How much value do you expect to be created by operating improvements and capital structure changes envisioned by CD&R? CD&R proposed changes to the following areas.
US RAC on-airport operating expenses: Labor per transaction, administrative and other costs had increased 41%, 65% and 30% respectively between 2000 and 2005. In addition, margins were not constant across locations and varied from 32% to -7%. CD&R proposed that the operating expenses could be reduced resulting in cost savings of $75M per year. b.
US RAC off-airport strategy: Hertz’s plan for expansion in off-airport locations had not generated the profit commensurate with the capital required to support it. Further, profit margins varied from 55% to -200% across off-airport locations. CD&R proposed that potential savings of $58M per year could be realized from this source. c.
European operating and SG&A: Hertz’s European SG&A expenses as a percent of revenue were nearly three times higher than those in the US. CD&R proposed that efficiencies from this source would be $33M per year. d.
US RAC fleet costs: Hertz had higher fleet costs as compared to its competition. However, this advantage that the competition held over Hertz was expected to go away soon, which would result in a more level playing field. e.
US RAC Nonfleet capital expenditures: Hertz spent more on capital expenses than its competitors. Reducing this to comparable levels with Avis would result in savings of $57M per year. f.
HERC ROIC: Aligning manager’s incentives to focus on ROIC was expected to result in significant savings, to the order of $32M per year. In total, CD&R was expecting to create approximately $255M per year. Conservatively, we would expect that CD&R would realize 50% of its projections, which amounts to approximately $127M per year.
How would you explain the proposed transaction structure developed by CD&R and its partners? Specifically, does it help or hinder the realization of the anticipated sources of value in the deal? The transaction structure can be summarized as follows:
Created a new special purpose entity – Fleetco – that would buy vehicles from OEMs and dealers and would finance the purchases through ABS and equity from Hertz, the parent company. b.
Fleetco’s ABS were secured by the fleet and repurchase agreements with car manufacturers. c.
Fleetco would lease the vehicles to Hertz, the parent company. Fleetco’s assets thus consisted of the rental cars and the cash contributed by the parent. The lease payments from the parent would pay the interest payments on the ABS debt. d.
The parent company maintained control of HERC and rented out equipment and serviced them. At first glance, the transaction structure described above does not seem to have any impact on the operating efficiencies that were generated through the deal and seems more to affect the financing aspect of the deal. The transaction structure was designed to maximize the funding obtainable through the RAC fleet and to tap the ABS market. However, digging a little deeper, we can see that CD&R wanted to achieve the following with this structure: a.
Stability in the business without having to restructure due to downturns. b.
Allow for volume purchases that would mitigate seasonal and cyclic fluctuations in car rental activity. c.
They also wanted to obtain sufficient liquidity to enable opportunities for future growth and expansion without refinancing. d.
Finally, lower the cost of capital than what was currently available under Hertz’s existing structure. The value expected to be derived from operating efficiencies were dependant on CD&R’s ability to make decisions without worrying about putting out short term fires and independence from the parent with regards to business decisions. The vision was broader, and depended on complete flexibility and autonomy, which they were able to obtain from this structure. With this structure and the resulting ability to take business decisions without...
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