Return to Cendant: Things Fall Apart

The company is trying to pick up the pieces, but the credibility gap lingers.
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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.

Late one April afternoon a year ago, a headline flashed red about accounting problems at

Cendant

(CD)

, and phones started ringing all over Wall Street.

Cendant was one of those stocks that everybody had to own, an aggressive player embodying everything that momentum and growth investors crave, a near symbol for the bull market of the late 1990s. Now it's a symbol of a different kind, signifying the dangers of groupthink and the fault lines in U.S. accounting practices.

The company had emerged from the December 1997 merger of

CUC

, a giant direct marketer, and

HFS

, a franchiser that held, among others,

Ramada

,

Howard Johnson

,

Century 21

and

Avis

. At the helm was former HFS head

Henry Silverman

, who regularly appeared in the big-spread gush jobs that magazines do on business' shining stars. "What drives him today is no longer the money," wrote

Time

in 1997, "so much as 'the fear of failure and the ego gratification of success. It's a way of expressing creative energy.'"

But on April 15 Silverman faced failure, in spades. The announcements that CUC had, before its merger with HFS, cooked the books, and that Cendant would have to restate its financials to slash as much as $115 million from 1997 earnings, sent Cendant shares into a tailspin overnight. Before it was halted, the stock dropped 28% in after-hours trading on

Instinet

.

The next day was worse. Cendant went into free fall at the open. For much of the morning, it traded only on

Nasdaq

, as the flood of sell orders overwhelmed a trickle of buy instructions, holding up Cendant trading on the

New York Stock Exchange

for nearly two hours. By day's end, 108 million shares had changed hands -- the most ever for a Big Board issue -- and Cendant finished at 19 1/8, down 16 1/2, or 46%, from where it had closed the day before.

The fall was simply devastating for Wall Street. Among mutual funds,

Janus

,

MFS

,

PBHG

,

Fidelity

,

Kaufmann

,

Putnam

,

T. Rowe Price

and

Alliance

all had big chunks. Hedge funds likewise took heavy hits. The story that everybody had to own, Cendant, ruined a lot of people's second quarters before they had even gotten going.

A year later, the people who Cendant says perpetrated the fraud are out. Former CUC head Walter Forbes was forced to resign. And "active investigations" about the accounting mess are "currently under way by various federal agencies," according to the company's 1998 annual report. The report says Cendant has sued its auditor,

Ernst & Young

. ("It never occurred to us that the financial statements certified by Ernst & Young were anything but accurate," says Silverman in the report.) In January, Cendant settled a major shareholder suit, taking a $228 million charge, though other class-action litigation is still pending. The company canceled the acquisitions of

American Bankers Insurance

(ABI)

and

Providian Home & Auto Insurance

. It sold noncore assets and used the money to finance debt and buy back stock.

But for a company that has broken Wall Street's trust, all this is still not enough.

"It's like the girlfriend that cheated on you with your best friend," says Seth Tobias, portfolio manager with the New York hedge fund

Circle T Partners

, who lately has traded in and out of Cendant on the long side. "There are some pretty large people that had stakes in this thing that for the rest of their careers they're going to say, 'I don't need this.'"

Of seven firms covering Cendant these days, all but

Merrill Lynch

, which maintains a hold rating, have buys on it. But the ill will is so strong that even if a firm's analyst comes out and says clients should buy Cendant, don't expect its sales force just to jump on the bandwagon. Why dredge up bad memories? Says one trader, "The Street has a short memory, but they do have some memory. You're climbing a real uphill mountain" to get a client to take some Cendant.

Perhaps Silverman put it best in the annual report: "It's safe to say that there is some credibility gap."

Small wonder, then, that Cendant's stock never recovered from the blowup. Indeed, it continued to fall into the summer as the full extent of the damage became clear, (In its forensic audit,

Arthur Andersen

would conclude CUC had booked about $500 million in bogus income.) The stock bumped up briefly when Walter Forbes resigned in late July, and then it fell with the rest of the market in the late summer and early fall.

It's bounced back from the Oct. 8 bottom of 7 1/2, but some investors are angered that the company repriced options for its 45 most senior executives on Oct. 14. 26.3 million were lowered to $9.81, while the remaining 10 million were priced at $12.26. The stock had closed at 9 7/8 that day. (The repricing was a "responsible and decisive action to ensure that Cendant continues to retain the best senior management team possible," said Silverman in the annual report.) Tuesday, the stock closed at 16 13/16 -- 54% below where it was the day before it fell apart.

For its part, the company says that it is trying to rebuild investor confidence. "A lot of people got hurt with what happened," says Denise Gillen, who works in Cendant's investor relations department. "But it's important to remember that the management team at Cendant now were not the perpetrators of that hurt. We're just working very, very hard at delivering the results. Talking about it isn't enough. We have to do it. We have to deliver."

But for some, even that effect isn't enough. Tobias -- who attributes more to luck than anything else his decision to unload three-quarters of his Cendant position just before the fall -- thinks the company is going to need a real shakeup to regain investors' trust. "I think the best thing that could happen to this company is Henry Silverman steps down," he says. "They spin off the Internet businesses, break the company down. Because in its present form, people are not going to give it the benefit of the doubt."

Eventually, investors got over Cendant. Quarters blown, taken out of the hunt for the top spot, of course they were bitter. But most could say to themselves, "I survived this, I survived the worst, and I am still here." It seemed that after getting through Cendant, everything else was going to be gravy.

Russia, Brazil,

Long Term Capital Management

lay in wait.

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