Description

Summary

    Hertz (HTZ) is one of three large rental car companies in the United States that (along with Avis and Enterprise) control over 90% of the market. As an effective oligopoly, HTZ should have benefited from this favorable market structure.  However, as we will explain later, Hertz was often the impediment to realizing the benefit of that oligopoly. As a result of Covid-related lockdowns and travel limitations, poor operating performance and its substantial debt, the company filed for Ch. 11 bankruptcy in May 2020. A group of investors led by Knighthead and Certares won an auction to purchase Hertz as part of the company's emergence from bankruptcy. Under the plan, the sponsors agreed to inject new equity into the company and backstop a rights offering that was made available to old equity (HTZGQ) and bondholders. Hertz will emerge from bankruptcy today, June 30th, and will trade on normal exchanges as well as through 144a markets being made on various investment bank trading desks. The bet here has two parts but is fairly straightforward - it's a bet on the private equity firm Certares's ability to materially improve the business and a bet that HTZ becomes a rational participant in the oligopolistic rental car market.  The company is currently benefiting from a strong pricing environment, with prices averaging 40% above 2019 levels due to a shortage in new car supply. While supply chain issues will resolve next year, we believe the US rental car companies can retain some of this price increase.  We think normalized EBITDA could range from $1.1 - $1.5bn. At 9x our normalized estimate, we think the stock is worth between $17.25 - $23.65 /share, vs. $12 current price (~50-100% upside). With 97% of the shares initially unregistered, institutional investors have the opportunity to purchase shares at a significant discount to the prices on the screen.  To frame the opportunity even further, the public HTZGQ stock is already pricing the new company at $17.50 per share while you can buy the unregistered 144a stock at $12.  Something is wrong with this picture - we believe HTZ is materially mispriced.

Bankruptcy Plan

    Under the plan, the sponsors are raising $7.5bn of new capital, consisting of $4.4bn of new common equity, $1.5bn of preferred equity, and $1.5bn of new debt. The existing equity received $1.53 in cash, 3% of the new equity, and the option of either warrants for 18% of the new company or participation in a $1.6bn rights offering. Almost all creditors are getting cashed out at 100% of their claim value with the exception of the unsecured bondholders who had the option to participate in the rights offering to the extent that existing equity holders elected warrants.  In aggregate 471.1mm new shares will be issued at a price of $10 per new share. 88% of old equity elected warrants, so 91mm of warrants were issued with a strike price of $13.80 per new share. We expect Hertz to emerge with $1.4bn of cash based on our sources and uses. Our numbers assume that in May and June the company generated $264mm of incremental cash beyond the cash balance disclosed by company at the end of April.

    We calculate enterprise value using treasury stock method on the warrants (assuming exercise of warrants is used to buy back shares at the then prevailing price) and exclude non-recourse vehicle financing. The current 144a offer price of $12 implies a $7.3bn enterprise value. 3% of the new equity went to the old equity. These shares, along with the warrants issued to the old equity, will be SEC registered day one and freely tradeable. 97% of the stock was issued to direct equity investors and rights offering participants. This 97% is legended under rule 144a and only tradeable with distressed desks between institutional investors. We expect the company will do a full IPO process in Q4 which will de-legend and register these shares and eliminate the valuation gap.  

Implied HTZGQ Valuation

• HTZGQ currently trades at ~$9 per share. Under the plan, HTZGQ shareholders receive $1.53 in cash, 3% of equity in the new company, and 0.66 warrants for new equity with a 30 year maturity.

• Despite the long maturity of the warrants, we only value them at a 10 year maturity because we don't think the market will give credit to the long dated nature of the warrant. 

• Using 30 vol and a 10-year maturity, $9 per HTZGQ implies $17.50 per new Hertz Share.

The Business

• Hertz operates the Hertz, Dollar, and Thrifty car rental brands across North America, Europe, and other international locations. Pre-Covid Hertz had 24% market share but that declined to ~20% through Q1 2021 as HTZ was forced to defleet more than Avis while in bankruptcy. 

• The industry is currently experiencing a significant cyclical tailwind from constrained supply and elevated demand. New vehicle supply is limited due to semiconductor supply chain constraints while demand is elevated as consumers have significant pent up demand from over a year of dealing with Covid. As a result, pricing is up ~40% vs. 2019 levels

• We anticipate that supply constraints will continue to impact the auto OEMs through mid 2022. Based off of IHS industry forecasts for automotive builds and conservatively assuming a pullback from 2Q21 retail demand levels, we anticipate that inventories will remain constrained through mid-2022 (implying a strong 2022 peak season for the rental car industry). Rental car companies are typically the lowest price buyer of new fleets, so they should be the last buying group to get the cars they want.

• Once the auto supply constraints are resolved, pricing comes down to company behavior. 3 companies control over 90% of the volume, but historically they could not maintain price. Avis put it best on their Q1 call: "For the full year of 2010 the Americas segment achieved an RPD of $57. For the full year 2019, the Americas segment achieved an RPD of roughly $57, an increase of 0% over the past nine years. In this same 2010 to 2019 period, the average hotel room night as measured by Bloomberg and STR is up over 30%. PRASM in this period, as measured by reported metrics of the public airline carriers, is up 40%.” 

• Hertz was often the bad actor in the market that sacrificed pricing for market share. Part of this is due to poor business strategy driven by its over-levered financial situation. Our checks suggest that some large contracts were bid to low single digit margins. Another part of Hertz’s bad behavior stemmed from its very old IT systems. Without the ability and data to do dynamic pricing, Hertz was often under-pricing and leaving money on the table. With Certares in place as sponsor, we expect both of these issues to be resolved.

Certares 

    Certares is a private equity firm with $4.5bn AUM that specializes in travel and leisure assets. Certares provides proprietary value add to Hertz through its experience in turn arounds and through creating partnerships with its portfolio companies. Its investments include American Express Global Business Travel (GBT), Internova Group, and TripAdvisor among others. When combined, Certares’s aggregate portfolio comprises the largest travel agency in the world with over $100bn of bookings in 2019.

    Partnerships with Certares’ portfolio companies provide significant incremental value. As an example, Hertz has stated that the preferred partnership with GBT will generate $136-$147mm of incremental EBITDA beyond its financial projections. GBT will create this value by directing business on its platform to Hertz and getting paid a small fee to do so. Since this incremental business will primarily use Hertz’s existing fleet, it results in a very high contribution margin.

    We believe that Hertz will enter similar partnerships with other Certares portfolio companies like Internova and TripAdvisor. In particular, TripAdvisor has high quality data on customers’ intent to travel. Knowing where customers will likely be traveling even a few weeks ahead of time will help Hertz to optimize its inventory geographically to maximize utilization and RPD. Typically consumers book their airlines and hotels much further in advance than they book rental cars. When combined, these partnerships could result in $400-500mm of incremental EBITDA that Hertz would otherwise not be able to achieve.

Financials

• Our model assumes pricing remains at elevated levels through H1 2021, after which price declines. We assume Hertz can maintain 2/3 of the price increases once the supply chain normalizes on a lower than historical fleet base.

• Our model includes the Amex GBT contract but does not include any incremental benefit from Certares partnerships which could be as much as an incremental $350mm of EBITDA.

Risks

• Normalization of new car supply results in increased rental car supply and lower pricing

• Failure to achieve partnerships with Certares portfolio companies

• Operational turnaround encounters problems

Catalyst

• Announcement of incremental partnerships

• Roadshow and “IPO"

• Continued strong pricing and earnings