Unheralded Success

Nov. 6, 2000
Tyco International's CEO Dennis Kozlowski methodically grows an industry behemoth.

Unassuming yet bold . . . a great motivator . . . A determined leader who wants results -- fast. That's how managers at Tyco International Ltd. describe their CEO, L. Dennis Kozlowski. In just over five years he has quietly transformed Tyco from an unheralded $4.5 billion company into a $29 billion multi-industry conglomerate. Yet Tyco still gets little acclaim outside the investment community, despite being one of the 50 largest public manufacturing companies in the world.

"I would have trouble coming up with someone else who has created the kind of value that Dennis Kozlowski has created" at Tyco in terms of cash flow, earnings growth, and market capitalization, says Wendy Caplan, analyst with ING Barings Furman Selz LLC, New York. "His record is nothing short of spectacular." He is a unique manager who, she says, leaves little to chance, always delivers what he promises, and is unmatched at building shareholder value.

Even shareholder activist Robert A.G. Monks, known for being a thorn in the side of business, calls Kozlowski "the best CEO in the country. Dennis has all the qualities you look for . . . whether it is superior operating performance or pro-shareholder corporate governance." Monks, a principal at Lens Inc., a Portland, Maine, investment fund, spent 10 years as a director at Tyco (1985 to 1994) before Kozlowski's acquisition binge began in late 1994.

One reason for the corporation's low profile might be Kozlowski himself. What strikes you about Tyco's chairman, CEO, and president is that he doesn't display the corporate trappings or self-importance one might expect from someone who, through more than 120 acquisitions in eight years, has put Tyco on the map of global corporations.

He has a great aversion to bureaucracy, avoids micromanaging, and insists that Tyco managers deal directly with each other -- that there be no one they need to go through to see someone else. "I was schooled under people who were formal and worked by appointment. I didn't like that approach," says Kozlowski. He also refuses to have scheduled staff meetings, doesn't write memos, and makes sure he is always accessible to his management team. There's a corporate staff of fewer than 130, even though Tyco has 182,000 employees in over 80 countries. The vast majority of the corporate employees do legal work for acquisitions and prepare securities and tax reports. Executives at its U.S. corporate offices in Exeter, N.H., as well as in New York, share secretaries. (Tyco is officially registered in Bermuda.)

The lack of acclaim outside the investment community doesn't bother Kozlowski. "Being famous is not something I ever wanted," he remarks. "It is not something I care about. I [just] wanted to be successful and create wealth for shareholders and myself."

Kozlowski, who joined the company as an assistant controller in 1976 and later ran three of its operating divisions before becoming CEO in 1992, has accomplished those goals. When fiscal 2000 ended Sept. 30, Tyco's earnings, before nonrecurring charges, had increased for the seventh consecutive year to $3.7 billion, for a compound annual growth rate of 35%. Its market capitalization stood at $80 billion, compared with $1.5 billion in 1992. Sales had increased nearly ninefold since 1994. And, since the end of fiscal 1998, its free cash flow (cash flow from operations minus capital expenditures minus cash dividends paid) had nearly tripled to more than $3 billion. (Kozlowski has profited as well. The value of his total compensation the last three years, as calculated by compensation expert Graef Crystal, was close to $300 million -- most of it in stock and almost 99% of it tied to performance targets, such as earnings increases of at least 20%.)

Kozlowski's strategy has been simple enough. He maintains an unrelenting focus on low-cost production and expands Tyco's margins by consolidating fragmented markets and adding market share through acquisitions. That has created leadership positions in its four business segments: disposable health-care and specialty products, telecommunications and electronics, fire protection and security systems, and flow-control products.

But it is his execution, say analysts, that has been flawless. "Given a choice between brilliant strategic vision and top-flight execution," says Kozlowski, "I would choose great execution," which he defines as "an unflinching focus on manufacturing efficiency -- every time."

Healthy Internal Growth

Although a cursory glance at Tyco's raw numbers indicates that Tyco's revenue growth is primarily acquisition-related, analysts argue otherwise. True, the $19 billion in revenues from the companies purchased since July 1997 (not including the acquisition of $2.7 billion Mallinckrodt Inc., a respiratory care, imaging, and pharmaceuticals company that was completed in October) is more than Tyco's revenues have increased since fiscal 1997. "Some investors worry that Tyco's growth would come to a halt if acquisitions slowed," says Harriet C. Baldwin, analyst with Deutsche Banc Alex. Brown, New York. But not only is Tyco's ability to find and execute acquisitions "without peer in the multi-industry world," she says that its internal growth -- which she estimates to be at least 18% in fiscal 2000 -- is "higher than its peers."

"Certainly Tyco is an acquisition machine," says ING Barings' Caplan. "But it produces top-line growth by taking existing products through channels of the acquired company and by moving products from acquired companies into another end market or distribution channel."

Tyco also has shown an uncanny ability to boost margins at companies it acquires and to generate remarkable free cash flow. "Tyco's phenomenal free cash flow" -- $661 million in 1998, $1.7 billion in 1999, and more than $3 billion in fiscal 2000 -- "shows that its under-lying business has been good," insists Michael Jaffe, director of basic industry research, S&P Equity Group, New York.

Jaffe and other analysts add that Tyco has an enviable track record of boosting top-line growth and doubling operating profits in less than a year at the companies it acquires. The most recent illustrations: AMP Inc. and Raychem Corp., which were acquired in 1999. "Our top-line growth and cost savings at Raychem and AMP have . . . exceeded our expectations by 200%," says Kozlowski.

Analysts suggest that the reason Tyco can so quickly improve costs at companies it acquires is that its acquisitions are well planned. Kozlowski targets companies with complementary products, companies that will open new geographic markets or distribution channels, and companies that fit into one of Tyco's four lines of business. He justifies deals on known cost savings, not potential revenue growth, and walks away from nine out of 10 deals. He won't do a hostile takeover and won't make a deal unless it immediately adds to earnings and is worth twice as much as buying back Tyco stock.

"There is no deal they need to do," says Phua Young, analyst with Merrill Lynch & Co. Inc., New York. "They are the consolidators in all of their businesses -- which even today are extremely fragmented." Tyco often is the market leader when it has just a 15% to 20% market share. "There is plenty of room for them to increase market share in each of their businesses," says Young.

Kozlowski's acquisition acumen and discipline aren't the only reasons for Tyco's success. He also has created an incentive system that keeps everyone at Tyco focused on driving out costs, and a culture where he sets the strategy and stays out of the way -- except when needed.

"I am involved in all acquisitions or when a manager is falling short of his or her financial goals," says Kozlowski. "Otherwise, I leave them alone to do their jobs. It is my job to lay out the strategic direction, to make sure the financial goals are laid out, and to make sure we have a good core of highly motivated managers who can plan well and execute."

Freedom and Rewards

Kozlowski gives his managers autonomy to run daily operations and rewards them handsomely through an incentive-compensa-tion system that's focused on growth and earnings targets.

The heads of both Tyco Electronics and Tyco Healthcare attest to that. "We have optimum freedom to run the operations," says Juergen W. Gromer, a 16-year veteran of AMP, who became president of Tyco Electronics after the merger 18 months ago. "There is no micromanaging. He leaves it up to us to decide what to do" in order to meet what Gromer calls "very clearly defined EBIT [earnings before interest and taxes] and cash flow targets."

What's more, says Gromer, the lack of bureaucracy at Tyco enables managers to make faster decisions. "Decisions don't have to be bounced back and forth" between corporate and business units, he says. "We don't have to wait to get approvals that in other companies would take four months. We have the freedom to do the things that are right for the business."

Richard Meelia, who became a Tyco manager in the 1994 Kendall Co. acquisition and who is now president of Tyco Healthcare, agrees. "We have almost total autonomy," notes Meelia, who says that he will discuss senior-level personnel issues and high-level deals with Kozlowski and that Kozlowski will periodically pose strategic questions, but that everything else is his decision to make. "The only constraint I have to is make the numbers," laughs Meelia.

Still, because Kozlowski "rewards you in a fantastic way," says Gromer, "the incentive plan . . . makes it fun."

The rewards are not just for managers. Since all employees benefit when performance targets are met -- even the lowest-paid employee can earn from one to three weeks of extra pay -- "the sacred cows that exist begin to disappear," says Meelia. "That gets people motivated to look for the things that only they can find."

In addition, except for a handful of executives at the corporate level, Kozlowski ties all incentives to division- or unit-level performance -- that is, the areas where they have direct responsibility and control. "We keep our incentives focused on growth over the prior-year period. And the better you do with that, the better you are rewarded," notes Kozlowski.

"It is classic capitalism at its best," he adds. "Each of our managers can achieve millions of dollars . . . for superior performance. We have no ceiling. It all depends on how successful they are at increasing earnings and cash flow" beyond the targets that are set -- which often are to double cash flow from the previous year and to improve earnings by a minimum of 20%.

"The very nature of the plan causes you to think about how you can become more efficient across your entire organization because you are paid on your ability to increase earnings," says Meelia. "He [Kozlowski] gets you to think beyond what you might normally do."

For example, Meelia points out that as a separate entity Kendall agonized over two acquisitions of $15 million and $35 million in the two years prior to its acquisition by Tyco. "Since we have been owned by Tyco, we have made 42 acquisitions. We would not have had that audacity on our own to think that we could grow from a $800 million business to a $7 billion business [with the addition of Mallinckrodt]. Dennis' boldness is catching."

Similarly, after Kendall became part of Tyco, Meelia dusted off plans for a major renovation of a gauze manufacturing plant in Camden, S.C., that previously he had shied away from because the cost was 65% higher than the normal rate of depreciation. But Kozlowski only had to see that the payback from the investment was legitimate before he urged Kendall to do it. "That investment probably lowered costs 12% to 15%," says Meelia, and it led to a "significant" increase in profitability and an improvement in market share of eight percentage points, he adds.

That's typical of Tyco manufacturing investments.

In Marinette, Wis., the company over a four-year period switched to team-based, cell manufacturing for its Sentry brand of portable fire extinguishers. That cut labor costs by 50% without any layoffs and reduced the manufacturing cycle time from three weeks to two-and-a-half hours.

Likewise, when the undersea fiber-optic cable market moved toward the use of large-core optical fibers, Tyco's manufacturing plant in Newington, N.H., began to use a different tube to encase the fibers. The new process requires less maintenance, gives Tyco better control over the physical dimensions and parameters, and improves the speed of production by 400%.

That's not the only way Kozlowski urges his managers to drive costs out of manufacturing. "We also put a strong emphasis on working capital, JIT inventory solutions, converting inventory into receivables, and receivables into cash in the quickest cycle that is possible," says Kozlowski. "We have a relentless focus on costs, productivity improvement, and quality. Every year we challenge our managers to make more -- and better -- units for less money. We don't have a fancy name for [it]. It is just a way of life."

What keeps Tyco managers focused on lowering costs when they've done it year after year? It's the incentive system, says Kozlowski. "It directly affects their pocketbook. If they have unnecessary costs, a percentage of that comes right out of their own compensation."

Job-Loss Challenges

Tyco's path to growth hasn't been without a few bumps, most of them related to its acquisitions. Tyco came under criticism for changing its financial reporting period twice between 1992 and 1997. Then, after a Dallas investor a year ago suggested irregularities in how Tyco accounts for acquisitions, the company became the subject of an eight-month investigation by the U.S. Securities and Exchange Commission. It was cleared in July of any accounting irregularities. In the aftermath of the investigation, Kozlowski says Tyco has made its 10K "more user-friendly" but is not disclosing "anything more than we did in the past. The SEC did its job. We have more credibility today than ever before."

That's a view held by most financial analysts. "When you make as many acquisitions as they do, you don't screw around with Washington -- and they don't," says ING Barings' Caplan. "Our view would be that they do -- and always have done -- consistent accounting."

Another criticism: The 120 acquisitions over the last eight years have resulted in closed plants and headquarters offices, and lost jobs. Tyco eliminated 25% of Raychem's workforce, 8,000 of the 48,000 workers at AMP; and 1,000 of the 8,000 people at ADT Ltd. On the day Tyco bought Batts Inc. of Zeeland, Mich., in April 1999 it announced it would close Batts' Michigan plants within nine months, eliminating 600 jobs.

"If you read the local newspapers [see Unloved in Zeeland], there will be plenty of negative criticism of Tyco," says ING Barings' Caplan. "But as a shareholder you had to read that and say, 'Yes!' It has created incredible shareholder value."

In most cases where Tyco has trimmed the workforce after acquisitions, says Merrill Lynch's Young, "it is clear that these companies have had excess costs. They [Tyco] merely are doing the jobs of what the managements before them should have done."

For his part, Kozlowski calls the workforce reductions "unfortunate" but "necessary" because "you have duplicative efforts at the time of an acquisition." And he's quick to point out that layoffs related to acquisitions "are the only times Tyco has made layoffs."

What's more, Kozlowski says that Tyco tries to announce its changes within a few weeks "so everyone remaining can focus on growth and not worry about more layoffs, and anxiety within the organization doesn't fester."

That's an approach that Merrill Lynch's Young suggests is best for all. "They don't let people dangle." And he adds that Tyco offers "generous" severance packages to both workers and managers.

So where does Kozlowski plan to take Tyco next? This year he negotiated the Mallinckrodt deal, created Tyco Ventures Inc. to invest in new technologies, and spun off the fiber-optic business to raise $2 billion so that the new entity, TyCom Ltd., in which Tyco retained an 87% stake, could build its own undersea fiber-optic network.

"There is no finish line whatsoever once you get into this," says Kozlowski. "In three to five years I would hope that we would be able to . . . once again double the revenues of the company and achieve a market capitalization of $200 billion. And, with the incentive system, to meet our goals we need to double the profits of the company within three years . . . and generate free cash flow in excess of $6 billion.

While that kind of challenge might overwhelm some executives, Kozlowski's personality makes such audacious goals the norm. "He is immensely able and has the ability not to be distracted," says Monks. "Dennis has always understood that he wasn't building a monument to himself. He just personally finds fulfillment in accomplishing objectives that others feel are difficult."

Go to Companion Story, "Unloved in Zeeland"

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