Online Extra: Why Cendant Is Resurgent
By Amy Tsao and Amy Barrett
Since the late 1990s, many investors have steered clear of travel and real estate services conglomerate Cendant (CD ). A massive accounting fraud uncovered at CUC International, a company it merged with in 1997, sent Cendant shares sharply lower. The CUC execs resigned in 1998, and Cendant sold nearly all of CUC's business. But it seemed as though the scandal still hampered the stock's performance, despite respectable growth in earnings and revenue.
Lately, though, investor sentiment appears to have shifted in Cendant's favor. Part of the reason is the concerted effort over the past two years to make its financials more transparent. The New York City-based operator of Avis car-rental agencies, Days Inn motels, and Century 21 real estate brokerages brought at least a half-dozen off-balance-sheet items back onto the books, including its highly leveraged vacation time-share financing division.
Cendant, which reported net income of $1.2 billion on revenues of $18.2 billion in 2003, also promised it would take a break from aggressive acquisitions -- the primary means by which it has grown the last several years. "The overarching objective was to prove that Cendant was capable of driving organic growth in its operating units and was more than an acquisition-driven company," Ronald Nelson, Cendant's CFO, said in a recent BusinessWeek interview. Those efforts have resulted in Cendant landing at No. 2 on the latest BusinessWeek 50 rankings of the country's top-performing companies.
Investors like what they see so far. Cendant stock has risen 82% over the last 12 months, to around $23 lately, while the broader market has increased 35% in the same period. And with economic conditions improving, the cyclical travel and hospitality segments are likely to gain momentum. That should help offset a potential slowdown in Cendant's mortgage-financing business, which likely will decline when interest rates start to rise.
The conglomeration's mix of businesses in which one strengthens just as another weakens is appealing to many investors. "It has terrific hedges everywhere you look," says George Foley, portfolio manager at Philadelphia-based Glenmede Trust Co. (Foley owns the stock personally, and it's also a holding at Glenmede.)
Many analysts say they're confident Cendant can continue to gain ground even after the strong showing of the past year. The pros figure that as Cendant's businesses keep growing and management's credibility continues to improve, the stock should command a higher price-earnings ratio than its current 12.5 times consensus 2005 earnings per share of $1.83.
Foley sees a forward p-e of 14 or 15 as earnings grow in the range of 12% to 15% in the coming years. And he sees the stock hitting $29 within the next 18 months. Similarly, Dimitri Kuriloff, director of research at New York City-based Capital Management Associates, expects the stock to gain at least 13%, to around $26 to $28, in the next six months. (The stock is a holding at Kuriloff's firm.)
If the U.S. can avoid terrorist attacks, investors are betting that 2004 will be a strong year for travel-related businesses, which account for half of Cendant's total revenues. Travel in 2003 was "soft," says Nelson, but he figures earnings before interest, tax, depreciation, and amortization (EBITDA) at hospitality businesses, making up 14% of revenues and including hotel franchises like Super 8 and Howard Johnson and time-shares, will be up from 10% to 20% this year. The signs are there, Kuriloff agrees. "We've seen luxury hotels starting to raise prices, and when the big guys come back, they [pull] everyone along," he says.
The biggest source of earnings growth within travel will be the vehicle-services business, which makes up about 32% of revenues and includes car rentals and the fleet-management business. Since late 2002, after Cendant bought almost all of the assets of bankrupt Budget, the parent has been integrating the Budget and Avis operations. "This year, we will see the benefit of synergies formed last year," Kuriloff says. Nelson expects EBITDA for vehicle services will rise 40%, to between $600 million and $650 million this year.
Cendant also continues to shed noncore businesses. It said in mid-March that it plans an initial public offering of Jackson Hewitt, its tax-preparation business. Standard & Poor's analyst Tom Graves figures that could raise $675 million. Since Jackson-Hewit is a small part of sales and not a critical business, Graves says he expects the IPO would be worth it -- despite the dilutive effect on earnings -- because the proceeds will likely go toward paying down debt. (Graves doesn't own the stock, and S&P doesn't provide banking services.)
Cendant is focused on debt reduction, predicting that it can pay off $2 billion this year, or a third of its total. That would make it far less leveraged, with a debt-to-capital ratio of 25% by yearend 2004, compared to 43% in early 2003. Others are taking comfort in a share-buyback program and a newly instituted dividend payout. "These make for good return on investment for the investor," Foley says.
Cendant still has room for improvement. The promised selling of its various services across divisions has yet to really take off. "If they make [cross-marketing] work, it becomes very positive," Kuriloff says. And Cendant is strengthening what had been perceived as weak corporate governance.
REAL ESTATE: FLAT?
Still, CEO Henry Silverman's pay remains "outlandish" relative to Cendant's performance, says Kuriloff. Silverman's 2003 pay totaled close to $23 million, not including stock options. "That's my biggest complaint," Kuriloff says. "Silverman's compensation is a reflection of the board [of directors'] respect for his vision, business model, and management skill," responds Len Coleman, presiding director and chairman of the board's compensation committee.
That skill likely will be needed again in 2004, especially in the real-estate units, which account for a third of revenues. Higher interest rates in the second half could bring mortgage-financing revenues down by up to 24%, Cendant predicts, even though other real-estate services could turn out a small gain. Near-term operating profits for real-estate services should be flat to somewhat lower in 2004, Cendant says.
A pickup in travel could keep Cendant growing at a decent clip. More important, it seems this scandal-tainted but solid company is taking a lot of the right steps to return to the good graces of investors.