Maybe the Enron collapse really is increasing corporate candor. Conseco's ( CNC) highly paid CEO, Gary Wendt, who has long told investors that things were pretty much OK at his beleaguered company, actually conceded the other day that fourth-quarter earnings weren't that good.

The quarter was "disappointing," Wendt said on a Thursday conference call. Detox, which has harried Conseco for more than two years, wholeheartedly agreed and briefly looked forward to some plain-speaking from Conseco's executives.

Alas, Wendt soon reverted to his old spin-minded form, arguing on the call that Conseco could make all its debt payments this year. But in reality, Conseco probably won't be able to meet the payments precisely because, as Wendt implied in his guidance, 2002 profitability isn't going improve from the fourth-quarter level.

Conseco stock dived 5% Friday to $3.50, leaving it more than 80% below its 52-week high.

Weakening

In the fourth quarter, Conseco reported operating earnings of 10 cents a share, compared with 18 cents in the third quarter and 13 cents in the year-earlier period.

Insurance earnings dipped slightly from the previous quarter, but it was Conseco Finance, the lending operation, that made the poorest showing. Across Conseco's loan portfolio, delinquencies rose, forcing Conseco to boost its loan loss reserve. And the profit margin on loans (made since an important accounting change in 1999) actually dropped in the fourth quarter, to 4.75% from 4.86% in the third. (Admittedly, another margin measure went up over the same period, but only very slightly.)


Off Peak
Conseco's rise and fall


Wendt gave startlingly bad earnings guidance for 2002 of 60 cents to 70 cents a share, and this is excluding goodwill amortization expenses, which companies no longer need to deduct. If Conseco makes 65 cents a share this year, it would work out to an average of 16 cents a share each quarter, which is worse than the 18 cents a share earned (without goodwill amortization) in the fourth quarter.

The CEO gave little explanation of why earnings would be so poor in 2002. There are two main reasons one can think of for the pathetic profits projection, and neither reflects well on Conseco. The first is that past-due loans are soaring; when debtors don't pay, creditors don't collect and have to keep bolstering their loan loss reserve. Second, Conseco is planning to reinsure a large chunk of its insurance business to raise cash to meet debt payments. But when it does this, it essentially forgoes earnings from those businesses it has reinsured.

Ballooning

There were precious moments Thursday. In the question and answer session, Wendt and his CFO were asked by three different people why a balance sheet item called "investment borrowings" had ballooned by more than $1.3 billion in the fourth quarter. Neither could really say why with any degree of certainty. At such moments, one is wise to recall just how much Conseco is paying Wendt .

Also Thursday, Conseco said it had agreed to pay out $120 million to settle a lawsuit that alleged that previous management had falsified loan data. That's quite a sum, and it doesn't really jibe with Wendt's previous comments on the suit. A year ago, he thundered: "Our counsel have conducted dozens of interviews and have found no evidence that there is any truth to the plaintiffs' allegations about fraudulent delinquency numbers. In fact, counsel have been able to establish that several key factual allegations contained in the complaint are demonstrably false: People who are supposedly quoted in the complaint swear under oath that the allegations are not true. So, needless to say, we'll be defending ourselves vigorously against these allegations."

Conseco claims it'll be on the hook for only about $20 million of the $120 million, hoping that its insurers will cough up the rest. But it's highly unlikely that they'll agree without a legal battle. Conseco didn't return a call seeking comment Friday afternoon.

Loosening

Conseco's depleted stock price suggests the company can't survive under its current debt load. But can it? To be sure, Conseco's chief banker, Lehman Brothers, raised the chances of survival by recently loosening a debt agreement in such a manner that it freed up more than $200 million of cash at Conseco Finance.

But default could still happen this year. Much depends on how much money Conseco's insurance subsidiaries, where much of the emergency cash generation will take place, are allowed to pay to Conseco's parent company, which is burdened by $4 billion of debt. State insurance laws put limits on the amounts subsidiaries can pay to parent companies. Similarly, it's not clear how recent losses of $50 million in the insurance companies' bond portfolios deplete that dividend capacity. But even if state laws don't impede dividend upstreaming by much, it's still going to be a squeeze to meet all the 2002 debt payments of $1.4 billion.

Conseco Finance is the real problem. Extrapolating from the fourth quarter's awful numbers, Conseco Finance could undershoot in a big way. When laying out where cash would come from to pay off the $1.4 billion in debt, Wendt said $310 million to $340 million could come from Conseco Finance, though he didn't specify a period. The fourth-quarter performance suggests Finance could miss that range by $100 million to $150 million.

Finally, it's key to remember that bank covenants dictate that half the proceeds from asset sales and reinsurance have to be paid to Conseco's bank creditors, most of whose loans come due after 2002. If the banks waive this right, Conseco will make it, but there's little incentive for them to do so. Securities and Exchange Commission filings suggest that the banks have already made sure they sit ahead of other creditors for insurance assets were Conseco to go bust.

Concerned readers often ask: "What will Detox do when it doesn't have Conseco to kick around?" We may soon find out.
Know any companies that the market may be misvaluing? Detox would like to hear about them. Please send all feedback to peavis@thestreet.com.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

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