Tyco’s Kozlowski resigns as CEO

Move comes amid a report he
is subject of tax-evasion probe

June 3 —  The news that the chairman and Chief Executive of Tyco International, Ltd., Dennis Kozlowski, resigned over the weekend in the midst of a personal tax evasion scandal, inspires some thoughts about the man’s own moral compass in life, as well as an observation or two about where he led the company from which he has now abruptly resigned.

IF REPORTS IN TODAY’S New York Times are correct — and Kozlowski’s resignation suggests there is little apparent reason to doubt them — the chairman and CEO of Tyco International is now resigning because he has become the target of a criminal tax fraud investigation by Manhattan district attorney Robert Morgenthau.
       The probe is said to focus on Kozlowski’s creation of an array of personal family trusts, into which he has moved hundreds of millions of dollars of family assets. The Times cites lawyers in the probe as asserting that Kozlowski may have used those trusts to purchase various goods and services without paying New York State taxes on them.
       The interesting thing about all this is, of course, that Tyco International itself is a kind of tax-dodger’s romper room. The company conducts nearly all its business out of various U.S. offices — most notably in New Hampshire and New York. But in 1997 the company bought a burglar alarm business that was based in Bermuda, and arranged the transaction so that Tyco itself became based in Bermuda.

This rearrangement of things instantly sheltered all Tyco’s non-U.S. income from U.S. taxation — a common tax sheltering device for growing numbers of U.S. companies. Indeed, were Tyco an individual and not a corporation, it would have been subject to U.S. taxation on all its worldwide income whether it repatriated to the U.S. or not.
       So, given what he’s set up with his company, maybe its not all that surprising that Kozlowski would have become entangled in a personal version of the same sort of thing. In a certain sense, both Kozlowski and Tyco are reflections of each other.
       On the other hand, don’t you think he should have known better? Kozlowski, 55, grew up in Newark, N.J., the son of a police detective, so you’d at least think he learned the difference between right and wrong.
       And you’d also think he could have applied those moral judgments to his business, since he has a degree in accounting, and has run Tyco for the last ten years, orchestrating dozens upon dozens of deals.

Maybe Tyco Intl. has been as clean as new-fallen snow all along. But Kozlowski’s own personal affairs now have an obvious cloud over them, and since he himself has been running Tyco for the last decade — a period during which Tyco as well began to structure its business around tax-avoidance strategies — it’s frankly hard to be confident about much of anything involving the company, especially when you consider the mind-boggling complexity of its financial filings.

During the 1990s, no one cared much of anything about the company’s financials (or indeed the financials of almost any company), and the stock just went up and up, driven aloft in the late bull market’s frenzy of momentum trading.
       By the summer of 1999, Tyco had ballooned into a more than $40 billion financial erector set of businesses, with interests in everything from electronics, to fire protection systems, to healthcare products and even undersea fiber optical cable company.
       At that point a well-known short-seller named David Tice began openly criticizing Tyco’s accounting methodology, focusing particularly on Kozlowski’s use of “pooling of interests” merger accounting, in which an acquiring company could greatly overpay in a takeover deal without generating any so-called “goodwill” writeoffs. 

Kozlowski instantly turned up on TV shows, attacking Tice as a short-seller who was simply trying to drive down Tyco’s shares. The press handled Kozlowski with kid-gloves throughout the affair, and when a Securities & Exchange Commission probe of the company ended the following year without bringing action, Kozlowski seemed vindicated.
       The stock thereafter recovered all its Tice-related losses and climbed by the beginning of last year to more than $61 per share. Thanks to an intervening stock split, this gave the company an overall market value on Wall Street of nearly $107 billion, making it one of the 100 largest companies in America.
       But through it all, the company remained little more than a financially engineered house of cards, with much of management’s time and attention devoted to activities that boosted earnings by lowering taxes. Typical example: to have a captive offshore finance subsidiary borrow money at, say, 4 percent, then re-lend it to a U.S. operation at, say, 8 percent. The 8 percent interest payment lowers the U.S. company’s taxes, whereas the 4 percent “profit” that flows to the offshore captive lender never gets taxed by the U.S.

In the midst of all of this - which apparently passed muster by the SEC and, we may presume, is thus wholly on the up-and-up - we have now discovered that Kozlowski was busy arranging his own personal affairs as if, so far as the State of New York is concerned, he himself was a one-man Tyco International.
       Along the way, Tyco’s share price has collapsed, from its January 2001 high of more than $61, to a closing price last Friday of less than $22, partly as a result of a series of bizarre missteps by Kozlowski, who earlier this year announced a plan to break the company up, then reversed himself and said he’d decided not break up the company after all.
       Watching those events unfold as they did, it was hard to escape the feeling that Tyco was being run by a man with other things on his mind. And with the benefit of hindsight we can now see what they were: His troubles with the New York D.A. were apparently beginning to close in on him.

Tyco’s latest quarterly financial statement, filed only two weeks ago, shows $33.2 billion of balance sheet equity, but 100 percent plus of it is accounted by goodwill from acquisitions. The company is operating in the red on an Income Statement basis, and its cash flow looks good only because it is $400 million light on capital investment and doesn’t have to shell out cold cash for its staggering balance sheet charges, which top $3.8 billion in the six months ended March 31.
       At $16.75 per share, the market is saying this stock is worth not much more than $33 billion, or barely one times revenues. But now that its chairman and CEO has left under a cloud of possible criminal wrongdoing, it seems a foregone conclusion that the stock is going to undergo a whole new round of skeptical scrutiny by the market. On Monday Tyco’s stock price dropped close to 23 percent, and ended the day at less than $17 per share — down from $60 at the start of the year. And Kozlowski tendered his resignation from the board of directors of the defense contractor Raytheon.
       Worst of all, because so much of Tyco’s business as a public company seems to have been conjured out of the same sorts of tax-related preoccupations that have now gotten Kozlowski himself in hot water, it’s hard to see why an investor would want to hold this stock at almost any price. This is a company in which the expectation of more bad news to come now seems to have become permanently a part of its public image - and who’d want to invest in a situation like that?