Case 4 Hertz

Submitted by : Alexey Kulchitskiy, Pavel Serov, Vladimir Shamanin, Denis Stepanenko
Question 1 What are the key sources of extra value for CD&R in the LBO of Hertz?

CD&R’s specialization was M&A of undermanaged divisions of large multibusiness

corporations and taking over operational control in order to increase business efficiency, rather than
expansion into new markets or growth above market rates. CD&R were convinced in Hertz’ brand, on-
airport market leadership, and strong historical performance. In assessing the factors described below,
we used the most conservative approach.

We have defined 2 main areas of extra value creation:

1. Operational efficiency optimization

1.1. U.S. RAC on-airport operating expenses
Decrease of labor, administrative and other operational costs, “tune up” optimal most profitable
locations. As margins varied significantly across different locations, a great opportunity of
optimization was available. CD&R aimed at reducing expenses by 5% over five years.
Projected savings $75 million per year (375 million $ in total) - $163,3 million per year (816.5
million $ in total)
1.2. U.S. RAC off-airport strategy
Shift from the expansion strategy to the profitable growth strategy, while closing mature locations that
failed to achieve positive contribution.
Projected savings more than $58 million per year (290 million $ in total) - $100 million per year
(500 million $ in total)
1.3. European operating and SG&A expenses
Decrease of high general and administrative costs in Europe by consolidation of back offices and
reservation systems.
Projected savings more than $33 million per year (165 million $ in total) - $100 million per year
(500 million $ in total)
1.4. US RAC fleet costs
As OEMs decided to move away from fleet deals, competitors’ fleet costs will have to rise and
converge to Hertz’s costs, making them increase their prices. Hertz’s margins could benefit from
upward pressure on prices while its own fleet costs held steady.
1.5. U.S. RAC nonfleet CapEx
Hertz can focus on nonfleet capex reduction to achieve an industry average level. This action could
save up to $90 million per year
Projected savings $50-90 mln per year (250-450 mln $ in total)
1.6. HERC focus on ROIC ratio
HERC managers have lack of motivation to keep the required level of ROIC. Reorganized bonus
scheme based on returns on capital will stimulate management to focus on ROIC
Projected savings $159 million over 5 years.

2. Financial efficiency optimization

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 2.1. Deal structure.
The main source of value from financial point of view is the deal structure, which allows CD&R to
split Hertz into 2 main companies: the fleet company (FleetCo), which will own all the fleets, and the
operating company (OpCO), which will make all the transactions with customers. This structure will
allow Hertz to maximize debt capacity by issuing asset-backed securitized debt with the fleets as
collateral. This move will also lower the cost of debt, as the company will be able to achieve a more
favourable debt rating. CD&R also has an advantage in performing this action as they have already
made an arrangement with Lehman Brothers and Deutsche Bank to provide ABS debt financing.
2.1. Tax shield.
The tax shield of the acquisition debt increases the value of the firm. As income flowing to equity is
taxed, while interest payments to debt are not, the capitalized value of cash flowing to debt is greater
than the same cash stream flowing to equity.

Question 2 What is the value of Hertz to CD&R in this transaction? Give an estimate what
percentage of the value in this deal comes from the key sources of extra value from question one
(operational improvements, changes in capital structure etc.).

In order to evaluate the company, we have created the DCF model with pessimistic and optimistic
scenarios. All generated cash is used to pay down long-term debt.
We made several adjustments co Corporate EBITDA to realize potential upsides and the add-up
depreciation to get New Gross EBITDA. We used a conservative growth rate for both RAC and HERC
(4%). Exit multiplies was used as pessimistic one -6x. Results are follows:

Conservative approach

Optimistic approach

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As we can see we got a range between 2 456,5 mln $ - 3 408 mln $. Moreover all upside provide
approximately 28,7% of such value.

In terms of estimating the weights of value adding sources, we would suggest, that the main source of
value creation was the operational improvements. They allow to greatly boost company’s profitability
(by affecting margins) while keeping the steady rate of growth. The second most important source was
Hertz restructuring: separating fleet company from operating company. This action leads to both debt
capacity maximization and cost of debt reduction. The percentage shares of these sources are 70/30%
correspondingly.

Question 3 What are the chances that $5.6 bln will be enough to beat the bid from Bain-
Blackstone-Lee-TPG consortium? What is the amount that you would recommend for CD&R to
offer?

After evaluating Hertz, we recommend that CD&R purchase Hertz for at least $2.5 billion (in this case
it will provide at least 25% return/year (Year 5 exit). If they want to achieve a 20% return/year, they
should offer $3 billion. But of course a higher offer price is recommended due to the competitive
nature of such bid.

We have calculated an IRR of the deal for each of 2 scenarios of each year of potential exit. See below:

Conservative approach

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Optimistic approach

In calculating the terminal value, we used the exit multiple approach due to the fact that this deal is an
LBO. The sponsor of an LBO will generally sell the target in five years, so it is more common to use
the exit multiple approach than the perpetuity growth approach.

We then subtracted the long term debt in 2010 from this value to find the equity terminal value, which
would be the selling price in five years. If CD&R were seeking for a return of 20%, they could actually
offer a higher bid for Hertz – about $3 billion to achieve a return of 20%. For $5.6 bln stake they will
absolutely overbid Bain-Blackstone-Lee-TPG consortium and will provide approximately 6% return
(not so good but we used really conservative assumptions).

It is clear that Hertz has a great potential and would provide positive synergies if the bidding group
was able to achieve the estimated EBITDA savings and create new sources of value for Hertz. If
CD&R believe in really good Hertz’s performance and want to beat Bain-Blackstone-Lee-TPG
consortium, their offer price should be increased up to $5.6 bln, but they will have to make every effort
to increase value of Hertz in order to receive decent returns.