Markets & Finance

Cendant Poised for a Comeback


By Tom Graves Standard & Poor's Focus Stock of the Week is Cendant Corp. (CD), which carries S&P's highest investment ranking of 5

STARS (buy).

Cendant is a large consumer and business services company whose reputation was tarnished in 1998 by reports of accounting irregularities and errors. However, since then, management of Cendant has been revamped, and settlements have been reached on shareholder litigation. Also, between late 1998 and mid-2000, Cendant sold 18 businesses for $4.5 billion, with proceeds largely being used to repurchase stcok and reduce debt.

In S&P's view, Cendant has increasingly positioned itself to rebuild confidence with investors and forge a growth path in which we at S&P expect that a large amount of free cash flow will be used, in part, for accretive acquisitions.

Cendant was formed through the 1997 merger of CUC International (renamed Cendant Corp.) and HFS Inc. The accounting problems that surfaced in 1998 have been linked to the CUC side of the business, and led to both the departure of some top executives and downward earnings restatements for 1995-97. While it can be argued that Cendant's current chairman and CEO Henry Silverman, who was heading HFS prior to the 1997 merger, should have been more aware of how CUC was handling its accounting, we believe that Mr. Silverman is a top-flight executive for reestablishing Cendant as an appealing growth stock.

DIVERSE ARRAY. Cendant operates in three principal divisions: travel, real estate, and diversified services. These businesses provide a wide range of consumer and business services, and Cendant looks for its businesses to complement one another and create cross-marketing opportunities. The company is the world's largest hotel franchisor, including properties operating under the Days Inn, Ramada (in the U.S.) and Super 8 brands.

Cendant is also a large franchisor of residential real estate brokerage offices, operating under the Century 21, Coldwell Banker and ERA names; provides corporate relocation services; and originates residential mortgage loans. Other businesses include the Avis vehicle rental business; insurance; a private car park operator in the U.K.; and the Jackson Hewitt tax preparation business.

In a declining interest rate environment, we look for Cendant's mortgage business to have good growth opportunities in the year ahead. First mortgage products are marketed to consumers through

relationships with corporations, financial institutions, and real estate brokerage firms, including franchisees in Cendant's CENTURY 21, Coldwell Banker and ERA systems.

The scope of Cendant's mortgage business has received a boost from a new alliance, announced in December 2000, through which Merrill Lynch's mortgage origination and servicing operations are to be outsourced to Cendant.

At year-end 2000, Cendant's lodging chains included 6,445 properties with about 541,000 rooms, while is real estate franchise business included thousands of independently owned and operated franchise offices. In its franchising businesses, Cendant licenses the owners and operators of independent businesses the right to use its brand names. Cendant does not own or operate hotels, real estate brokerage offices or tax preparation offices. Instead, the company provides its franchisee customers with services designed to increase their revenue and profitability.

GOOD DEALS. During the past six months, Cendant has announced a series of transactions that we generally like. A pair of recently completed acquisitions is expected to add to earnings per share in 2001, and through a divestiture and a spin-off, we see opportunities for Cendant to create more value than may have been the case if these assets had been retained.

In March 2001, Cendant acquired, in a transaction valued at about $937 million, all of the shares of rental car company Avis Group Holdings, Inc. that it did not already own. As a result, Cendant's car rental business is now comprised of the Avis franchise system and the car rental operations of Avis Group, which was formerly Cendant's largest Avis franchisee. Also, through the acquisition of Avis Group, Cendant acquired PHH Arval, a leader in the fleet management services business; and Wright Express Corp., a leading U.S. fuel card service provider. Wright offers fuel and vehicle expense management programs to corporations and government agencies.

For 2000, Avis Group reported revenue of $4.2 billion, exceeding Cendant's total revenues of $3.9 billion from continuing operations in 2000. Avis's net income in 2000, after preferred stock dividends, was $102 million. Although the Avis acquisition added a large amount of "hard" assets (e.g. Avis-owned vehicles) to its asset mix, we expect that agreements enabling the company to resell used vehicles will limit the amount of inventory risk in this business.

In early April 2001, Cendant acquired Fairfield Communities, Inc., which operates a business through which vacation ownership interests are sold, in a transaction valued at about $635 million. For 2000, Fairfield reported revenues of $587 million, and income, before merger-related expenses and a special gain, of about $64 million. In February 2001, Cendant's Move.com Internet real estate business and its Welcome Wagon International unit were acquired by Homestore.com. As a result of the transaction, CD owns about 21.5 million Homestore.com common shares. As of early April, these shares had a market value of about $485 million.

In October 2000, the company said it intended to spin off ownership of its individual membership and loyalty businesses to CD shareholders via a tax-free distribution. The individual membership business is now being treated as a discontinued operation, and the spinoff may be completed by mid-2001. Including about 24.3 million memberships, this business provides customers with access to a variety of discounted products and services in such areas as retail shopping, travel, personal finance and auto and home improvement. Cendant affiliates with business partners such as leading financial institutions, retailers, and oil companies to offer membership as an enhancement to their credit card, charge card or other customers.

Cendant is developing an online travel portal which is expected to launch in late 2001. The company is hoping to maximize growth opportunities of its existing travel businesses and take advantage of its experience with the move.com portal. The travel portal would leverage new technology, coupled with access to Cendant's lodging, timeshare, car rental and travel agency services to address a range of consumer travel needs.

BRIGHTER PROSPECTS. In connection with settling shareholder litigation, Cendant has agreed to pay about $2.85 billion in cash. Cendant says that it intends to finance the cost of the settlement in a manner that it maintains the company's investment grade debt ratings. Including higher interest costs related to litigation settlement, we look for Cendant's earnings per share in 2001, before unusual items, to reach $0.97, followed by an increase to $1.10 in 2002. In 2000, after excluding various items, but including losses related to the recently divested Move.com business, Cendant had EPS of $0.91.

Recently, Cendant's access to capital has included the February 2001 private placement of $1.2 billion of principal amount of zero coupon senior convertible contingent notes due 2021, for gross proceeds of about $750 million. In March, Lehman Brothers Inc. exercised an option to purchase an additional $246 million principal amount at maturity of notes. Under various conditions, each $1,000 principal amount of the zero coupon notes could be convertible into 33.4 shares of Cendant common stock.

Also in early 2001, Cendant sold 46 million common shares to Lehman Brothers Inc. at $13.20 a share, net of selling concessions, resulting in net proceeds of $607 million. A portion of the proceeds from the offerings was used to fund the Avis acquisition.

Year-to-date, the stock has sharply outperformed the S&P 500, following significant underperformance in 2000. In the year-ahead, we look for favorable near-term catalysts to include a favorable interest rate environment for Cendant's mortgage business and one or more accretive acquisitions in the travel or real estate areas. In addition, S&P anticipates that the cloud over Cendant from accounting and lawsuit problems will further dissipate, with investors increasingly focusing, instead, on prospects that the company will generate a large amount free cash flow, and that it will put this cash to good use.

Our six-to-12 month target price for the stock is $18, or about 28% above its current level. This target represents a p-e of 16 times estimated 2002 EPS. S&P recommends buying the stock for capital gains. Graves is the entertainment, gaming and leisure analyst for Standard & Poor's


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