Keep It Simple, Cendant
Cendant Corp. (CD ) Chairman and CEO Henry R. Silverman recently got a rude reminder that investors hate surprises. On Sept. 25, Cendant, the New York-based travel, real estate, and financial-services concern, announced that its mortgage-servicing unit was taking an aftertax charge of $175 million, gutting third-quarter earnings. Why? Thanks to the current refinancing wave, many of the mortgages on which Cendant collects servicing fees have been prepaid, forcing the costly write-down.
The market's response wasn't long in coming: By day's end, Cendant's stock plunged 13%, to $11.25. But nasty surprises aren't the only thing dragging down Cendant, which traded at around $20 in December. After a year of corporate and accounting scandals, investors have also turned bearish on companies such as Cendant--a deal-driven conglomerate with a complex web of businesses whose individual performance is difficult to assess. "The market doesn't like acquisition-a-day companies anymore," says Gregory L. Jackson, portfolio manager at Harris Associates LP, which held 14.3 million Cendant shares as of mid-year. "People are craving simplicity."
Unfortunately, simplicity was never Silverman's forte. Through a string of deals over 12 years, he built a diverse roster, including such brands as the Howard Johnson and Days Inn hotel chains, real estate brokerage Century 21, and Avis rental cars, as well as travel reservations operator Galileo International and a hodge-podge of financial services, including tax preparation and insurance. Silverman's rationale: Such diversity produces stable but solid earnings growth. He argues that Cendant's two primary businesses, travel and real estate, make sense together, for example, because when the business cycle drags one down, the other is usually up.
While investors initially cheered, they now want him to halt the acquisitions. For starters, not everyone is convinced the fit is right. Legg Mason Wood Walker Inc. analyst Thomas S. Underwood, for one, argues Cendant is unlikely to find big synergies in the travel business with Galileo, which Cendant bought for $1.9 billion last October. If the reservations service favors Cendant's franchised hotels or car rentals, Underwood says, it may alienate potential customers.
Just as important, deal-weary investors today would prefer Silverman pay down Cendant's $5.2 billion in debt and buy back shares. Stripping out the external boost from acquisitions, they argue, would provide a clearer view of how strong profit growth and cash flow are at the various Cendant units, which this year are expected to earn $1.3 billion on revenues of $14.2 billion.
But a clearer view alone may not quiet the critics. Cendant's stock is now trading at a price-earnings ratio of just under 7, based on projected 2003 profits of $1.7 billion. Even embattled Tyco International Inc. is trading at 7.6 times forward earnings--a sign of how skeptical Wall Street has become of Cendant. Some now argue that Silverman may eventually need to break up of the company if the stock weakness persists. Lehman Brothers Inc. analyst Jeffrey T. Kessler, for one, says Silverman may need to separate its travel and real estate businesses if the stock continues to lag the underlying value of Cendant's various units, which most analysts estimate in excess of $20 a share. But Kessler argues that should happen only if Cendant's units can be capitalized to receive an investment-grade rating that would allow them to borrow at competitive rates.
For his part, Silverman insists a breakup is not on the agenda. But he appears to be listening to his critics. After closing a string of deals worth $3 billion in the past 12 months alone, he says he's curbing acquisitions for now. To improve transparency, he paid $230 million earlier this year for a real-estate brokerage firm that was previously part of an off-balance-sheet entity. And Silverman says Cendant plans to sell its financial-services unit, which lacks competitive advantage.
Having survived a near-meltdown of the company after accounting irregularities surfaced in the wake of the 1997 merger of Silverman's HFS Inc. and consumer-services company CUC International Inc., Silverman clearly wants to prove the Cendant model works. While he made his name as a dealmaker, Silverman has to show once and for all that he's also a solid operator.
By Amy Barrett in Philadelphia