Late on Sunday, Hertz Global Holdings (HTZ) announced that it will acquire Dollar Thrifty Automotive Group (DTG) (a smaller rival in the vehicle and equipment rental and leasing services industry) for $2.3 billion in cash. This means a price of $87.5 per share for DTG. On Friday, the shares of DTG closed at $81, while HTZ closed at $13.15. The merger would result in the formation of a rental car market leader in an industry that has seen a lot of consolidation over the years. Hertz said it expects cost synergies of $160 million per year. We recommend buying HTZ as it is set to acquire DTG and benefit from synergies.
Hertz is paying a premium of 8% over DTG's Friday closing price. This is far more than the $41/share offer made in 2010. Thus, this is a far better win situation for DTG shareholders than for HTZ shareholders.
Hertz operates from 8,750 locations in 150 countries for its vehicle rental business segment and approximately 330 locations for the equipment rental business segment. The acquisition gives Hertz (a premium brand) access to two well known mid-tier and deep value brands of DTG: Dollar and Thrifty. The Dollar brand includes 260 locations in the U.S. and Canada, while Thrifty has 326 locations as of December 2011. Both brands have Rent-A-Car services along worldwide franchises (59 for Dollar and 75 for Thrifty, exclusive of the U.S. and Canada). The Thrifty brand also includes used cars' retail sales network. The joint entity will now serve all customer segments from premium to deep value.
Hertz expects a cost saving benefit of $160 million per year (41% from fleet, 10% from procurement) due to greater productivity, and elimination of task duplication and efficiency, in addition to higher power over suppliers. Sales are also likely to grow faster considering the joint entity will now also have competitive advantages over its peers. The companies jointly control 37% of the U.S. airport market.
The companies will now jointly compete against companies like Avis Budget Group (CAR) and Enterprise Rent-A-Car for the vehicle rental segment. For the equipment rental business, HTZ competes with the likes of United Rentals (URI) and Sunbelt Rentals (held privately). The picture below, from Hertz's latest presentation, gives an idea of the different brands serving different client categories.
The two step acquisition (a cash tender followed by a cash merger for any remaining outstanding shares) will commence when Hertz files a tender offer statement and DTG files a solicitation/recommendation statement with the SEC (expected time early September). The financing will come from DTG's and HTZ's cash on hand and new borrowing ($1.95 billion commitment is in place).
The deal is expected to close in Q42012, provided that:
- Hertz gets a definitive agreement to divest the Advantage brand (which it had acquired in 2009 following its parent company's bankruptcy) to get anti-trust clearance from the Federal Trade Commission. Hertz has now announced an agreement to sell Advantage for $16 million to Macquarie Capital and Franchise Services of North America (FSNA) has been reached. A favorable outcome can be expected from the FTC. The company expects this to come in mid-October). Advantage brought in $214 million in revenues last year.
- Gets a majority of DTG's outstanding shares tendered.
Recent Quarter's Performance:
Hertz's sales were up 7.4%, according to the latest quarterly results, due to an increase in revenues from both car rental and equipment rental. Diluted EPS (adjusted) for Q22012 were a record $0.35/share, compared to $0.26 in Q22011.
Hertz re-iterated its revenue and EPS guidance of $8.9 - $9 billion and $1.28 - $1.38/share (on 450 million shares) respectively. Analysts expect $8.9 billion in revenues and 1.33/share for EPS. The company has a strong earnings surprise history to complement its 8.2% revenue growth and 17% long-term earnings growth.
Dollar Thrifty reported record 2Q2012 diluted EPS of $1.69, compared to $1.36/share for 2Q2011. The company expects fleet costs to continue to improve. The company also benefits from a weak economy, as used car sales pick up. The realized gain from used car sales were $36.8 million for the first six months. DTG expects used car sales to continue being strong for at least the rest of the year. These used car sales will help diversify Hertz's operations, after it acquires DTG; the latter had engaged in share repurchases i.e. $127 million for 2012. $273 million remains under the share repurchase program as at June 30, 2012. Due to this, DTG increased the full year EPS estimate to $5.25-$5.70/share from $5-$5.60/share.
Both companies have considerable debt. DTG's debt-to-equity ratio is 228%, while for HTZ it is 550%. Hertz's net corporate debt increased by $100 million in 2Q2012 as compared to 2Q2011. The interest coverage ratio for DTG is a healthy 4, but only 1.11 for HTZ, which will get worse when the company takes on more borrowings for the acquisition. However, Hertz is committed to reducing debt and getting an investment grade rating. For competitors like CAR and URI, the interest coverage is a low 1.45 and 1.03 respectively.
The operating cash flow (trailing twelve months) was $515 million for DTG and $2.7 billion for HTZ.
YTD, Hertz's stock price is up 12% and DTG's is up 15%. Pre-market, DTG is up 7.3%.
Hertz has a PEG ratio of 0.44, while DTG has a PEG ratio of 0.52. This shows the growth in the industry can be bought cheaply.
We can see a significant upside potential for HTZ, post merger, according to the cheap multiples above. The average target price is $20 for Hertz with a buy rating according to analysts.
We recommend buying Hertz in view of the synergies from the DTG acquisition, as well as due to its own financial performance.