FINANCE MASTERS
In the second part of our profiles of the winners of CFO's 2000 Excellence Awards in the US, the CFOs of Fairchild Semiconductor and Tyco explain their strategies.

Winner: Joseph Martin
Category: Turnaround Management
By George Donnelly

Joe Martin had just decided to help with the semiconductor industry's first leveraged buyout when some peers had a question for him. "They said, 'Are you out of your mind?'" recalls Martin, now the CFO of Fairchild Semiconductor International, the US-based entity that emerged from the LBO of several former divisions of National Semiconductor in 1997.

In a world full of hot new chips, Fairchild's product line is far from the leading edge of technology. Other semiconductor companies race to produce the fastest and tiniest microprocessors, or to focus on dynamic random-access memory chips. Fairchild makes "building block" chips, which work with the memory chips and microprocessors to help move and shape information.

With lots of jobs for Fairchild chips to do on the circuit board, "we don't focus on a singular solution," says Martin, who describes his company's products as "the parts that go around all those whiz-bangs and allow them to operate."

Mundane? Maybe. Taken for granted? Certainly. At National, Martin says: "We would hire design engineers for the sexy products, [while] these products were second-class citizens and really didn't get the capital infusion." But where others saw a humdrum commodity business, Martin saw great potential. Today, Fairchild's components are ubiquitous, capable of being specialized for a range of industries - and steadily profitable.

Martin and Kirk Pond, another former National Semiconductor executive who eventually became CEO of Fairchild, wanted to liberate these less-than-exciting businesses. But they first had to convince Brian Halla, National Semiconductor's CEO, to let go. It wasn't a hard sell, as it turned out, because Halla was visualizing taking National into the system-on-a-chip technology that was hot at the time, and was open to a cash infusion.

Martin and Pond were offered National's Logic, Discrete and Non-Volatile Memory divisions. The price: US$550 million for a group of operations that produced US$690 million in revenue and had 6,500 employees. The operations of Fairchild - a semiconductor pioneer before being absorbed as a subsidiary of Schlumberger, and later National Semiconductor - would be reborn in a new corporate home in Maine in the US.

But first, Martin and Pond had to find the money. The two men, who at the time were commuting to Silicon Valley from their homes in Maine, found themselves pitching the LBO idea to skeptical investment firms that seemed to want a more compelling story. "We sat across from people and I said, 'We're going to double the company in three years and here's how we're going to go do it,'" says Martin. With each polite, noncommittal response, "we'd walk out of meetings and we'd say, 'The guy didn't buy it, didn't believe it,'" he says.

When someone did buy it, though, "it was amazing," adds Martin. That someone was Credit Suisse First Boston (CSFB), which underwrote a ten-year, US$300 million high-yield issue, and co-led a US$195 million credit facility, with the venture arm of Citicorp providing the equity. And it set off one of the semiconductor industry's least-noticed successes: a triumph of aggressive financing, smart marketing positioning, and growth that won Martin the 2000 CFO Excellence Award in the Turnaround Management category.

"Nearly everything Fairchild Semiconductor has accomplished in the last three years has Joe's mark on it," says CEO Pond. "He has been intimately involved in our market strategy and our growth plan."

A Prophet of Innovation

After some rough early times - including an identity crisis on Wall Street and a chip-market collapse in 1997 - Fairchild today is thriving. It has made several acquisitions, along with two public stock offerings. Operating earnings for the first half of 2000 soared to US$153.2 million from US$35.5 million, benefiting from the company's broadening range of products in numerous markets. Annual revenue now exceeds US$1.7 billion, and market cap has skyrocketed to more than US$4 billion.

Martin himself has become a prophet of innovation for building-block semiconductors, which he would never describe with the dreaded "c" word: commodity. "These are multimarket products that some people like to classify as commodities," the CFO says. But really, most of them vary, and Fairchild's "are differentiated from our competitors' because of either performance, size or speed."

Securing this new reputation, though, has meant Martin has had to convince Wall Street that there is beauty in what some see as low-margin banality. While "hotter" chips may have higher gross margins, he points out, they require twice the research and development expense and offer shorter product life cycles. Fairchild's R&D expenses run about 6 percent of sales, and many of its products have a shelf life of more than a decade.

By turning in operating margins on a par with those of the fancy chip makers, however, Fairchild managed to enhance its reputation. And its R&D certainly has been out of the ordinary - with activity that marks a drastic change from the National Semiconductor days.

That has led to a dam-burst of new ideas. "As management declined to invest in the product lines, the water level just kept building and building," he says. "So for us to knock down the dam, it was like, turn 'em loose!" And when the money started flowing, he found "so much energy, so many ideas, so much intellectual property, [and] so much talent."

Bargain Hunting

Those ideas helped Fairchild fare well when the bottom fell out of the semiconductor industry three years ago, as did its "multimarket" approach that has broadened its base to include such noncomputer customers as makers of cars, consumer appliances and video games.

The company found itself able to offset price declines, as deep as 20 percent in its Logic segment, by increasing volume and lowering manufacturing costs. And with the company healthy, Fairchild found the downturn to be an opportunity for some acquisition bargains.

In December 1997, it purchased Raytheon Semiconductor for US$117 million in cash. With the Asian economic crisis brewing, Martin also kept his eye on South Korea.

One of Korea's largest electronics groups, Samsung, needed cash, so he pressed it to sell its Power Device division for US$415 million, or one times revenue. The deal, completed in early 1999, made Fairchild a serious player in the analog market.

"The Samsung property was never for sale," says Martin. "I went over there at least a half dozen times prying this thing out of them. Finally, with a little help from their economic situation, things came together. Our competitors died a thousand deaths when we announced the deal."

Still, when Fairchild needed to float more debt, Martin had to go back to Wall Street to tell the company's story again. "You talk about the worst timing in the world," he says. "Try to convince somebody to lend you another half a billion dollars when prices are crashing and the semiconductor industry is arguably in its worst downturn in history." Fairchild issued a US$300 million bond at 10 3/8 percent, and got the rest of the funds through refinancing its senior credit facilities.

But Martin believes Fairchild still lacks the investor respect it deserves. Its shares trade at a low multiple in the mid-teens. The market still doesn't understand the company, he says. "So part of our job is to convince, to educate, to articulate who we are. And more important, who we aren't."

George Donnelly is a senior editor at CFO, CFO Asia's sister publication in the US.

Winner: Mark H. Swartz
Category: Mergers & Acquisitions
By Stephen Barr

Tyco International was supposed to be the next Cendant, a corporate behemoth brought to its knees for aggressive accounting practices a few years back. Allegations surfaced in 1999 that Tyco, the acquisition-hungry industrial products conglomerate, had set up "cookie-jar" reserves to pump up future profits, and had encouraged several targets to take big, premerger write-offs.

"Everyone was expecting us to be next," acknowledges CFO Mark H. Swartz. But as short-sellers swarmed and the stock swooned, falling more than 50 percent, Swartz and chairman and CEO L. Dennis Kozlowski insisted that Tyco had done nothing wrong. They held meetings with investors and analysts, offered pointed rebuttals of rumors deemed "unfounded and malicious," and practically invited the Securities and Exchange Commission (SEC) to investigate.

Which the SEC did, eventually clearing Tyco in July. So sure was Kozlowski of that outcome that he nominated Swartz for a 2000 CFO Excellence Award in the Mergers & Acquisitions Management category at a time when the investigation was still pending. "We were very, very confident of our accounting," declares Kozlowski.

"Despite all that people were saying and what was happening to the stock price, we knew what the truth was," adds Swartz during an interview with CFO, his first since the SEC backed off.

Yet the 40-year-old finance chief was not named the M&A category winner for dodging the armor-piercing bullet of regulators. Rather, the award reflects a recent flurry of deal making that no other company can match. Tyco's tightly structured acquisition approach has been an unqualified success, one having no need of smoke-and-mirrors accounting.

Over the past three years, the Bermuda-based US-listed company has finalized more than 350 acquisitions, with a total purchase price of about US$28 billion. Each - from the 250 or so worth less than US$5 million to the largest, the US$11 billion deal for AMP Inc. - has fit neatly within one of Tyco's four business segments: telecom and electronic components, health care products, fire and security services, and flow controls.

Analysts expect revenues for fiscal 2000 ending September 30 to approach US$30 billion, up from US$9.8 billion in 1997, with earnings rising to US$2.15 a share, a 330 percent increase. Hovering near 60, Tyco's stock is more than 10 percent higher than it was before the accounting clamor, and nearly triple its value three years ago.

Tyco, says Wendy Caplan, an analyst at ING Barings, "is a well-oiled machine" when it comes to M&A. And Swartz, she adds, is the one who supplies the grease.

Living with Deals

Swartz arrived at Tyco in 1991 with a discipline for doing deals. He'd been a due diligence consultant at Deloitte & Touche for several years, and was hired by Kozlowski to assemble an M&A team. After Swartz was named CFO in 1995, the management team spelled out a stringent acquisition strategy. Every deal had to be friendly and immediately accretive to earnings, and the target company had to strengthen an existing Tyco business.

Perhaps most innovative, Tyco began developing a pool of operating-unit employees who would take part in every stage of the deal-making process. Swartz's theory: those who have to "live with a deal" will do a better job at due diligence and integration than any outsider might. The effect of such an approach, Swartz says, is that Tyco managers identify more than 500 possible acquisition targets in any given year - and walk away from the vast majority of them.

In addition, Tyco will not do a hostile deal, for the simple reason that such a charged situation typically hampers due diligence and integration planning. Without the target's buy-in, the information available for forecasting pro forma results may be limited, and the support from the acquired workforce for meeting postmerger objectives may be harder to attain. "The advantage of doing only friendly deals is that [Tyco] can get behind the numbers," says Jack Kelly, a Goldman Sachs analyst in the US. "And once in control, they can move quickly."

Not only has every Tyco acquisition been accretive, but the company refuses to factor any top-line growth into the financial models. "Anything that isn't accretive on a cost-reduction basis gets shot down," says Swartz. That doesn't mean that Tyco doesn't pursue revenue enhancements when it puts these complementary businesses together, but a sizable return is not dependent on such synergies. "They don't talk about sales growth when they announce a deal," notes Caplan of ING Barings. "That's always gravy on top."

As for Tyco's in-house approach to M&A, Swartz told CFO in 1996 that some 60 employees had been drawn from the business units to work on different deals. "If you have good people, they should be able to take their knowledge of your business and look at another business, and come up with various assumptions," he explained at that time.

Such a philosophy holds today, though now several hundred employees have deal-making experience. "Since we're buying businesses in areas where we're already involved," Swartz confirmed recently, "we rely on the people already in those businesses."

Organic Growth

As savvy as Tyco has become at doing smart deals that boost revenues, Swartz points to internal growth rates and mounting free cashflow (operating income less capital expenditures and dividends) as the key indicators that its acquisition efforts are paying off. In its third-quarter results, reported in July, the company announced 17 percent sales growth from existing businesses, up from 11 percent the year before, and free cashflow of US$1.9 billion for the first nine months of fiscal 2000, which exceeds the amount for the entire previous year.

"Not only have we been able to bring in companies that have added to our size, but we have been able to grow them at a very fast rate," says Swartz. "And it's the organic growth that is the report card on the health of the business."
Internal growth is strongest in the telecom and electronic components segment (about 25 percent), and Swartz credits the ability to find businesses that fit well. AMP, for instance, had a bloated bureaucracy, and declining revenues and profits.

Since completing the purchase in mid-1999, Tyco has not only taken out US$1 billion in costs, but it has also applied the same focus on customer service and new-product introductions that was part of its existing electronic components unit. Sales are now growing 20 percent annually, and the business is making money.

One of Wall Street's favorite Tyco deals was the 1997 acquisition of AT&T's submarine systems, for US$850 million. The business was marginally profitable, but since merging it with its own underwater fiber-optic telecommunications cable unit, Tyco has become the world's largest and most integrated supplier. Boasting operating margins of 20 percent, Tyco sold 20 percent of the business to the public in July. Recently, those shares had a market capitalization of US$21.5 billion.

Swartz believes the single most compelling sign of Tyco's deal-making prowess is the increase in free cashflow. That total was US$231 million in fiscal 1997, and is expected to top US$4 billion in 2001.

In the year since Tyco was hit with charges of accounting legerdemain, the company kept making acquisitions, though it completed fewer big ones. All were for cash, because using the depressed stock would have been costly to shareholders. But according to Swartz, relieved by the "clean bill of health" from the SEC, what this corporate crisis imperiled was not the company's ability to do deals.

Evidently, they succeeded: Tyco's internal growth rate accelerated while the company was under the gun. Mark Swartz, clearly, is not a CFO to be sold short.

Stephen Barr is senior contributing editor at CFO, CFO Asia's sister publication in the US.