WHO THE HELL IS HENRY SILVERMAN? HE'S THE KING OF FRANCHISING, FOR ONE THING. HE'S ALSO THE CEO WHOSE STOCK HAS BLOWN AWAY INTEL AND MICROSOFT SO FAR IN THE 1990S. NOW HE'S GOING TO TRY SOMETHING REALLY BIG.
(FORTUNE Magazine) – Henry Silverman is making his way out of the meeting room at San Francisco's Ritz-Carlton hotel, and it's taking forever. A standing-room-only crowd of money managers has been on hand to hear him talk about his company at Montgomery Securities' annual September investment conference, and at every turn there's somebody who wants to offer congratulations or kind words.
"You're the only large-cap stock I own," says hedge fund manager Larry Greenberg. Chimes in Fidelity Contrafund's Will Danoff: "Henry's the best."
Maybe it's just something in the air, just the giddy hype that permeates what has become the must-attend investment event of the 1990s (Silverman calls it "the Predators' Ball for equities"). But check in with people nowhere near the conference, and you find that, if anything, the praise gets even thicker. "Henry's a genius," says Steve Bollenbach, Hilton's hard-nosed chief executive. Rainwater Inc. CEO Darla Moore, proclaimed by this very magazine to be "the toughest babe in business," melts at the mention of Silverman's name. "He's one of my heroes," she gushes. "He's a great capitalist." Says Morgan Stanley money manager Kurt Feuerman, who at one point this year had 20% of one of his mutual funds invested in Silverman's company: "Henry is one of the great businessmen of the era."
Wow. What a guy. But wait a minute, you say. Who the hell is Henry Silverman?
Henry Silverman is a 57-year-old grandfather who lives on Manhattan's Upper East Side and works in a swell 41st-floor midtown office with a Central Park view. In the 1980s he was a leveraged buyout artist of modest repute--a regular at the original Beverly Hills "Predators' Balls" hosted by junk-bond house Drexel Burnham Lambert, but not quite a big enough deal to rate a mention in Connie Bruck's chronicle of those days, The Predators' Ball. Then, when stock replaced high-yield bonds as the cheapest way to build a company, Silverman adapted his tactics to fit the times. He assembled a corporation that seemed to perfectly suit the sensibilities of the modern mutual fund manager, and built it into one of the greatest stock market success stories of the 1990s.
HFS, the company Silverman started in 1990, went public in December 1992 at a price, adjusted for subsequent splits, of $4 a share. Less than four years later--a couple of weeks after Silverman spoke at last year's Montgomery investment conference--it hit 79d. That's a return of almost 2,000%. During that period, only two sizable companies, disk drive maker Iomega and telecom equipment manufacturer Tellabs, topped that performance, according to Zacks Investment Research. Since then HFS's stock has struggled; only in late September did it again begin to approach last fall's levels. But its return to investors during its five years as a public company still puts all but a few others--Dell Computer being the only one larger than HFS--to shame.
If you agree that a 2,000% return to investors is amazing, you'd have to call the return to founder stupendous. At the start, says Silverman, he invested "several hundred thousand dollars" of his own money in HFS; his company stock and options are now worth some $700 million.
HFS achieved these prodigious results without having anything to do with computer networking or health care or any of the other famously hot industries of the decade. Instead the company's growth secret has been chiefly this: It buys other companies, preferably ones with well-known brands, few assets, and lots of customers.
It all started in 1990 when Silverman, then head of the leveraged buyout fund at the Blackstone Group, a New York merchant bank, spent $170 million to purchase the franchising rights to two tired hotel brand names: Ramada and Howard Johnson. Hospitality Franchise Systems, as the company he formed came to be called, went on to buy five more hotel brands--Days Inn, Travelodge, Super 8, Village Lodge, and Knights Inn--making it the world's largest hotel franchiser. Then, after a wrong turn into the gambling business, the company shortened its name to HFS and became the world's biggest franchiser of real estate brokerages, buying Century 21, Coldwell Banker, and ERA. Last year it bought Avis (this September it spun off most of the car rental company, keeping only the brand name and the reservations system). Next was Resort Condominiums International, which dominates the business of vacation time-share exchanges. Then PHH, the leading corporate relocation company as well as a big name in vehicle fleet management and a smaller one in residential mortgages.
In the process, HFS profits rose from $18 million (21 cents per share) in 1992 to $170 million ($1.29 per share) in 1996. That seems impressive, but in a time of rising stock prices and credulous investors--a time like the 1990s, that is--anybody with a high enough P/E ratio can cobble together big earnings increases with a flurry of acquisitions. That's what the conglomerates of the 1960s did, only to collide with economic reality when the stock market began imploding in the early 1970s. Silverman doesn't deny this. "Any dope with a checkbook can buy a company," he likes to say. "It's what you do afterward that matters."
True enough. And for Silverman, the moment of truth has arrived. Up to now, he's been able to argue with justification that his company is no conglomerate but a simple, focused franchising machine. Yes, running a hotel is different from renting a car, but HFS doesn't run any hotels or car rental agencies, it just sells the franchises and handles the reservations. With the PHH merger, however, that business model began to change. Now, with Silverman in the midst of his biggest deal yet--a $12 billion merger of equals with direct marketing giant CUC International--it is changing a lot.
The new corporation will be called Cendant ("Every name we liked, either somebody already had it or it wasn't trademarkable or it meant something pornographic in another language," Silverman says.) Cendant will be big, with revenues that place it smack in the middle of the FORTUNE 500, and a market capitalization that as of Sept. 29 would rank it 72nd among American companies, just ahead of Merrill Lynch. It will be complicated, with 30,000 employees and an enormous array of businesses. It will also be pretty much complete--neither Silverman nor his new business partner, CUC's CEO Walter Forbes, foresees big acquisitions as part of Cendant's near-term business plan. (There is one major deal already in the works: If Hilton's Bollenbach succeeds in his bid for ITT, he will let Silverman license the franchising rights for ITT's Sheraton hotels.)
So how will this giant that is Cendant grow? Well, that's where the story gets interesting. Silverman, who thus far has seemed so in tune with the times in his choice of business strategies, is now staking his future on something so dated, so passe, so unbearably 1960s as synergy. You know, as in: selling CUC travel club memberships to people who stay in Days Inns; selling PHH mortgages to people who buy houses from Century 21; renting Avis cars to Coldwell Banker agents who stay in RCI-arranged time-shares on vacations paid for by selling houses to people relocated by PHH.
This is a hard sell to 1990s investors--which is why news of the PHH and CUC mergers sent HFS's stock price reeling (as the chart on the previous page shows). The skeptics' argument is simple enough: Don't these people know that cross-selling has been tried before, in the same industries, with some of the same companies? Don't they remember ITT's failed attempt to combine Avis and Sheraton into a travel juggernaut? Don't they remember Sears Roebuck's fervent (and misplaced) hopes that Allstate, Dean Witter, and Coldwell Banker would synergize happily to turn around the company's sagging fortunes? Don't they remember Allegis?
In fact Silverman vividly remembers Allegis, United Airlines' ill-fated mid-1980s bid to corner the travel market by buying Hertz, the overseas Hilton hotels, and Westin. He was part owner of a few Westin hotels at the time, and noticed they were getting tons of bookings from United and sending Hertz lots of customers.
"I, from personal experience, was a true believer in the benefits of cross-marketing," he says. "If you actually do your homework, which none of these children who manage money ever do, you'll see that it did work at Allegis." So what broke up the company? According to Silverman, it was a pilots' strike, a sharp rise in jet fuel costs, and bad investor relations by the company's CEO. Three things, that is, that will never plague a company that Silverman has anything to do with.
For one thing, Silverman has learned not to buy anything so fraught with hassles and risks and capital expenditures as an airline. "I've always dreamed of franchising an airline," he says, "but I haven't been able to figure out how to do it." As for investor relations, if there is one thing Henry Silverman has learned in his long and sometimes weird career, it's that you need to be nice to your big shareholders.
Consider whom he had to answer to in his highest-profile venture before HFS, running the leveraged buyout fund at corporate raider Saul Steinberg's Reliance Group Holdings in the 1980s. Investors in the $120 million fund included a group assembled by Drexel Burnham Lambert junk bond king Michael Milken--among them Milken himself, Seema Boesky (then the wife of arbitrageur Ivan), financier Carl Lindner, and casino magnate Steve Wynn. "It was like playing the violin in front of Isaac Stern," Silverman says. "I had all these sharks masquerading as barracudas as my investors."
Before Reliance, Silverman--whose father was CEO in the 1960s and early 1970s of Talcott National Corp., then a leading commercial finance company--had spent most of his career as a freelance dealmaker of sorts. His first job after graduating from the University of Pennsylvania law school in 1964 was as an assistant to Steve Ross, then in the early stages of assembling the empire that eventually became Time Warner. Silverman went on to work in investment banking, then ran and dismantled a miniconglomerate called ITI Corp., then started doing deals on his own.
He'd gather investors, buy a smallish company, tweak its business plan, then sell it. He went through several radio and TV stations, Yoo Hoo Chocolate Beverage, and the Delta Queen Steamboat Co.--a deal he did with vulture investor Sam Zell, who still owns most of the company. Together with Steinberg he went into the bus-shelter business. That turned into a near disaster when their unsuccessful attempts to land a New York City contract became the subject of a grand jury investigation; but the two were never charged with anything and ended up winning contracts in Philadelphia, Miami, and other cities.
Silverman made pretty good money but achieved nowhere near the prominence of the people he did deals with. He was, he jokes, "the Zelig of the corporate world." (Zelig, a Woody Allen movie character, was a nobody who repeatedly found himself next to famous people in the middle of historic events.) It was the $120 million buyout fund at Reliance--and the availability of hundreds of millions of dollars more in Drexel junk bond funding--that gave him his first opportunity to perform on a larger stage.
The Reliance buyout fund bought a family-owned Southern motel chain called Days Inn in 1984, quickly expanded it into a national brand through aggressive franchising, took it public, took it private again, and finally sold it in 1989. Critics in the hotel industry said Days let quality standards slip in order to land more franchisees. Silverman's barracuda investors had no reason to complain--the Days deals turned a $30 million investment into $180 million in just five years. But the hotel chain, laden with high-interest debt, went bankrupt two years after he sold it.
While running the Reliance buyout fund, Silverman also bought a handful of TV stations in cities with large Hispanic populations and cobbled them together into the country's No. 2 Spanish-language TV network, Telemundo. Telemundo struggled during Silverman's tenure as corporate advertisers shunned the Hispanic market, and went bankrupt three years after he left Reliance in 1990 to run the Blackstone Group's buyout fund. (Telemundo is now a money-making public company.)
This wasn't a spectacular record, and it appears to have left a lot of casual observers on Wall Street deeply suspicious of Silverman's subsequent accomplishments. Silverman's years of experience did endow him with a unique set of qualifications: He knew more about running a company than just about any dealmaker on Wall Street. And he knew more about Wall Street than just about any CEO. But even his friends had no inkling that he was about to become one of the more spectacular late bloomers in business history.
Bollenbach, who had gotten to know Silverman in the mid-1980s when he was CFO at Holiday Corp. and Silverman was running Days Inn, stopped by Silverman's office after leaving Donald Trump's employ in 1991. Silverman offered to make him a partner in his fledgling venture, with the two of them splitting everything fifty-fifty. Bollenbach turned him down. "There went $200 million," the Hilton CEO now says. (Actually, it's more like $350 million.)
At Days Inn in the 1980s, Silverman had made an important discovery. "What he found was that the predictable earnings of a franchise business were music to the ears of Wall Street," says Mike Leven, who was president of the chain during most of Silverman's time as CEO and went on to be president of Holiday Inn and founder of an HFS wannabe called U.S. Franchise Systems. "It's not burdened by depreciation; it's not burdened by the cyclical nature of the hotel business."
That was the initial genius of HFS--the first major hotel company that didn't own or even manage any hotels. Not that it looked so smart at first. Forty-five days after Silverman bought the Ramada and Howard Johnson brands from the largest owner of both chains' hotels, Prime Motor Inns, the Gulf war broke out. Americans stopped traveling, and before long Prime filed for bankruptcy. Then the company that had bought Days Inn from Silverman in 1989 went belly up, and Silverman swooped in and bought the Days brand as well.
Throwing hundreds of millions of dollars at a bankrupt industry was not popular with most of Silverman's new partners at Blackstone. But before long it became clear that it didn't matter if hotel owners were bankrupt, or even if they'd been foreclosed on by the bank--somebody still had to pay the franchise fees. What's more, in times of trouble, many independent motel owners switch to franchise operations in hopes that a brand name will bring in more business. Earnings rose sharply. Silverman had created a growth company out of the ruins of a stagnant, cyclical industry. It was clearly time to go public.
Over the years, Silverman had developed a knack for telling investors exactly what they wanted to hear without seeming to pander to them. This gift became apparent during the pre-IPO road show in November and December of 1992. At first the Merrill Lynch investment bankers had big trouble lining up money managers willing to listen to Silverman--Are you kidding, a hotel company? One that doesn't even own any hotels?--but by the time the tour reached its end in the country's mutual fund capital, Boston, the word of mouth about Silverman's spiel had made Hospitality Franchise Systems into if not a hot IPO, at least a warm one. Boston fund companies like Fidelity, Scudder, and Massachusetts Financial Services ended up buying much of the IPO.
"Basically, I walked out of the room knowing that this was gonna be a successful business model," says MFS Emerging Growth's John Ballen, who snapped up more than 15% of the offering. "That is not the impression that you often get." Ballen was even more impressed when, the day after the SEC-imposed post-IPO quiet period ended, his phone rang and Henry Silverman was on the other end, calling to give him an update on developments at the company.
Silverman's investor-relations behavior is still as aggressive today, and he doesn't just talk--he delivers. Never in its five years as a public company has HFS missed the consensus quarterly earnings estimates made by brokerage analysts and compiled by I/B/E/S.
It is of such touches, coupled with rising earnings, that a high stock price is made. And for an acquisitive corporation, stock price is of the essence. Essentially, the higher your P/E ratio is, the smarter your acquisitions look--and HFS has in recent years generally been able to keep its P/E well above 30.
Still, just because a deal looks smart doesn't mean it is. Many a company has squandered the seemingly magical accounting benefits of a high P/E by making dumb acquisitions or mismanaging the companies it buys.
Silverman structured HFS to minimize such dangers. The company's practice of avoiding tangible assets--be they hotels or rental cars or real estate brokerage offices--is sometimes derided as financial gimmickry. But it's more than that: HFS is giving up potential profits in return for protection from potential losses. So even a mistake, such as HFS's tentative 1994 foray into the gaming business, ends up not being all that painful--because HFS never actually bought a casino. What's more, by focusing on selling franchises instead of running hotels or car rental operations, HFS is less likely to overtax its managers.
These managers are led by John Snodgrass, a 40-year-old Tennessean who headed up the franchise sales operation at Days Inn in the 1980s and is now president of HFS. While CEO Silverman works out of Manhattan and spends much of his day dealing with investors, Snodgrass is based at HFS headquarters in Parsippany, N.J., leading what is essentially one big sales force. Office space at the company's two Parsippany buildings is parceled out between brands--Century 21 and Coldwell Banker are on the same floor; Howard Johnson and Ramada in the same room--whose executives compete with each other to sell franchises. Compensation is based heavily on meeting performance quotas, and those who repeatedly fail to make their numbers don't stick around.
For the hotel industry, this single-minded focus on franchise sales is new but not revolutionary. And HFS's performance in that business has been good, but not spectacular--revenues are rising at a rate of around 9% a year. In real estate, the company has set itself a more daunting task: transforming an industry now dominated by local agents who rely on personal connections into one ruled by national brands. Some in the industry doubt the effort will succeed--"I think what they have is a problem with brand-name importance," says Dave Liniger, founder and chairman of rival RE/MAX--but if it does, the rewards could be huge.
The future of HFS (Cendant, that is), however, isn't just about selling more franchises. It's a future Silverman first glimpsed while reading the New York Times one Wednesday morning back in January 1992. Buried inside the paper was an article about a new deal between Pepsi and Pennsylvania State University: Pepsi would pay the university $14 million in order to become its exclusive cola supplier (and chief athletic sponsor). If Penn State's 70,000-odd students were a valuable enough resource to get Pepsi to fork over millions, Silverman figured, then the people staying in HFS's 150,000 hotel rooms (the number is now almost 530,000) ought to be worth something too. It turned out they were worth a lot less--Silverman says after he negotiated with both Pepsi and Coca-Cola, Coke agreed to pay HFS "several hundred thousand dollars" to become the "preferred" provider of vending machines to HFS hotels--but it was the first trickle of what has become the company's fastest-growing profit stream.
After Coke came a deal with AT&T to offer better-than-usual rates to HFS hotel franchisees and to give HFS a share of the new revenue AT&T took in from the program. Now there are 85 such preferred alliances. To give an idea of their size and importance: The world's second-largest insurance broker is a company named Aon. HFS, with which it has a preferred provider agreement, is its single-largest account.
The discounts that franchisees get from these deals make HFS brands more attractive to them; the money that providers pay HFS to land the deals is almost pure profit. Not surprisingly, the company's executives have increasingly begun thinking of its franchisees, and its franchisees' customers, as valuable resources to be mined. The value is most apparent in real estate: When people buy a house, they're often also in the market for a refrigerator, painting services, homeowner's insurance, and the like. The problem is, real estate agents making $5,000 commissions aren't all that interested in the $20 bonus they might get for steering a customer to a fridge made by an HFS preferred provider.
That's where CUC comes in. Started in 1973 by a Cambridge, Mass., management consultant named Walter Forbes, who believed computers would be the next wave in shopping convenience, CUC (it stands for Comp-U-Card) evolved into a telephone-marketing juggernaut that sells memberships and then offers its members low prices on a huge array of products. This may sound a little iffy as a business plan, but in fact it has turned out to be rock solid: Members, who pay an average of $49 to belong to CUC clubs like Shoppers Advantage and Travelers Advantage, renew at a rate of more than 70% a year. And because CUC makes its money from member dues, not product sales, its earnings are far steadier and easier to predict than retailers' profits usually are.
CUC lured most of its 71 million members through mailings to credit card holders. And while technological progress means Forbes' initial dream of selling via computers is coming true--CUC is already one of the Internet's biggest merchants--finding potential members to recruit is still CUC's top priority. That, and making sure no one else is moving in on its extremely lucrative territory. "We've always kept a very wary eye on any company that comes near our space," says Forbes. "HFS came out of nowhere."
At first CUC thought about buying HFS, but HFS's rapid growth and high stock price quickly rendered that out of the question. In 1995 the two companies entered into an agreement through which people calling HFS hotel reservations centers were asked if they were interested in certain travel discounts and, if they answered yes, were transferred to CUC operators. The venture netted CUC a million new members in its first year.
HFS executives, meanwhile, became convinced that the company needed direct-marketing help if it was going to sell its hotel and rental car and real estate customers something more than rental cars, hotel rooms, and houses. So, after flirting with Signature, a Montgomery Ward division that's the No. 2 direct marketer, Silverman decided to merge with No. 1.
The merger, announced May 27, was not immediately popular with Wall Street. Although faithful HFS investors like John Ballen of MFS, who has also owned CUC since 1986, saw it as a logical next step--"They were either going to be fierce competitors or end up together," he says--the general reaction was one of puzzlement.
Over the past couple of months, Silverman has been doing his best to explain himself. At September's Montgomery conference he offered the first concrete evidence that Cendant will deliver at least some of those synergies he's banking on. By selling to customers of HFS real estate brokerages, PHH Mortgage has already nearly doubled its monthly volume since joining HFS. In 1998, Silverman predicted, PHH will be the second- or third-biggest mortgage originator in the country--up from 13th in the first six months of this year. In June, he continued, HFS handed over to CUC 1.6 million names off its customer lists. So far, CUC has been selling memberships to them at twice the rate it achieves on the names it gets from banks. That improvement could boost Cendant's pretax earnings 40% if it continues for the other 78.4 million names HFS will pass on to CUC marketers over the next four years.
All very impressive. But there's another worry. Last year, when Silverman announced that he would begin selling up to 5% of his HFS holdings each year, some investors fretted that he might be easing his way out. But Silverman says Cendant is his "final frontier." He and Forbes will share power, with Forbes focusing on CUC's international and Internet businesses and Silverman in charge of everything else. After their employment contracts run out in five years, Silverman figures both he and Forbes will step aside and let someone younger run things.
If HFS, and by extension Cendant, is nothing but a fluffy concoction of Silverman's cleverness and the 1990s bull market, this could bring disaster. But if Henry Silverman really is the genius all those people say he is, he might just be able to look forward to a relatively peaceful--and wildly prosperous--retirement.
REPORTER ASSOCIATE Rajiv M. Rao