Tyco Locking In Higher-Margin Service Revenue


In its second quarter as a stand-alone company, Tyco reported respectable operating results, given the challenging macroeconomic environment. An intense focus on North America security project selection continues to constrain revenue, but to the benefit of higher-margin service revenue in the future.

There are a lot of benefits with management’s continued selectivity in North America commercial security projects. However, not all projects carry a service component, such as monitoring. Therefore, it’s critical for Tyco Integrated Security, the rebranded North America commercial business, to seek projects that have associated service work. Management of the presplit Tyco evidently was not choosy enough in specifying what projects it chose to take on, and new management of Tyco has made this effort one of its key strategic objectives.

With reported North America installation and services segment orders down 19% in the first quarter, and given the roughly 50/50 split between security and fire, we estimate security orders were down close to 40%. While that decline may seem severe, it is lapping a particularly strong quarter for orders. Since this is a concerted management effort and not the result of worsening competitive dynamics, the long-term margin profile of the projects the firm is currently booking should be materially stronger.

Already, segment margins have improved 110 basis points year over year despite costs associated with the separation of the ADT residential security business from the commercial security business Tyco retains. The negative effects on revenue growth will subside as we approach the end of the fiscal year. It is not as if revenue has fallen off a cliff, though: Overall organic revenue still grew 1% in the quarter.

The other parts of the business are mostly performing to plan. The rest of world installation and services segment saw flat organic revenue growth in the quarter as a result of continued softness in the nonresidential construction market abroad. “Green shoots” cited during the conference call and improved orders and backlog should pave the way for better growth in the back half of the fiscal year.

The global product segment had a difficult margin performance in the quarter because of a $6 million environmental remediation charge and timing of product shipments, but we think these issues are transitory in nature. Management continues to ramp associated research and development and sales and marketing spending in the segment as it sees healthy growth opportunities with above-company-average margins. Quarterly earnings per share of $0.40 eclipsed internal guidance by a penny and rose 11% year over year on a normalized basis.


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