Return to Cendant: Cendant's Second Chance

Value players hunt for upside in the one-time go-go darling.
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Editor's note: This column is part of a three-day series on Cendant, running April 14 through April 16. An overview details

TSC's

coverage.

Who woulda thunk it?

If someone had proposed that

Cendant

(CD)

-- the go-go, mo-mo stock of early 1998 -- would be a value play by the following year, they would have been dismissed as quickly as Columbus, Galileo or Namath.

Despite the radioactive glow around Cendant, analysts and fund managers who'll be quoted on the company -- and there are still plenty who won't -- say that underneath the turmoil of reorganization, its fundamentals look pretty darned good. That's a dangerous idea to be floating about a company that almost single-handedly whacked the 1998 returns of many professional money managers after accounting fraud nearly halved the stock price in one session.

"If you cut through all the clutter of nonrecurring items, its core business is performing quite well," says Rob Nicoski, an analyst with

U.S. Bancorp Piper Jaffray

in Minneapolis, who rates the stock a buy and has a price target of 26. "It's the classic show-me stock." (His firm hasn't done underwriting for Cendant.)

And while Cendant may not regain its former status as

the

aggressive momentum stock of the moment, the company's new focus and emphasis on internal growth mean its shares seem set to rise as investor confidence returns. But that hasn't happened, at least not yet: Shares have fallen 15% since Cendant released its fourth-quarter results in February.

Tim Ghriskey, senior equity portfolio manager with

Dreyfus

, doesn't think the hazy conditions will endure. He says he loaded up on Cendant shares after the stock stabilized. "Where it's trading now, it's at a big discount," he says. "On a sum-of-the-parts analysis, it's worth in the mid-20s." Dreyfus held 5.2 million Cendant shares Dec. 31, according to

Technimetrics

.

After the crisis, Cendant decided to change strategic hats: It got off the acquisitions trail, launched a $1.4 billion share buyback, sold off assets worth $1.3 billion and said it would focus on growing four areas: travel, real estate, alliance marketing and other business services.

Real estate, which includes brokers, relocation and mortgages, proved to be the star of the bunch, driving growth in the fourth quarter. Cendant's

Century 21

,

ERA

and

Coldwell Banker

units are among the five largest real estate brands in the U.S., commanding about 20% of the overall market. And its mortgage unit saw cash flow triple in the fourth quarter.

Meantime, the company can leverage its existing base by passing customers from one brand, like relocation services, to another, like mortgages, says Bill Moore, senior analyst with

Forum Capital Markets

in Old Greenwich, Conn. (His firm hasn't done any underwriting for Cendant.)

Cendant's travel business consists of hotel franchises like

Days Inn

,

Howard Johnson

and the U.S.

Ramada

hotels, as well as

Avis

car rental franchises, a timeshare unit and vehicle management. It saw cash flow grow 12% in the fourth quarter.

But both the hotel and real estate industries have their question marks. The real estate market, after several heady years, is expected to slow, making it essential for Cendant to pick up market share. And the hotel industry may be facing overcapacity.

Goldman Sachs

analyst Steven Kent, in a recent report on the industry, said he expects "the hotel companies will show tepid results in the first quarter and the share performance will be lackluster at best." (Cendant is on Goldman's recommended list -- its highest rating -- and Goldman has performed underwriting for the company.)

The bulls argue that because Cendant is a franchiser, instead of an owner, of hotels, it's somewhat insulated from market slumps. In fact, lower occupancy and room rates might spark independent operators to convert to one of Cendant's midpriced or economy brands to get marketing clout, name recognition and access to centralized reservation systems, says Nicoski.

In its alliance marketing business, where the accounting problems originated, membership revenue climbed 31% in the fourth quarter. The company's databases of names are extremely valuable, say investors. "They have such great access to a huge number of customers that they can sell that access to other people," says Moore. Earlier this month, Cendant said it will turn its sights on the entertainment industry, offering Hollywood producers the chance to promote their latest films, for example, to customers waiting on hold at a hotel that's part of the Cendant franchise.

There is a hitch, though. "The pace of membership enrollment wasn't up to the Street's expectations. It didn't meet the extrapolated growth curve of some of the more

growth-oriented investors," says Robert Littell, value fund manager with

Marque Millennium

. Despite the question of membership growth, he's picked up 200,000 Cendant shares within the past six months, he says.

The company also is proposing to sell three of its Internet properties --

RentNet

,

Match.com

and

Bookstacks

(including

Books.com

) -- to better focus on its Internet membership businesses like NetMarket. Cendant management is "is practical about their approach to the Internet, and they're not growing it to the detriment of overall earnings," Nicoski says.

Ah yes, earnings. Thanks to a raft of special charges related to reorganization and the fraud, Cendant's balance sheet is still a pain to get through. In February, the company reported a fourth-quarter loss from continuing operations of $302 million, or 36 cents a share. In the year-earlier period, the company lost $181 million, or 22 cents a share. Revenue, however, climbed 29% to $1.4 billion.

Earnings are likely to be back-end-loaded in 1999, since first-quarter comparisons will be hurt by changes in how it accounts for membership revenue and by a one-time gain last year. First-quarter earnings are due out April 21, the company says, and it is comfortable with full-year earnings estimates from $1.04 to $1.10 per share. (Because the earnings report is set to be released next week, Cendant executives said they wouldn't comment further for this story.)

And there are other issues still hanging over Cendant stock. There's pending litigation by common shareholders, for one. The company has already taken a $228 million fourth-quarter charge to settle a class-action lawsuit brought by the holders of PRIDES securities -- which oblige holders to buy common stock -- that were issued months before the blowup. Fund manager Ghriskey notes, however, that the company has plenty of insurance, which should substantially reduce the financial burden of lawsuits.

There are other problems for the company's supporters. Half of the 14 analysts who tracked Cendant in March 1997 have dropped coverage, contributing to a lower profile for Cendant stock in the brokerage community. "The institutional guys don't want to have egg on their faces," says one

Morgan Stanley Dean Witter

broker. "You can burn them once, but not twice. Even if Cendant comes out with a good quarter,

institutions don't care about the numbers, and that's usually all they care about."

The company also didn't win many fans when it repriced options for senior management, something it said was necessary to retain talent. Maybe so, says Forum Capital's Moore, but "people look at

CEO Henry Silverman and wonder, 'Why can't I reprice my stock?'"

It will take several more quarters of solid earnings growth before investors come back to the stock in numbers, analysts say. "It was a momentum stock for a momentum player," says Moore. "It needs to find a new value base of investors or reprove itself as a momentum play."