CUC-HFS Merger Draws
Negative Market Reaction
By SUSAN PULLIAM
Staff Reporter of THE WALL STREET JOURNAL
What do you get when you marry one controversial stock with another?
More controversy.
Wall Street on Wednesday gave the raspberry to the proposed $10.9
billion megamerger of CUC International and HFS, despite the two
companies' contention that CUC's direct-marketing capabilities can help
HFS cross-sell services to customers of its real-estate, hotel, rental-car and
vacation-timeshare franchises.
Responding partly to downgrades by analysts at Robertson Stephens and
Alex. Brown, shares of CUC, which will be issued to current holders of
HFS, fell 1 3/4 to 23 1/4, and HFS itself fell 4 1/4 to 54 3/4, in composite
trading on the New York Stock Exchange.
The proposed marriage pairs two companies that have in the past been
viewed skeptically on Wall Street for surprisingly similar reasons. In the
case of HFS, investors have long questioned how long Chairman Henry
Silverman can continue to fuel earnings growth by rapidly adding new
companies to his stable of famous franchises such as Ramada, Howard
Johnson, Century 21 Real Estate and Avis. Reflecting such skepticism,
HFS stock has had some big ups and downs, but is about even for the past
year.
CUC, meanwhile, was itself a favorite target of short sellers, who try to
spot overvalued stocks, back in the early 1990s. At that time, its shares
were flying because of its own strategy of aggressively acquiring new
databases of customers to whom it could sell its own services, which offer
discounts on shopping, dining, travel and insurance. The short sellers
questioned, however, whether CUC's hyperactive acquisition strategy,
combined with its aggressive accounting practices, disguised the fact that
profits on new customers were shrinking.
Recently, however, CUC had built up new credibility on Wall Street. It
had won over its early critics by churning out what investors love best:
cash. And, after an unexpected entry into the software business last year
that sent its stock drifting downward for one year, investors were finally
warming to CUC's new strategy of marketing on the Internet.
And now this. "Just when we thought we understood CUC, which had
clearly indicated it would stick to its core business, it chooses to merge
with HFS, which is in a significantly different business, in our view," said
Robertson Stephens analyst Keith Benjamin, who downgraded the stock
Wednesday to "long-term attractive" from "buy."
It doesn't help matters much that investors and analysts are confused about
why CUC should merge with HFS at all, despite the investor-relations
blitz that accompanied the deal, including the usual conference calls with
managements of both companies. "This is an extremely confusing
situation," said Mr. Benjamin. "It's not clear to me why CUC needs to
merge with HFS to use their lists," he said.
Indeed, CUC and HFS have already had a marketing arrangement for
CUC's travel services since 1994. As another investor put it, "If milk is
cheap, why does CUC need to buy the dairy?"
Wednesday's drop in shares of HFS, meanwhile, was driven by the
decline in the price of CUC, which will issue 2.4 of its own shares,
currently worth $55.80, to holders of each HFS share. One analyst, Mark
Mutkoski of BT Securities, downgraded HFS shares to "market
performer" from "strong buy" on the news. HFS, he said, deserved more
of a premium.
HFS still has supporters among Wall Street analysts, and the stock's
enthusiasts, by and large, think the deal's a winner. One of the biggest
bulls on HFS, Morgan Stanley's Neil Barsky, called the deal a
"cross-selling nirvana" in a note to clients.
But some investors wondered what happened to the cross-selling that was
already supposed to materialize from the franchise smorgasbord Mr.
Silverman has already laid out. Even Mr. Barsky admitted in his note
Wednesday that real-estate agents and hotel clerks haven't turned out to be
the best cross-sellers for HFS's other brands.
Investors also question whether CUC, not to mention HFS, can keep up
its earnings growth after the marriage. Alex. Brown analyst Christopher
Feiss downgraded CUC to "buy" from "strong buy" because of concerns
that CUC's growth rate will fall, at least in the short run. He reckons the
two companies' combined revenue growth should fall to between 15% and
20% this year, compared with 20% for CUC alone this year if it weren't
merging.
Mr. Feiss said in a note to clients Wednesday that he thinks CUC shares
will trade in the 31-to-32 range over the next six months to a year, based
on a 25 multiple of his $1.25 per-share estimate of 1998 earnings for the
combined companies.
Not all CUC watchers are so certain that investors will continue to value
CUC shares at a multiple that high, as they have in the past, because CUC
is hooking up with a company, HFS, whose businesses and earnings are
more volatile. Says one CUC shareholder: "CUC's business is more
annuity-like and less tied to the economy than HFS." |
