a very strong balance. With free cash flow conversion
(FCF/NI) of ~100% consistently and $1.82 billion in cash on hand, Tyco has no liquidity issues. The
balance sheet has a very conservative net debt/net capitalization ratio of ~12% versus the industrial peer’s
average of ~20%. In mid-April, Standard & Poor’s raised Tyco’s credit rating to A- from BBB+.
In the middle of this fiscal year, Tyco reinstated its share buyback program. In FY10 Q3, the company
repurchased 15.8 million shares for $575 million under its existing $1 billion repurchase program. On the
conference call following the quarter, Mr. Breen suggested that the company will use the remaining $325
million under the repurchase program in Q4. A new repurchase program announced later this year would
be well received by the market as an efficient way to return money to shareholders and should provide
upside to the company’s stated EPS guidance.
Exhibit 10 below shows the DuPont analysis for Tyco over the preceding five years. DuPont analysis is a
useful tool that focuses attention on three critical elements of financial management: operating
management, asset management, and capital structure management. Keeping in mind that Tyco
underwent significant restructuring during this time which may have inflated or suppressed some of the
values presented below, there is still useful information that can be found in this exercise.
Initiate Coverage - Buy
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TYC - August 18, 2010
Exhibit 10. TYC DuPont Analysis
Profit Margin (Net Income ÷ Revenue)
Total Asset Turnover (Revenues ÷ Average Total Assets)
Return on Investment (PM * TAT)
Equity Multiplier (Average Total Assets ÷ Average Total Equity)
Return on Equity (ROI * EM)
2009
(10.4%)
63.4%
-6.62%
2008
7.7%
65.6%
5.04%
2007
(9.4%)
38.6%
-3.64%
2006
21.0%
27.2%
5.72%
2005
18.4%
26.4%
4.87%
1.9 x
2.0 x
1.9 x
1.9 x
2.0 x
10.58%
9.80%
(12.65% )
9.98%
(6.83% )
In DuPont analysis, operating management is approximated by net profit margin. In 2007 and again in
2009, significant restructuring charges were taken below the operating line which resulted in a net loss for
the company. Excluding these items, net profit margin would have been 6.3% in 2009 and 6.1% in 2007
and would have resulted in a return on equity consistent with previous years. Total asset turnover, a
measure of asset management, increases significantly in 2008 relative to previous years due mainly to the
spin-off of Covidien and Tyco Electronics. Finally, as a measure of capital structure management, the
equity multiplier has remained fairly constant through time despite the restructuring efforts of the
company. The main conclusion to be drawn from this exercise is that the return on equity is being
primarily driven by the equity multiplier. Senior managements focus during this time period has been
scattered as the business has undergone significant changes and I would expect to see marked
improvement in terms of operating and asset management going forward now that the portfolio of
businesses has been trimmed down to management’s desired core operating segments.
Relative Valuation
Taking the industrial conglomerate industry valuation analysis from Exhibit 9 above one step further, here
I show what that target price for Tyco could be if its multiple was an average of the current peer group
multiple. Remember, previously I pointed out that there seems to be two groups within the Industrial
Conglomerates industry. GE, MMM, and TXT are given a valuation premium relative to CSL, MDR, and
TYC and I made a case for Tyco to receive a higher multiple consistent with the first group. However, I
used all five companies in the peer average and thus the multiple may be skewed slightly to the low side.
An average of the target prices presented in Exhibit 11 below would yield a target price of roughly $44.
Exhibit 11. Tyco Relative Valuation to Peer Group
High
P/FE
P/S
P/B
P/EBITDA
P/CF
Initiate Coverage - Buy
18.4 x
2.6 x
5.8 x
29.8 x
13.0 x
Low
8.4 x
0.2 x
0.3 x
0.9 x
1.2 x
Median
13.5 x
0.9 x
1.3 x
4.1 x
5.3 x
Current
12.5 x
1.1 x
1.3 x
6.3 x
7.5 x
Peer Avg.
Multiple
14.1 x
1.1 x
2.1 x
6.8 x
8.2 x
Target Value
per Share
$
3.07
$
33.16
$
28.06
$
5.83
$
4.86
Target
Price
$ 43.29
$ 35.15
$ 59.49
$ 39.74
$ 39.88
Page 12
TYC - August 18, 2010
Equity Valuation – Multiples
Another method to value Tyco as presented in Exhibit 12 is the absolute multiples approach. At first
glance, while comparing Tyco’s current multiple to its median, it would appear that Tyco is fairly valued
and possibly even slightly overvalued. However, I would make the argument that the time period over
which these multiples were compiled (the previous ten years) represents flawed data and that the
multiples that Tyco should be awarded by investors should be higher going forward. First of all, this time
period represents a decade of operational and reputational restructuring by the company and senior
management. Since former Chief Executive Officer Dennis Kozlowski was removed from office in 2002,
due to significant fraud allegations, the company has changed dramatically.
As discussed previously, several segments have already been spun-off (Tyco Electronics, Covidien,
European Waterworks) and the remaining “problem” segment (Electrical and Metal Products) will be
spun-off early next year. This leaves Tyco with a much more stable, recurring revenue base and a chance
to use its strong free cash flow for acquisitions to drive growth in its core operating segments and fund
additional repurchases to return cash to shareholders.
A price target of $45 is appropriate based on this absolute multiples analysis.
Exhibit 12. Tyco Absolute Valuation
High
P/FE
P/S
P/B
P/EBITDA
P/CF
Initiate Coverage - Buy
18.4 x
2.6 x
5.8 x
29.8 x
13.0 x
Low
8.4 x
0.2 x
0.3 x
0.9 x
1.2 x
Median
13.5 x
0.9 x
1.3 x
4.1 x
5.3 x
Current
12.5 x
1.1 x
1.3 x
6.3 x
7.5 x
Target
Multiple
15.0 x
1.3 x
1.5 x
8.0 x
10.0 x
Target Value
per Share
$
$
$
$
$
3.07
33.16
28.06
5.83
4.86
Target
Price
$
$
$
$
$
46.05
43.11
42.09
46.62
48.64
Page 13
TYC - August 18, 2010
Equity Valuation – Discounted Cash Flow (DCF) Method
The most accurate measure of valuation for Tyco is found by creating a discounted cash flow (DCF)
model. The model used here, and found in Appendix B, is similar to many models available today.
Revenue, cost, margin, and working capital assumptions were made for the period 2010-2012 and more
general estimates were made for the period 2013- 2020. The assumptions used in the DCF model are
generally consistent with current analyst expectations; however they do vary in some areas. I believe that
Tyco will be able to drive stronger top line growth in the coming years thanks to better than expected
synergies at Broadview and a pick-up in the late cycle process control industry which benefits the Flow
Control segment. The growth in Flow Control is driven by infrastructure investments made by
developing economies and I feel confident that concerns over a double-dip recession are overblown at the
current time. Despite my projections for above trend top line growth, my cost and margin estimates
remain fairly in line with historical precedent and could be a source of upside surprise to my estimates.
While I am optimistic that management sees upside potential for margins, I will wait for further details
and actions taken to improve the cost side of the business before revising my estimates upward.
Even though management is currently, and I expect will continue in the future to repurchase shares in the
open market, I have not modeled any repurchases into my DCF. Any action taken by management on this
front will be upside to my model beneficial to shareholders.
Two additional assumptions regarding my model relate to the discount rate (10.0%) and the terminal
growth rate (4.0%). I am comfortable with these assumptions for several reasons. First of all, the
discount rate is warranted given the stability of the revenue base that Tyco has developed over the past
few years. With 40% of the company’s revenue now coming from services, it is much easier to predict
future growth. Secondly, a terminal growth rate of 4.0% is warranted because of the company’s exposure
to the global economy, not just the United States and Western Europe. While these developed economies
are no doubt important to Tyco’s success in the future, Asia Pacific and the Middle East will be much
more important in five years than they are today.
Given the above assumptions, I model that Tyco’s current fair value per share is roughly $46. A good
exercise to check the two most input-sensitive assumptions that I used is to do a sensitivity analysis on the
discount rate and the terminal growth rate. Exhibit 13 shows the sensitivity of the target price to changes
in the inputs and Exhibit 14 shows the sensitivity of downside risk and upside potential. It is clear that
the downside risk to the valuation is minimal, while the upside potential is significant. I believe this is
because of the overall conservative nature of the assumptions used to develop the model and general
stability of Tyco’s operations.
Exhibit 13. DCF Model Price Target Sensitivity Analysis
Discount Rate
Growth Rate
####
9.0%
9.5%
10.0%
10.5%
11.0%
11.5%
2.0%
$
45 $
42 $
39 $
37 $
35 $
33
2.5%
$
46 $
43 $
40 $
38 $
36 $
34
3.0%
$
49 $
45 $
42 $
39 $
37 $
35
3.5%
$
51 $
47 $
44 $
41 $
38 $
36
4.0%
$
54 $
50 $
46 $
42 $
39 $
37
4.5%
$
58 $
52 $
48 $
44 $
41 $
38
Initiate Coverage - Buy
Page 14
TYC - August 18, 2010
Exhibit 14. DCF Model Percent Upside Sensitivity Analysis
Discount Rate
Growth Rate
#####
9.0%
9.5%
2.0%
19.9%
12.0%
2.5%
24.8%
3.0%
30.6%
3.5%
10.0%
10.5%
11.0%
11.5%
5.2%
(0.8%)
(6.2%)
(11.0%)
16.2%
8.7%
2.1%
(3.7%)
(8.8%)
21.0%
12.7%
5.5%
(0.8%)
(6.4%)
37.5%
26.5%
17.2%
9.3%
2.4%
(3.7%)
4.0%
45.7%
33.1%
22.6%
13.7%
6.0%
(0.6%)
4.5%
55.8%
41.0%
28.9%
18.8%
10.2%
2.9%
Initiate Coverage - Buy
Page 15
TYC - August 18, 2010
Summary
Tyco has developed a portfolio of businesses with industry leader status, a global presence, and strong
financial flexibility.
Given the approximate valuation based on relative multiples, absolute multiples, and DCF analysis, I am
initiating Tyco with a Buy rating and a $45 price target with minimal risk.
Tyco has a number of potential catalysts which could force investors to reconsider their views on the
company’s shares. First of all, by early next year when the Electrical and Metal Products segment has
been spun-off, essentially all of the necessary restructuring of Tyco’s business model will be complete.
Emerging from this eight year process will be a leaner, more stable, diversified revenue base which
management can focus on growing. Management’s focus is already heading in that direction as the
company’s recent acquisition of Broadview Security for $2.0 billion completed in January shows. This
deal is still being underappreciated by the market. With a very attractive balance sheet and strong free
cash flow it should not take long for management to fill up the acquisition pipeline and wait for the
opportune time to create shareholder value. If the multiple required on an acquisition is too high,
management has shown recently that it is willing to buy back shares in the open market as a method to
return capital to shareholders. Tyco is no longer a company that will be tied to its past or sitting on its
hands. Management is ready to grow the company once again.
In addition, potential re-inclusion in the S&P 500 index would be a major boost for current shareholders
as index funds will be forced to take a position in the stock and asset managers will look more closely and
consider adding it to their portfolio.
Risks
I have identified the risks to Tyco’s shares as limited at the current time. Because of the issues of
stemming from the 2002 corporate scandal with Mr. Kozlowski and Mr. Swartz, many investors have
turned away from Tyco. Those who remain shareholders today represent a more conservative base with
few little growth or momentum investors involved. As seen in the sensitivity analysis in Exhibits 13 and
14 above the risk/reward is roughly 5:1. However, as with any investment there are risks that may change
the story and the investment suitability materially. Some of these risks include:
Unsuccessful Broadview integration.
Sustained global economic weakness.
Prolonged, sharply lower non-residential construction expenditure.
Declining consumer confidence.
Stronger U.S. dollar.
Initiate Coverage - Buy
Page 16
TYC - August 18, 2010
Sources
I, Jordan Winters, hereby certify that the views about the companies and their securities discussed in this
report are accurately expressed. Information contained in this report may be found in the company’s
annual, quarterly, and proxy filings with the Securities and Exchange Commission(1) and additional
information was obtained from Morgan Stanley(2), Cowen and Company(3), and AllianceBernstein
Research(4). Charts were also obtained from Thomson Reuters Baseline.
Initiate Coverage - Buy
Page 17
TYC - August 18, 2010
Appendix A – Selected Financial Data
TYC
GAAP
(mil $)
Net Revenue
ADT Worldwide
Flow Control
Fire Protection Service
Electrical and Metal Products
Safety Products
Corporate and Other
Total Revenue
Consensus
FYE
2012E
FYE
2011E
9,409
3,902
3,409
1,502
1,559
0
19,781
19,240
FYE
2010E
8,633
3,842
3,359
1,410
1,513
0
18,757
18,365
FYE
2009
7,775
3,828
3,359
1,343
1,506
0
17,811
17,362
Costs & Expenses
Cost of Product Sales
Cost of Services
SG&A
Class Action Settlement, net
Separation Costs
Goodwill and Intangible Asset Impairment
Restructuring, Asset Impairment, and Divestiture Charges
Total Costs & Expenses
ADT Worldwide
Flow Control
Fire Protection Service
Electrical and Metal Products
Safety Products
Corporate and Other
Operating (Loss) Income
Interest Income
Interest Expense
Other Expense, net
(Loss) Income from Continuing Operations before Income Taxes and
Minority Interest
Income Tax Expense
Minority Interest
(Loss) Income from Continuing Operations
FYE
2008
7,015
3,850
3,428
1,392
1,552
0
17,237
7,584
3,559
4,657
0
0
2,705
17,486
16,722
16,101
219
18,724
7,731
4,418
3,839
2,272
1,934
5
20,199
9,200
3,923
4,906
(10)
4
10
225
18,258
FYE
2007
FYE
2006
FYE
2005
7,288
3,766
3,726
1,974
1,719
4
18,477
7,205
3,135
3,150
1,949
1,624
3
17,066
7,104
2,806
3,182
1,798
1,682
93
16,665
8,495
3,722
4,776
2,862
105
59
7,667
3,555
4,425
0
49
0
7,232
3,503
4,699
0
0
0
190
20,209
15
15,711
40
15,474
1,402
566
310
183
229
(396)
2,295
1,252
519
296
164
218
(413)
2,035
1,120
436
279
107
214
(445)
1,711
233
518
68
(940)
(789)
(577)
(1,487)
906
618
325
342
284
(534)
1,941
817
457
283
159
274
(3,722)
(1,732)
907
356
241
319
196
(664)
1,355
952
336
202
295
278
(872)
1,191
40
(257)
(20)
38
(263)
(19)
36
(267)
(18)
44
(301)
(7)
110
(396)
(224)
104
(313)
(255)
46
(279)
0
39
(322)
(296)
2,057
(370)
(2)
1,791
(322)
(2)
1,461
(263)
(2)
(1,751)
(78)
(4)
(335)
(1)
(324)
(4)
612
(304)
(1)
(29)
(2)
1,197
0
0
0
1,685
1,467
1,197
(1,798)
1,553
(1,742)
3.54
0
0
3.54
3.08
0
0
3.08
2.51
0
0
2.51
(3.87)
0.07
0
(3.80)
2.26
0.95
0
3.21
(5.10)
1.58
0
(3.52)
1.63
5.54
(0.03)
7.14
1.15
4.96
0.04
6.15
3.53
0
0
3.53
3.54
3.07
0
0
3.07
3.07
2.50
0
0
2.50
2.50
2.54
(3.87)
0.07
0
(3.80)
2.25
0.94
0
3.19
(5.10)
1.58
0
(3.52)
1.59
5.39
(0.03)
6.95
1.13
4.68
0.04
5.85
476
478
476
478
476
478
473
473
464
488
495
495
503
521
503
542
Cash & Cash Equivalents
Accounts Receivable
Inventory
Accounts Payable
Change in Working Capital
2,591
3,086
1,840
1,582
(192)
2,495
2,907
1,688
1,444
(177)
2,405
2,743
1,550
1,318
(147)
2,354
2,629
1,443
1,244
427
1,519
2,986
1,877
1,608
(209)
1,894
2,900
1,783
1,637
(236)
2,193
2,748
1,619
1,557
N/A
N/A
N/A
N/A
N/A
N/A
Depreciation and Amortization
Capital Expenditures
1,286
692
1,219
656
1,158
623
1,133
709
1,154
734
1,148
666
1,180
556
1,204
516
Net (Loss) Income
Net Earnings Per Share
Basic
(Loss) Income from Continuing Operations
Income from Discontinued Operations
Cumulative Effect of Accounting Change
Net (Loss) Income
Diluted
(Loss) Income from Continuing Operations
Income from Discontinued Operations
Cumulative Effect of Accounting Change
Net (Loss) Income
Consensus GAAP
Guidance
Weighted Average Shares Outstanding
Basic
Diluted
Initiate Coverage - Buy
458
(2,524)
1,122
1,467
35
1,095
(2,196)
1,685
Income from Discontinued Operations, net of Income Taxes
(1,833)
1,431
782
817
581
2,773
2,492
3,590
3,073
Page 18
TYC - August 18, 2010
Appendix B – DCF Model
Tyco (TYC)
Analyst: Jordan Winters
8/18/2010
Year
Revenue
2010E
17,811
% Grow th
2011E
18,757
5.3%
EBT
1,711
EBT Margin
Interest
Interest % of Sales
Taxes
Tax Rate
Net Income
2,035
19,781
5.5%
2,295
2013E
20,770
5.0%
2,389
2014E
21,809
5.0%
2,552
2,945
4.2%
3,043
27,047
4.0%
3,137
28,129
4.0%
3,235
11.5%
249
244
237
249
262
274
287
300
312
325
338
1.4%
1.3%
1.2%
1.2%
1.2%
1.2%
1.2%
1.2%
1.2%
1.2%
1.2%
263
322
370
385
412
444
465
476
492
506
522
18.0%
18.0%
18.0%
18.0%
18.0%
18.0%
18.0%
18.0%
18.0%
18.0%
18.0%
1,467
1,219
1,685
14.9%
1,207
1,754
4.1%
1,184
1,878
7.0%
1,156
2,024
7.8%
1,143
2,117
4.6%
1,076
2,169
2,239
2.5%
1,123
3.2%
1,170
2,307
3.0%
1,217
2,376
3.0%
1,266
6.5%
6.5%
6.1%
5.7%
5.3%
5.0%
4.5%
4.5%
4.5%
4.5%
4.5%
(147)
(177)
(192)
(470)
(491)
(513)
(536)
(558)
(580)
(603)
(628)
-1.0%
-1.0%
771
893
981
Capex % of sales
3.5%
3.5%
3.9%
4.3%
4.5%
1,584
% Grow th
1,853
16.9%
NPV of Cash Flows
10,426
NPV of terminal value
11,683
53%
Projected Equity Value
22,110
100%
1,928
4.1%
1,575
-18.3%
1,561
-0.9%
-1.0%
1,028
4.5%
1,625
4.1%
-1.0%
1,076
4.5%
1,581
-2.7%
-1.0%
1,123
-1.0%
1,170
4.5%
1,612
4.5%
1,659
1.9%
2.9%
-1.0%
1,217
4.5%
1,703
2.7%
-1.0%
1,266
4.5%
1,748
2.6%
47%
Terminal Value
8.89%
Shares Outstanding
26,007
4.4%
11.6%
-1.0%
Projected EV/EBITDA
2,869
24,959
2020E
11.7%
656
Current EV/EBITDA
4.6%
2019E
11.8%
-0.9%
Projected P/E
2,743
23,907
2018E
12.0%
623
Current P/E
4.8%
2017E
12.0%
-0.8%
Free Cash Flow Yield
22,856
2016E
11.7%
Subtract Cap Ex
Free Cash Flow
2015E
11.5%
1,158
% of Sales
2012E
11.6%
22.6%
Plus/(minus) Changes WC
4.0%
10.8%
1,197
% of Sales
10.0%
Terminal FCF Growth =
9.6%
% Grow th
Add Depreciation/Amort
Terminal Discount Rate =
Free Cash Yield
14.9
12.2
10.6
18.5
15.1
13.1
6.9
6.1
5.6
8.4
7.4
6.8
30,304
5.77%
Terminal P/E
12.8
Terminal EV/EBITDA
7.1
478.0
Current Price
$ 37.30
Implied equity value/share
$ 46.25
Upside/(Downside) to DCF
24.0%
Debt
4,274
Cash
2,405
Cash/share
Initiate Coverage - Buy
5.03
Page 19