A Real Unsavory Deal

Editor's Note: An earlier version of this article erroneously referred to an IPO when in fact Realogy was spun off from Cendant. We regret the error.

The news that Realogy (NYSE: H  ) will be taken private by Apollo Management LP embodies everything that's currently wrong with Wall Street.

Consider these comments from a recent Wall Street Journal article on the company:

"'The view of the board is that companies with declining earnings and no visible growth should be private,' said Realogy Chairman and Chief Executive Henry R. Silverman. Buyout shops 'have a much longer-term view. The people who own our stock have a five-second view. These are the kind of people whose performance is graded weekly, monthly, and annually. They don't have that kind of patience.'"

If Silverman wasn't happy with public ownership by investors, why did Cendant, a former Motley Fool Inside Value selection, spin off Realogy to shareholders in the first place? Apollo had already approached Realogy about a buyout. Could it be that Realogy's senior executives wanted a chance to fatten up their stock options, only to surrender when the market wouldn't price Realogy higher? As noted in a New York Times article:

"Mr. Silverman, who had been criticized for huge paydays while he was at Cendant, stands to make about $135 million by selling all of his shares and stock options as part of the deal. Mr. Silverman ... is expected to stay on until his contract expires at the end of next year. However, Mr. Silverman will not be an equity participant with Apollo in the deal, and his out-of-the-money stock options (those below the strike price) will be canceled."

Quite a payday for Mr. Silverman. The poor investors who bought Realogy shares at $25 come out OK, with a 20% profit. But those who wanted to hold their shares through a real estate turnaround (which should vault Realogy shares to the $40-$50 level) are now out of luck. Apollo Management will benefit from that increase in shareholder value down the line -- and the CEO will earn $135 million to hand over the company. One day, Apollo will probably take Realogy public again at a fat profit (generating more fees for the bankers). From the Times:

"'Our earnings are going down,' Mr. Silverman said. 'We're probably not going to see a recovery until 2009. This deal is an insurance policy.'"

Does this sound like an executive afraid his options would go underwater for a year or two? I doubt it. The first earnings warning only came in October, two months after Realogy shares started trading. The company also spent a lot of cash buying back shares soon after it was spun off. So Realogy used cash after it was spun off to buy back shares from the open market, and then gave the top management cheap or free shares. Looks like an insider's merry-go-round to me. How does that serve shareholder interests? In my opinion, it doesn't. Once again, from the Times:

"The deal is expected to close in the spring of 2007, but Realogy may solicit other buyout proposals until Feb. 14. in what is known as a 'go shop' provision. Should it accept another offer, Realogy will pay Apollo a breakup fee.

"Mr. Silverman said the company decided against a full auction because it could be 'very destabilizing to the staff and customers.' He said that the deal with Apollo meant 'an outcome is guaranteed' that the company would be sold and that a potential higher offer could still be sought."

You also have to wonder whether someone looked at the 11 million shorted Realogy shares and said, "Hey, here's a quick way to make $55 million from the hedge funds betting against Realogy's turnaround." Keeping the auction open prolongs the uncertainty for the trapped shorts and offers another buyer a chance to pay even more.

The whole deal appears unsavory: a company is spun off, and then it sells out to private interests less than six months later; obscene options grants and paydays for the CEO; depriving shareholders of future value increases to benefit private raiders; and so on.

Ridiculous antics like these are why I have kept the majority of my portfolio in international stocks since 2003. Who needs Wall Street's grief?

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Fool contributorDale Baker, a private client portfolio manager and former U.S. diplomat with extensive experience in Europe and Africa,has no position in Realogy for himself or his clients. He doesn't even own his own house. He still welcomes your questions or comments atdabmu@yahoo.com.


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