Tyco International (click ticker for report: ) issued updated guidance for its fiscal year 2012 fourth quarter Monday morning, while announcing details of its forthcoming spinoff. The firm, once a huge conglomeration of various industrial businesses, has separated its different segments during the past several years, and its current iteration will become three different entities. Management believes the new firms will be able to fully maximize growth opportunities that may not be available to the combined entity.
We generally like spinoffs; they tend to create value for patient shareholders and sometimes create buying opportunities in the smaller company (as valuations can often become mispriced). Tyco will remain in the fire protection and security business, while ADT will house its residential security operations, and a third flow control business will merge with Pentair (click ticker for report: ). Though cyclical, we like Tyco’s core fire protection and security business, which is among the largest in the world in terms of market share.
For the current quarter, Tyco expects $2.75 billion in revenue in its fire & security segment. However, the company will take a $40-$60 million charge related to uncollectable receivables in China, thus lowering its operating margin in the segment to 11.2%-12% from its previous expectation of 13.5%. Operating margin guidance was also reduced in the ADT segment, to 23.5%-23.75 (down 125 to 150 basis points year-over-year compared to its previous guidance for 150 to 200 basis points of margin expansion). Still, we don’t view either event as material to the firm’s long-term valuation, though the charge for uncollectable receivable speaks to some of the difficulties with doing business in China.
Though the spinoff may create value for shareholders (as it forces investors to value each business on an individual basis), we think the company is fairly valued at current levels. It scores just a 3 on the Valuentum Buying Index (our-stock selection methodology), so we wouldn’t be adding shares to the portfolio of our Best Ideas Newsletter at this time.