Hertz Global Holding Inc. Market Cap (as of 21/03/2014): $12.04bn
On March 18th, 2014 Hertz, global player in the car rental sector, announced the spin-off and successive IPO of its equipment rental business (HERC henceforth), which will allow Hertz to collect about $2.5bn.
The announcement was released after months of rumors as the US rental company began to consider the disposal of its construction rental division in December 2013 following several years of investor consternation concerning the unified business model. Indeed, Hertz is trading at a P/E multiple of 12.7x, well below its main competitor, Avis Budget, which trades at 16.6x. Such a difference is mainly due to the lower valuation of the equipment rental business due to its higher capital intensity compared to the rest of Hertz business. In fact, according to J.P. Morgan analyst Kevin Milota, Hertz could expect to save $267mm and $250mm of net fleet investments in 2013 and in 2014 respectively as a result of the disposal.
Thanks to the separation of HERC, thus, Hertz expects to unlock significant value for shareholders and to benefit from a large upside. Indeed, the spin-off will allow both companies, namely Hertz and the “new” HERC, to operate as pure play companies and, above all, to attract more focused investors. Furthermore, Hertz will benefit from more stable earnings and cash flows (which potentially reflect more stable returns to shareholders) while HERC will have a clear and independent growth strategy supported by a suitable allocation of resources. Finally, HERC development has some significant opportunities stemming from a recovering U.S. construction sector and several opportunities of consolidation in the sector.
With regards to the financial structure of the companies, Hertz, which in 2013 recorded an increase in consolidated revenues of 19% to $10.77bn, is expected to raise about $2.5bn that will be used in a $1bn share buyback plan and to pay down debt. As a consequence, Hertz aims at achieving a “best-in-class” financial profile with Net Corporate Debt-to-Corporate EBITDA below 3.0x by 2014 and a future range set between 2.5x and 3.5x apt to manage seasonal needs as well as to maintain financial flexibility. With regards to the aforementioned ratio, Net Corporate Debt is the net debt excluding the whole net fleet debt, while Corporate EBITDA represents EBITDA adjusted for car rental fleet costs (mostly leasing and depreciation).
It’s worth to note, that the very nature of the sector allows players to sustain a high level of leverage as the car rental business is generally characterized by low capital intensity due to the high debt funding needs for car fleet and extremely low non-fleet capital expenditures.
On the other hand, HERC is expected to record a stable growth over the next two years, leading to a 2015 EBITDA forecast of $0.9bn. These forecast a 5.5x P/E multiple and imply a market value of $4.8bn (according to the Financial Times).
The company is expected to have a Net Debt-to-EBITDA ratio of 3.5x – 4.0x at separation with the objective of gradually reducing leverage over time thanks to stable earnings and strong free cash flow generation.
Hertz share price reacted positively to the announcement, rising by almost 5% on March 14th. This comes to no surprise, as investors appreciate spin-offs that allow companies to increase their focus. Lots of research has been published on the matter showing that on average a spin-off announcement, especially if focus increasing, is accompanied by positive returns. According to Forbes for example, between 2002 and 2012 more than 80 American companies completed spin-offs worth at least $500m; of these, the parent companies delivered an average 35% return and the spun-off subsidiaries a 70% return (compared to a 22% return for the S&P).
The company has hired Bank of America Merrill Lynch and Barclays to work on the separation. The target spin-off is expected to be completed by early 2015 and is subject to customary closing conditions.
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