Net Play Carries Cendant and Sovereign

The whiff of an Internet strategy brings out the bulls.
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If it isn't the Internet again -- this time bringing a half-dead company back to life.

Options traders are learning that the Internet can resurrect the bad, the ugly or the simply mediocre. As one options trader cracked in a recent research piece: "I put .com after my mother-in-law, and now everybody loves her."

Cendant

(CD)

, which gets as much affection in the markets these days as the average mother-in-law gets everywhere else, benefited from rumors that the company might be acquired by Internet titan

America Online

(AOL)

. The story lost some steam Tuesday after a

Lehman Brothers

analyst put out a research note calling the buyout chitchat "farfetched," but some options traders kept busy buying calls for the second straight day.

The Lehman analyst, Jeff Kessler, did go on to say that, notwithstanding the overhanging shareholder litigation, there are "reasonable ventures or partnerships that the two companies might explore."

Options investors took Kessler's words to heart, and the August 25 call options on Cendant gained 1/4 ($25 per contract) to 5/8 ($62.50) on volume of 2,500 contracts, compared with open interest of 826 contracts. Cendant stock, meanwhile, was down 3% to 16 9/16.

On Monday, the same AOL-Cendant rumor drove volume in Cendant's April 20 calls to almost 3,000 and its May 17 1/2 calls to a volume of about 800.

Cendant was formed by the merger of membership retailer

CUC International

, which ran membership businesses such as discount clubs, and

HFS

, a brand franchiser. It owns such highly recognizable names as the

Coldwell Banker

real estate company,

Avis

rental cars and

Ramada Inn

hotels.

A year ago, Cendant's stock plunged nearly 50% on word that accounting irregularities had been found at the former CUC unit. Cendant later reported discovering three years' and $600 million worth of fictitious sales and earnings. Numerous shareholder lawsuits are pending, as are investigations by the

U.S. Attorney

in New Jersey and the

Securities and Exchange Commission

.

But the Internet ether has somehow tranquilized the market to those realities. In sum, Kessler posited, probably no takeover will materialize, but "partnerships, joint ventures, possible subsidiary acquisition -- yes." Moreover, it's unlikely that AOL would want to take on the potential liability of Cendant's class-action lawsuits.

AOL, he added, "would be attracted to 100 million users of Cendant's various business franchises and services," among them Internet businesses such as

rent.com

(apartment rentals);

match.com

(dating); and

Bookstacks Inc.

(books, recorded music), "as well as over 30 million individual memberships."

Cendant, for those without the historical background, "has been a takeover rumor for a while, but today's activity is nothing unusual compared with the past few months," said Todd Salamone of

Schaeffer Investment Research

.

The Internet ionosphere combined with Lehman's remarks also helped juice options in

Sovereign Bancorp

(SVRN)

, a mid-Atlantic regional bank.

Sovereign management spent Monday in Boston on a Lehman-sponsored marketing trip and has scheduled a meeting with sell-side analysts to discuss its "strategic direction," Kessler wrote. "Rumors are flying that the company may be gathering analysts together to more fully describe the direction of its Internet strategy."

These factors are pushing the action in Sovereign's call options. Its July 17 1/2 calls gained 3/8 (or $37.50 per contract) to 2 1/8 ($212.50) on volume of 526 contracts, compared with open interest of 248. The stock crept up 1/4 to 16 1/8.

Not too shabby for a small regional bank based in Wyomissing, Pa., with 300 retail commercial banking offices in eastern Pennsylvania, New Jersey and northern Delaware. Regional banks have taken on a certain luster with investors because of the ongoing consolidation within the sector. That typically is enough to get speculators going.

This time, the Net business rumors added some momentum as well. Kessler said: "If management does articulate a well-thought-out Internet strategy tomorrow, all these initiatives combine to make Sovereign a more valuable acquisition target" with potential for earnings growth in the mid-teens.

"The Internet speculation run-up misses the real story here," Kessler went on to say in his note. "On the deposit and fee income side, Sovereign continues to make itself more valuable to its banking customers."

Kessler was on a conference call and wasn't immediately available to comment on his Cendant/Sovereign research note, put out on

First Call

Tuesday morning.