TYCO INTERNATIONAL LTD TYC
November 18, 2011 - 6:25pm EST by
sandman898
2011 2012
Price: 46.71 EPS $3.59 $4.07
Shares Out. (in M): 471 P/E 13.0x 11.5x
Market Cap (in $M): 22,000 P/FCF 13.8x 12.0x
Net Debt (in $M): 3,873 EBIT 2,286 2,530
TEV ($): 25,873 TEV/EBIT 11.3x 10.2x

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Description

Tyco will separate into three companies within the next twelve months. All three are high-quality industry leaders that will be growing sales in 2012 and are likely to be either acquired or recapitalized post-separation. A year from now, the stock will be worth $54 as three stand-alone businesses and could be worth as much as $70 to strategic buyers. 

VALUATION

 

Price

 

$46.71

 

 

Consensus

09/2011

09/2012

09/2013

(x) Shares

0.471

 

 

 

 

 

 

MV

 

22.0

 

 

Sales

17.0

18.0

19.0

(+) Debt

 

4.1

 

 

(x) Margin

19.9%

20.3%

20.4%

(+) Other

 

1.1

 

 

   EBITDA

3.4

3.6

3.8

(-) Cash

 

(1.4)

 

 

EV/EBITDA

7.7x

7.1x

6.7x

EV

 

25.9

 

 

EPS

$3.24

$3.59

$4.07

                   

 

Company

Sales

Margin

EBITDA

Multiple

Value

$/Share

ADT North America Residential

3.4

46%

1.6

8.0x

12.6

$27

Flow Control

3.9

14%

0.5

7.0x

3.8

$8

Commercial Fire & Security

10.5

14%

1.5

7.5x

11.1

$24

Total

16.9

20%

3.6

7.6x

27.6

$59

(-) Net Debt

 

 

 

 

(3.9)

($8)

(+) FCF 09/11-09/12

 

 

 

 

1.6

$3

MV at Separation

 

 

 

 

25.3

$54

 

BACKGROUND

Edward Breen arrived at TYC as its new CEO in 2002 only a month after Dennis Kozlowski had been forced to resign for looting $600MM. The company was in disarray, consisting of hundreds of disparate acquisitions that had never been fully integrated. Worse, TYC was facing a liquidity crisis with suppliers demanding cash on delivery just as $11B of the company’s $28B in debt was coming due. In his first six months, Breen replaced the entire board of directors and fired 290 of the top 300 members of the corporate team. He then focused on operations and pulled out of a couple of businesses and closed hundreds of facilities to increase cash flow, swinging into a $1B profit in 2003 and then $3B in 2004. Over the next few years the business paid down billions of dollars of debt until it initiated a three-way spin-off in 2007 which resulted in the separation of Covidien (COV) and TE Connectivity (TEL). Then in 2010, with net debt down to about a year’s worth of FCF, TYC started returning all of its FCF to shareholders.

In April of this year, shares popped from $44 to $52 on rumors that Schneider Electric (SU FP) was looking to buy the company.  It was reported that there had been discussions but when the news was leaked shares of SU FP tanked because investors were concerned about risks of a huge cross-border transaction, forcing the company to later put out a release noting that it was “not currently” in discussions. TYC’s stock eventually settled around $47. A notable deal occurred in June when Bain and Hellman purchased Securitas Direct for $3.4B, beating out Stanley Black & Decker (SWK) as well as a handful of private equity firms.

In September, TYC announced that it would engage in a second three-way spin-off within the next twelve months, in what would be a grand finale on Breen’s legacy at TYC. Management has been careful to keep the tax structures of the businesses intact and to avoid considering any real bids such that any of the three could be acquired immediately following separation. In addition, due to continued cost cutting at the corporate level, higher public company costs will be offset by continued cost savings such that there will not be an increase in overhead upon separation.

 

ADT NORTH AMERICA RESIDENTIAL

 

ADT Value / Share based on EBITDA

 

6.0x

6.5x

7.0x

7.5x

8.0x

8.5x

9.0x

9.5x

10.0x

1,200

$15

$17

$18

$19

$20

$22

$23

$24

$25

1,300

$17

$18

$19

$21

$22

$23

$25

$26

$28

1,400

$18

$19

$21

$22

$24

$25

$27

$28

$30

1,500

$19

$21

$22

$24

$25

$27

$29

$30

$32

1,600

$20

$22

$24

$25

$27

$29

$31

$32

$34

1,700

$22

$23

$25

$27

$29

$31

$32

$34

$36

1,800

$23

$25

$27

$29

$31

$32

$34

$36

$38

1,900

$24

$26

$28

$30

$32

$34

$36

$38

$40

2,000

$25

$28

$30

$32

$34

$36

$38

$40

$42

 

 

 

     

EV/Sales

 

EV/EBITDA

 

P/E

Ticker

Name

 

Price

 

2011

2012

 

2011

2012

 

2011

2012

9735 JP

SECOM CO

3,535

 

1.01x

0.98x

 

4.7x

4.4x

 

13.2x

12.4x

SWK

STANLEY BLACK & DECKER

63.66

 

1.32x

1.20x

 

8.1x

6.9x

 

12.3x

10.7x

GFS LN

G4S

 

235.70

 

0.65x

0.61x

 

7.3x

6.8x

 

10.2x

9.2x

SECUB SS

SECURITAS

60.15

 

0.52x

0.49x

 

7.7x

7.2x

 

10.7x

9.8x

PSG SM

PROSEGUR

32.52

 

0.89x

0.85x

 

7.0x

6.7x

 

11.9x

11.2x

TOTAL

       

0.89x

0.85x

 

7.3x

6.8x

 

11.9x

10.7x

There are roughly 110MM homes in America and around 20MM of them have home security. ADT acquired its main competitor in 2010 when it purchased Broadview which had 1.3MM accounts. Today, the company has more than 6MM households or about a 26% share which is nearly ten times larger than their closest competitor. The business has a slow but steady mid-single-digit growth rate. ADT generates about half of its sales through its internal network of 9,000 sales representatives and the other half through dealer networks where the company pays about $1,000 per account. During the worst quarter in the downturn it grew 4% and right now it is growing 6%. Around 90% of revenues are recurring with customers paying around $36/month to monitor their homes for theft, fire, flood, and carbon monoxide and this average monthly price has gone up every single month for the last four years. Prices should continue to increase 3-4% going forward with ADT Pulse, an upgraded service that runs a little over $50/month, but allows homeowners to control their surveillance, security, lighting, and thermostat using their iPhone. ADT Pulse was rolled out to the internal sales force last year and the percentage of accounts that upgraded has steadily increased from 15% in Q1, to 16% in Q2, to 20% in Q3, to 23% in Q4 with the potential to increase to 30%. The company should benefit from this tailwind in 2012 especially as ADT Pulse gets fully rolled out to the dealers. 

ADT is a very attractive LBO candidate given its dominance, predictability, high margins, and recurring nature of cash flows. If growth stalls management can immediately boost FCF to cover interest payments by dialing down on the growth rate, enabling the company to safely assume a significant amount of debt. At a recent event a UBS analyst suggested that their credit team believed a buyer would be able to finance the company with 5-6x turns of debt. There is one last round of synergies from the Broadview integration that will start benefiting earnings in 2012. Finally, reported tax rates will be in the 30% range, but because the amortization of an alarm system can be accelerated for statutory purposes, as long as the business is growing ADT benefits from a cash tax rate of less than 20%.

Historically, alarm businesses have been difficult for the market to value, largely because they tend to expense a large amount of the acquisition costs for a service relationship that can last for years, resulting in margins that contract when the business is growing. For this reason, the industry tends to standardize valuations by looking at them as a multiple of recurring monthly revenue (RMR). Broadview was acquired for 42x and most prior acquisitions have taken place anywhere between 40-60x RMR. For ADT, RMR should be near $250MM next year. Given its industry dominance, ADT should trade towards the high-end of this range. Additionally, in a world of limited growth and over-the-top competition, ADT would be a highly strategic asset for a national cable company. 

The move to separate the North American ADT from its international counterpart and to re-domicile it in the US should maximize its appeal to the likely cable company suitors.  Citigroup 09/19/11

While I will be stepping down as Tyco’s chairman and CEO following the completion of the separation, I plan to remain involved with all three companies. I will serve on the boards of the flow control and fire and security companies and will be an advisor to the ADT North American residential security company. With Comcast’s emerging presence in the residential security industry, I believe that it is appropriate for me to resign to avoid even the appearance of conflict between Comcast and what soon will be a standalone ADT home security company.  As a result, I am tendering my resignation from the Comcast board of directors. – Ed Breen 11/03/11

I have been in personally in conversations with cable operators, with telco operators, with other players and industries that are somewhat associated around this and I just don't want any appearance of any conflict as we move forward with the stand-alone security company. – Ed Breen 11/16/11


FLOW CONTROL

 

Flow Control Value / Share based on EBITDA

 

5.0x

5.5x

6.0x

6.5x

7.0x

7.5x

8.0x

8.5x

9.0x

450

$5

$5

$6

$6

$7

$7

$8

$8

$9

475

$5

$6

$6

$7

$7

$8

$8

$9

$9

500

$5

$6

$6

$7

$7

$8

$8

$9

$10

525

$6

$6

$7

$7

$8

$8

$9

$9

$10

550

$6

$6

$7

$8

$8

$9

$9

$10

$11

575

$6

$7

$7

$8

$9

$9

$10

$10

$11

600

$6

$7

$8

$8

$9

$10

$10

$11

$11

625

$7

$7

$8

$9

$9

$10

$11

$11

$12

650

$7

$8

$8

$9

$10

$10

$11

$12

$12

 

 

 

     

EV/Sales

 

EV/EBITDA

 

P/E

Ticker

Name

 

Price

 

2011

2012

 

2011

2012

 

2011

2012

CAM

CAMERON INTERNATIONAL

 

49.32

 

1.78x

1.51x

 

10.8x

8.2x

 

18.5x

13.5x

FLS

FLOWSERVE

 

96.95

 

1.26x

1.18x

 

7.9x

6.9x

 

12.4x

11.0x

PNR

PENTAIR

 

36.83

 

1.46x

1.34x

 

9.8x

8.6x

 

15.1x

13.2x

IEX

IDEX

 

34.67

 

1.90x

1.73x

 

8.7x

7.7x

 

13.7x

12.5x

RBN

ROBBINS & MYERS

 

46.50

 

2.04x

1.70x

 

7.9x

7.1x

 

15.6x

14.1x

WTS

WATTS WATER TECHNOLOGIES

 

35.35

 

1.06x

1.00x

 

7.9x

7.0x

 

16.1x

13.5x

CFX

COLFAX CORP

 

28.61

 

1.79x

1.67x

 

10.9x

9.6x

 

20.8x

17.6x

CIR

CIRCOR INTERNATIONAL

 

31.30

 

0.74x

0.69x

 

8.0x

6.4x

 

14.8x

11.0x

GRC

GORMAN-RUPP

 

27.57

 

1.58x

1.98x

 

9.9x

8.7x

 

18.1x

15.9x

MPR

MET-PRO

 

9.01

 

1.06x

0.96x

 

8.0x

6.5x

 

17.8x

14.1x

TOTAL

       

1.52x

1.43x

 

8.3x

7.4x

 

15.9x

13.5x

TYC is the global leader of valves for the oil and gas, energy, mining, and water industries.  Sales are 60% valves, 20% water systems, and 20% thermal controls and are fairly geographically diversified with 40% of sales coming from Asia, 30% EMEA, and 30% Americas. About 40% of the business is aftermarket and replacement, but overall these products are late cycle given that a lot is tied to longer-lead time infrastructure projects. For this reason, annual revenue just turned positive in Q3 after two years of declines driven by four sequential quarters of increasing backlog to current levels of $1.7B up 18% from the prior year. Management has guided to sequential operating margin expansion each quarter of 2012 as incremental margins of 35% should drive operating margins to 14% in the second half of the year. Breen noted that “Flowserve’s portfolio is interesting,” in regards to the potential benefit of combining valves with pumps to offer full system solutions.

COMMERCIAL FIRE & SECURITY

 

Commercial Fire & Security Value / Share based on EBITDA

 

5.5x

6.0x

6.5x

7.0x

7.5x

8.0x

8.5x

9.0x

9.5x

1,100

$13

$14

$15

$16

$18

$19

$20

$21

$22

1,200

$14

$15

$17

$18

$19

$20

$22

$23

$24

1,300

$15

$17

$18

$19

$21

$22

$23

$25

$26

1,400

$16

$18

$19

$21

$22

$24

$25

$27

$28

1,500

$18

$19

$21

$22

$24

$25

$27

$29

$30

1,600

$19

$20

$22

$24

$25

$27

$29

$31

$32

1,700

$20

$22

$23

$25

$27

$29

$31

$32

$34

1,800

$21

$23

$25

$27

$29

$31

$32

$34

$36

1,900

$22

$24

$26

$28

$30

$32

$34

$36

$38

 

 

 

     

EV/Sales

 

EV/EBITDA

 

P/E

Ticker

Name

 

Price

 

2011

2012

 

2011

2012

 

2011

2012

SIE GR

SIEMENS

 

72.10

 

0.93x

0.90x

 

6.4x

5.9x

 

10.3x

9.5x

UTX

UNITED TECHNOLOGIES

 

76.11

 

1.30x

1.20x

 

7.7x

7.2x

 

13.9x

12.8x

ASSAB SS

ASSA ABLOY AB-

 

154.50

 

1.99x

1.85x

 

11.9x

10.2x

 

12.9x

11.6x

HON

HONEYWELL INTERNATIONAL

 

52.75

 

1.21x

1.15x

 

7.8x

7.1x

 

13.2x

11.9x

SU FP

SCHNEIDER ELECTRIC

 

38.97

 

1.18x

1.13x

 

7.1x

6.9x

 

10.7x

10.3x

JCI

JOHNSON CONTROLS

 

29.76

 

0.58x

0.53x

 

7.0x

6.2x

 

10.0x

8.4x

ETN

EATON

 

43.92

 

1.09x

1.03x

 

7.5x

6.8x

 

11.1x

9.8x

IR

INGERSOLL-RAND

 

31.20

 

0.82x

0.82x

 

6.3x

5.9x

 

11.5x

9.9x

CSL

CARLISLE

 

43.07

 

0.97x

0.91x

 

8.3x

6.9x

 

14.9x

12.3x

CR

CRANE

 

45.62

 

1.11x

1.06x

 

7.5x

7.0x

 

13.6x

12.1x

DBD

DIEBOLD

 

31.11

 

0.78x

0.76x

 

8.7x

7.8x

 

14.1x

13.8x

TOTAL

       

1.09x

1.03x

 

7.5x

6.9x

 

12.9x

11.6x

TYC is the largest provider of commercial fire and security products and services globally. Sales are split between 55% security and 45% fire. About 45% of the business is from recurring contracts which should increase as a percentage over time, followed by 38% system installs and 17% products. About 40% of sales are in North America. The security portion of revenues here is ADT’s non-North American operations, which are predominantly commercial accounts all over the globe. Unlike the prior two spinoffs, Commercial Fire & Security has a fair amount of variance in its remaining segments, though additional disclosure should go a long way.

So when you hear SimplexGrinnell in North America, it's not a products company. We sell products from our products company into it, but Simplex is actually all the thousands of vans you see traveling around this country doing service, and that's the difference. I think that's the value in the gem. So what I like about the separation also, when you take the biggest piece, which is the commercial fire and security, the $10B of revenue, it is very low capital intensity. Very low, and the way I look at it is the capital is the capital that's sitting in the 20,000 vans every day. That is literally the capital, what's in our pipeline getting into that van. So the returns in this business are huge. But it's the business model. And I think that's going to be very attractive when investors can isolate that and actually see it. – Ed Breen, 09/21/11

In Q3, management has stated that TYC has another $0.4-0.5B in cost savings over the next few years, with the majority in this business, as the back offices of fire and security are integrated. In Q4, this was increased by another $0.125-0.150B as new integration projects were uncovered. These integration projects should have a two-year or better payback.


SEPARATION

 I'm a big believer that there is going to be consolidation in these industries. I think you've already been watching some of that occur and we want our businesses to be able to play in that environment in their respective industries. – Ed Breen, 09/19/11

We took the last four years to get the portfolio here. We have really solidified a very, very strong management team in each of the three businesses, and that's past the CEOs that we announced. We've been planning this and we've really embedded a lot of the right people we want even for a public company, so we had that. We have momentum in the businesses, again obviously after the recession, and our late-cycle businesses are now kicking in. And remember, Tyco has a fair amount of late-cycle businesses in flow control and commercial construction-related businesses. And so, we're seeing momentum continue there. And I would say, more importantly probably when you set all of that aside, the businesses are in great shape. They're market-leading companies. They literally are the leader in their respective businesses. They are in very good shape operationally, and so it's like, why not now? Let's get going and let's do it and it's time to get moving– Ed Breen, 09/21/11

Firm

Date

Takeout

Notes

BofA

10/20

$56

8x EBITDA fire/flow, 7x EBITDA ADT

Sterne Agee

11/07

$60

8x EBITDA ADT

Bernstein

11/18

$63

3.5x sales ADT, 2.5x sales flow, 1.3x sales fire

FBR

11/17

$64

8.5x EBITDA fire, 8.5x flow, 8.5x EBITDA ADT

Citi

11/16

$69

12x EBITDA flow, 10x EBITDA fire, 11x EBITDA ADT

Langenberg

04/29

$72

8x EBITDA fire/flow, 10x EBITDA ADT

JP Morgan

09/21

$74

11x EBITDA fire, 10x EBITDA flow, 12x EBITDA ADT

 

EARNINGS RECORD

Management provided 2012 guidance on 11/16 of $3.50-3.60. They took a conservative view given macro uncertainty and left themselves a margin of safety in the share count and tax rate embedded in their numbers. The company has a solid track record of exceeding quarterly expectations which is likely to continue through the separation.

Year

2006

2007

2008

Quarter

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Street

1.52

1.68

1.93

1.98

1.73

1.88

0.62

0.56

0.61

0.58

0.67

0.73

Reported

1.56

1.80

1.96

2.04

1.80

1.96

0.55

0.57

0.73

0.67

0.88

0.81

Versus

+

+

+

+

+

+

-

+

+

+

+

+



Year

2009

2010

2011

Quarter

Q1

Q2

Q3

Q4

tyQ1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Street

0.47

0.41

0.45

0.54

0.64

0.54

0.64

0.66

0.68

0.68

0.73

0.86

Reported

0.61

0.55

0.58

0.61

0.65

0.59

0.72

0.74

0.75

0.73

0.85

0.92

Versus

+

+

+

+

+

+

+

+

+

+

+

+

 

RETURNING CASH

Management has earmarked another $0.2-0.3B for tuck-in acquisitions over the next year, but the remaining FCF is being returned to shareholders through a $0.5B annual dividend and aggressive buybacks. The company has $0.5B outstanding under its existing authorization after management bought back $0.2B in the last 45 days which amounts to just over 1% of the shares outstanding.

 

RECAPITALIZATION

Management has indicated that the majority of the separation costs will be associated with refinancing debt with the intention of maintaining investment-grade ratings through the separation. That said, even at investment grade the company could easily add another $1B in debt. And while the refinancing will result in a substantial one-time cost, it should result in lower interest rates going forward.

   

Rate

Amount

Interest

Market

YTM

Interest

Commercial Paper

0.37%

102

0

100

0.37%

0

6.00% due 2013

6.00%

655

39

109

1.45%

9

4.13% due 2014

4.13%

499

21

107

1.76%

9

3.38% due 2015

3.38%

499

17

105

2.12%

11

3.75% due 2018

3.75%

249

9

106

2.74%

7

8.50% due 2019

8.50%

750

64

126

4.24%

32

7.00% due 2019

7.00%

431

30

122

3.25%

14

6.88% due 2021

6.88%

715

49

125

3.62%

26

4.63% due 2023

4.63%

248

11

103

4.27%

11

Total

 

4,148

241

 

2.85%

118

115

 

Catalyst

Beat and raise earnings reports, additional separation disclosure, and speculation into the seperation.
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