Travel and real estate conglomerate Cendant
On the auction block.
Gone is No. 2 tax preparer Jackson Hewitt
Gone is mortgage and fleet-management services company PHH
Gone is vehicle-fleet service provider Wright Express
Gone last week, for approximately $1.8 billion in total consideration (and a $1 billion pre-tax profit), was Marketing Services, a value-added membership, insurance, and loyalty marketing company.
In the shopping cart.
While Cendant was busy pruning, it also made some timely acquisitions to help solidify its No. 1 or No. 2 position in its marketplaces. Cendant bought online travel company Orbitz last November for $1 billion (net of cash).
In 2004, it also snapped up the U.S. rights to hotel brands Ramada and Days Inn from Marriott International
Although the new company names have not been selected, and the Cendant name is heading for retirement, here's what investors will be getting:
Real Estate Services is the largest real estate brokerage franchisor and operator. It also includes employee relocation, title agency, and real estate settlement businesses.
The Travel Network is the largest timeshare exchange company and the largest marketer of European vacation rentals.
Hospitality (see you at the suite!) is one of the world's largest lodging companies, with nine well-known brands. It will also include the world's largest developer, marketer, and manager of timeshares.
- Vehicle Rental will include Avis and Budget.
Wall Street shrugs
While it may be cigars for everybody at Cendant, the newly introduced quadruplets aren't getting any respect on Wall Street. With the general market solidly higher, Cendant's stock was down 4.7% at midday.
The company expects these four strong and focused pure-play companies to unlock the full value of Cendant's businesses. However, today's message from the market is, "It's all about earnings." In today's press release, Cendant pre-announced that earnings for the third quarter will be $0.44 a share. That's at the low end of company guidance. Even worse, the previously expected 25% increase in EBITDA (earnings before interest, taxes, depreciation, and amortizations) will come in at 14% in the fourth quarter.
A look at the details
This is a complex transformation. "It is expected that the new companies will be prudently and conservatively capitalized," the key sentence of the press release states, "which is expected to offset any potential exposure to added market volatility they may face as focused businesses, while at the same time providing flexibility for long-term growth." That's a great objective, and it's bolstered by the company's decision to reassess its $2 billion share-buyback plan.
The stock is trading for 13.5 times 2006 expected earnings, and the combined company was expected to grow earnings 13% a year for the next five years. That's hardly a rich valuation. Management expects the resulting pure-play companies will be able to grow and be analyzed on their own merits, which should provide an opportunity for share-price expansion that conglomerates are rarely afforded on Wall Street.
That said, the subtler points of this situation deserve analysis. How much will the separate businesses collaborate? Will they share client lists? Will they work together to maximize cross-selling opportunities? In my understanding, this was a crucial part of Cendant's old all-in-one business model. They were able to offer customers more complete solutions to their needs and share data among businesses to draw in new customers. I imagine the four new companies will similarly work together, since each should benefit from cooperation with the others.
Perhaps more significantly, all but the real estate segment's assets are securitized. That means that each asset is financed by asset-backed securities (ABS) -- a collateralized debt obligation, where the underlying asset serves as a lien in the event of a default. The individual credit ratings of the separate companies will therefore become extremely significant; Cendant was a notch above junk rating in its combined form, a very precarious position. A better credit rating is integral to lowering the cost of financing, which may help improve economic returns earned on assets.
In my unscientific opinion, the credit ratings of the separate entities will be less than Cendant's is now. Each separate business will be far more cyclically exposed than the current company; though its divisions' movements aren't in lockstep, Cendant in its present form is already slightly exposed to cyclical fluctuations. Economic shifts could have a bigger effect on the four new companies' interest coverage on a period-to-period basis, which could limit their ability to tap asset-backed securities markets in a cost-effective way. Cendant management expects that only the vehicle rental division will carry a lower credit rating, while the other three companies emerge unscathed. I'm not sure that makes sense.
Foolish final thoughts
For now, it's hard to make any accurate predictions of the new companies' chances. We still don't know how they'll allocate debt and use their asset-backed securities. It's just as important, in my opinion, that we don't yet know how much more free cash flow Cendant will produce before its split. If Cendant's warning about an EBITDA shortfall comes to pass, it may limit the company's ability to reduce its debt in the short term.
For now, the market's not buying the four-is-better-than-one sales pitch. Cendant stock fell 6.6% in today's trading, setting a new 52-week low. But, with EBIT covering the annual interest expense by 13 times (on a trailing-12-month basis), the company is not headed for near-term trouble. Today's low could be a buying opportunity that will eventually reward patient investors -- but that, too, remains to be seen.
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