Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Talk about fast and furious. It's hard to find better words to describe the skid in car-rental company Hertz Global Holdings Inc.'s stock: 

Hurtz
Hertz has destroyed shareholder value since it bought Dollar Thrifty. The deal should have produced more strategic benefits, but instead left it financially unhealthy.
Source: Bloomberg

Hertz plummeted 78 percent in the past 12 months, and this week's disastrous earnings report signaled the worst may not even be over yet. The company made a series of strategic mistakes over many years, but at the center of them is a merger that delivered a heap of debt and little else. 

In 2012, Hertz paid about $2.6 billion in cash to buy Dollar Thrifty, its discount competitor. Today, the combined company is valued at just $1 billion, and it has a total of $14 billion of debt. After reviewing the transaction and its aftereffects, Gadfly has determined that it's troubled, one of four ratings we assign past deals.

Hertz-Dollar Thrifty Scorecard
Source: Bloomberg
Note: Operating margin in "before deal" column is for fiscal 2012, while "now" column shows trailing 12-month figure. Net leverage compares Q3 2012 and Q1 2017.

Industry consolidation was supposed to give Hertz greater ability to raise prices. Look at airlines: They were able to jack up fares following their own consolidation, which restored profits and even lured back once-disillusioned investors such as Warren Buffett to the industry. But when Hertz's last CEO, John Tague, a former United Airlines executive, thought he could impose price hikes in the same way, he learned car-rental companies are a different animal. The strategy backfired, causing Hertz to instead relinquish market share.

Think about it. When you need to rent a car, there are usually a variety of brands and price points to choose from. Nothing's cheap, but a traveler these days is more likely to be put off by steep flights and hotel rates than car rental costs.

Hertz's aging vehicles and wrong model mix haven't helped matters. Its fleet is heavy in compact cars and sedans, a turnoff for customers who have favored SUVs and roomier options lately. The Hertz brand itself is supposed to be geared toward business customers, but good luck getting a corporate bigwig into a car with 50,000-plus miles on it.

After Hertz bought Dollar Thrifty, its fleet also shifted toward what are called "risk cars" -- or cars the company bought outright with the intention of some day reselling, rather than vehicles it could sell back to automakers at predetermined prices under repurchase agreements. The strategy, which has dinged rival Avis Budget Group Inc., too, was based on the idea that they could take advantage of higher prices being paid for used cars. But resale values are way down. 

Dollar Thrifty wasn't a bad business -- at least not after its old boss Scott Thompson fixed it up. (And come to think of it, it probably would have been better to have kept him on after the deal closed instead of hiring Tague.) Rather, Hertz managers were poorly equipped to handle the merger.

Losing Business
While Hertz grapples with plunging resale values, rental revenue has also slumped
Source: Bloomberg

Less than two years after the deal closed, Hertz found itself mired in an accounting scandal and had to correct three years of financial statements. Then-CEO Mark Frissora, who spent years pursuing a takeover of Dollar Thrifty, finally got his deal but then had a whole new headache. He stepped aside in 2014 and Tague gave it a shot for a while, during which time the stock price dropped to $21 from $94. This past January, Tague departed and was replaced by Kathryn Marinello, who was most recently a senior adviser to Ares Capital Management. She's also served as a CEO twice before and has been on the boards of General Motors Co. and Volvo AB.

Carl Icahn, the billionaire hedge fund manager and largest shareholder of Hertz, seems to be fan of Marinello's. He praised her appointment as his stake continues to drop in value. The rest of Hertz's investors need more convincing.

They say that if your car spins out, steer it in the direction of the skid. That seems to be Marinello's approach. She's decided to plow ahead with ridding Hertz of its less-popular, smaller vehicles, while buying up new models, even though that means more pain in the near term for investors. After Hertz reported a loss for the first quarter that was almost double what analysts projected, Marinello reminded them that there's more work to do:

"2017 will take the brunt of the earnings impact, with 2018 better positioned to reap the benefits."

For bondholders especially, 2018 seems far off. Moody's on Tuesday downgraded Hertz's corporate family rating to B2, while its 6.25 percent coupon bonds due in 2022 fell to a low of 88.25 cents. The company's net debt is now inching close 5 times trailing 12-month Ebitda, which puts it near a level that could violate covenants. 

Hertz's Dollar Thrifty acquisition should be a lessen to other buyers who have been loading up on debt to juice revenue and profit. It leaves little room for error, and as we've seen with Hertz, there can be lasting damage. Hopefully a new strategy from yet a third CEO will save this lemon.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. For 20/20 Hindsight, Gadfly studies past deals and grades them (from positive to negative) Slam Dunk, Polite Clap, Meh, Troubled or Cringeworthy. In assessing Hertz's Dollar Thrifty takeover, we took into account the flawed strategy around used cars and rental price increases, the debt burden and the ensuing value destruction.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net