24 October 2005

What a damn mess

From today's New York Times (my bold, of course):

October 24, 2005
Cendant to Spin Off Many of Its Business Units
Cendant, the $18 billion conglomerate that was built through the acquisitions of dozens of the nation's most prominent businesses like Century 21, Avis, Days Inn and Orbitz, is planning a radical breakup into four different companies.

The move, which company announced today, is perhaps the most vivid acknowledgment that the latest era of conglomerates built through mergers and acquisitions may be over.

Under the plan approved by Cendant's board Sunday, the company will be divided into four parts - one each for Cendant's real estate, travel distribution, hospitality and vehicle rental businesses. Each unit will be spun off into a separate publicly traded company. Current Cendant shareholders will receive shares in each and will continue to receive dividends. For customers and employees, the change should mean little, at least in the near term.
The breakup of big conglomerates like Cendant is being driven in large part by investors' newfound desire for companies to be more focused and narrow - what bankers and analysts like to call "pure plays" - as opposed to large empires with disparate businesses. The stock prices of many big companies, like General Electric and Citigroup, have suffered in recent years, and some analysts attribute their sluggishness to what is often called a "conglomerate discount."
For Cendant, which also owns the Budget rental car system, Ramada and Super 8 hotels and the Coldwell Banker real estate business, among others, the breakup is a complete about-face aimed at reviving its lagging stock price, which has remained stagnant ever since the company merged with CUC International in 1997. It was later discovered that CUC had been involved in what was then considered the largest accounting fraud in history. Cendant's stock price has hovered from $20 to $25 over the last two years and closed Friday at $20.90 a share.
Mr. Silverman, the company's largest shareholder, called his conglomerate strategy a "financial success, but a stock market failure," noting that the company is financially strong, but that investors have not rewarded the company's stock price.

"You can have a great business strategy, but if it's not moving the stock price, it's not working," he said. "This is a classic case of the sum of the parts is worth more than the whole."
Still, not all breakups or spin-offs have worked. Viacom's stock price, for example, has not moved much higher since it announced its plan to split in two, leading some investors to question whether such moves really "unlock shareholder value." Even Mr. Rietbrock mentioned in his note about Cendant that, "we're typically cynical of financial engineering that only rearranges the pieces of the puzzle."

However, Mr. Rietbrock and Cendant may have reason to believe that its split will increase the company's share price. Over the past year, Cendant has spun off three different units; in both cases, investors benefited. Other historical examples, like the breakup of Dun & Bradstreet , resulted in huge gains.

Cendant traded up briefly, then tanked on an otherwise bullish session, down 6.77% to $18.77. So is this a buying opportunity? Will the value of the underlying companies be unleashed?

I question that premise. What underlying value? The travel industry has been terrible, and that's basically three out of the four parts of the new Cendant. And profitable units, like income tax preparer Jackson Hewitt have already been sold off. TheStreet.com today discussed Cendant's terrible performance.

The company said the market's valuation doesn't reflect its businesses' strong operating and financial performance, but Cendant delivered a weak third-quarter report card Monday and an ominous forecast about its consumer travel businesses. The company said earnings will be 44 cents a share, at the low end of guidance and below the 46-cent consensus from Thomson First Call.

Yeah, sign me up for that.

TheStreet.com pointed out that Expedia is down since Barry Diller spun it off. Why would Wall Street treat Orbitz any differently? Personally, I'm finding that more companies are offering their lowest rates on their own websites. I use Orbitz for a quick comparison on flights and car rentals. I find the cheapest option, and then go to that company's own website to pull the trigger on the transaction, saving me a few bucks. I'm using Orbitz, in the worst sense of the word, using their tools and bandwidth, leaving them nothing. Sounds like a money maker to me.

How about the real estate holdings (Century 21 and Coldwell Banker)? Yeah, I want to throw money into that industry after its peak. With Craigslist, more people are selling FSBO, or with cut-rate firms like Foxtons. I have a feeling the money's been made here already.

With all these good feelings about Cendant in mind, I pulled the Free Cash Flow numbers for CD off of Morningstar.com. I admit I'm new to this, but these numbers are a horrific sight to behold. I assume that much of Cendant's free cash went into its diverse array of acquisitions, but still, check 'em out:

96 - 93.8
97 - (1042.7)
98 - (1993.8)
99 - 377
00 - 1168
01 - (12,486)
02 - (16,310)
03 - (8043)
04 - (7620)
TTM (5249)

Yes, that's three positive FCF years out of ten. Since 01, Cendant's free cash flow has been NEGATIVE 50 BILLION DOLLARS. Ooof. Say it with a Dr. Evil voice. $50B is just not funny.

So we're left with two piddling positive arguments:
1. The new companies will not be sullied with the controversial Cendant name; and
2. The new companies will be easier to value independently, as opposed to being valued in conglomerate form?

I'm not sure I want to be around next summer when the market values these travel and real-estate companies on their own. It could get uglier than this mashed-up mess called Cendant.


John Coumarianos said...

Generally speaking, spinoffs done for no other reason (i.e., no economic reason) than the fact that the conglomorate is getting a "conglomorate discount" can be good opportunities. After all, how reasonable is it to give a company a discount because it's a conglomorate and you can't figure out what sector weightings you're satisfying with it in your index-hugging mutual fund? What you want as an investor is a situation where things are being done for non-economic reasons -- like this. Additionally, many S&P 500 and large-cap funds wind up having to dump the spun-off piece just because they can't hold small stocks -- in other words,again, for no economic reason. A book that discusses spin-offs and the opportunities they provide is "How to be a Stock Market Genius" by Joel Greenblatt. It's a cheesy title, I admit, but an extremely useful book.

As for Cendant, Orbitz, etc...., I can't say that I've looked at the companies closely. They do look poor, as you say. I do, however, own Expedia. One of the things you can do when a company announces a spinoff is look at SEC filings of "pro-forma" numbers -- what the spun-off business would have earned by itself had it been on its own previously. I was impressed with Expedia's numbers, though, I admit, I'm less than thrilled with it now.

I guess time will tell if Expedia's decline is the result of large-cap funds dumping it indiscriminately or if it's suffering economic impairment for the reasons that led you directly to hotel websites.

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