Critiqueing Keystone and Hertz: Management Can Improve Their Current Situations

Includes: HTZ, KEYS-OLD, LKQ
by: Jerry Marks

About 85% of our vehicles are disposed of through auction. . . (But) We believe that the dealer direct has a lot of benefits both for us on the timing and reducing the pipeline (number of days idle). And in providing benefits to dealers in that they save transportation costs, in some cases flooring costs. And it can be a "win win." So I see this as being a third or more of our opportunity in 2008 and going forward.

Source: Joseph Nothwang, Hertz (NYSE:HTZ) Executive Vice President and President, Vehicle Rental and Leasing, The Americas and Pacific. Hertz 2Q07 earnings conference call. August 2, 2007

A Resource Center for Management and the Board
Today's piece may be interpreted as overly critical of some of the things going on at a couple companies in the index.

From my perspective, I look at my criticism of Keystone's (KEYS-OLD) board as a deep admiration of what management has done with the company and what I thought they could still do.

And with Hertz, I just look at my criticism of their succession plan as something that the board can improve on (we all can improve somewhere), not that it is necessarily a bad board.

As you may recall, my goal is to enhance your understanding, not serve as a cheerleader for management (or in today's case the board of directors).

It is the difference between the sell side (brokerage community) where the business model is predicated on conflicted banking business and "access to management" (they get paid trading commissions for bringing management teams into fund managers on road shows). And my business model that is predicated on the idea of delivering you the best insights (without conflicts of interest) in return for a subscription fee that will be announced shortly.

Now having said that, I don't want to swing the pendulum so far that I just end up being a mean and nasty critic. I (like most people) prefer focusing on the positives. But when society's resources (capital) are at stake, I simply think it is irresponsible to neglect concerns for fear of being seen as "a mean person."

And yet I think I should make management teams aware that I am also here for them. And since I am broadening my scrutiny (as you will read momentarily) to the board of director's I should also make myself available as a resource center for them as well.

I don't talk to the media. I don't talk to portfolio managers (for the most part).

I just feel I am doing those individuals a disservice by getting caught up in the herd mentality. Don't get me wrong I try my best to respond to any specific questions about the industry or a company if they email it to me. Or in the case of the media, forward them any articles I have written related to a subject they are working on.

But I feel it is only fair that I make myself accessible to management teams should they want some advice or to bounce an idea off of me (and anyone who has read the legal section of my website knows it is efficient insights llc policy not to accept fees from public management teams).

So it essentially becomes free consulting for them. And is something that has naturally evolved over the last few years with a good chunk of the management teams already.

I haven't advertised this fact because frankly I don't chase after management teams for "face time." For the most part I feel if I can learn something from them beyond what I can read in the 10K, they have done something wrong. Instead, I feel I can learn so much more about them and their strategy from industry participants (employees on the ground, vendors, customers etc).

But if I am going to criticize management (and now the board), I feel it is only fair that I make myself accessible to them. This way if they are concerned about how I (or the general investment community) might react to something, they are welcome to bounce the idea off of me first.

Keep in mind, I really don't want to know anything that is not in the public domain because it places me in "radio silence" (hurting my mission) until a management team has made an announcement. So if it does involve something of this nature I ask that they do it as sparingly as possible.

But I feel it is only fair that a critic make him/herself as accessible as possible to the management teams and boards they are criticizing.

I think it can help avoid some of the problems you see happening with Keystone today, and hope this is a reasonable compromise.

Quick Thoughts on Keystone's Proxy
As you are probably aware, on Friday Keystone filed a proxy outlining the board of director's reasons for unanimously recommending its shareholders approve the merger with LKQ Corp. (LKQX).

First and foremost I want to apologize for taking so long to give you my thoughts on the topic. And I will try to give you some more detailed thoughts regarding all of the arguments laid out in the proxy in the near future.

But since people have been contacting me wanting to know my thoughts, I thought I would give you my quick take on the issue. The bottom line is that I find it difficult to encourage shareholders to vote against the merger with LKQ.

Let me be clear. I do not approve of the price. And I believe the proxy provides a college text book case of how a board of directors should not act during a merger situation.

Whether it was hiring investment bankers (JP Morgan) that did not understand the industry, which I did not have too much of a problem with initially until I read the bankers fairness opinion that said they pretty much based everything on management's expectations/outlook (which they would not disclose).

Or how the finance committee/bankers did not think something was wrong with the offer when a private equity firm was offering a similar value LKQ was offering (when the private equity firm doesn't get the synergies LKQ would get). And the only difference between LKQ's offer and the private equity firm was that LKQ was further along in the process.

Or how the board dismissed the idea of selling to someone else by saying automotive aftermarket companies had too many differences in their business models (although they didn't seem to have a problem using these companies in a peer multiple valuation analysis later).

I think the finance committee (and bankers) completely forget the fact (and once again probably because they did not hire bankers that understood the industry) that there are some recyclers/steel companies that could get HUGE synergies from a merger with Keystone.

Even the tax consequences Keystone shareholder's now must face versus a stock deal.

Just paragraph after paragraph seemed to explain to shareholder's (in my opinion) just how bad the board of directors acted.

But (to really rub salt in the wound), the board did something even worse. The board agreed to pay LKQ a $30 million termination fee and up to $1.4 million in certain transaction-related expenses if the board accepts a superior proposal.

At that point, I think the board has seriously hindered the company's marketability. And why I have difficulty in telling shareholder's to reject the bid.

As I have said in the past, I have been kind of torn over this issue already because I have tried to balance what is in the best interest of society (which I believe is a merger of LKQ/Keystone), with what I think is fair for Keystone's shareholders.

And when you combine a $30 million noose around the company's neck, you start to find little options but to approve the deal.

Although I have to admit, remaining an independent company (without a sale to someone else) is still (in my opinion) a viable option. I just think the proxy focused too much on the market psychology and risks associated with the Ford International Trade Commission [ITC] and ignored the possibilities of what the existing management team could deliver (in operating income) in the coming years.

I think few will debate that I have been the leader in pointing out the risks associated with the Ford ITC issue. And yet I still ranked Keystone in the top ten. And more recently I wrote about how a Supreme Court ruling had the potential to improve Keystone's position with this risk factor.

As I have written, manufacturer resistance is a perpetual issue and a risk. But it is something that I think only slows an inevitability towards greater alternative parts usage in the coming years.

So saying the company should sell to LKQ because they were worried about how the stock was reacting to these issues is perhaps the dumbest reason in the world to sell a company. Let the returns the company generates over time determine its value. Don't let market psychology tell you what it is worth.

Like I said, all things that I will try to go into more detail on in the near future.

Now a couple groups have purportedly filed class action lawsuits against Keystone.

I am not a big fan of litigation.

I think we make our own beds and we should lie in them.

But it has taught me that there is another area of due diligence that I need to improve on; the Board of Director's.

Historically, I have focused my attention on management teams, employees/associates, vendors, customers, etc. Don't get me wrong, I try to learn a little about each board member.

But recently (even beyond Keystone), it is becoming crystal clear that the board of director's of all of the companies need to come under greater scrutiny.

Who are these board members? How/why were they selected? And most importantly, philosophically, what do they feel their responsibility is to shareholders?

It is an issue I intend to focus on over the next couple quarters.

And speaking of a board of director's that probably could improve a little, let's turn to a conversation that occurred on the Hertz conference call. . .

Hertz Conference Call Quotes: The Board Needs To Adopt a Real Succession Plan
As you may recall, last quarter I conducted a survey of all of the companies in the index about their succession plans.

My specific question was if one of the company's top 3 executives were to leave for some reason, had the board had identified a replacement?

Below is the response I received back from Hertz Management:

Jerry, it would not be appropriate for us to comment on a Hertz Global Holdings' board of directors action but I can tell you that we have a lot of long tenured people in our organization. This gives us bench strength across our business segments and in the corporate organization.

Source: Lauren Babus, Staff Vice President, Investor Relations, Hertz

Given Hertz's bench strength, I think it surprised me that Hertz was one of the companies in the index that was not able to simply say: "yes."

Shortly thereafter the company announced its CFO Paul Siracusa will retire August 31, 2007.

And Christina Woo (Morgan Stanley) raised the issue on the conference call (almost compelling me to take back a lot of my criticisms of the sell side investment research community).

Below is the conversation that took place on Thursday's call:

Succession planning for key staff? With Paul retiring after 38 years I was a little bit surprised to see that there hadn't been someone picked to take over that role. Could you just comment, you know broadly, on the succession plans and your thought process?

Source: Christina Woo, Morgan Stanley. Hertz 2Q07 conference call

Sure, I guess Christina, we have a well planned process for CFO succession. We're following that plan. Having Elise step in while Paul is still here and available for consultation ensures continuity and internal development of talent. So very logical for us. We thought this was very well planned and orchestrated process. So I am surprised you are surprised.

Source: Mark Frissora, Chairman and CEO of Hertz. August 2, 2007 2Q07 earnings call

So Elise I thought is a temporary CFO while you look internally and externally for a more permanent replacement?

Source Christina Woo, Morgan Stanley, Hertz 2Q07 conference call

That's exactly right, she is one of the internal candidates.

Source: Mark Frissora, Chairman and CEO of Hertz. August 2, 2007 2Q07 earnings call

So in general, with your succession planning, is it fair to say that your philosophy is to have someone in the interim while you look for that permanent replacement? I guess that's the part that caught me off guard. That there hadn't been a more assured permanent position.

Source Christina Woo, Morgan Stanley, Hertz 2Q07 conference call

Well, Paul announced his retirement. And given what we are doing in the company he felt it was good to have new leadership. And we have internal talent that we have groomed for that leadership. So we are letting that internal talent step in. And we are doing an external search as well to validate that we are getting the best available talent for the job. Again, that's the best way we can explain it to you.

Source: Mark Frissora, Chairman and CEO of Hertz. August 2, 2007 2Q07 earnings call

I am going to have to share Ms. Woo's surprise.

I think Hertz's board needs to have a more defined succession plan.

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