'98 Year In Review
December 17, 1998

Loser #1 - Cendant Corp.

by Yi-Hsin Chang (TMF Puck)
Down 44.7% as of 12/15/98

When it rains, it pours.

For consumer and business services company Cendant Corp. (NYSE: CD), it's been raining cats and dogs for most of 1998. As far as losers go, Cendant -- ironically derived from the Latin root of "ascendant" -- is the hands-down winner for the year, especially among big-name U.S. companies. Its stock plummeted as low as $6 1/2 in early October from a high of $41 11/16. In fact, Cendant shares dropped 47% (to $19 1/8 from $36) and lost $13.9 billion in market capitalization in a single day, April 16 -- the day after the company said it had discovered "potential accounting irregularities" and expected to restate earnings for 1997 and possibly other periods.

The company initially warned it might have to cut 1997 and 1998 earnings each by $100 million to $115 million, or $0.11 to $0.13 per share. Three months later, Cendant said restatements would lower 1999 EPS by about twice that, $0.22 to $0.28, and 1998 EPS by $0.05 to $0.06 lower than previously expected. What's more, 1996 and 1995 would also be affected, reducing earnings by roughly $150 million for 1996 and $100 million for 1995.

How did Cendant get in such a mess? Well, current Chairman, President, and CEO Henry Silverman has said he regretted the merger between his former company, HFS Inc., and direct marketing firm CUC International that created Cendant. As it turns out, all of Cendant's accounting problems came out of CUC. Now, these weren't some careless errors that could happen anywhere. Far from it. CUC inflated earnings by about $650 million in the last three years by, in Cendant's own words, outright committing "widespread and systemic" accounting fraud with "intent to deceive."

According to Cendant's probe, CUC's former CFO and controller orchestrated the improper accounting effort. Apparently, CUC artificially inflated acquisition charges to help meet earnings expectations. It also put off recognition of returned credit card purchases and membership cancellations to increase its revenue, cash, and working capital on paper. Plus CUC improperly amortized marketing expenses for attracting new members. It even dreamt up "fictitious" sales to boost top-line growth -- "large amounts" of accounts receivable in the first three quarters of 1997 were, in fact, fabricated, with no customers or sales of services to match.

The good news is that most of the executives and directors Cendant derived from CUC have been ousted, including former Cendant Chairman Walter Forbes, who was chairman and CEO of CUC. Forbes was forced to resign following an outcry from investors -- more than 70 shareholder lawsuits have been lodged against the company -- and a highly unusual move: a letter from 44 Cendant executives urging the company's directors to fire their chairman. From the beginning, Forbes has maintained he knew nothing of the accounting irregularities. But, as the petitioning Cendant executives pointed out, as CEO, Forbes should have known. "We're all accountable for our performance," said one executive vice president. "We can't work for someone who isn't held to that same standard."

After Forbes stepped down, Henry Silverman, the former head of HFS, was given the additional title of chairman. The once acquisitive Cendant quickly became a divestitive Cendant. It called off its planned acquisition of American Bankers Insurance (NYSE: ABI) -- a deal that would have diluted earnings per share after the sharp decline in Cendant's share price -- as well as its agreement to buy Providian Auto & Home Insurance Co. In October, Cendant also announced plans to buy back $1 billion in shares. So far, it has repurchased about $100 million of stock.

Just as quickly as it had previously acquired companies, Cendant has been selling off non-core assets, including several former CUC units. In August, the company said it would sell Hebdo Mag International, which publishes classified advertising, to a group led by Hebdo management for $523 million in cash and stock. Then in September, it announced the sale of Cendant Asset Services, a property management and sales subsidiary, to Freddie Mac (NYSE: FRE) for an undisclosed sum.

In November, Cendant announced it would sell its software division to France's biggest publisher, Havas SA (majority owned by the country's largest water utility, Vivendi SA) for an initial $800 million plus an additional $185 million depending on future profits. Cendant might also sell its online marketing businesses, which are losing around $50 million a year. According to Silverman, his company has received unsolicited offers to buy "every one of [its] businesses."

Although this accounting debacle has been utterly embarrassing and demoralizing, Cendant's business model remains intact. This is the same company with the same well-known brands and the same profitability for which investors were willing to pay more than $40 a share early this year. The revenue from certain fraudulent former CUC units accounted for less than a third of Cendant's total revenue last year. So the bulk of the company's top line actually involves such ubiquitous and untainted brands as Avis, Century 21, Coldwell Banker, Days Inn, Howard Johnson, and Ramada.

In fact, you could say the company is getting its house in order and is starting with a clean slate. Cendant has been purged of its base elements, and with former HFS finance staff handling all of the accounting, its books from here on out are likely to be squeaky clean, especially because the company knows its accounting methods will be scrutinized by investors, analysts, and SEC officials. And by selling off underperforming assets, Cendant streamlines its operations and further strengthens its financial position. Silverman projects the company will increase earnings by 20% a year for the next five years.

There are also signs that Cendant is slowly but surely winning back investors' confidence. In late November, the company was able to sell $1.55 billion in bonds -- more than triple the originally projected amount -- to some 100 investors. Cendant had initially proposed selling $500 million in bonds. Another telling sign is the company's share price, which gradually has climbed up from as low as $6 1/2 in early October to the $18 to $20 range now, two months later.

Don't expect Cendant shares to shoot back up to $40 any time soon, as it will take time to heal the wounds of deception. But considering how low Cendant has fallen, there's nowhere to go but up.

Cendant Company Information:
Trades on NYSE under symbol CD
Cendant's Web Site (www.cendant.com)
Current Quote
Cendant's Chart

Other Related Cendant Links:
Cendant the Defendant -- Fool on the Hill -- 7/14/98
Rising Accounting Fraud -- Fool Plate Special -- 7/14/98
D-Cendant -- Fool on the Hill -- 4/16/98
D-Cendant, Part 2 -- Fool on the Hill -- 4/17/98

Next Loser -- Specialty Finance Cos.