Description

Introduction / Thesis:

• On November 16th Hertz closed an $87.50 all-cash tender offer for Dollar Thrifty. We believe this merger removes an overhang and will allow the industry to try to drive higher rental rates.  We estimate the deal will create 28 cents in cost synergies in 2013. HTZ will rerate to the 10-12x P/E and 6x-7x EV multiple that it traded at prior to the DTG deal overhang.  We estimate Hertz will earn $2 of EPS in 2013 driven by cost savings and pricing.
• Hertz could also spin off its construction and industrial rental equipment business. Potential buyers of the equipment business include United Rentals, Ashtead, and private equity. 
• We believe that sentiment around the rental car industry will improve in a consolidated environment.  We see the stock over $22 by the end of the year, given earnings of $2/share in EPS in 2013.  HTZ currently trades at 5.8x EBITDA versus 6x for CAR (historically trades at a premium) and 7.5x historical average.  

Hertz is the largest worldwide airport car rental brand, operating from approximately 8,500 corporate and licensee locations in approximately 150 countries. Hertz also operates one of the world's largest equipment rental businesses, Hertz Equipment Rental Corporation, offering a diverse line of rental equipment as well as new and used equipment for sale to customers ranging from major industrial companies to local contractors and consumers.

Financials / Valuation:

Rental car valuations reached historical lows over the past two years (reaching 4x EV/corp. EBITDA) over macro-economic concerns and the two year stalemate of HTZ trying to buy DTG. 

Since the 2009 recession when Hertz traded under $3 per share and Avis Budget and Dollar Thrifty were near bankruptcy, the rental car companies multiples have been depressed (5x currently vs. 7.5x pre-recession historical average).  The GM/Chrysler bankruptcies and the financial guarantee companies losing their AAA ratings annihilated residual values (down 18% in six months) and hampered rental car company’s ability to borrow.  In a typical recession, while used car values decline (typically mid-single digits), rental companies sell their fleet, raise rates to consumers on a tighter fleet, and generate significant free cash flow.  While I acknowledge HTZ’s cyclicality, we believe their ability to liquidate inventory into a large and liquid used car market, secular dynamics favoring rental over ownership in equipment rental, and the companies large free cash flow make it less subject to macro vagaries than is currently being rewarded by the market.  I believe that HTZ should trade closer in line to its historical multiple.  

I also believe the market is not properly discounting the strategic importance and synergies of Dollar Thrifty.  The Dollar and Thrifty brands provide HTZ a springboard to expand in value-leisure which is the fastest growing segment of the rental car industry and very complimentary to the Hertz premium brand.  While the Hertz brand is synonymous with mid-week corporate travel, the Dollar and Thrifty brands have significant share in the weekend leisure and international in-bound segments in the US’s largest leisure markets such as Florida, Hawaii, California, and Las Vegas.  Additionally, the combination of corporate and leisure allows Hertz corporate vehicles that are sitting idle on the weekend to be utilized for Dollar Thrifty leisure rental.  This has the potential to drive vehicle utilization from the low 80s to the high 80s.  

HTZ also has opportunities to grow the Dollar and Thrifty brands internationally and this could drive significant revenue synergies.  In Europe, where Thrifty in particular has strong consumer awareness but had been hampered by lack of investment, every 1% gain in market share, generates $100ml in revenue.  We believe that a 1% gain in market share is very achievable for Thrifty (especially when considering the capacity that has been pulled out of the European rental car industry via bankruptcies).  We expect HTZ to discuss revenue synergies for the first time by the analyst day (March 2013) and believe that when is all said and done, they could be in excess of $200ml (other Dollar Thrifty revenue opportunities include off-airport, and distributing Dollar and Thrifty through the vast HTZ travel network).  Revenue synergies and incremental costs savings (in addition to the $160ml announced) could add another $0.50 to earnings (which is significant off of a $2 base). 

I view favorable opportunities for positive pricing in a rental car industry consisting of 3 players that make up 90% of the market.  While pricing has been negative for the past two and a half years, HTZ ability to discount via a value brand versus the online travel agencies may boost industry pricing.   

I am also constructive on HTZ’s equipment rental business known as HERC (post the DTG acquisition only high single digits percentage of EBITDA).  This business is benefiting from housing starts and outsourcing trends which favor rental over ownership.  This business will grow double digits for the new few years with 70% incremental margins.  Ultimately, I think that HTZ will be a pure play car rental company and will divest HERC.  Depending on the structure and valuation, this will likely be a large deleveraging event for HTZ.   Potential buyers include United Rentals, Ashtead, and private equity.

Please note that rental car companies are generally valued (particularly by lenders) using Corporate EBITDA and Corporate net debt.  Corporate EBITDA includes interest and depreciation expenses from vehicle debt.  Corporate debt excludes vehicle debt.   

Catalysts:

• Updated synergies and announcement of revenue synergies in February
• Evidence of rate growth in 1Q earnings
• Strategic action on equipment rental business in late 2013

Risks:

• Macro weakness
• Mis-execution of DTG integration
• Pricing war with Enterprise in low-end leisure

Catalyst

Updated synergies and announcement of revenue synergies in February

Evidence of rate growth in 1Q earnings

Strategic action on equipment rental business in late 2013