Like most companies, Tyco International suddenly quit thinking about acquisitions on the morning of Tuesday, September 11. Unlike most, it was back pursuing its aggressive M&A stance in less than a week.
Not that Tyco—a conglomerate with headquarters in Exeter, New Hampshire, and Pembroke, Bermuda—wasn’t as stunned as any company by the terrorist attacks. Indeed, CEO Dennis Kozlowski and CFO Mark Swartz were at the Essex House, in midtown Manhattan, at the time, talking to 400 investors and analysts, with Tyco’s acquisitions the main topic. “We were under way for about 20 minutes when we heard about a fire at the Trade Center,” says Swartz, adding that the meeting of shaken New Yorkers, understandably, never resumed.
But within a month, Tyco, one of the most acquisitive companies of the past 10 years, had nearly closed the $2.3 billion Sensormatic deal; gotten back on track toward a December close for a second acquisition, of medical-equipment maker C.R. Bard; and begun positioning itself for changes it figured the terrorist attacks might provoke in the deal-making environment. Among the trends Tyco expects: smaller acquisition targets and a tendency to pay cash rather than stock.
As a whole, Corporate America hasn’t yet returned to the business of M&A. Tallies of announced deals, both big and small, slowed to a crawl in September—a falloff that came on the heels of already sharply lower activity. Indeed, the September downturn dragged third-quarter mergers to their lowest volume in five years. “We’re holding hands and trying to maintain relationships with our clients,” says Gary Finger of Houlihan Lokey Howard & Zukin, an investment bank that targets mainly middle-market clients.
Moreover, notes Thomas Lys, a professor at the Merger Week program at Northwestern University’s Kellogg Graduate School of Management, CFOs have to readjust their thinking about acquisition targets to reflect new economic realities, especially in situations where overcapacity makes M&A unattractive. “They will either adapt,” he says, “or they will be teaching.”
Those companies that choose to reenter this puzzling M&A environment may learn a lot from Tyco’s experience in the weeks after September 11.
For the first few days, the company was “trying to figure out where we stood in the world,” says Swartz. “We weren’t focusing on M&A; we were thinking about getting respirators to firemen in New York and Washington, along with health-care supplies,” he explains. (In all, 400 portable respirators and 30 cases of wound-care packages were among the Tyco products provided for rescue work in the first days after the attacks.) And the aid efforts “ended up being very therapeutic” for Tyco’s employees, according to the CFO.
Tyco executives needed a little therapy of their own when trading resumed the following week. The company’s stock price fell 18 percent (from $47.71 to a low of $38.24) in the first 10 days after the attacks, while its target closest to being acquired, Sensormatic, suffered a 17 percent loss (from $22.96 to $18.70) in the widespread sell-off. But almost as quickly, that acquisition began to garner unusual interest. Sensormatic, based in Boca Raton, Florida, makes video surveillance equipment of the kind airports and other facilities are now buying to beef up security, and it fits neatly into the fire and security services division of Tyco. Share prices for Tyco and Sensormatic began creeping back during the measurement period—starting two days after trading resumed on September 17–that established the exchange rate for the Tyco shares that Sensormatic holders would receive. Tyco shares returned to their preattack level in early October, while Sensormatic has exceeded its September 10 trading price.
“We breathed a sigh of relief” when the share prices bottomed out early, notes Swartz. “No one knew where stock prices were headed. Had stock prices significantly fallen off, it would have raised major questions with the Sensormatic board” about whether the deal could be completed. Tyco’s $3.2 billion acquisition of C.R. Bard also seems to be progressing smoothly; like Sensormatic, Bard is noncyclical, and thus it is more attractive during the current recessionary mood that is punishing consumer- and travel-related industries most.
“I hate to use the word ‘positive,'” says Swartz of his company’s purchase of Sensormatic in an environment in which its products could see stronger demand. Tyco, of course, could not have forecast the source of that demand, but was drawn to Sensormatic’s strategic fit with its ADT security business. Going forward, though, worsening economic conditions have confirmed its resolve to pay more attention to noncyclical lines—at least until the end of the “severe-to-light recession” that Swartz expects. (The more cyclical of its five lines are telecommunications and electronics, and flow control. Tyco also has a financial services business.)
A Future For Cash
Because of recessionary concerns, Lys likes not only Tyco’s choice of noncyclical acquisitions but also its plan to reduce the use of stock for deals—something experts often say leads to overpaying for a company. “With stock prices down, the cheap currency is gone,” notes Lys, “so companies would have to use more cash” than they would have before September’s downturn. About 40 percent of deals in recent years have been all-cash transactions, with the remaining 60 percent divided fairly equally between all-stock and stock-and-cash deals, and deals without announced terms.
When Swartz says, “The predominant number of deals we do will be cash deals” for the foreseeable future, that’s a big change for Tyco. The company has opted to pay in Tyco shares for about half its acquisitions in recent years, including the Sensormatic and Bard deals. “Our stock is undervalued right now,” he says, “and we’re not going to put out much at these [price] levels.”
Merrill Lynch & Co. analyst Phua K. Young, who follows Tyco, thinks the commitment to pay cash for deals may have to be tempered, however, to reflect this year’s acquisition of finance subsidiary CIT. Tyco must “balance the use of cash or stock against the potential impact on CIT’s credit rating,” he says. And in early October, Tyco did make an offer to pay $796 million in company stock for the 11 percent minority stake it didn’t already own in TyCom Ltd., an undersea telecommunications cable company. Despite the overcapacity in that industry, analysts say, Tyco wants to eliminate the publicly held portion of TyCom to reduce the concerns of Tyco investors.
Young, who was one of the attendees at Tyco’s meeting that fateful morning, expects the company’s acquisitions to keep coming. “I would imagine that nothing has changed,” he says, and that it “will continue to be very opportunistic.”
A Blast of Realism
Indeed, while experts predict a continued slowdown in merger activity, companies such as Tyco and General Electric Co., which have strong balance sheets and aggressive internal acquisition teams, may see a pickup. Certainly, Swartz doesn’t discount the possibility that the number of deals may increase, even if they are smaller on average. “We are well positioned right now,” the CFO says, noting the upgrade from Standard & Poor’s Corp. (from A- to A) that reduced Tyco’s cost of funds last spring.
In fact, Swartz says he’s noticed more acquisition candidates raising their hands to catch Tyco’s notice. And he insists that his basic wish list has not changed. First on that list, he says, is the ability to cut costs at the target operation. “We never predicate based on top-line growth,” he says, “and we are risk-averse. Our approach to acquisitions historically has been that every acquisition has risk in it. So everything we do is designed to decrease that risk—from due diligence, to conservativeness in estimating revenues and cost reductions, to making sure we pay a reasonable price.”
Before long, the concentration on price could even mean a return to candidates in the electronics field, where the prices companies were asking during the first eight months of 2001 seemed quite high. “September 11 has hit home with many of these [corporate] sellers,” says Swartz. “They’re becoming more realistic.”
The hits keep coming in Tyco’s acquisition binge.*
|Company Bought (Month Completed)||Price||Terms||Division|
|C.R. Bard (Expected 12/01)||$3.2 bill||Stock||Health care|
|Sensormatic (Expected 11/01)||$2.3 bill.||Stock||Fire & security|
|CIT (6/01)||$9.2 bill.||Stock & Cash||Financial|
|Simplex Time Recorder (1/01)||$1.1 bill.||Cash||Fire & security|
|Lucent Power Systems (12/00)||$2.5 bill.||Cash||Electronics|
|Mallinckrodt (10/00)||$4.2 bill.||Stock||Health care|
|Thomas & Betts Electronic OEM (7/00)||$750 mill.||Cash||Electronics|
|Siemens Electro Products (11/99)||$1.1 bill.||Cash||Electronics|
*includes only deals of $750 million or more.
Source: Tyco International