Complacency is not an option.

• Author: KABACK, HOFFER
• Position: Tyco International's L. Dennis Kozlowski - Interview

Smartly crafting deal upon deal, he has built a business that dominates its industry niches and delivers billions in shareholder value. How does Tyco's L. Dennis Kozlowski do it?

BACK IN THE 1980s, Tyco International was, to put it bluntly, a dinky company. Its main claim to fame was that every so often it launched a hostile tender offer. Sometimes it received greenmail; sometimes it wound up buying the target.

Tyco has not been dinky for quite some time. When L. Dennis Kozlowski took over as CEO in 1992, Tyco's revenues were about $3 billion and its market cap about $1.5 billion. For the fiscal year ended September 30, 1999, revenues were over $22 billion and, as of mid-April 2000, market cap was about $75 billion.

Much of Tyco's remarkable growth has come through acquisitions -- well over 100 of them. During my conversation in late February with Kozlowski in Tyco's New York offices, I asked him what size deal was required to be brought to his attention when one of Tyco's division presidents was contemplating an acquisition. I expected an answer on the order of "$10 million or so." Instead, Kozlowski emphasized that even a $1 million services deal was a matter that he personally, as CEO, had to "sign off on."

Kozlowski believes in decentralizing management of Tyco's operating divisions; clearly, he does not believe in decentralizing control over what he perceives as enterprise risk. Doing a deal involves the assumption of liabilities; that, in turn, involves the assumption of risk to Tyco.

This theme manifests itself in other ways, too. For example, Kozlowski won't do a hostile takeover; a hostile deal inherently has more uncertainties (and therefore more risk) than a friendly one. Second, Tyco emphasizes recurring revenue streams and abhors high-tech, short life-cycle products. Third, Kozlowski is girding in advance for the next recession.

Tyco's emphasis on risk control does not, however, mean that it looks to buy assets only on the cheap. A mere glance at Tyco's year-end balance sheet reveals a significant amount of goodwill and other intangibles; the company's tangible book value is measurable with a micrometer.

Though Ben Grahamites might shudder at Tyco's market cap vis a vis its balance sheet, the company's record of multiyear growth in revenues, earnings, and free cash flow has been stellar. Tyco is an industrial company (and a quasi-conglomerate to boot); yet, because of its superb growth record, it has, for the last several years, been favored by Wall Street and by the financial press. Even Barron's has given the company warm write-ups (as in "Meet the Next Jack Welch," its cover-page title in an April 1999 profile of Kozlowski). Momentum players bought Tyco stock. It performed well for them -- until October 1999.

MY COLUMN in the last issue of DIRECTORS & BOARDS ("The Politics of Market Cap Destruction," Winter 2000) discussed how Tyco's stock got killed (down to $22 1/2 from $53) during the October-December 1999 period following the issuance of a research report by Dallas investment firm David W. Tice & Associates. That report referred to "adept use of 'cookie jar' reserves" and suggested that Tyco's reported operating margins of over 15% should be adjusted downwards by more than a third. By year-end 1999, Tyco's stock price had partially recovered. When I talked with Kozlowski, it was in the mid-30s; as this issue went to press, Tyco shares traded in the mid-40s.

Though the SEC initiated in December an informal inquiry into Tyco's accounting, it is difficult to believe that the Commission will act against Tyco. As Bear Stearns commented in an October 1999 comprehensive report on Tyco's accounting, two key points support that view: 1) Tyco's accounting not only conforms to, but it is required by, GAAP, and 2) the SEC has already fully reviewed Tyco's accounting four previous times without requiring any substantive changes.

Losing $50 billion of market value in two months is, however, enough to unsettle any CEO. Kozlowski and Tyco fought back through conference calls with analysts and improved disclosure in the 10-K. Stockholders nevertheless endured some painful "marks to market." One portfolio manager, quoted in Barron's in November, admitted: "I think I've aged about three years over the last two weeks."

Press coverage of a company, and stock market perception of that company, are interrelated. What tone will the financial press adopt towards Tyco going forward? Mergers & Acquisitions magazine wrote in its February issue that "controversy over questionable accounting practices has left shareholders wondering whether corporate hubris undermined an otherwise sound acquisition strategy." The Wall Street Journal in mid-February published a front-page article implying that Tyco was a monopolist in the garment-hanger business. In addition, Tyco may be at semi-war with New York Times columnist Floyd Norris: his October 29, 1999, column on the company's accounting prompted Tyco to release a sharply worded "Dear Floyd" letter accusing him of misleading readers and the marketplace and to request that the Times "issue the appropriate correction." (It didn't.)

Tyco may confront an ongoing public relations and communications problem even as it strives to meet its business goals of organic growth coupled with accretive acquisitions. Kozlowski believes that Tyco's operating and growth story speaks for itself. At the same time, he acknowledges that that story needs to be emphasized more by Tyco management.

DENNIS KOZLOWSKI attended Seton Hall, a New Jersey coilege. He worked at SCM Corp. and at Cabot Corp. before joining Tyco in 1976. A helicopter and airplane pilot, he sometimes flies the Tyco helicopter himself.

Neither Kozlowski's name nor his picture would likely ring a bell with John Q. Daytrader (who would, in contrast, instantly recognize the names and photos of Jeff Bezos and Steve Case). Indeed, when performing due diligence, Kozlowski is often able personally to inspect the putative acquiree's plants incognito.

On the corporate governance front: in its most recent proxy statement, Tyco opposed three separate shareholder proposals. One urged the adoption of a specific definition of "independent director"; Tyco responded that it was better to leave to the board the evaluation of a director's independence rather than require it to adhere to rigid criteria. Tyco also noted that the proposed definition of "independent director" would include even a close pal of the CEO's. (On this same subject, see my column "Pals on the Board" DIRECTORS & BOARDS, Winter 1997.) The second proposal called for Tyco (incorporated in Bermuda for tax reasons) to reincorporate in Delaware. The third requested that the Tyco board refrain from adopting a poison pill or similar shareholder rights plan; Tyco indicated in response that it was terminating its existing rights plan (inherited through acquisition) but that it would be unwise to tie the hands of the board should circumstances in future warrant the adoption of such a plan.

KOZLOW5KI'S PRIDE in Tyco's achievements is transparent. The Q&A that follows amply demonstrates this. Our conversation also reveals that his goals for the company are without bound. He conveyed the same message in the following statements from his most recent letter to shareholders:

* "Where growth, margin improvement and cost reduction are concerned, Tyco has no finish line."

* "Every year, we challenge managers to make more and better units for less money. We don't have a fancy name for our continuous improvement program. It's just a way of life."

* Although we have done well thus far, complacency just never seems to be an option."

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