Cendant's Credibility Problem
Wall Street analysts have been saying for years that travel and real estate conglomerate Cendant Corp. (CD ) is undervalued. And for years it has only gotten cheaper. A 46% gap now separates Cendant's stock price from analysts' average price target, the widest of all of the companies in the Standard & Poor's (MHP ) 500-stock index, according to Bloomberg.
To bridge the chasm, Cendant announced in October that it will break up into four separately traded units: hospitality, real estate, travel distribution, and vehicle rental. Said Chief Executive Henry R. Silverman in the press release announcing the breakup: "The market has not fully recognized the value of the company....We and our advisers believe the sum of the parts has a value in excess of our current share price."
Investors believe otherwise. Since the breakup plan was announced, Cendant's shares slumped by as much as 19%, to around 15, a multiyear low.
Why the vote of no confidence? Management's credibility is declining by the day. If the stock's slide continues, Cendant might find relief only outside the public capital markets. "Going private," says analyst Carol Levenson of GimmeCredit, a New York-based debt research firm, "could be an increasingly attractive alternative."
To be sure, Cendant, a growth-by-acquisitions success story until it merged with a company riddled with accounting fraud in 1997, is dirt cheap by several measures. According to Thomson Financial (TOC ), its price-to-earnings multiple is just 13, compared with industry and market multiples of 30 and 20, respectively. Its price-to-cash-flow ratio stands at around a third that of rivals and of the broad market. And this for a company that threw off more than $2 billion in free cash last year from a portfolio that includes national brands Avis, Budget Rent A Car System, Century 21 Real Estate, Ramada, and Orbitz. Its valuation "cannot get much lower for a company generating this kind of cash flow," says David M. Stamm, an analyst at Johnson Asset Management, which holds shares.
The gap between Cendant's perceived value and the market's interpretation is baffling. Some Wall Street analysts are saying the stock price will rally at least 50% over the next year, once Cendant unlocks the supposed billions in hidden value. But traders who bet on such spreads haven't fully accepted that proposition. If the credit market believed in Silverman's rosy scenario, it would not have hiked Cendant's annual debt insurance cost by 20% in just one week in February. "There are many variables that impact the cost of credit default swaps, not the least of which is speculation in the marketplace," responded Cendant spokesman Elliot Bloom in an e-mail message to BusinessWeek.
Management hardly inspired confidence by issuing two earnings warnings since announcing the breakup. On releasing its fourth-quarter earnings in February, Cendant said it expected low-single-digit growth in earnings before interest, taxes, depreciation, and amortization (EBITDA) for 2006, far less than the previous guidance of 10% to 12% growth.
The reason for the lowered forecast? Tough times at Cendant's travel distribution and vehicle services divisions. Cendant announced a $425 million charge in its travel distribution business, chiefly to write off its disastrous $350 million purchase in 2005 of Ebookers, Europe's No. 2 travel Web site. In December, management said it anticipated a charge in the range of $200 million to $300 million. Cendant also spent more than $1 billion apiece to buy out Orbitz and Gullivers Travel.
"Billions of dollars in cash flow should have been returned to shareholders," says Tim Fidler, director of research at Ariel Capital Management LLC, which owns shares. Instead, the money went to expensive acquisitions. The company points out that it's installed new executives with substantial online-travel experience.
Cendant's real estate brokerage business also seems shaky as the housing market starts to cool. CIBC World Markets (BCM ) estimates that each percentage-point drop in sales volume or price in 2006 would strip a penny from Cendant's earnings per share. In the fourth quarter, notes Frank K. Lee of capital-structure research firm CreditSights, Cendant's real estate EBITDA dropped for the first time in four years. Writedowns could follow.
All of which, say doubters, is destabilizing Cendant's balance sheet. Goodwill, or the amount paid for an acquisition above the current market value, "is turning into bad will," says Lee. Excluding Cendant's assets under management -- chiefly its rental car operations, which are pledged against secured debt and therefore distanced from shareholders -- the company's goodwill of $12 billion at yearend 2005 actually exceeded stockholders' equity of $11.3 billion, Lee calculates. As Cendant writes down more, he explains, it is "dollar-for-dollar writing down what the company is worth." The charges, responds Bloom, "bear no relationship to the current market value of the company."
Against this backdrop sit the controversial pay packages of CEO Silverman, who founded the company's forerunner in 1990. He netted about $24 million in salary, bonus, and long-term compensation in 2004, after pocketing $23 million in 2003. For 2005, a year that saw Cendant shares fall 21%, the company awarded Silverman $22.3 million.
"People are upset at how Silverman has been paid, the performance that he has turned in," and ill-timed share buybacks, says one large investor. "The only people who lose are shareholders." Bloom disputes that Silverman is overpaid. "Henry Silverman's bonus is based on the operational performance of the company, not on the stock price," he wrote.
There is, of course, another way for Cendant to escape its troubles: the private-equity route, whether through a leveraged buyout or the piecemeal auctioning of assets to buyout firms.
Cendant is no stranger to private equity. Last year, Silverman, a former partner at New York-based Blackstone Group LP, sold the firm's marketing services division to private-equity firm Apollo Management LP.
Cendant's cash flow-centric businesses lend themselves to private-equity financial engineering. Avis and Budget, for example, could be valued richly after Hertz's $15 billion buyout last year. The recent buyouts of hotel chains La Quinta, Wyndham International, and Fairmont Hotels & Resorts cast a similar halo on the lodging operations of cendant, the world's second-largest hotel franchiser. "In hospitality and vehicles, it's a no-brainer for private equity," says Stamm. "Cendant has lower-end brands, but they generate a ton of cash flow."
Could Cendant be taken out in one fell swoop? Management half-jokingly threw out a $25 billion to $30 billion price tag in a recent conference call, well in excess of the company's total value of around $20 billion. "They obviously should entertain offers," says CreditSights' Lee. "But I don't think anyone in their right mind would spend $25 billion to $30 billion."
They might not have to. Private-equity firms could pay only half of Cendant's hypothetical asking price if its businesses keep deteriorating. Lee says that if the real estate and travel distribution markets keep declining, the company's stock could fall an additional 30% to around $11.68, implying an enterprise value of just under $12 billion. It is, he concedes, a worst-case scenario.
That would still be a big deal by private-equity standards. But it's possible if, say, corporate buyers agreed to buy two of the businesses and private equity bought the rest -- along the lines of the recent buyout of grocery chain Albertson's Inc. (ABS ). "I don't think size is a problem here," says Lehman Brothers Inc. (LEH ) tax and accounting analyst Robert Willens.
Roger C. Altman, the head of New York-based Evercore Partners Inc., which is co-advising Cendant on the breakup, dismisses the private-equity option, insisting that a buyout would be too big and that a piece-by-piece sale would be prohibitive tax-wise. He argues that the company's recent spate of bad news makes the four-way breakup plan all the more compelling for investors. "The value gain opportunity for shareholders in the split company is even larger with the stock decline," he says. Can cold comfort be written down?
By Roben Farzad and Amy Barrett