By Matt Doiron
Tyco (TYC)'s stock has risen this year, though over the last few months it has fallen to the point where it is only up 13% for 2012. The company provides a number of security products including security systems (including under the ADT brand), fire detection products, and flow control systems. Late in 2011, the company's board decided that these three business units had little to do with each other and would create more value if they were spun off. The flow control business will merge with Pentair (PNR), with Tyco shareholders owning the majority of the combined company. The residential security business will be spun out into a separate company and Tyco will maintain control of the fire detection and suppression business unit.
Partly because hedge funds like investing in spinoff situations, Tyco saw a good deal of interest from hedge funds in the first quarter of 2012. Mason Capital Management initiated a position of 3.2 million shares. Iridian Asset Management and York Capital Management both increased their positions by at least 25%, and reported owning 4.8 million and 4.0 million shares respectively. Lee Ainslie's Maverick Capital didn't add any shares, but kept its holdings constant at 6.0 million making it the top 13F holder of the stock. In addition, billionaire Ken Griffin's Citadel Investment Group increased its position in Tyco 71% to 2.2 million shares (see more of Ken Griffin's stock picks). With all these investors adding shares, and yet the stock price not budging since the end of March, current investors are likely getting in at a level where the hedge funds think the stock is a buy.
Two insiders have sold stock earlier this year not connected to stock options, at prices between $50 and $55 per share. While it is possible that these senior vice presidents were skeptical of continued rises in the stock price, insiders may sell for many other reasons. The sales related to stock options, too, were likely driven by a desire to hold cash or diversify portfolios.
Tyco's 10-Q for the quarter ending in March, which was the second quarter of its fiscal year, showed a rise in both products and services revenue compared to the same period in 2011. This contributed to a small increase in revenue for the first six months of Tyco's fiscal year. Net income was down for the first half of the year earnings per share were down 15%, ignoring the effects of discontinued operations (which contributed positively to earnings last year and very little this year). However, much of this decline was due to separation and restructuring charges as a result of the spin-off decision. The recently released earnings report for Tyco's third quarter beat expectations. Though net income was down from the third quarter of last year, this was again partly due to separation and restructuring costs, which are not likely to recur once the company has split up. The market had a weak positive reaction to the report as the stock opened up about 1%.
Tyco's peers include a number of diversified machinery businesses. General Electric (GE) trades at similar earnings multiples to Tyco, with a trailing P/E of 18 and a forward P/E of 12 (compared to 18 and 13 for Tyco). Of course, while GE produces a number of machine products it also has a number of other businesses including a large financing arm. Honeywell (HON), perhaps a closer peer due to its inclusion of sensing and security products in its portfolio of businesses, has seen good earnings growth recently and is priced for it, trading at 20 times trailing earnings but a similar forward ratio. United Technologies (UTX) has earnings ratios in the teens as well. On that basis all four companies appear about level in terms of their pricing relative to their fundamental value; however, these three peers also pay higher dividend yields than Tyco if that is of interest to investors.
There's no compelling reason to pick Tyco according to a value, growth, or income thesis. The reasons these hedge funds are getting behind it are the attractive economics and empirical performance of spinoffs. The stock does not seem to be particularly overpriced and once the breakup of the company into three - with one unit merging with Pentair - is complete, management of each piece may be better able to focus on delivering value.