Answer 4 questions for Finance Case Study: Hertz

Please read the attachment below and answer these questions:How does the dual-track process used by Ford to initiate “consideration of strategic alternatives” affect the bidding process for Hertz?In what ways does Hertz conform or not conform to the definition of an “ideal LBO target”? Do you believe Hertz is an appropriate buyout target?Strategically, what value-creating opportunities can the sponsors exploit in this transaction?How realistic are the key assumptions that underlie the Bidding Group’s projections in case Exhibits 8, 9, and 10? Which assumptions are most likely to have the largest impact on returns?

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For the exclusive use of T. Trinh, 2018.
Rev. Jun. 14, 2016
Bidding for Hertz: Leveraged Buyout
In late summer 2005, Greg Ledford, managing director and head of automotive and transportation
buyouts at the Carlyle Group, found himself examining his BlackBerry atop the Great Wall of China. Though
he had planned to be sightseeing with his daughter, his immediate focus was to finalize the terms of the
second-largest leveraged buyout in history. The target in question was Hertz, a subsidiary of the Ford Motor
Company, which was up for sale. Ledford needed to decide the price he and his co-investors would offer for
Hertz as well as assess the potential returns and risks of the deal. Already months of work, many dollars of
due diligence, and arrangement of tentative financing had gone into the bid. Complicating matters, he knew
he faced tough competition from a rival buyout group, no doubt engaged in a similar process.
The race to win Hertz had been set in motion several months earlier, when William Clay Ford Jr., the
chairman and CEO of Ford, announced plans to explore “strategic alternatives” for Hertz in April 2005. That
announcement was followed in June 2005 by the filing of an S-1 registration statement setting up a “dual
track process” that would result in a Hertz IPO should other sale prospects fail. Ledford, who spoke to
senior Ford managers on a regular basis, had gleaned that there was interest on Ford’s part for an outright
sale of Hertz. He believed a private sale that was competitive with an IPO would be viewed favorably by Ford
due to its greater up-front cash proceeds and certainty of execution. When no strategic buyer surfaced,
Carlyle, Clayton, Dubilier & Rice (CD&R), and Merrill Lynch Global Private Equity (collectively “Bidding
Group”) joined forces to bid on Hertz. It faced competition from another buyout consortium that included
Texas Pacific Group, Blackstone, Thomas H. Lee Partners LP, and Bain Capital LLC.
Hertz Ownership History
Hertz’s ownership history was characterized by a series of sales, public offerings, and leveraged buyouts
(Exhibit 1).1 The company was first established in 1918 by 22-year-old Walter L. Jacobs as a car rental
operation with a modest inventory of 12 Model T Fords that Jacobs personally had repaired and repainted.
The venture was immediately successful, leading Jacobs to expand and generate annual revenues of
approximately $1 million within five years. At the $1 million mark, in 1923, Jacobs sold his company to John
Hertz, president of Yellow Cab and Yellow Truck and Coach Manufacturing Company, who gave his name
to the company, creating “Hertz Drive-Ur-Self System” and a brand name that had endured ever since.
Information on company history was obtained from the company website: (accessed July 31, 2008).
This case was prepared by Susan Chaplinsky, Professor of Business Administration, Darden Graduate School of Business, and Felicia Marston,
Professor, McIntire School of Commerce. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an
administrative situation. Copyright 2008 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order
copies, send an e-mail to No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or
transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
This document is authorized for use only by Tan Trinh in Advanced Topics in Firm Valuation Spring 2018 taught by Shelly Canterbury, George Mason University from January 2018 to July
For the exclusive use of T. Trinh, 2018.
Page 2
John Hertz sold his investment three years later to General Motors (GM). In 1953, GM in turn sold the
Hertz properties to the Omnibus Corporation, which simplified the company’s name to “The Hertz
Corporation” in connection with a public stock offering on the New York Stock Exchange (NYSE). In late
1987, together with Hertz management, Ford Motor Company participated in a management buyout of the
company. Hertz later became an independent, wholly owned subsidiary of Ford in 1994. Less than three years
later, Ford issued a minority stake of shares through a public offering on the NYSE on April 25, 1997. In
early 2001, Ford reacquired the outstanding shares of Hertz and the company again became a wholly owned
subsidiary of the Ford Motor Company.
Hertz Financial History and Business Segments2
The large investor interest in Hertz over time was due in part to the company’s proven financial ability.
In fact, the company had produced a pretax profit each year since 1967. During the period 1985 to 2005,
revenues had grown at a compound annual growth rate of 7.6% with positive year-over-year growth in 18 of
those 20 years. Over the past same period, Hertz had emerged as a truly global enterprise; it had car rental
operations in 145 countries, and more than 30% of its total revenues were from outside of the United States.
Hertz was among the most globally recognized brands and had been listed in BusinessWeek’s “100 Most
Valuable Global Brands” (limited to public companies) in 2005 and every year since it was eligible for
Hertz currently operated in two business segments: car rental (“Hertz Rent A Car” or “RAC”) and
equipment rental (“Hertz Equipment Rental Company” or “HERC”). In 2005, it was estimated that RAC
would comprise 81% of company revenues and HERC 19%. RAC was supported by a network of franchises
that together with company-owned facilities operated in more than 7,600 airport and local locations
throughout the world. The company led its competition in the airport car rental market in Europe with
operations at 69 major airports. Hertz owned and leased cars from more than 30 manufacturers, most of
which it had long-term leasing and replacement agreements with. The equipment rental segment offered a
wide range of earthmoving, material handling, and electrical equipment; air compressors; generators; and
other equipment. Hertz rented equipment through 360 branches in the United States, Canada, France, and
Spain and had an extensive network of international licensees outside these markets.
For the year ended December 31, 2005, Hertz was expected to generate revenues of $7,410 million and
EBITDA of $2,759 million. Hertz’s most recent income statements and balance sheets are shown in
Exhibit 2 and Exhibit 3, along with pre-LBO projections for the full year 2005.
The Car Rental Market
U.S. rental car revenues in 2004 totaled approximately $17.4 billion, an improvement of 5.5% over 2003
(Exhibit 4). U.S. industry-wide revenues were, in turn, approximately two-thirds of global revenues.
Competition within the global car rental industry was keen and highly concentrated among a few companies.
In the United States, the top three competitors, Enterprise Rent-A-Car, Hertz, and Avis Rent A Car (owned
by Cendant Corp.), captured approximately 68% of the estimated 2006 market revenues and the top six
captured almost 94% of the total. Hertz led in the airport rental segment of the industry while Enterprise
dominated the nonairport rental segment. In 2005, it was estimated that approximately 79% of the U.S. RAC
revenues would be airport-related rentals. Hertz’s market-leading share of the airport rental market was
2 Information on business segments is from Hertz Global Holdings, Inc, 3/30/2007 Form 10-K (Annual Report) (Park Ridge, NJ: Hertz Global
Holdings, Inc., 2007).
This document is authorized for use only by Tan Trinh in Advanced Topics in Firm Valuation Spring 2018 taught by Shelly Canterbury, George Mason University from January 2018 to July
For the exclusive use of T. Trinh, 2018.
Page 3
attributed in part to its “Hertz #1 Club Gold” program. About 50% of RAC’s vehicle rentals came from Club
Gold members.
The car rental business was affected by general economic conditions and more particularly by conditions
in the travel industry, especially airline traffic. There was a high correlation between airline traffic (number of
enplanements) and industry-wide rental revenues. Following the September 11 terrorist attacks on the United
States, there was a sharp downturn in enplanements, but they finally seemed to be rebounding in 2004. The
U.S. Department of Transportation predicted enplanements would grow at an annual rate of 3.7% from 2004
to 2010.3
Partially due to 9/11, off-airport rentals, which consisted primarily of insurance replacement (rentals
provided by insurance companies while the policyowner’s automobile was out of service), local business
travel, and leisure travel, had recently grown at a faster pace than had airport rentals.
The Equipment Rental Market
As of August 2005, the size of the North American equipment rental market in revenues was believed to
be $25 billion, while that of France and Spain were approximately $4 billion and $2 billion, respectively. But
because HERC only offered certain types of equipment, Hertz’s applicable market was somewhat smaller.
The equipment rental market was more variable than the car rental market and depended mostly on
industrial productivity, particularly commercial and residential construction. Over the past 15 years, the best
estimates of growth suggested the market had grown at an annual rate of approximately 9.7%. During this
time, there was a trend toward companies in need of equipment renting rather than owning it, which was
expected to continue. The market had experienced rapid growth in the 1990s but had slowed considerably
between 2000 and 2003 with the decline in the economy. The equipment rental market had recently started to
rebound from the 2000–03 levels, a rebound which was expected to continue.
Unlike the car rental market, the U.S. equipment rental industry was highly fragmented with few national
competitors. Other major national scale operators like Hertz included United Rentals, Inc., and RSC
Equipment Rentals, a division of the Atlas Copco Group. The equipment rental business was highly
competitive, and rental prices had started declining in 2001 and did not improve in North America until 2004.
Prices in France and Spain had yet to stop declining.4
Instead of a concentrated source of revenues (U.S. airports), customers of the equipment rental industry
were widely scattered throughout the country. This complicated the distribution of equipment and reduced
the opportunity to achieve scale in operations, encouraging local players to compete with large businesses.
Nonetheless, Hertz was a top player in the industry, ranking third based on 2005 revenues. Hertz’s diverse
customer base also helped to alleviate some of the risks of cyclicality and seasonality present in the industry.
Tough Times at Ford
Ford’s acquisition of Hertz in January 2001 reflected the strategy of its then CEO and president, Jacques
A. Nasser. Nasser had been promoted from president of Ford’s worldwide automotive operations to become
CEO in December 1998.5 At the same time, Bill Ford Jr., a great-grandson of Henry Ford, assumed the role
U.S. Department of Transportation.
Consortium internal documentation on Hertz LBO.
5 Keith Bradsher, “The Top Spot at Ford is Returning to a Ford,” New York Times, September 12, 1998.
This document is authorized for use only by Tan Trinh in Advanced Topics in Firm Valuation Spring 2018 taught by Shelly Canterbury, George Mason University from January 2018 to July
For the exclusive use of T. Trinh, 2018.
Page 4
of company chairman. Nasser’s strategy was to turn Ford into something, anything, other than a traditional
car company. He attempted to shrink Ford’s mainstream automotive divisions and remake it into a leading
consumer company in automotive products and services. Known for his abrasive style, Nasser frenetically
pursued his strategy, jetting around the world and working 20-hour days. He acquired Volvo, Land Rover,
Hertz, and spent billions pursuing noncore operations. During Nasser’s three-year tenure, Ford’s onceimpressive $15 billion cash reserve dwindled to less than $1 billion by 2001.6
In November 2001, Bill Ford Jr. assumed the CEO role at Ford replacing Nasser. After the turbulent
years of Nasser, Bill Ford’s ascension to CEO was greeted enthusiastically.7 But Ford inherited a company
that had lost $5.5 billion the previous year and whose future held great uncertainty. While Ford had a strong
line of trucks, its passenger car line was lagging. By mid-2002, Ford was losing $190 per vehicle because of its
bloated cost structure and intense pricing pressure from competitors.
Although Ford proposed several restructuring plans that would reduce costs and reenergize its passenger
car line, his plans were not enough to stem the company’s decline. By the time he announced the company’s
intentions to explore strategic options for Hertz in April 2005, Ford’s stock price had fallen to less than $10
per share. The company continued to lose money, especially in its North American operations.8 Rumored to
be facing a potential downgrade in its bond rating, Hertz looked to be a viable candidate for Ford to raise
some much-needed cash to shore up its bond rating and attempt to return its car operations to profitability.
Hertz as an LBO candidate
Although Ford owned 100% of Hertz, Hertz had operated largely without oversight by or obligation to
Ford.9 Members of the Bidding Group had individually evaluated Hertz and believed it to be an attractive
leveraged buyout candidate.
Operating Synergies
Hertz’s two business segments presented large opportunities for operational improvement. The key
drivers of the rental car business included the number of transactions, the length of each rental, revenue per
rental day, and fleet utilization. Transaction volume, which was a good indicator of market demand, typically
followed growth in the general economy and enplanements. Rental length was largely dependent on customer
and end-product mix. Leisure and insurance renters generally rented cars for longer periods than business
travelers. Another major driver of revenues was price, or revenue per rental day. Utilization of the fleet also
played an important role in determining profitability and return on assets.
Improvement in any of these drivers had the potential to yield substantial increases in revenue. With
travel finally beginning to rebound after the events of 9/11, the near-term market trends appeared favorable,
and management had projected transaction volume to grow 6.9% in 2005. With respect to price, the Hertz
brand was exceptionally strong and recognized worldwide. Hertz had shown an ability to sustain a premium
pricing strategy, which was in part due to its loyal customer base. Although Hertz was the price leader in the
market, it could not impose higher rates if competitors chose not to follow.
Kathleen Kerwin, “Ford’s Long, Hard Road,” BusinessWeek (October 7, 2002).
Tim Burt and Nikki Tait, “The King of Detroit: Man in the News: Bill Ford,” Financial Times, November 3, 2001.
8 Bernard Simon, “Ford Hit by Falling North American Sales,” Financial Times, July 19, 2005.
9 In January 2001 when Nasser repurchased Hertz outstanding shares, Ford paid $710 million for the 18.5% of the company it did not already own.
It paid $35.50 per share or an 18% premium for Hertz’s shares. The acquisition implied a value of approximately $3.8 billion for Hertz equity at the
This document is authorized for use only by Tan Trinh in Advanced Topics in Firm Valuation Spring 2018 taught by Shelly Canterbury, George Mason University from January 2018 to July
For the exclusive use of T. Trinh, 2018.
Page 5
Hertz was one of the largest private-sector purchasers of new cars in the world. In 2004, the company
operated a peak fleet of 300,000 cars in the United States and approximately 169,000 in its international
operations. Fleet usage was highly seasonal—it peaked in the second and third quarters of the year and
declined in the first and fourth quarters as leisure travel waned. Significant cost savings could arise from right
sizing the fleet (purchasing and disposing of cars) to match seasonal demand. Historically, Hertz had
purchased the majority of its cars from Ford, but in recent years, it had moved to decrease its reliance on
Ford vehicles. In part, this was in response to U.S. auto manufacturers’ decision to reduce fleet sales to
bolster their own profitability. This had two effects on Hertz and its competitors. First, it increased vehicles
costs and second, it increased the proportion of “at risk” vehicles potentially subject to declining residual
values.10 An increase in vehicle costs in 2006 was expected to increase Hertz’s acquisition costs and hence
fleet capital spending by proportionately more than the previous year.
The Bidding Group compared Hertz with peer firms and with its own historical results to identify the
following operational savings.11
1. Current adjusted EBITDA margins were approximately 400 basis points (bps) below 2000 levels and
were 100 to 200 bps below those of Avis.
2. From 2002 to 2005E nonfleet-related operating expenses had increased by 38% and had outpaced
revenue growth by 6%.
3. Hertz’s off-airport growth strategy had resulted in significant losses. The Bidding Group would look
to rationalize this strategy.
4. U.S. RAC’s nonfleet capital expenditures (CAPEX) as a percentage of sales were considerably higher
than Avis’s long-term CAPEX levels.
5. Europe RAC’s SG&A as a percentage of sales and on a per-day basis were three times higher than
those in the United States.
6. HERC’s return on assets lagged that of competitors, reflecting an inefficient use of capital. In 2005,
HERC’s rental revenue on fleet assets was projected to be 70.5%. By comparison, the returns for
RSC and United Rentals were expected to be 85% and 116%, respectively.
All told, the Bidding Group believed that an amount between $400 million and $600 million in annual
EBITDA savings (relative to 2005 levels) was attainable by 2009. These estimates of operational
improvements were confirmed by external industry advisors who had been hired as part of due diligence.
The Bidding Group had also carefully evaluated Hertz’s management team. The current management
team had considerable industry experience but, partially as a result of Ford’s hands-off management style,
they operated in an insular manner and had not been pressured to excel. The existing compensation structure
was based on market share, and new incentive plans were planned that would target cash flow and capital
usage metrics. If removal of the current CEO, Craig Koch, proved necessary, an experienced manager,
George Tamke, had been identified to step in. Tamke, who was currently a partner at CD&R, was formerly
vice chair and co-CEO of Emerson Electric, and had successfully led CD&R’s Kinko’s transaction.
10 During 2004, Hertz purchased 85% of its U.S. and 74% of its international cars under fleet-repurchase programs with automobile manufacturers.
Under these programs, automobile manufacturers agreed to repurchase the cars at a specified price subject to certain car conditions and mileage
requirements. The repurchase programs limited the residual risk that Hertz bore on “program cars.” The average holding period for a new car was
11 months in the United States and 8 months in its international operations.
11 Consortium internal documentation for Hertz LBO.
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