Conseco Hurtles Zeroward as Cash Crunch Mounts

Short of cash to pay off its debts, Conseco (CNC) has apparently resorted to conjuring it out of thin air.

The battered lender and insurer reported third-quarter operating earnings Tuesday that met its recently lowered forecast, while warning that fourth-quarter profits would fall short of analysts' expectations. But earnings numbers mean little to investors at this point in Conseco's decline. Cash flows and debt dominate the story, and fears that a liquidity squeeze will strangle Conseco have driven the stock down 80% in the space of just six months.

"The company's liquidity continues to raise a solvency issue," says Colin Devine, a Salomon Smith Barney analyst who has been critical of Conseco (his firm hasn't recently underwritten for the company). "We continue to urge investors to sell the stock."

Conseco, which didn't immediately return a call seeking comment, has set a 1:30 p.m. EST conference call to discuss the results. The stock was off 9 cents Tuesday at $3.95, just above its 52-week low of $3.77.

Crunchier?

Recognizing the concern that Conseco won't have enough cash to make $1.39 billion in 2002 debt payments, CEO Gary Wendt sought in Tuesday's earnings release to show investors where the necessary funds will come from. Problem is, Wendt ends up showing that Conseco's core businesses can't be relied upon to produce $1.39 billion in cash. As a result, he says as much as $410 million will come from a source mysteriously named "cash generation options, as necessary." He lists these options as: "Changes to operations, reinsurance and co-insurance, refinancing, noncore asset sales, noncore business line sales and other capital market alternatives."

Running Out of Patience Investors send Conseco stock lower

Sure, in theory, these types of activities could raise cash. But Conseco has spent the last 18 months doing many of these activities and has still ended up struggling to pay its creditors. How much more can the company do? How many buyers are out there for assets Conseco wants to sell? Recall that Conseco admitted earlier this month that it couldn't sell its major medical insurance business.

What's more, Wendt's cash production estimates for core businesses are irresponsibly optimistic. He reckons Conseco Finance, the company's lending arm, can generate $310 million to $340 million, which is around the same amount that he forecast at the end of 2000. How can this number stay the same when bad loan losses, delinquencies and repossessions have all skyrocketed through 2001? Moreover, the estimate doesn't square with the recent announcement that certain loans sold by Conseco Finance will generate only $10 million in 2002, down from the original estimate of $120 million.

The insurance company's cash-generation target of $450 million to $500 million is also a stretch. Third-quarter results were weaker than second-quarter numbers across the board. Insurance regulator A.M. Best put Conseco's financial strength rating on watch for a downgrade earlier this month. If the rating is cut, brokers would write fewer Conseco policies. In addition, depending on their view of Conseco's financial standing, state insurance regulators may prevent the insurance arm from sending money up to the parent company, where the debt is held.

Drying Up?

One other notable number in the earnings release was the jump in certificates of deposit at Conseco's bank, which has been a major source of borrowing and liquidity for the company's credit card business. CDs rose $223 million from second-quarter levels to nearly $2 billion at the end of the third quarter. As Conseco's problems mount, investors may be less willing to lend money to Conseco by investing in CDs. And bank regulators may also call a stop if they think Conseco is in jeopardy.

The bond market is very pessimistic about Conseco's outlook. Bonds the company issued to great fanfare at the end of June are now trading at around 51 cents on the dollar, signaling the market's belief that default is likely. If that happens, debt holders would struggle to get their money back, and, of course, the firm's equity would be wiped out. Odd, then, that equity investors are still giving Conseco a market worth of $1.35 billion.

Barring a miracle, this stock is going to zero. And, as many of you Conseco bulls will recall, you heard it here first -- two years ago.

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