tyco international ltd. (tyc $37.30) - fisher college of ... summer - tyco.pdf · financial...

Analyst:

JORDAN WINTERS

330-881-3173

[email protected]

Tyco International Ltd.

(TYC – $37.30)

TYC – Initiate Coverage - BUY

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.

August 18, 2010

Price: $37.30

Rating: Buy

Price Target: $45

Projected Return: 24%

Beta: 1.22

52-Week Range: $30.01-$40.61

Industry Group: Industrial Conglomerates

2010E 2011E 2012E

EPS

$2.50 $3.06 $3.51

P/E

14.6x 11.9x 10.4x

Consensus

$2.50 $3.07 $3.54

Revenue (Bil)

$17.8 $18.8 $19.8

2Q10A 3Q10A 4Q10E 1Q11E

EPS $0.59 $0.72 $0.65 $0.70

Consensus $0.55 $0.64 $0.65 $0.70

Revenue (Bil) $4.17 $4.27 $4.42 $4.31

2Q09A 3Q09A 4Q09A 1Q10A

EPS $0.55 $0.58 $0.54 $0.65

Consensus $0.42 $0.45 $0.61 $0.60

Revenue $4.15 $4.24 $4.42 $4.25

Debt

$4.17 B

Cash

$1.82 B

S/H Equity

$14.1 B

Enterprise Value

$19.1 B

Net Debt

$2.34 B

Net Debt-to-

Capitalization 12.9%

Shares O/S (Mil)

497.69

Market Cap. (Bil)

$18.16

Avg. Daily Vol. (6

mos. in 000s) 6,195

Dividend $0.84

Yield

2.30%

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TYC - August 18, 2010

Initiate Coverage - Buy

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



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.



Other members of senior management include:

Name Age Position

Christopher J. Coughlin 57 Executive Vice President and Chief Financial Officer

Naren K. Gursahaney 48 President of ADT Worldwide

Patrick Decker 45 President of Flow Control

George R. Oliver 49 President Tyco Safety Products

Edward C. Arditte 54 Senior Vice President, Strategy and Investor Relations

Carol Anthony Davidson 54 Senior Vice President, Controller and Chief Accounting Officer

John E. Evard, Jr. 63 Senior Vice President and Chief Tax Officer

Arun Nayar 59 Senior Vice President, Corporate Development and General Tax

Counsel

Judith A. Reinsdorf 46 Executive Vice President and General Counsel

Laurie A. Siegel 53 Senior Vice President, Human Resources and Internal

Communications

Shelley Stewart, Jr. 56 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



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 cross-



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 multi-

family 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



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.



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 14th,

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)



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.



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

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.

High Low Median Current

P/FE 1.2 x 0.8 x 1.0 x 1.1 x

P/S 1.1 x 0.8 x 1.0 x 1.0 x

P/B 1.3 x 1.0 x 1.1 x 1.2 x

P/EBITDA 1.5 x 0.8 x 1.2 x 1.2 x

P/CF 1.2 x 0.8 x 1.1 x 1.1 x



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

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.

CSL GE MDR MMM TXT TYC

EV/Sales 0.8 x 4.0 x 0.4 x 2.4 x 1.2 x 1.2 x

EV/EBITDA 6.9 x 27.9 x 3.5 x 8.6 x 16.2 x 6.9 x

P/FE 12.5 x 13.1 x 9.5 x 13.9 x 21.5 x 12.5 x

P/CF 7.9 x 7.5 x 5.5 x 11.6 x 8.7 x 7.5 x



Exhibit 10. TYC DuPont Analysis

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

2009 2008 2007 2006 2005

(10.4%) 7.7% (9.4%) 21.0% 18.4%

63.4% 65.6% 38.6% 27.2% 26.4%

-6.62% 5.04% -3.64% 5.72% 4.87%

1.9 x 2.0 x 1.9 x 1.9 x 2.0 x

(12.65% ) 9.98% (6.83% ) 10.58% 9.80%Return on Equity (ROI * EM)

Equity Multiplier (Average Total Assets ÷ Average Total Equity)

Return on Investment (PM * TAT)

Profit Margin (Net Income ÷ Revenue)

Total Asset Turnover (Revenues ÷ Average Total Assets)

High Low Median CurrentPeer Avg.

Multiple

Target Value

per Share

Target

Price

P/FE 18.4 x 8.4 x 13.5 x 12.5 x 14.1 x 3.07$ 43.29$

P/S 2.6 x 0.2 x 0.9 x 1.1 x 1.1 x 33.16$ 35.15$

P/B 5.8 x 0.3 x 1.3 x 1.3 x 2.1 x 28.06$ 59.49$

P/EBITDA 29.8 x 0.9 x 4.1 x 6.3 x 6.8 x 5.83$ 39.74$

P/CF 13.0 x 1.2 x 5.3 x 7.5 x 8.2 x 4.86$ 39.88$



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 Low Median CurrentTarget

Multiple

Target Value

per Share

Target

Price

P/FE 18.4 x 8.4 x 13.5 x 12.5 x 15.0 x 3.07$ 46.05$

P/S 2.6 x 0.2 x 0.9 x 1.1 x 1.3 x 33.16$ 43.11$

P/B 5.8 x 0.3 x 1.3 x 1.3 x 1.5 x 28.06$ 42.09$

P/EBITDA 29.8 x 0.9 x 4.1 x 6.3 x 8.0 x 5.83$ 46.62$

P/CF 13.0 x 1.2 x 5.3 x 7.5 x 10.0 x 4.86$ 48.64$



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

#### 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$

Gro

wth

Rate

Discount Rate



Exhibit 14. DCF Model Percent Upside Sensitivity Analysis

##### 9.0% 9.5% 10.0% 10.5% 11.0% 11.5%

2.0% 19.9% 12.0% 5.2% (0.8%) (6.2%) (11.0%)

2.5% 24.8% 16.2% 8.7% 2.1% (3.7%) (8.8%)

3.0% 30.6% 21.0% 12.7% 5.5% (0.8%) (6.4%)

3.5% 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%

Discount Rate

Gro

wth

Rate



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.



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.



Appendix A – Selected Financial Data

TYC

GAAP FYE FYE FYE FYE FYE FYE FYE FYE

(mil $) 2012E 2011E 2010E 2009 2008 2007 2006 2005

Net Revenue

ADT Worldwide 9,409 8,633 7,775 7,015 7,731 7,288 7,205 7,104

Flow Control 3,902 3,842 3,828 3,850 4,418 3,766 3,135 2,806

Fire Protection Service 3,409 3,359 3,359 3,428 3,839 3,726 3,150 3,182

Electrical and Metal Products 1,502 1,410 1,343 1,392 2,272 1,974 1,949 1,798

Safety Products 1,559 1,513 1,506 1,552 1,934 1,719 1,624 1,682

Corporate and Other 0 0 0 0 5 4 3 93

Total Revenue 19,781 18,757 17,811 17,237 20,199 18,477 17,066 16,665

Consensus 19,240 18,365 17,362

Costs & Expenses

Cost of Product Sales 7,584 9,200 8,495 7,667 7,232

Cost of Services 3,559 3,923 3,722 3,555 3,503

SG&A 4,657 4,906 4,776 4,425 4,699

Class Action Settlement, net 0 (10) 2,862 0 0

Separation Costs 0 4 105 49 0

Goodwill and Intangible Asset Impairment 2,705 10 59 0 0

Restructuring, Asset Impairment, and Divestiture Charges 219 225 190 15 40

Total Costs & Expenses 17,486 16,722 16,101 18,724 18,258 20,209 15,711 15,474

ADT Worldwide 1,402 1,252 1,120 233 906 817 907 952

Flow Control 566 519 436 518 618 457 356 336

Fire Protection Service 310 296 279 68 325 283 241 202

Electrical and Metal Products 183 164 107 (940) 342 159 319 295

Safety Products 229 218 214 (789) 284 274 196 278

Corporate and Other (396) (413) (445) (577) (534) (3,722) (664) (872)

Operating (Loss) Income 2,295 2,035 1,711 (1,487) 1,941 (1,732) 1,355 1,191

Interest Income 40 38 36 44 110 104 46 39

Interest Expense (257) (263) (267) (301) (396) (313) (279) (322)

Other Expense, net (20) (19) (18) (7) (224) (255) 0 (296)

(Loss) Income from Continuing Operations before Income Taxes and

Minority Interest 2,057 1,791 1,461 (1,751) 1,431 (2,196) 1,122 612

Income Tax Expense (370) (322) (263) (78) (335) (324) (304) (29)

Minority Interest (2) (2) (2) (4) (1) (4) (1) (2)

(Loss) Income from Continuing Operations 1,685 1,467 1,197 (1,833) 1,095 (2,524) 817 581

Income from Discontinued Operations, net of Income Taxes 0 0 0 35 458 782 2,773 2,492

Net (Loss) Income 1,685 1,467 1,197 (1,798) 1,553 (1,742) 3,590 3,073

Net Earnings Per Share

Basic

(Loss) Income from Continuing Operations 3.54 3.08 2.51 (3.87) 2.26 (5.10) 1.63 1.15

Income from Discontinued Operations 0 0 0 0.07 0.95 1.58 5.54 4.96

Cumulative Effect of Accounting Change 0 0 0 0 0 0 (0.03) 0.04

Net (Loss) Income 3.54 3.08 2.51 (3.80) 3.21 (3.52) 7.14 6.15

Diluted

(Loss) Income from Continuing Operations 3.53 3.07 2.50 (3.87) 2.25 (5.10) 1.59 1.13

Income from Discontinued Operations 0 0 0 0.07 0.94 1.58 5.39 4.68

Cumulative Effect of Accounting Change 0 0 0 0 0 0 (0.03) 0.04

Net (Loss) Income 3.53 3.07 2.50 (3.80) 3.19 (3.52) 6.95 5.85

Consensus GAAP 3.54 3.07 2.50

Guidance 2.54

Weighted Average Shares Outstanding

Basic 476 476 476 473 464 495 503 503

Diluted 478 478 478 473 488 495 521 542

Cash & Cash Equivalents 2,591 2,495 2,405 2,354 1,519 1,894 2,193 N/A

Accounts Receivable 3,086 2,907 2,743 2,629 2,986 2,900 2,748 N/A

Inventory 1,840 1,688 1,550 1,443 1,877 1,783 1,619 N/A

Accounts Payable 1,582 1,444 1,318 1,244 1,608 1,637 1,557 N/A

Change in Working Capital (192) (177) (147) 427 (209) (236) N/A N/A

Depreciation and Amortization 1,286 1,219 1,158 1,133 1,154 1,148 1,180 1,204

Capital Expenditures 692 656 623 709 734 666 556 516



Appendix B – DCF Model

Tyco (TYC)

Analyst: Jordan Winters Terminal Discount Rate = 10.0%

8/18/2010 Terminal FCF Growth = 4.0%

Year 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Revenue 17,811 18,757 19,781 20,770 21,809 22,856 23,907 24,959 26,007 27,047 28,129

% Grow th 5.3% 5.5% 5.0% 5.0% 4.8% 4.6% 4.4% 4.2% 4.0% 4.0%

EBT 1,711 2,035 2,295 2,389 2,552 2,743 2,869 2,945 3,043 3,137 3,235

EBT Margin 9.6% 10.8% 11.6% 11.5% 11.7% 12.0% 12.0% 11.8% 11.7% 11.6% 11.5%

Interest 249 244 237 249 262 274 287 300 312 325 338

Interest % of Sales 1.4% 1.3% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2%

Taxes 263 322 370 385 412 444 465 476 492 506 522

Tax Rate 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0%

Net Income 1,197 1,467 1,685 1,754 1,878 2,024 2,117 2,169 2,239 2,307 2,376

% Grow th 22.6% 14.9% 4.1% 7.0% 7.8% 4.6% 2.5% 3.2% 3.0% 3.0%

Add Depreciation/Amort 1,158 1,219 1,207 1,184 1,156 1,143 1,076 1,123 1,170 1,217 1,266

% of Sales 6.5% 6.5% 6.1% 5.7% 5.3% 5.0% 4.5% 4.5% 4.5% 4.5% 4.5%

Plus/(minus) Changes WC (147) (177) (192) (470) (491) (513) (536) (558) (580) (603) (628)

% of Sales -0.8% -0.9% -1.0% -1.0% -1.0% -1.0% -1.0% -1.0% -1.0% -1.0% -1.0%

Subtract Cap Ex 623 656 771 893 981 1,028 1,076 1,123 1,170 1,217 1,266

Capex % of sales 3.5% 3.5% 3.9% 4.3% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%

Free Cash Flow 1,584 1,853 1,928 1,575 1,561 1,625 1,581 1,612 1,659 1,703 1,748

% Grow th 16.9% 4.1% -18.3% -0.9% 4.1% -2.7% 1.9% 2.9% 2.7% 2.6%

NPV of Cash Flows 10,426 47%

NPV of terminal value 11,683 53% Terminal Value 30,304

Projected Equity Value 22,110 100%

Free Cash Flow Yield 8.89% Free Cash Yield 5.77%

Current P/E 14.9 12.2 10.6 Terminal P/E 12.8

Projected P/E 18.5 15.1 13.1

Current EV/EBITDA 6.9 6.1 5.6 Terminal EV/EBITDA 7.1

Projected EV/EBITDA 8.4 7.4 6.8

Shares Outstanding 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 5.03

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