hertz presentation
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Investing in Sponsors-Backed IPOs: The Case of Hertz
- Jeetpal Jain- Katarzynaborys - Nidhi Poddar - Mansi Thakar- Shreya Gupta
CASE OVERVIEW
- Case Issue
- Lease structure
- Hertz Capital Structure
- IPO Valuation
- Decision
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MAJOR ISSUE IN THE CASE
• Hertz Corporation was a car rental Co. owned by Ford
• Ford Motor decided to sell Hertz in 2005 because - Ford core US auto business was facing trouble - Monetize Hertz to improve Ford balance sheet
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Clayton, Dubilier, and Rice CD&R)
CarlyleGroup
Merrill Lynch Global private equity
Three PE firms combined to purchase Hertz for $15 billion.
PE firms invested some funds and accepted large outstanding debt which resulted in the deal being a “leveraged buyout (LBO)” deal
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FINANCING STRUCTURE OF ACQUISITION
29%68%
3 %
Equity
Debt
Transaction Fees & Ex-penses
PE firms contributed to equity by the way of bringing cash
Accepted Hertz’s debt (68%). Later restructured the debt portfolio by refinancing the old debt
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POST ACQUISITION - Time Line to IPO
PE firm acquired Hertz from Ford
December 2005 November 2006July 2006
Initiated IPO – Road show
Listing
7 Months later of acquisition PE firm initiated for Hertz
IPO
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HERTZ IPO PROFILE
No. of common stock issued 88.235 Million Shares
% of shares offered Diluting 27.5% of the total stock after the offering
Share Price Initial file price range $16 to $18, but then lowered to $15
Net Proceeds from IPO Approximately $1260.3 Million
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Skepticism of IPO
Questions raised how much value could PE
created in 7 months time
Borrowed $1000 million to pay special dividend of
$4.32 per share
immediately after
acquisition
IPO proceeds ( $1260.3 M) used to repay $1000 M to
debt
Remaining would be used to pay special cash dividend
to stockholders
on IPO record date
Nil IPO proceeds
planned to be used for
improving operating efficiency
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CASE ISSUE
Alec Berg faced with a decision whether to invest in
IPO of Hertz Corporation?
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BUSINESS REVENUE SEGMENTS
Segment Business B/S effect
Car rental (RAC)
Bought fleet assets on lease from its own subsidiary company and run on rental
Finance lease accounting in its book of accounts
Equipment rental (HERC)
Directly bought the equipment of various type and give on rental
Normal accounting treatment
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Investor
Vehicles & Rights under manufacturers
program
Manufacturers & Dealers
Lessee/Servicer
The Hertz Corporation
Issuer/Lessor
Hertz Vehicle Financing
LLC
Notes$
Lease of Vehicles
Monthly Lease Payment
$
Investor
RAC fleet assets taken on lease from subsidiary company
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Selected Items of Financial Performance (Dollars in Millions, unless otherwise noted)
Year Ended December 31, 2005 (Millions)
Cash and equivalent 844
RAC fleet assets (Finance lease asset) 8391
Total Assets 18581
Fleet debt (Lease payment due) 7223
Non-fleet debt (Corporate debt) 5292
Total Debt 12515
Equity 2262
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HERTZ’s LEVERAGED CAPITAL STRUCTURE
2005
BV Debt/Capital 85%
BV Equity/Capital 15%
Debt/Equity 552% 85%
15%
Debt/CapitalEquity/Capital
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VALUATION
Using Discounted Cash Flow Valuation to value Hertz IPO
-Calculating cost of equity (CAPM)
-Calculating cost of debt
-Calculating WACC of Hertz
-Finding FCFF
-Finding FCFE
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Calculation of Beta
Industry Name Auto & Truck
Number of Firms 25
Average Beta (Regression beta) 1.08
Market average D/E Ratio 189.97%
Tax Rate 22.94%
Unlevered Beta 0.44
Cash/Firm Value 11.14%
Unlevered Beta 0.49
Hertz D/E Ratio 552%
Hertz Marginal Tax Rate 40%
Levered Beta Hertz 2.13
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Calculation of Risk Premium 2005 S&P Index 1248.29
Dividend Yield 3.34%
Estimated Growth rate 8%
T-Bond rate 4.39%
High growth period 5 years
Growth rate in Terminal Year
4.39%
1248.29 = 45.03 48.63 52.52 56.72 61.26 63.95
(1+r) (1+r)^2 (1+r)^3 (1+r)^4 (1+r)^5 (r-4.39%)*(1+r)^5
Required (ROE) ( r) = 8.47%
Risk Premium =Required return on equity - risk free rate
Risk Premium = 4.08%
+ ++ ++
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Cost of Equity ( Hertz) = using CAPM
Risk free rate + beta * (Market Risk premium)
4.39% + 2.31 * (4.08%) = 13.08%
Risk Free Rate
US treasury 10-year bond (2005) = 4.39%
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Calculation of cost of debt – Using synthetic ratings Interest Coverage Ratio = EBIT Interest Expenses EBIT (2005) 1041.67 Interest Expense (2005) 500 Interest Coverage Ratio = 2.08 Estimated Bond rating B Default Spread 2005 4.00% Risk Free rate (US treasury 10-year bond (2005) 4.39% Pre-tax cost of debt (Risk free rate + Default spread) 8.39% Marginal Tax Rate (2005) 40% After tax cost of debt 5.03%
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Calculation of Weighted average cost of capital (WACC) BV of Equity 2266.2
Cost of Equity 13.08%
Equity/ capital 15.33%
BV of Debt 12515
After tax cost of debt 5.03%
Debt/capital 84.67%
WACC of Hertz 6.27%
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Income Statement 2005, (Millions)
Revenues 7469
Direct Operating expenses 4189
SG & A expenses 639
EBITDA 2641
Depreciation 1600
EBIT 1042
Interest Expense 500
Provision, benefits for taxes on income -179
Minority Interest -13
Net Income 350
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Calculation of FCFF for Year 0 2005
EBIT 1041.67
Tax 33.89%
EBIT (1-t) 688.65
Add: Depreciation 1599.69
Less: CAPEX 2015
Less: Change in Working Capital 29.00
Free cash flow to firm (FCFF) for Year 0 244.35
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Net CAPEX – ∆ WC = (444.3)
Cost of Equity = 13.08%k
Cost of Debt = 5.03% Weights Equities = 15.33% Debt = 84.67%
Discount at cost of capital (WACC) = (15.33%)*(13.08%) + ( 84.67%)*(5.03%) = 6.27%k
Risk Free RateUS $ risk free rate = 4.39%
Beta = 2.13 Risk Premium = 4.08%+ *
Unlevered Beta for the sector = 0.49
Hertz's D/E = 552%
Current cash flow to firmEBIT (1-t) = 688.65- CAPEX = 2015+ Depreciation = 1599.69- Chg WC = 29.0= FCFF = 244.35
k
Firm Value = 13685 + Cash = 843 - Debt = 12515 = Equity = 2013
k
Terminal Value = (287)/ (5.61%-4.39%)
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0 1 2 3 4 5 TerminalEBIT (1-t) 688.6 741.7 798.8 860.3 926.5 997.9 1074.7Net CAPEX – ∆ WC 444.3 488.7 537.6 591.4 650.5 715.5 787.1FCFF 244.3 252.9 261.2 268.9 276.0 282.3 23574.3PV FCFF 223.7 204.3 186.0 168.8 152.7 12750.0
Terminal Year - Cost of capital = 5.61Growth rate = 4.39%
Decision
Free cash flow to equity investor is positive
Thank you
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