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The politics of market cap destruction.

Tyco's experience shows how the mere accusation of accounting impropriety can produce the punishing effects of guilt.

DURING THE impeachment process, President Clinton bemoaned the "politics of personal destruction." The stock market possesses a powerful counterpart. For even the suggestion of accounting irregularities can have devastating consequences to a company.

Consider the $25 billion obliteration in Tyco International Ltd. (TYC) market value from early October to mid-January.

Tyco CEO Dennis Kozlow-ski has been remarkably successful in growing Tyco from about $3 billion in sales in 1992 to over $22 billion today, largely through numerous acquisitions (using its high p/e stock) followed by cost improvements.

Up until October, Tyco benefited from laudatory press. But then: in early October, when TYC was about $53, Dallas investment firm David W. Tice & Associates Inc. wrote a report saying that Tyco's success was due to "adept use of 'cookie jar' reserves" and that "a look 'behind the numbers' gives cause to question Wall Street's enthusiasm" for the company. Tice suggested, among other things, that Tyco's reported operating margins of over 15% for the last few years should be adjusted downwards by more than a third.

The share price promptly got chopped. On October 28, Bear Stearns accounting analyst Pat McConnell and her colleagues wrote a 32-page report challenging Tice's analysis. Conclusion: "We have absolutely no reason to believe that there have been any accounting irregularities at Tyco."

On October 29, New York Times columnist Floyd Norris questioned Tyco's disclosure of writeoffs, pre-closing, by companies it was in process of acquiring. Norris volunteered that he had been "tipped off about the issue" by TYC short seller Jim Chanos. TYC got chopped again.

And then, on December 9, Tyco announced that the SEC had commenced an "informal inquiry" into its acquisition charges and reserves. TYC got totally destroyed after that announcement: it traded (intraday) as low as $22 1/2. At that price, the decrease in TYC's market cap from just two months earlier was about $50 billion. (As of January 18, TYC had recovered to the high $30s after announcing good 1Q earnings and a stock buyback.)

Is Tyco's accounting clean or is it not? And, if it is clean, what dynamic is at work (in the financial markets and in the world at large) such that billions of dollars of value can be destroyed in this way?

It's highly probable that TYC's accounting is clean. To reach that conclusion, I could have spent hours playing with the numbers and revisiting the relevant accounting pronouncements. But there was no need to undertake all that toil once Pat McConnell, repeatedly ranked by Institutional Investor as Wall Street's top accounting analyst, came out with her detailed analysis. If McConnell concludes that a company's accounting is clean, it's an excellent proposition that that is so.

Nor is Bear Stearns alone. More than six other Wall Street firms also put out strongly positive reports on Tyco and its accounting.

Why, then, did institutional holders dump TYC as though it carried anthrax? Several possible mindsets: (a) "Where there's smoke, there's fire"; (b) "I'm guessing the accounting is probably okay but others will sell it off so I should too"; (c) "Could this be son of Cendant/Sunbeam?"; (d) "I need to protect my Christmas bonus by not letting my boss see TYC on the position sheet"; and (e) "TYC momentum is finito. Blow it out and move into some other momentum stock."

In a market where businesses with zero earnings enjoy multibillion-dollar market caps and podiatrists day-trade stocks in between seeing patients, it is predictable that some institutional money managers will lack the wit to distinguish (a) among a Cendant, a Sunbeam, and a Tyco, and (b) between complex (but proper) accounting and activities touching on fraud.

Yet these kinds of distinctions must be made. Otherwise, mere accusation bootstraps itself into guilt (or the tangible effects of guilt). And perception -- including guessing at what others' perceptions will be -- replaces reality.

In a piece that is simultaneously a commentary on -- and a sharp example of -- that bootstrap perspective, the Financial Times on December 10 wrote that Tyco's stock has been "badly, perhaps fatally, punctured[ldots] [it] does not matter that[ldots] no impropriety has come to light. The only thing that matters is that investors no longer believe in Tyco's growth story. This belief is likely to prove self-fulfilling[ldots] Tyco has largely been stripped of the power to make acquisitions" (emphasis mine).

"Momentum" mentality aside, what has happened to Tyco does not, at core, invoke images of virulent tulipmania and Holland. The better geographical referent is Salem Village.

Hoffer Kaback is president of Gloucester Capital Corp., and has served on several boards.
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Publication:Directors & Boards
Geographic Code:1USA
Date:Jan 1, 2000
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