When Edward D. Breen took over as CEO of Tyco International Ltd. in July 2002, some questioned whether the Bermuda-based company could be saved. The embattled conglomerate was at the time reeling from accounting scandals involving Breen's predecessor, Dennis Kozlowski, who is now in a New York state jail cell.

By most accounts Breen has accomplished a remarkable turnaround. He has shrunk Tyco's once $28 billion debt load by two-thirds, while growing free cash flow by more than 400% to $4 billion-plus annually. Now, though, Breen faces what could be an even bigger challenge. Frustrated with a sagging stock price, Breen announced in January that the company will break into three independent businesses, a move expected to cost about $1 billion and take nearly a year to complete.

As it stands now, Tyco is a collection of more than 2,000 operating units with disparate businesses in healthcare, electronics, fire and security, and engineered products and services. Under Breen's plan Tyco will spin off its $12 billion electronics unit and fast-growing $9.5 billion healthcare division to shareholders, leaving the $18 billion fire, security and engineered products and services business under his direction.

"We have determined that separating into three independent companies is the best approach to enabling these businesses to achieve their full potential," said Breen when unveiling the plan. "Healthcare, electronics and [fire, security and engineered products] will be able to move faster and more aggressively, and ultimately create more value for our shareholders, by pursuing their own growth strategies as independent companies."

Healthcare -- where the breakup is reportedly referred to by some as "Operation Freedom" -- will have the financial freedom to pursue acquisitions and fuel growth. Electronics, meanwhile, will be able to react more quickly to price fluctuations for natural resources and shifting market conditions. The unit has been slowed in recent years by high raw material prices and slowdowns in key markets such as automotive.

Breen faces enormous challenges in attempting this breakup. He must reassure customers and keep managers focused on operational issues during what will surely be a trying time. He'll have to address complex tax issues, unwind IT systems and address capital needs of the soon-to-be independent units, all while deflecting critics who allege Tyco's stagnant stock price is due more to external conditions than internal operational issues that can be resolved through a breakup.

Breen is pursing a strategy that has had mixed results on Wall Street. In the past eight months alone, media company Viacom Inc., travel and real estate conglomerate Cendant Corp. and financial services provider American Express Co. have pursued similar strategies.

Cendant Corp. plans to sell its travel business and spin off its real estate, vehicle rental and hospitality holdings by year's end. The company's stock is off about 15% since the plan was announced in October. Viacom spun off its radio and television assets as CBS Corp. in January. Since then shares of CBS Corp. are trading around $25.40, a dime off of its opening day price, while Viacom shares are down about 5%. American Express has fared better with its spinoff, Ameriprise Financial Inc., which is trading around $49, up from $37 when it launched in September 2005. American Express' stock has held steady in the low $50s.

Tyco can look to its own recent history for lessons as well. The conglomerate in July 2002 spun off its commercial and consumer finance business, CIT Group Inc., to shareholders at $23 per share. Advocates argued that it would free CIT's credit rating from Tyco's ongoing difficulties and allow the unit to attract value investors who wanted no part of its parent's scandal-plagued past, but by year's end, shares of the independent entity traded down nearly 15%, in part because growth-starved Tyco shareholders were not particularly eager to hold shares of a more conservative finance company either.

Time, though, has been kind to CIT. The company recently traded at around $54 per share, more than double the offer price, an indication that patience is paramount. "It can take time for the market to accurately assess the value of an enterprise," says a Tyco investor who asked not to be named. "CIT is a good example of the core belief that a child given full attention and who is responsible for its own future will thrive over a child that must fight for attention as part of a larger family."

Breen has at least one thing going for him as he undertakes the Herculean task of splitting Tyco in three. The company's different business units were never closely intertwined, and restructuring experts say that each could benefit from being out on its own.

Healthcare may have the most to gain. Competitors such as General Electric Co. and Siemens AG have used multiple acquisitions to build their healthcare businesses in recent years. Meanwhile, analysts have speculated that Tyco, coming off years of financial scandals, has been trigger-shy about announcing a big healthcare deal. A standalone healthcare company whose shares enjoy a higher multiple than those of the current parent could change the dynamic. Post-breakup, Rich Meelia, who has served as president of Tyco Healthcare since 1995, could use that currency to move his company into new areas and ensure its place as a long-term survivor in a competitive industry.

A lot of the breakup work to be done, advisers say, is the time- and money-consuming process of hammering out details on issues such as health benefits, compensation, corporate policies and allocating contingent liabilities such as ongoing litigation. IT systems, too, must be unwound. Part of Breen's challenge is to make sure that each of the companies to be spun off has the back office foundations in place to make it as an independent.

There are potentially complicated tax structures that must be considered as well. For instance, Breen needs to be sure that what remains of Tyco is not subject to capital gains in the spinoff and, assuming he wants to execute a tax-free spinoff, that the transaction meets the requirements of IRS Section 355. The spinoff distribution of stock can be made tax-free to the corporation and the shareholder under 355 if certain requirements are met, including that at least 80% of the subsidiary's equity goes to existing shareholders and that the spinoff is motivated by a proven corporate purpose as opposed to a shareholder purpose.

A further challenge will be to assure that each of the newly independent companies will have adequate capital. This can help protect Tyco from future shareholder litigation should one of the units falter. Tom Wardell, a corporate attorney with McKenna Long & Aldridge LLP in Atlanta, explains that the overriding legal standard that applies to spinoffs is that all enterprises must be considered viable operating entities after the spin.

"Because it is virtually certain that the two units will not perform identically, the risk of shareholder litigation is quite high," Wardell says.

Plans for allocating existing corporate debt and cash have to be worked out as well -- and will, of course, receive careful scrutiny. "Banks and creditors who will now no longer enjoy the comfort of a parent's implicit or explicit guarantee on the debt of the spinoff are going to take a hard look at the company," says Robert F. Bruner, dean of the Darden Graduate School of Business Administration at the University of Virginia and author of "Deals from Hell: M&A Lessons that Rise Above the Ashes." "They need to see the cash flow is there to assure that the independent company can manage its debts on its own."

Beyond the financials and the systems, Tyco must also worry about the teams that will be running the independent operations. Breakup experts warn that the spinoff process will present extra burdens and distractions to managers who are normally focused on operations.

"Management presumably has its hands full managing the business, and closing a transaction can be a full-time job," says one restructuring consultant who has worked with Tyco in the past and wished to remain anonymous. "On top of their management duties, officers have to be talking to lenders, visiting suppliers and assuring employees and other constituents that the business will survive and prosper as an independent."

Keeping open the lines of communication is critical to making the transaction successful, he adds, as employees and other concerned parties are likely to assume the worst as breakup plans are disclosed. In the end, however, there is no amount of communication that can completely put interested parties at ease.

"You can communicate the heck out of something, but people don't believe it until the deal closes and they see what the actual situation turns out to be," the consultant says. "A new company's first statement will give the world its first impression, so it is important to be consistent in your message and to be clear about what is going on."

That means Breen and his team must be careful not to overestimate or over-promise. Some near-term confusion and loss of productivity is inevitable. The question is what lies beyond it. - Lou Whiteman

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