Friday, June 29, 2007

Bondholders Scream Foul as Tyco Splits

High & Low Finance
The New York Times
June 29, 2007

Bondholders can be the forgotten investors in corporate America. Nobody ever promises to “maximize bondholder value.” Nor should they. Bond investors do not own the company, as shareholders do. They merely have a contractual relationship with it.

But what happens if the company decides to run roughshod over the contract? Will the courts protect the bondholders?

That is the issue being fought in federal court in Manhattan over the actions of a company known to every aficionado of corporate scandals, Tyco International.

At issue is what Tyco’s contract with its bondholders provides. The bondholders thought that bond indentures provided protection against having most of the company’s assets moved to other companies, where they will no longer be available to secure the debt.

Tyco’s bond indentures used language that is identical to the wording in many other investment-grade bonds. Glenn Reynolds, a bond analyst at CreditSights, argues that a Tyco victory would make it much easier for leveraged buyout firms to break up companies, perhaps helping shareholders but leaving bondholders stuck with notes that are worth far less than they were. Companies could be cut in two or three, with the bonds securing the less desirable part of the company.

“The entire high-grade market is standing by, wondering how much new structural risk will be injected into their markets by the de facto gutting” of indentures, he wrote.

Tyco grew under the leadership of L. Dennis Kozlowski, whose current residence, the Mid-State Correctional Facility, is about a four-hour drive from his old Fifth Avenue apartment that included such necessities, paid for by Tyco, as a $6,000 shower curtain and a $2,960 set of coat hangers.

The new management, led by Edward Breen, a former president of Motorola, decided last year that the company should be split in three, spinning off one company with Tyco’s electronic businesses and another with its health care assets. The separation is effective today.

Tyco will be left with its other businesses, including the home security business, and it is that company that will secure the bonds in question. The market thinks that company is worth about 40 percent of the total.

The bondholders fear the new Tyco will be a prime candidate for a leveraged buyout, which could saddle the company with more debt and reduce the value of existing bonds.

Is the split allowed by the bond indentures? They provide that if “all or substantially all” of Tyco’s assets are transferred to another company, then that company must assume the debt as well. To the bondholders, the fact that most of the businesses that backed the bonds will be gone is clear evidence that the indenture is being violated.

Tyco argues that it has every right to do that. After all, the assets being transferred out do not represent “nearly all” of the company’s assets. But just to be safe, it tried to buy back the bonds — for more than they were trading for but for less than it would have to pay if it redeemed them.

That plan failed when many bondholders refused to sell. But now the company plans to go ahead with the split, and fight it out in court. If it loses, it could be forced to redeem $3.7 billion in bonds under terms specified when the bonds were issued. The company will not say how much that would cost it over what it offered to pay for the bonds, but the bondholders estimated the figure at $95 million.

In their suit, the leading bondholders — the Knights of Columbus and several insurance companies — get in some reminders of the bad old days at Tyco, calling it one of the “more infamous exemplars of corporate dishonesty, lawlessness and unaccountability” in American history.

The most prominent court ruling on the rights of bondholders, on which the pending suit relies, is a 1982 decision by the United States Court of Appeals for the Second Circuit on the liquidation of Sharon Steel by Victor Posner, one of the most colorful, and least scrupulous, corporate raiders of the era. Sharon bondholders managed to stop Mr. Posner from stripping the assets that backed their bonds.

That was not Mr. Posner’s only visit to federal court. One judge denounced him for being “contemptuous of the interests of public shareholders,” a phrase that could later have been applied to Mr. Kozlowski.

Mr. Breen has strived mightily to repair Tyco’s reputation. A Tyco mission statement, quoted by the bondholders, promises “processes and practices that promote integrity, compliance and accountability.”

The bondholders claim the company’s treatment of them “belies this worthy aspiration,” but that is not the issue. The issue is simply whether Tyco is violating the contract it signed with the bondholders.

But this case could end up setting a precedent that will be long remembered by investors. Mr. Breen’s Tyco could end up being linked to Mr. Posner’s Sharon Steel whenever bondholders go to court to complain they are being abused.

That is, presumably, not the kind of legacy Mr. Breen most desires.


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