In his book You Can Be a Stock Market Genius (review at ThinkingAboutMoney.com), Joel Greenblatt discusses the investment opportunities that come from investing in special situations – such as corporate breakups and mergers.
Over the next few weeks, Cendant is breaking itself up into four companies. You may not have heard of Cendant, but you’ve certainly heard about the companies it owns. In a few weeks Cendant will turn into the following:
- Travelport – about to be sold for $4.3 billion, the best known brands of this travel services company are Orbitz and cheaptickets.com.
- Reology – One share of this new company will be distributed for every 4 shares owned by current Cendant stockholders. The best known brands of this real estate services company are Coldwell Banker, ERA and Century 21.
- Wyndham – One share of this new company will be distributed for every 5 shares owned by current Cendant stockholders. The best known brands of this hotel and timeshare company are Ramada, Howard Johnson, Days Inn, Super 8, Travelodge, AmeriHost Inn, RCI and a so on.
- The remaining company will be changing its name to closer correspond to the rental car business it keeps – Avis and Budget.
Joel’s book suggests that these kinds of breakups present unique investment opportunities. First, the market tends to give the individual companies a higher value as separate companies than as one. Second, there are often parts of the deal that are missed by the market until well after the breakup. Finally, after a breakup like this the mutual funds and hedge funds that own shares in the parent stock often rearrange their portfolio (i.e. sell shares that were disbursed) because they no longer match the fund category or goals.
I decided it might be an interesting challenge to dig further into this rather complex deal.
Before going further, let me remind you that I am not an accountant, and certainly did not have the time to read the hundreds of pages of documentation filed with the SEC on these various deals. So what you are about to read is guesswork. Intelligent guesswork I hope, but guesswork nonetheless.
Part of the problem is that for all the hundreds of pages of documentation available on this deal, they mostly consist of guesswork on the part of the company (so my own analysis becomes guesswork on top of guesswork – not a great formula for accuracy). Also, remember that during a breakup of this sort, many of the numbers you read are in a sense made up – Cendant has pretty much total control over how assets and liabilities are allocated to the various companies, and can shift value among them in the form of separation adjustments.
As tough as that is, this particular deal is made more complex by the fact that Travelport is being sold. All we really know is that it’s being sold for $4.3 billion – it’s not at all clear how that sale ultimately impacts the current financial statement. Unlike the corporate spin-offs, where Cendant generates pro-forma financial statements that estimate what the individual company’s financial status would have looked like if it had been a separate company during the past reporting periods, similar information does not (yet) exists for the Travelport sale.
Finally, the most recent financial statements available to work with are the year end 2005 statements. The first quarter statement is available, however the revenues of the different companies are seasonal, so I decided it’s better to use the last annual report and give up on some currency than to use the later quarterly report.
Looking for Surprises
Despite the complexity of the Travelport deal, I did not find anything remarkable in the overall structure of the deal. The only thing I found somewhat puzzling was the allocation of income across the four companies.
Cendant showed $869 million income last year (excluding discontinued operations). Unfortunately, the annual report provided no way to divide that number among the individual divisions. It did indicate the division of income on an EBITDA basis. Normally I ignore this figure, but it’s all I had to work with in this case, so I used those percentages to get these income figures for the various segments:
Reology: $451 million, Wyndham: $281 million, Avis/Budget: $167 million, Travelport: $38 million.
Now here’s where it got interesting. In the United Pro-Forma Combined Condensed Statement of Income for 2005 (what a mouthful!), that proposes what the income would have been had Reology been a separate company, the income after adjustments is as follows:
Reology: $492 million, Wyndham, $341 million.
Hmmm… Perhaps Cendant believes income would have been higher had the companies been separate? I think it’s more likely we’re seeing the effect of depreciation. My guess is that the Travelport income is probably close to the EBITDA value (not much in the way of assets to depreciate or huge debt in an airline reservation business); whereas the rental car business has very high depreciation (all those new cars depreciate considerably as soon as they go into service).
In other words, it seems like Cendant is moving income into the Reology and Wyndham chains. By these numbers Avis/Budget will show basically no earnings after the breakup. This has an impact on what comes next.
Pricing the Pieces
With no hidden treasures found, there remain two questions. 1 – Is the sum of the values of the individual companies likely to immediately be worth more than the current value of Cendant? If so, it might make sense to buy Cendant now and take the distributions. 2 – What are likely fair stock prices for the individual companies once they start trading?
This becomes an exercise in company valuation. Again, it’s tough to decide the best way to do this, so I tried several different ways. For Reology and Wyndham I looked at earnings and likely P/E ratios. For Avis/Budget, I assumed little or no earnings, so explored Price/Book or shareholders equity and Price/Sales (I checked these rations for Reology and Wyndham as well). Then I looked at ratios among competitors. I also examined the results both with and without the Travelport sale (part of the $4.3 billion cash will be distributed to Reology and Wyndham as well).
Here are the likely share prices I came up with:
P/E = 15 – Reology 27, Wyndham 24
P/E = 20 – Reology 37, Wyndham 32
(Numbers are without/with Travelport)
| Price/Equity = | 1.5 – Reology = 8.8/17 |
| 1.5 – Avis = 37/68.4 | |
| 3 – Wyndham = 39/48 | |
| Price/Sales = | 1 – Reology = 27 |
| 2 – Wyndham = 33 | |
| 0.7 – Avis = 35 |
Again, the ratio I used was that of comparable companies in the business. Note: the Avis/Budget numbers assume Cendant goes through with a planned 10:1 reverse stock split.
Assuming the Travelport sales happens; take a look at the market cap of the sum of the companies using the lowest valuation:
Reology @ 17 + Wyndham @ 32 + Avis @ 35 = $15 billion
$15 billion is the current market cap of Cendant.
Coincidence? Probably. The most this tells me is that my guesses are probably somewhere in the ballpark (at least when taken as a whole – I may be wildly off on the proportions).
This does, however, also tell me that there is no incentive to buy Cendant at this time unless you really want to own these four companies.
Conclusion:
The Cendant story is an interesting one and bears watching. But right now I’d take a wait and see attitude. I don’t see any reason to buy Cendant shares at this time in order to take part in the distribution. Instead, I plan on waiting until the companies start trading independently.
I would probably avoid Reology. Though it’s been hugely profitable, I believe we are going into a period of declining real estate transactions (See “The Realtor Bubble” ) which is likely to severely impact real estate agencies.
Both Wyndham and Avis/Budget are interesting. Higher gas prices may impact both however. In this respect, Wyndham is a safer bet. With lodging scattered all over the world, any shift from distant vacations to vacationing closer to home will leave their revenue stream largely intact. Strength in lower cost chains could lead to growth as people try to cut costs when traveling.
Wyndham stock will be very interesting at anything under $30. Avis/Budget will be interesting anywhere under $35 (after the reverse split). Wyndham over $40 and Avis/Budget over $45 is probably overpriced (keep in mind again that these are based on guesses that may be way off).
Watch for a possible impact in price when the Travelport sale closes in mid August (however, whether it drops on failure, or rises on success will depend on which way the market factors the chances of success into the initial trading price).
Watch for a possible major adjustment after 3-6 months of independent operation when we start getting real numbers for the individual companies.