Searching for symptoms of Enronitis has become all the rage. “The one constant in the market is the herd mentality,” says Mike Kinneally, chief investment officer at Bank of America Asset Management. “Misery loves company.”
Tyco appeared to be a classic case. Within four weeks its share price halved, bond prices would drop by $6 and recover again within one day, and prices on the default swap went from as tight as Libor plus 115 basis points to L+1150, with the widest trade struck at L+875.
Enronitis simply provided an excuse. Such wild gyrations in prices were actually caused by decisions made by its executives and their advisors, Goldman Sachs, decisions which betrayed a fundamental misunderstanding of the changing focus of the markets to companies with huge debt loads and potential accounting irregularities.
The diversified manufacturer with interests ranging from fire alarms to financial services and undersea telecommunications systems to healthcare, had looked for shareholder value by expanding rapidly by acquisitions – making it just the sort of company that will face trouble in deteriorating markets. Tyco’s debt load made matters even worse. The company had a total of $23 billion of debt at the start of the year, including $4.5 billion in commercial paper, and investors were concerned that the company might face a liquidity crisis.
On January 22 Dennis Kozlowski, Tyco’s chairman and CEO, announced what he thought was the plan to allay investor fears and arrest the fall. But it appears to have been based on his continued belief that investors were concerned only about growth at any price. The plan was a 180-degree turn in strategy: the company could create up to 50% more value for shareholders, he said, by breaking up into four parts – this after years of insisting that acquisitions provided better earnings and returns. It’s hard to imagine that investors would ever swallow that kind of about-turn .
The stock price increased slightly, by just $1.10 to $47.55, and then started to head south as fears over accounting gave way to fears over liquidity. A day later it fell 5% as investors voiced concerns that spinning off the various parts through IPOs, rather than by distributing new shares to those who already held Tyco stock, was no way to increase shareholder value. It was, by contrast, dilutive, and aimed more at reducing the firm’s huge $23 billion debt load than at serving their needs.
Matters worsened on February 4th when Tyco announced that it would tap its back-up lines of credit to the tune of $5.9 billion to get working capital, and to provide it with the means to repay all its commercial paper. It smelt like fear to investors. By the end of February the default swap had traded in, but only to L+450, while the stock was down 50% since the start of the year .
Bang goes Tyco’s reputation for creating shareholder value.
