Short-seller Meyer argues these purchase accounting liabilities become cookie jar accounts -- accounts which Tyco management can use at its discretion to absorb a variety of operating costs. "GAAP rules allow mainly for the capitalization of professional fees," Meyers argues. "But Tyco management lumps in a host of other expenses that don't make it into the income statement or cash flow numbers."
Of course, Tyco is not alone in its handling of these types of expenses. Edward Ketz, an associate professor of accounting at Penn State's Smeal School of Business, notes that many companies use purchase accounting liabilities to camouflage costs. When a company's operating expenses are hidden in liability accounts, Ketz says it becomes easier for that company to grow earnings consistently. Currently, Tyco is carrying more than $600 million worth of expenses in purchase accounting liabilities on its balance sheet.
But Bob Willens, a tax and accounting specialist at Lehman Brothers, insists that Tyco is playing by the rules. "The accounting they employ is of very longstanding validity," he says. "The EITF [Emerging Issues Task Force] directs that where in connection with an acquisition a restructuring charge is taken, that charge is part of the purchase price for the target company and is therefore part of the goodwill that arose from the acquisition."
Dressing Down the Tarting Up
Even Tyco critic Meyer concedes that Tyco's practices are consistent with GAAP. Nevertheless, he argues that Tyco management often resorts to financial machinations to suit its interests. One example: Meyer claims the company repeatedly lumps operating expenses in with acquisition-related charges, thus hiding costs.
The company also tends to include a lot of one-time or non-recurring charges on financial statements. Disclosures for these special charges in 10-K filings tend to be voluminous and complex. During the 12 quarters ended September 31, Meyer claims Tyco took $2.4 billion in special charges, at an average of $200 million per quarter. Critics say it's much easier for Tyco management to show expanding operating margins by reporting a raft of non-recurring charges. Moreover, a number of Tyco critics claim the company's management makes its deals look better than they actually are. How? By artificially deflating the operating results of an acquisition target in the final weeks before a deal is closed, they charge.
Take the case of Raychem Corp, a maker of power arresters, leak detectors and other electronic devices. Tyco bought the manufacturer for about $3 billion in cash and stock in 1999. In a recent article in the Wall Street Journal, the treasurer at Raychem claimed Tyco executives urged him to speed up bill payments in the months before Raychem was bought.
According to the story, Lars Larsen, then Raychem's treasurer, sent an E-mail to finance department employees at the time of the acquisition. In that message, Larsen reportedly said, "Tyco would like to maximize cash outflow from Raychem before the acquisition closes." Larsem added that Raychem "agreed to do this, even though we will be spending money for no tangible benefit either to Raychem or Tyco."
Tyco's McGee denied Larsen's claims, telling the Journal that the payments discussed in the E-mails were investigated by the SEC in 1999 and 2000 as part of a more comprehensive examination of Tyco's accounting. The commission ended its investigation in mid-2000, however, taking no action against Tyco.
Nevertheless, the Raychem incident is not the first time Tyco has been accused of tarting up deals by speeding up payables and slowing down receivables, "This becomes even easier to do," notes Penn State's Ketz, "when (a company's) acquisitions are not disclosed publicly."
700 Deals Tend to Add Up
Apparently, Tyco does a lot of that. In February, Tyco management acknowledged that it spent about $8 billion over the past three fiscal years on 700 acquisitions -- acquisitions that were never made public. In fiscal 2001, Tyco paid $4.19 billion in cash for unannounced deals, which works out to about 37 percent of the $11.3 billion in cash the company spent on all deals that year.
Tyco does state in its financial filings the "net" amount of cash it pays for acquisitions. Mark Swartz, Tyco's CFO, reportedly said the company doesn't disclose details on its numerous smaller deals because they aren't "material" to a company as big as Tyco. But Swartz has reportedly said that Tyco may include more details about smaller acquisitions in future financial filings.
Others maintain that Tyco management takes advantage of accounting rules by writing down to zero the net asset value of the companies it acquires, thus allowing Tyco to capitalize most of the price it paid as goodwill on the balance sheet. And since the earnings hit from goodwill amortization has now disappeared courtesy of FAS 142, this strategy would seem to be all the more appealing. "The key question here isn't: 'Is the company's accounting practices illegal,'" notes Whall, "but rather 'Do they mislead investors,'" The answer in Tyco's case is that they do."
Some of Tyco's owners seem to agree. On February 8, a group of shareholders slapped Tyco with a suit claiming that company management routinely obscures company finances to artificially inflate its stock share price. The suit also alleges that Tyco uses accounting tricks to hide its true financial condition.
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