Tyco couldn’t sell new debt in the capital markets the way a reputable company could. Tyco, even with Breen stage- managing the damage control, wasn’t a reputable company.

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Tyco, page 2

Breen ordered ADT to develop and increase its own sales team and stop relying so much on dealers. “We let our sales force atrophy,” says Breen, who for years was one of the sample case–carrying Willy Lomans who schmoozed cable operators for General Instrument, the Chicago-based electronics manufacturer.

Worse, a number of the customers ADT paid so much to acquire dropped the service as soon as their initial contract term expired, if not before. The dealers hadn’t determined if the customers they sold to Tyco would be reliable long-term subscribers; they just wanted to pump up their commissions. So customer-attrition rates rose. In 2003, ADT lost a worrisome 16 percent of its recurring revenue this way.

Growing your own sales force takes time, however. According to Nigel Coe, an analyst at Deutsche Bank, growth at ADT fell to 1.3 percent over 2005 and 2006. “Organic growth [at ADT] severely and consistently underperformed the market,” Coe says. But as Breen told the investment community, growth wasn’t Tyco’s short-term imperative. “I figured that if I made 10 decisions, seven were going to be OK,” he says. “The three I got wrong we’d be able to fix.” The slowdown in growth exacerbated another problem. One of the most reliable and profitable components of ADT’s revenue stream is its recurring-services business. ADT is, in a sense, a subscriber business, like a cable-TV operator or traditional magazine publisher. Customers sign up, then keep paying year after year for security-monitoring services. Around half of ADT’s worldwide sales are reliable and recurring.

When a company allows growth to slow, and the new-customer count goes down, it loses chances to accrue — and allows a decrease in — such reliable recurring revenues. That brought down ADT’s monthly average revenue per user, a key benchmark. But Breen was determined that ADT would get its own customers. What he demanded of ADT’s management, was, essentially, eat what you kill — and make customers a source of steady cash flow for the long term.

Since the inception of the new sales model, Breen has encouraged ADT’s sales force, now 4,000 in North America alone, to organize itself into residential and commercial teams. These specialists are better able to help develop and sell services that appeal in the long term to their markets, which boosts recurring revenues. Fewer customers who defect means spending less to replace defectors; more of the new customers are additives rather than replacements. The cycle starts to become constructive instead of pernicious. “Breen’s internal-growth emphasis is a higher-value proposition for shareholders,” Kelly says. “When you grow internally, you’re controlling your own destiny.”

There was a long period before this change in the sales model began to develop a noticeable momentum. But by last year, the shift had started to pay off. In the third quarter of 2007, growth at ADT reached 4 percent. Now two-thirds of its new accounts are recruited by its own salespeople, and subscriber acquisition costs have fallen 25 percent, to around $750. Average monthly revenue per user has grown from $37 to $44, and customer attrition has fallen to around 12 percent. North American operating income was 16.6 percent in 2006. Also noteworthy: In 2006, ADT contributed almost $1 billion in operating income to Tyco.

In other areas, ADT isn’t performing as well. Its performance in Europe is a particular problem: Operating income in that part of the world is a measly 6.3 percent, 10 percentage points poorer than in North America. Overall, ADT has substantially regained momentum, and practices in place in North America are being introduced around the world. Much like drip irrigation, this improvement will take time to take effect — especially in Europe, where contracts run for five years, not three as in the U.S. Nevertheless, ADT has the market-dominating resources to maximize all advantages.

Step 3

Grow It:
Deconstruct the Company

Given the circumstances that led Tyco to recruit Breen, corporate structure was a major issue. It couldn’t keep going as it had been. However, determining the optimal structure wasn’t an urgent survival issue. So Breen put off considering it. You don’t wash the windows, after all, when the house is on fire.

Under Kozlowski, Tyco was drastically different from the industrial companies where Breen learned to be a CEO. It wasn’t just a conglomerate — it was an organizational Tower of Babel. Between 1997 and 2001, Tyco spent some $70 billion acquiring more than 1,000 companies.

“Executives would come in on Monday and ask, ‘Who are we going to acquire today?’ ” Breen says. “They were M&A people. [To them, Tyco] was, in effect, a big private-equity firm.”

Although Tyco had promising companies in its sprawling portfolio, it was messy. “Nothing was integrated properly,” Breen says. “They didn’t have any discipline in place. There were a lot of good companies, but no real foundation.”

Once Tyco was no longer on life support, Breen planned to make it more coherent — specifically in the service of growing organically, rather than by acquisition. Tyco had GE’s scale and complexity without GE-caliber housekeeping and organization. It had interests in four main business categories: health care and medical devices; electronic connectors and components; fire-protection and security products and services; and flow-control equipment (such as valves). It had $40 billion in revenues, around 250,000 employees, was made up of 2,180 legal entities and was in 4,000 locations. The company had 35,000 employees in China alone. “We had five world-leading large platforms, but there was no synergy between them,” Breen says. He believed that the platforms grew differently, were affected by different factors, used different approaches to gain market share, had different capital requirements and appealed to different sorts of investors. “At some point, you have to sit back, take your personal emotion out of it and ask yourself: ‘Would a different structure be better for the long term?’”

Breen’s vision was to separate the health- care business (now named Covidien) and the electronic-components business (now named Tyco Electronics) and spin each one off to shareholders. When he discussed the deconstruction project with the board in the summer of 2005, Breen insisted that all three companies would have their own independent board of directors, capable management, adequate capital, strong cash flow and balance sheets sound enough to give their debt investment-grade rating. He wanted to make sure that no one would grouse that the spun-off companies were foster children equipped too poorly to compete. As with other aspects of running Tyco, the separation presented significant challenges. When a company is as hastily cobbled together and poorly integrated as Tyco was, separating it into parts isn’t as smooth as cutting a birthday cake. It’s more like untangling spaghetti. Because of its scandal-ridden past, Tyco faced unresolved ERISA and shareholder class-action lawsuits and about $2.1 billion of tax liabilities owed for 1997 through 2000, as well as other legal hassles. All such negative legacies had to be allocated as equitably as resources were.

But Breen and the board were convinced that the three companies would be better off if on different paths, with more freedom to pursue their self-interest and more focus on their particular businesses, than if they were kept in harnesses. The separation occurred this past June 29.

The old Tyco, an embattled outpost of many quickly erected tents and temporary dwellings, had ceased to exist — or, at least, as it was conceived and conglomerated by Kozlowski. The new Tyco International gives Breen a much smaller sandbox in which to play. It was a company with revenues of $41 billion in fiscal 2006. The new Tyco has annual revenues of $18.6 billion. Operating income has diminished from $4.1 billion in 2006 to $1.5 billion. Shareholders’ equity has decreased from $35.4 billion in 2006 to $15.5 billion. But the combined performance of the three companies indicates that the spin-off led to a combined $58.4 billion market cap.

Plus, one gets the impression that Breen is more comfortable with the new, leaner Tyco. Because of the various programs to reduce waste and increase efficiency, the new ship is trimmed to respond more quickly to the helm. “A lot of people kind of grooved on crises,” Breen says. “But now we’re operating with a different mindset: how to grow the business organically by becoming more efficient and using our resources better. What a lot of people don’t realize yet is that this is a normal company now.”

The Bad Old Days

To appreciate the enormity of the task Ed Breen faced in restructuring Tyco, it helps to recall the outsized career of his infamous predecessor, Dennis Kozlowski — and the frenzy of dealmaking that produced the unwieldy conglomerate Breen inherited. Kozlowski joined Tyco — then a small New Hampshire–based manufacturing and technology company only recently listed on the NYSE — in 1975 as a $28,000-a-year accountant. By 1992, he had climbed all the way to the corner office, and Tyco had grown into a conglomerate with $3.1 billion in sales. Kozlowski soon began making acquisitions on a grand scale (obtaining 200 companies one year, nearly one for each working day), earning himself the nickname “Deal- a-Day Dennis.” From 1997 through 2001, Tyco’s revenues rose by an astonishing 48.7 percent per year, and just before Kozlowski’s fall, reached $34 billion. BusinessWeek named him “The Most Aggressive CEO,” and he seemed destined to join the ranks of such legendary conglomerate builders as Harold Geneen and Jack Welch.

But while few executives in the history of capitalism rose so high, fewer have fallen so far. Kozlowski’s problems began in 2002, when a New York State grand jury indicted him for tax evasion — for, of all things, buying millions of dollars’ worth of master paintings and having them shipped to Tyco’s New Hampshire address to avoid paying sales tax. Prosecutors dug further. Allegations emerged that Tyco paid $30 million for his apartment (including $6,000 for a shower curtain) and $1 million for his wife’s fortieth-birthday party (in the guise of a shareholder meeting). Tyco’s market capitalization dropped more than $90 billion as the scandal spread — more even than Enron’s at its peak.

Kozlowski was ultimately convicted, along with his chief financial officer, Mark Swartz, for misappropriating some $600 million in company and shareholder funds. In 2005, he was sentenced to eight and one-third to 25 years in prison, making him eligible for parole in 2014. These days, he’s known as Prisoner 05A4820 at the Mid-State Correctional Facility in Marcy, New York.

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