Henry Silverman's Long Road Back

He's fighting to restore Cendant's reputation

The anger was eating away at Henry R. Silverman. It was May, 1998, and at the urging of a worried friend, he went to see a psychiatrist. Cendant Corp., the company Silverman formed through a high-profile merger in late 1997, was engulfed in what would become the accounting scandal of the decade. As he sat in the psychiatrist's office on New York's Upper East Side, the therapist, who Silverman says has treated his share of executives with legal problems, asked bluntly, "Are you the vic or the perp?" Silverman didn't have to mull over this one for long. "I'm the vic," he said.

The answer speaks volumes about Silverman's life for the past year and a half. Many Cendant critics would snort at the notion that he's a victim. They believe Silverman has only himself to blame for the ill-fated merger of his franchising company, HFS Inc., with direct-marketing outfit CUC International Inc. But in Silverman's mind, it was the business equivalent of an assault. Before the shrink could ask many more questions, Silverman laid it out for him: "I said, `This is not about Mommy and Daddy. I'm in touch with my feelings. I know how I feel. I'm consumed with rage."'

It has been quite a comedown. Until two years ago, Henry Silverman was a Wall Street darling, the savvy dealmaker who built HFS into a giant franchiser of such brands as real estate brokerage Century 21, hotels like Ramada and Howard Johnson, and the Avis rent-a-car system. Silverman earned a reputation for delivering stellar earnings and stock price gains through a steady stream of acquisitions. With a sharp eye for detail and a relentless focus on financial performance, he proved a competent operator, quickly integrating independent businesses such as real estate brokerages and a mortgage-origination operation. While there was often as much controversy as admiration surrounding Silverman's frenzied dealmaking, few doubted his ability to end up on the winning side of a transaction.

EXIT STRATEGY. The CUC merger was to have been Silverman's masterstroke. He saw CUC, a direct-marketing outfit that sold memberships in discount buying clubs such as Shoppers Advantage and Travelers Advantage, as the perfect partner. The idea was to feed the names of all the customers HFS channeled through its hotels and real estate brokerages into the CUC direct-marketing machine. CUC would then sell them memberships in its discount-buying clubs and, eventually, financial services such as insurance. Silverman also figured CUC's team, viewed as Internet gurus for creating the online shopping site Netmarket, could help extend his brands to the Web.

It wasn't just the prospect of synergies that was driving the deal. Everyone knew that dealmaking provided much of the fuel for Cendant's roaring stock price. On their own, HFS's businesses would have generated 10% to 15% in annual earnings growth, analysts had predicted. That was decent, but certainly not the 20%-plus growth rate Wall Street had come to expect from Silverman. He knew if he could continue to deliver higher growth from a bigger company, he would be rewarded with an even richer price-earnings ratio. Joining with CUC would also help him counter fears on Wall Street that his company was vulnerable to a recession--discount buying clubs, after all, were seen as countercyclical.

For Silverman, now 59, the deal was also an exit strategy of sorts. In January, 2000, he was to move over to the post of chairman and hand the Cendant CEO reins to CUC founder Walter A. Forbes. Silverman and his wife of 22 years, Nancy, would be sending their teenage daughter off to college then. He envisioned a less frenetic pace, spending shorter workdays on long-term strategy and hunting for deals, no longer tied down with the headaches of managing a huge company. There would be more time for tennis, indulging his love of historical novels, and relaxing in South Florida, where the couple was hunting for a new home. "He'd have some time to enjoy the fruits of his business career," says Nancy.

That plan, of course, evaporated in April, 1998, along with nearly $13 billion of Cendant's market capitalization. That's when New York-based Cendant first uncovered massive improprieties in the former CUC. A subsequent investigation by Cendant's audit committee revealed that CUC executives had used a variety of "irregular" accounting entries to inflate earnings before charges by $500 million over three years. Errors jacked up earnings an additional $200 million. Forbes resigned from Cendant in July, 1998. Through a spokesperson, he declined to comment on any aspect of this story.

For Silverman, the personal toll was heavy. "My own sense of self-worth was diminished," he recalls. Close friends worried that his anger would consume him. Darla D. Moore, co-manager of Goff Moore Strategic Partners LP and wife of billionaire investor Richard E. Rainwater, recalls a dinner shortly after the scandal broke. She was seated next to Silverman, and as guest speaker Henry Kissinger got up to speak she looked at her friend, who seemed suddenly quite gray. "As bad as it seems, nobody has died," she leaned over to whisper to him. "But if you don't get some relief [from the pressure], you'll be the first to go."

Silverman has found ways to channel his rage. On the advice of his psychiatrist--he met with him twice--Silverman finds time to exercise every day, usually hitting the gym after work. But there is a professional goal that also keeps Silverman going: his quest for redemption. Although he claims to spend little time fretting about his legacy, friends say he is driven by the desire to rebuild his credibility. Money manager Frederick R. Kobrick, who had a short-lived deal in 1998 for Cendant to market his funds, recalls Silverman's words shortly after Forbes resigned: "Fred, I'm going to get my reputation back."

That won't be easy. While most big shareholders who were burned in the Cendant stock meltdown don't blame Silverman directly, many are critical of the due diligence he did before the CUC merger. How, they wonder, could the master dealmaker have failed to detect such a massive problem? Others fault him for assembling an unwieldy board, and many still fume over the board's 1998 decision to reprice millions of worthless options for Silverman and other senior managers. Silverman insists that no amount of searching could have turned up fraud and that a large board was the inevitable result of the merger. He says now he regrets accepting the repricing.

While Silverman's reputation is far from rebuilt, his first goal--to stabilize Cendant--has been achieved. He sold 18 noncore assets to help finance an aggressive $3 billion stock repurchase plan. Cendant's operations today are centered around hotel and real estate franchises, along with the discount buying clubs and other services such as tax preparation. Silverman also sought to swiftly settle a wave of shareholder lawsuits. The result: a preliminary deal on Dec. 7 to pay $2.83 billion to settle nearly all of the litigation. Cendant did not admit any liability.

Although the scars are still fresh, there are signs Silverman is regaining some of his old swagger. The most obvious example is the deal he struck in December for Liberty Media Corp. to buy $400 million of Cendant stock and warrants. Liberty will work with Silverman's team to expand the reach of Cendant's brands on the Web. Silverman sees the partnership with Liberty Chairman John C. Malone as a vote of confidence in his leadership from a notoriously tough investor. "We don't need the capital," Silverman says. "We need the credibility." Sure enough, investors responded to the legal settlement and the Liberty deal by bidding Cendant's stock price up to more than 26 in late December, from a 52-week low of 14 9/16 the month before.

But Cendant still faces daunting challenges. For one thing, analysts warn that the company may see slower growth this year in a number of businesses, including the mortgage operation, where higher rates have slowed originations and squeezed margins. That's the biggest reason why Cendant's stock has settled back down to about 18. Investors also may have been spooked by an announcement that Silverman will begin exercising 7 million options that expire in 2001--and he hasn't said whether he'll hold or sell those shares. Meanwhile, Silverman is having to play catch-up on the Internet, where he wants to build Web sites to drive customers to his brands. The bottom line: Cendant's earnings before interest, taxes, and depreciation--including losses generated by its new real estate Web portal--should rise just 4%, to $1.8 billion, in 2000, says Morgan Stanley Dean Witter analyst Michael Happel. Revenues will likely be down 11%, to $4.8 billion, he says, because of the asset sales.

Silverman is bent on convincing investors the company can still take off. He says it is not too late to make up lost ground on the Net, and he expects that his diverse holdings and ability to gain market share will offset any impact from a slower housing market. To spread the word, he set out in February on a two-week road show, visiting about 50 current or potential shareholders.

"ONE-TIME MISSTEP." As he makes the rounds, Silverman's certain to get questions about whether he will ultimately sell off Cendant, a move some investors believe is likely. Silverman clearly listens to what investors have to say. The Liberty deal, for example, came after David Siminoff, analyst at Cendant investor Capital Research & Management Co., suggested that Silverman talk with Malone. "It may be impossible for Henry to regain the luster he had in the go-go HFS days," says Craig Bibb, managing partner at Jasper Funds, a Cendant shareholder. "But if he can get Cendant's stock price moving again, investors are likely to view the CUC deal as a massive, but one-time, misstep."

If Henry Silverman once thought he could escape the day-to-day grind, it's a dream long departed. Cendant's top 10 executives have gathered in November, 1999, at the midtown offices for their monthly meeting. After Stephen P. Holmes, head of Cendant's travel division, discusses his unit's operations, Silverman zeros in on one figure: revenue per available hotel room. The figure is declining for the industry as a whole. But Holmes's data shows it trending above budget for some Cendant chains. Good news, right? It doesn't sit right with Silverman. He grills Holmes for several minutes, but the executive can't explain it. Later, Holmes does some digging and determines that a new computer system that more accurately captures revenue figures--not a shift in business fundamentals--is responsible. He fills in his boss during their daily phone conversation, which Silverman prefers over e-mail or memos. "If you don't call him," Holmes says, "he'll call you."

Silverman is a study in contrasts. Formal, almost aristocratic in his bearing, he favors monogrammed shirts and a plush office that's sprinkled with Georgian antiques. But his speech is blunt, with a manner more like a street fighter than the prep school-educated son of privilege that he is. The Silvermans are regulars on the New York social circuit, with close friends like GOP fund-raiser Georgette Mosbacher.

But Silverman is hardly gregarious, with wife Nancy making sure they can cut out of most parties by 10:30 p.m. To let his hair down, Silverman sometimes holds poker games when he's on the road with his management team. "There is nothing people like more than to take a couple hundred dollars off the boss," he says. His biggest passion is the New York Yankees, viewed from a box seat at Yankee Stadium. Silverman's dream as a kid was to play center fielder for the team. "But my skill didn't match my ambition," he notes.

Instead, he took an early interest in his father's world of business. Herbert R. Silverman, now 87, was CEO of the commercial finance company Talcott National Corp. The elder Silverman recalls taking his teenage son on a business trip when, after one presentation to analysts, Henry quizzed him on why he had said certain things. "For a 15-year-old, it was amazing," he says. Silverman's own drive seemed to stem from the desire to emerge from his father's shadow. "You want to be recognized for what you achieved rather than what your parents achieved," he offers.

Family connections didn't hurt Silverman's early career. After graduating from the University of Pennsylvania Law School in 1964 and a stint in the Naval Reserve, Silverman's father got him a job as assistant to Steve Ross, who was building what would become Warner Communications. Silverman later went to the investment banking firm White, Weld & Co. He first drew Wall Street notice in the 1980s as a sidekick to corporate raider Saul Steinberg at his Reliance Group Holdings Inc.

There was no denying Silverman's knack for good timing. While at Reliance, he snatched up the Days Inns of America Inc. hotel chain in 1984 in a $600 million leveraged buyout. Silverman managed to sell it in 1989, at the peak of the hotel market, for $765 million. Days Inns, saddled with heavy debt, filed for bankruptcy two years later. And Silverman, now with HFS, walked back in and bought it a second time--minus some real estate and a mortgage portfolio--for just $259 million.

Still, he was always playing second fiddle to people like Steinberg and Stephen A. Schwarzman and Peter G. Peterson, founders of the investment banking firm Blackstone Group, where Silverman worked. So when he began building HFS in the early 1990s, Silverman didn't generate tremendous industry buzz. "He was more of a walk-on," says John W. Ballen, portfolio manager of MFS Emerging Growth Fund, who bought into HFS's initial public offering in 1992.

That made the later success of HFS all the sweeter. Silverman cobbled together a franchising powerhouse that included hotel brands Howard Johnson and Days Inn, real estate brands ERA and Century 21, as well as mortgage origination services. The company was light on hard assets--HFS didn't own the hotels or the local broker's office. But the result was a cash machine. Helped by Silverman's rapid-fire dealmaking, HFS posted years of stellar earnings growth. Its shares soared from a split-adjusted IPO price of 4 in late 1992 to 77 7/16 at the time of the merger with CUC. That 1,836% increase dwarfed the 120% rise in the Standard & Poor's 500-stock index over the same period.

Silverman was finally front and center, winning nonstop accolades from investors. "He was golden," says Lawrence Auriana, portfolio co-manager of the Kaufman Fund. For Silverman, the wait had been worth it: "It's like a guy who is 40 years old being asked to pitch the opening game of the World Series, and he pitches a shutout."

CHUMMY BOARD. But four months after closing the deal with CUC, that streak came to an abrupt end. At an Apr. 9, 1998, meeting, two CUC accountants made a stunning disclosure to Cendant's then chief financial officer, Michael P. Monaco. According to an investigation by Cendant's audit committee, the accountants outlined adjustments that CUC managers made to inflate 1997 results. Monaco, who now runs the company's direct marketing operation, called Silverman to deliver the bad news. His initial response was disbelief. Nancy Silverman recalls: "He got a knot in his stomach, but I think in his heart he thought there is something somebody isn't seeing, that this can't be."

That weekend the Silvermans celebrated Passover with Apollo Advisors founding principal Leon D. Black's family in Bedford, N.Y. Silverman couldn't eat and had a hard time sitting still. "He was uncharacteristically green and very quiet," Black recalls. Silverman knew the accounting problems would have to be disclosed and that the market's reaction was likely to be swift and brutal. "I knew a firestorm was descending on me at warp speed," Silverman says.

It turned out to be worse than that. Late on Apr. 15, Cendant put out a press release saying that 1997 earnings before charges were overstated by as much as $115 million and that the company might have to restate earlier results as well. The next day, the stock plummeted more than 46%, to 19 1/16. But a subsequent investigation by Cendant's audit committee revealed the accounting irregularities were larger than originally thought and that 1997 earnings would have to be cut by $245 million after taxes. By early October, the stock was at 7 1/2.

Plenty of investors who saw their stock crater believe that Silverman bears some responsibility for the Cendant fiasco. Some question whether his team did adequate homework on the CUC deal. "Obviously, the due diligence wasn't sufficient," says MFS's Ballen, who still holds Cendant stock in his Emerging Growth Fund.

But Silverman rejects charges that he was remiss. "I'm not defensive about the due diligence we and our advisers and other professionals performed," he says. "The fact is that no amount of diligence would have discovered the fraud." Sources close to Cendant say that because the deal was structured as a merger of equals, neither side had the leverage to demand unfettered access to each other's books. Silverman's team did ask for certain nonpublic financial information, including figures on the profitability of each of CUC's buying clubs, the sources say. But CUC execs argued that if the deal fell through, that could give HFS an advantage.

In the wake of the scandal, Silverman and the Cendant board came under fire. Detractors charged that the Cendant deal resulted in a huge board heavy with directors who had had business ties to Cendant or Forbes. Silverman says the 28-member board came about because he didn't want to remove any HFS directors and in a merger of equals, both sides needed equal representation. Did he think the directors were too chummy with management? "No one complained about corporate governance when in five years [HFS] stock went from $4 to $80," he counters.

Many investors were also irked by the board's decision to reprice 17.2 million of Silverman's options to his benefit in September, 1998. Although he can't exercise all of them until 2002, at Cendant's current price Silverman's new options have a market value of about $85 million. True, one-third of Siverman's options were revoked in the repricing, and a third were only exercisable at more than twice the share price at the time. And while all of Silverman's original options were completely vested, the repriced ones vest over several years. Still, many investors felt the action had a let-them-eat-cake quality. "That was egregious," says New York State Comptroller H. Carl McCall. New York owns about 2.5 million shares. Brian Mulroney, the former prime minister of Canada who serves on the Cendant board and was on the compensation committee when the options were repriced, says the move was made in order to retain Cendant's management team. "We did what was in the interest of shareholders," Mulroney says.

Still, shareholders exacted some retribution in the settlement of their lawsuit. Under the terms, Cendant agreed that a majority of board seats will go to independent directors, directors will be elected annually, and future repricings will be approved by shareholders, among other changes. Silverman now admits it was a mistake to accept the board's repricing: "I should have said, `Thank you very much, but I'm turning this down because I will become the lightning rod for this issue.' And I was."

It is a Tuesday morning in January, and Silverman is being put through his paces by Rufus Graham, a personal trainer. As Silverman does a series of sitting chest presses, Graham stands over him barking like a drill sergeant. "Drop your shoulders. Breath out. Use your weight. Come on, you're in control." Later, during a break, Graham is boasting about the change in Silverman's condition since he started training. His bench press, for instance, has risen from 65 to 150 pounds. "It's not fun. It hurts," Silverman says. "But you like the results."

The physical makeover has been almost as grinding as the overhaul of Cendant. Every day, Silverman puts himself through some physical exercise, be it weightlifting, aerobics, or tennis. "It was like he was preparing for battle," remarks Richard A. Smith, CEO of Cendant's real estate division.

In a sense, he was. One close friend, who spoke not for attribution, says Silverman's anger at the former CUC management sometimes reached the point of "fixation." While he won't speak of Walter Forbes directly, those close to him say Silverman has only contempt for his onetime partner and his team. Every senior manager in the former CUC's Stamford (Conn.) offices has been replaced. Attorneys for several CUC executives did not return phone calls, or declined to comment. A lawyer for former CUC President and Cendant Vice-Chairman E. Kirk Shelton said his client did not participate in and had no knowledge of any accounting irregularities. Silverman, though, is clearly hoping the government investigation will result in indictments. "Somebody committed crimes here," he says. "We'd like to see those somebodies punished."

Sources close to Silverman say his anger also extended to outsiders involved with the deal. According to one Silverman ally, a once close friendship with Bear, Stearns & Co. Vice-Chairman Michael L. Tarnopol, a key HFS investment banker, was strained in the wake of the accounting blowup. Bear Stearns received a $30 million fee for advising on the merger, according to filings related to the deal. Silverman and Tarnopol declined to comment on their relationship. Bear Stearns would not comment on any aspect of the deal.

Silverman is also going after Ernst & Young, CUC's accountants. In January, 1999, Cendant filed suit, charging that the firm was grossly negligent in its audit of CUC. Ernst & Young has filed a countersuit, denying Cendant's allegations and contending that the company's "efforts to blame its own fraud on E&Y are spurious and wholly unfounded."

The stress led to a period of relative isolation for the Silvermans. They curtailed their social life in the year after the accounting scandal, reemerging only in late 1999. "We didn't have the heart to sit and talk about it," says Nancy Silverman. They spent a lot of time over the past two summers at a house rented from Mosbacher in Southampton, N.Y. It was a refuge against the waves that would batter Cendant.

The first was Russia's financial crisis in late summer of 1998, which triggered a flight to quality in the credit markets. Rates on Cendant's more than $3 billion in commercial paper jumped from about 5% to 5.3%. Things got worse in October when the company's debt ratings were cut. For a few days, Cendant could only borrow overnight in the commercial paper market. That meant Cendant was rolling over hundreds of millions of dollars in that paper daily. The company managed to cut back on its commercial paper borrowing by about $2 billion.

Silverman also had to scramble to keep the businesses he was trying to sell from unraveling. In September, 1998, he flew to the West Coast, meeting with employees at Sierra On-Line Inc., a software outfit that he wanted to unload. The situation was volatile. Richard K. Thumann, then Sierra's general counsel, says executives felt CUC, which had purchased Sierra in 1996, had mismanaged the integration of Sierra with other CUC software operations. Silverman let them vent, and then started hammering out new compensation packages--including small ownership stakes--that encouraged people to stay on. "He gave us the tools to hold that company together," Thumann says.

The asset sales continued into 1999, ultimately raising $4.5 billion. But while the December shareholder settlement removed a major uncertainty, there has been no rush back into the stock. Once CUC's massive accounting irregularities were reversed, it was clear the membership business wasn't the profit engine originally expected. So the cross-marketing bonanza Silverman had envisioned from driving HFS customers to those clubs won't provide much of a payoff. Higher interest rates will hurt, too.

"They've had the wind at their backs with a booming housing market for the last few years," says Morgan Stanley Dean Witter's Happel. "In the next year or so, it will be in their faces."

It's almost like the good old days. On Dec. 16, 1999, Silverman is heading into New York to appear on CNN's Moneyline to talk about his favorite subject: deals. Cendant announced earlier that day that Malone's Liberty Media was investing $400 million. Malone personally will buy 1 million shares and join Cendant's board. Traffic is snarled heading into the Lincoln Tunnel, but Silverman seems not to notice. He's energized, talking about the possibilities the Liberty deal offers and the congratulatory calls he has gotten from some big investors. Their enthusiasm is easy to understand: Cendant stock jumped 40% on the news. "I haven't had calls like that in 20 months," he says.

Silverman is betting the Liberty deal will help Cendant make up ground on the Net. "They really fell behind," says Seema Williams, senior analyst with Forrester Research Inc. Liberty will work with Silverman's team to exploit a number of Web possibilities. That could include delivering broadband services built around Liberty's cable networks--such as the Travel Channel unit of Discovery Communications Inc., which is 49% owned by Liberty--to the millions of customers Cendant reaches through its hotels and time-share resorts. "The stock price was down, and he has great assets," says Liberty CEO Robert R. Bennett. "I would imagine there are all kinds of things down the road that we can do."

Silverman envisions a host of other Web connections. Cendant is building a real estate portal dubbed move.com. The site, featuring services from house-hunting to furnishing a new home, was launched on Jan. 27, and Cendant plans to issue a tracking stock in April. But it faces tough competitors, including Homestore.com Inc. and MSN HomeAdvisor. Cendant also has the option to take a big stake in Netmarket, the struggling Internet shopping service it spun off last year. But for that stake to pay off, Netmarket's management must cut the unit's high member turnover and improve its performance.

Given the challenges Silverman faces, some Cendant watchers think he may not be done selling. Cendant's stock has not recovered enough for him to resume a major buying spree, but he clearly wants to redeem himself in shareholders' eyes. "If there are pieces they can sell for high multiples, I'm sure they'll consider that," says Bibb at the Jasper Funds. Others say they wouldn't be surprised to see Liberty buy all of Cendant. Cendant and Liberty declined to comment. But Silverman doesn't get emotional at the thought of selling a piece, or even all, of Cendant. "If somebody wants to make a fair offer, fine," he says. "But if someone wants to steal the company, we'll fight fiercely."

Indeed, Silverman's friends say he has recaptured much of the old bravado. Last fall, Michael A. Leven, who worked for Silverman at Days Inns and now heads competitor U.S. Franchise Systems Inc., stopped by Cendant's office to see how his former boss was holding up. When Silverman walked into the room, he smiled broadly and challenged his visitor: "Are you here to buy or are you here to sell?" "Well, Henry," Leven said, "I guess you're back." Now, Silverman just has to prove that to Cendant's battered investors.

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