Fitch Affirms Tyco International's Ratings at 'A-'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the Issuer Default Rating (IDR) and long-term debt ratings for Tyco International Ltd. (Tyco; NYSE: TYC) and Tyco International Finance S.A. (TIFSA) at 'A-'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings reflect Tyco's geographic diversification, well-established positions in its fire and security markets, improving operating profile, and financial flexibility. Total adjusted debt/EBITDAR at June 27, 2014 was 2.0x, roughly flat compared to the end of fiscal 2013, and within the range expected by Fitch. Cash balances are temporarily high due to the recent completion of two material divestitures that enhanced Tyco's focus on the commercial fire and security markets and generated substantial cash proceeds.

In the third fiscal quarter, Tyco sold ADT Korea for approximately $1.9 billion and the remaining share of Atkore for $250 million. Tyco is using a large portion of cash proceeds to repurchase shares. Pro forma earnings and cash flow will be slightly lower as a result of the divestitures. Fitch does not expect Tyco to use proceeds from the divestitures to pay down debt. However, ongoing improvements in operating results at the company's core businesses, and a gradual return to higher FCF anticipated after 2014, should mitigate the negative impact of the divestitures on credit metrics.

Tyco continues to integrate and streamline operations, which is expected to support higher margins. Margins are also supported by Tyco's increased selectivity around projects in the security business. This strategy initially had a negative impact on volumes, but the company could see a higher mix of recurring revenue over time. Fitch estimates approximately 25% of revenue comes from recurring services, which are relatively stable, and help to offset cyclicality in the installation business.

The cash impact of special charges increased to $392 million in the first nine months and include restructuring, environmental payments, and tax-related payments under Tyco's separation agreements. Cash charges will likely continue through at least 2015, but at declining levels. At June 27, 2014 net asbestos liabilities totaled $148 million, the majority of which is related to Tyco's Yarway subsidiary, which filed for bankruptcy in 2013. Tyco expects to pay $100 million to Yarway to settle an intercompany liability, but asbestos claimants have not agreed to a plan of reorganization, and Tyco's ultimate liability could change.

Other rating concerns include potential tax liabilities related to Tyco's separation transactions in 2012 and 2007. The IRS asserts the company owes income taxes of approximately $1.0 billion for the 1997 - 2000 tax years. The amount includes penalties but not interest which could be substantial. The IRS claim relates to intercompany debt on which the IRS has disallowed $2.86 billion of interest and related deductions. If its claim is upheld, the IRS could potentially demand additional income tax payments for similar deductions totalling $6.6 billion in subsequent periods.

A resolution of the tax dispute could take several years, which would defer the cash impact. Any payments that might eventually be required would be shared with the other companies involved in both of Tyco's separations in 2012 and 2007. While not expected, an inability of the other companies to share in any future payments would increase Tyco's liability. If the IRS makes claims on all $9.5 billion of deductions and ultimately prevails, Fitch estimates Tyco's share of the income tax liabilities could total approximately $600 million, plus interest. An adverse outcome involving a large payment is currently beyond the rating horizon but could potentially lead to a negative rating action.

Fitch estimates free cash flow (FCF) after dividends in 2014 will be in a range near $100 million or more, compared to FCF of $291 million in 2013. The amount in 2014 excludes substantial cash received from the disposals of ADT Korea and Atkore. FCF continues to be reduced in the near term by cash payments for special charges. As Tyco gradually funds these items, FCF could gradually return toward a normalized annual level of at least $500 million over the next two years or so, depending on the timing of cash charges. FCF would also benefit from an increase in operating margins as Tyco completes restructuring and integration actions and as non-residential construction markets improve. Concerns about low FCF are mitigated by Tyco's solid liquidity and its conservative debt structure.

Cash deployment in the near term is concentrated on share repurchases. Tyco expects to repurchase approximately 30 million shares in the second half of 2014 which could result in total repurchases in excess of $1 billion for the full year. Additional repurchases are likely in 2015. In addition to share repurchases, Tyco has completed or announced more than $100 million of acquisitions in 2014 compared to more than $250 million in 2013. Acquisitions are a key part of Tyco's strategy to expand its presence globally and in higher-growth emerging regions.

At the end of fiscal 2013, pension plans were underfunded by $388 million (U.S. $148 million; foreign $248 million). Tyco estimates it will contribute at least the required $53 million to its pension plans in 2014; contributions to global plans totaled $37 million through the first nine months. U.S. plans were 82% funded, up from 67% in 2012. More than half (63%) of Tyco's gross pension obligations are outside the U.S.

Tyco's liquidity at June 27, 2014 included $1.9 billion of cash and a $1.0 billion bank credit facility that matures in 2017. The company also held $277 million of time deposits. Cash balances will be substantially lower after additional share repurchases are completed but should remain at a solid level that supports Tyco's cash deployment. The bank facility backs commercial paper issued under a $1 billion program. There are no material debt maturities scheduled until October 2015 when a $258 million note is due. Debt totaled nearly $1.5 billion of debt at June 27, 2014. Tyco also has substantial leases which Fitch considers in adjusted debt leverage metrics.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--FCF remains weak longer than expected due to weak operating results or high cash charges. Fitch expects FCF will increase to approximately $300 million - $400 million in 2015, depending on the timing of cash charges, and FCF/total adjusted debt will improve above 10% over the long term;

--High spending for share repurchases or acquisitions leads to a sustained increase in leverage, including total adjusted debt/EBITDAR above 2.5x;

--Liquidity is impaired by an adverse tax decision or higher-than-anticipated asbestos liabilities.

Future developments that may, individually or collectively, lead to a positive rating action include:

--Strong earnings or debt reduction lead to total adjusted debt/EBITDAR consistently below 1.50x - 1.75x;

--FCF/total adjusted debt improves toward 20%;

--Contingent tax liabilities are eventually resolved.

Fitch has affirmed the following ratings:

Tyco International Ltd.

--IDR at 'A-';

--Senior unsecured notes at 'A-';

--Short-term IDR at 'F2'.

Tyco International Finance S.A.

--IDR at 'A-';

--Senior unsecured revolving credit facilities at 'A-';

--Senior unsecured notes at 'A-';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

The Rating Outlook is Stable.

Additional information is available at www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=847934

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Contacts

Fitch Ratings
Primary Analyst
Eric Ause, +1 312-606-2302
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Jason Pompeii, +1 312-368-3210
Senior Director
or
Committee Chairperson
Craig Fraser, +1 212-908-1310
Managing Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eric Ause, +1 312-606-2302
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Jason Pompeii, +1 312-368-3210
Senior Director
or
Committee Chairperson
Craig Fraser, +1 212-908-1310
Managing Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com