With all the recent spin-offs, break ups and franchise buyouts, the auto rental industry is starting to resemble Europe after the fall of Communism.
Less than a year after Ford let go of Hertz in a leveraged buyout, the company—now called Hertz Global Holdings Inc.—is preparing to go public. Not three weeks after Hertz announced its filing in July did Vanguard, operator of the National and Alamo brands, enter the fray. Purchased out of Chapter 11 bankruptcy in October 2003, the company is expected to IPO by the end of this year as well. Avis Budget Group, the lone remaining piece of the former Cendant empire, started trading on its own in September.
What does the future look like for these pending IPOs and the industry in general? And how could it possibly affect you?
The Changing Landscape
In 2005, the local rental market experienced higher revenues than the airport segment for the first time. Hertz is aggressively pursuing off-airport locations with Hertz Local Edition. Avis Budget is in the midst of stated plans to expand its local market presence by more than 500 locations in three years.
Meanwhile Enterprise, the insurance replacement and local market leader and pioneer, is experiencing double-digit growth in fleet size and revenue at airport locations, and the Dollar Thrifty Automotive Group is buying back shares and gobbling up available franchises across the country.
The industry has finally rebounded from post-9/11 doldrums with pre-9/11 revenues. Yet it still faces considerable challenges: higher interest rates, fleet costs and vehicle prices.
“There hasn’t been a period where there has been so much going on that potentially has a long-term effect on the dynamics and landscape of the business,” says Neil Abrams, president of Abrams Consulting Group. “The old rules of doing business no longer work. They [auto rental companies] are all in this evolutionary stage where they’re moving into markets, revenue channels and business strategies that they’ve not exercised before. The supply chains, disposal channels and types of markets are in the throes of reevaluation.”
The economic boom of the late 90’s gave the travel and transportation industry a boost, with 2000 being a peak year for revenue. And then came 9/11 and the fallout, which only exacerbated the impending implosion of the dot-com industry. During the recession car rental companies, and the travel and transportation industries in general, were jolted into realigning their fleets and reevaluating their whole business model, Abrams says.
Today revenues are finally approaching pre-9/11 peaks, but profits are mixed.
Dollar Thrifty Auto Group reported net income of $37.3 million for the first six months of 2006, compared to $24.3 million over the first half of 2005.
Hertz, Avis Budget and Vanguard, however, saw revenues rise in the first half of 2006, only to experience a steep drop in net income compared to 2004.
Enterprise reported a company record $9.04 billion in worldwide revenues in fiscal year 2006. Because it is privately held, Enterprise does not have to share net income figures. But that it’s the most profitable car rental company is no secret.
Nonetheless, Enterprise faces the same profit pressures as the other majors. [PAGEBREAK] What’s Eating Profits?
The Federal Reserve raised interest rates 17 consecutive times since June 2004 before deciding to hold rates steady in August. Both Hertz and Avis Budget say their decrease in net income is primarily due to increased interest expense.
In addition, fleet costs are up 25 percent in the past two years, says Abrams, and increased competition has helped prevent rental rates from keeping pace.
The Big 3 domestic automakers are no longer in the business of supplying the auto rental industry with cheap cars. The days of fat incentives are over and guaranteed depreciation programs are shrinking.
GM is coming through on its stated goal to reduce daily rental sales, which were down 20 percent year over year in August and 26 percent in September.
In Ford’s case, there will be simply fewer cars on the bargaining table. Ford’s accelerated “Way Forward” plan includes a reduction in North American fourth-quarter production by 21 percent, or 168,000 units, compared with the fourth quarter a year ago. Rental fleets’ piece of the pie will be cut by about 33,000 vehicles, under present allocations.
Hertz, who has in recent years bought at least half of its cars from its former parent and 19 percent from GM, experienced a 17 percent rise in depreciation expense for its 2006 fleet.
Vanguard, joined at the hip with GM and DaimlerChrysler (82.5 percent and 16.2 percent of total fleet in 2005, respectively) saw a 15 percent rise in depreciation expense. Both companies expect those depreciation losses to go higher.
The domestic manufacturers’ woes on Wall Street have also aggravated the debt situation. As the credit ratings of the manufacturers have gone down, the amount of collateral a car rental company must put up to finance their fleets has increased.
Rolling with the Punches – Why the car rental industry is looking good
Higher fleet costs, vehicle costs and interest rates remain a threat. Yet the car rental industry has an advantage over its travel and transportation brethren.
The number of vehicles in a rental fleet can be more easily ramped up or down depending on demand, unlike lodging or airlines, which have to deal with far more expensive and inelastic assets.
Taking an airplane out of service and consolidating routes takes months. And, in the lodging industry, “when business is off you can’t lop off the top four floors of a hotel,” Abrams notes.
RAC’s can unload cars in bad times, albeit affecting residual values. But they can also dip into the aftermarket to move vehicles into fleet in a matter of days. And aging a fleet for an extra month before remarketing—-with little effect on the renter—-can save a lot in capital spending. [PAGEBREAK] Welcome HTZ and VCG
In the midst of these financial and fleet management pressures, the majors are launching their IPOs. Memorize these stock tickers: VCG (Vanguard) and HTZ (Hertz). Both will soon join DTG (Dollar Thrifty) and CAR (Avis Budget) on the Big Board.
Private-equity fund managers The Carlyle Group, Clayton Dubilier & Rice Inc. and a private equity affiliate of Merrill Lynch bought Hertz in a leveraged buyout from Ford in December 2005 for about $15 billion. They plan an initial public offering of $1 billion in common stock later this year.
The Vanguard IPO is also being brought by a private equity investor, hedge fund behemoth Cerberus Capital Management L.P. Cerberus bought Vanguard out of bankruptcy in 2003 for a steal at $223 million.
Far less than Hertz’s $1 billion, the company is seeking to raise $300 million in common stock, according to its SEC S1 filing.
“Vanguard is finding its way out of bankruptcy,” says Abrams. “Based on the numbers they appear to be turning things around with their image, their market share and their core market segments that had eroded.”
Beware the Quick Flip?
Hertz may have the prestige name and a solid corporate foundation, yet some Wall Street analysts don’t look too keenly on leveraged buyout firms that “flip” companies for quick profits.
A leveraged buyout (LBO) involves the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. This allows LBO firms to make large acquisitions without having to commit a lot of capital. LBO firms are not in it for the long haul. The goal is to improve a company’s balance sheet, bring the company public, and take their profit from the sold shares.
What could an LBO firm possibly do in less than a year, in Hertz’s case, to improve a company’s worth?
“They install what I refer to as a hot management style,” says Ben Holmes, publisher of Morningnotes.com, an independent research firm. “They go in and slash and burn. They have guys whose job is to find fat and get rid of it. These transactions are not to make the company stronger and increase shareholder value, except for themselves as shareholders,” Holmes told ARN.
Outspoken venture capitalist Paul Kedrosky posted on his blog: “While it’s nice to see the boys and girls are able to flip something the size of Hertz in a scant seven months, it's still a little surprising.”
Kedrosky wonders why Hertz’s private equity backers are going public in such a hurry after they had $1 billion dividended back to them and thus already taken much of the risk from the deal. He theorizes that higher gas and car prices don’t bode well for future earnings.
“It seems clear this should be read as a savvy and strongly negative insider statement about the car rental business. Buying (in the IPO) when so many smart people are selling is rarely a good idea,” he concludes. [PAGEBREAK] A recently published study suggests that quick flips don’t provide the value investors seek.
The study, by Jerry Cao of Boston College and Josh Lerner of Harvard Business School, looked at 500 initial public offerings from 1980 to 2002 brought by private-equity firms.
The IPOs that were brought within a year of the leveraged buyout underperformed the Standard & Poor’s 500 by 5 percent. IPOs completed more than a year after being bought out yielded a 23 percent higher return.
Betsy Snyder, a credit analyst for Standard & Poor’s and a longtime car rental industry watcher, makes a distinction between leveraged buyouts in the car rental industry and those of other industries.
“You can’t add that much debt to these [car rental] companies because they’re already so highly leveraged to start with,” she says.
“Cerberus is not a quick flip,” says Snyder. “I think they’re taking advantage of market opportunities. I don’t think they bought it and will dump it because they’ve lost confidence in the company.”
“In Hertz’s case, they didn’t add that much debt to the balance sheet, but interest and operating expenses were up.”
Snyder says the buyout firms refinanced Hertz when interest rates were rising. They used rental vehicles as collateral, so those cars are tied up with the financing.
“Before, all their debt was unsecured. If something happened, they could sell the cars. They don’t control the cars anymore,” she says.
Why these IPO’s are good for the industry
In as much as playing the stock market is like gambling, it’s hard to predict the short and long-term performance of Hertz’s and Vanguard’s IPOs.
Hertz and Vanguard will soon join Dollar Thrifty and Avis Budget Group as standalone public companies. And as such, their operations are much more transparent than they were when privately held or part of major conglomerates such as Ford, Cendant and AutoNation.
These car rental companies must make public their financial filings, purchase agreements with manufacturers, business strategies, corporate operations and salaries. As a result, the effects of rising interest rates and fleet costs, and changes in business practices, can be charted with hard numbers.
Over time, trends and patterns emerge and can be benchmarked in individual companies and the industry as a whole, providing a gauge against which other companies can measure their growth.
“Any scrutiny of the industry is positive for those that have stake or equity in the industry,” Abrams says. “It puts the rental industry on the radar screen. People are talking about it. People are analyzing it. And at the end of the day it provides value to the operators in the industry, whether you’re a large global brand or a local independent.”
Late Breaking News: Hertz Sets Share Pricing Range
The underwriters for Hertz Global Holdings Inc. have set a pricing range for its upcomgin initial public offering of 88.2 million shares of $16 to $18 per share. The company is valuing itself at around $5.45 billion, according to an SEC filing.