The Avis Ipo: Buyer Beware
Rent-a-car giant Hertz Corp. went public in April, and for individual investors such as Roland Ott, Hertz has been one dreamy ride. An executive at sairGroup in Zurich, Ott bought 400 shares at the $24 offering price and watched as they soared above $39. In July, when the stock hit a rough patch, Ott sold out, bagging a profit of nearly 50% in 12 weeks. "I was very happy," he says, adding that he may look at Hertz's archrival, Avis Rent A Car Inc., which by October expects to sell stock of its own.
Mr. Ott, words to the wise: Proceed with caution.
Yes, both companies are in the car-rental business. And yes, the trend toward higher rates that is lifting Hertz also will buoy Avis. But Avis has designed a far different vehicle for public ownership. "Hertz is a very stable, well-managed company with modest leverage," says a Wall Street analyst who knows both rivals well. "Avis is a very risky, highly leveraged proposition."
The Avis stock offering would be the second major transaction for the company in less than a year. Last fall, the employee-owned company sold itself for $806.5 million to HFS Inc., a Parsippany (N.J.) creation of financier Henry R. Silverman. Franchisor of such businesses as Ramada hotels and Century 21 Real Estate offices, HFS has used a blitz of buyouts to multiply its revenues tenfold, to $2 billion, in five years. Right now, HFS is awaiting an $11 billion stock merger with mammoth marketer cuc International Inc.
MISSING PARTS. With Avis coming public again, neither HFS nor underwriter Bear, Stearns & Co. would discuss the deal in any detail. But a securities filing lays it out: HFS hopes to sell public investors 75% of Avis Rent A Car--ARAC for short--for $225 million. Sound cheap?
Not when you read the filing and discover that ARAC is not what most people think of as Avis, the world's No.2 car-rental concern, with 4,200 outposts worldwide all tied together by computerized reservations and management systems. That network still exists, but Avis' key assets--its brand name, franchising operation, and computer systems--won't be part of ARAC. Instead, those corporate jewels will stay with HFS, where Silverman expects to exploit them across business lines. HFS, for example, could use Avis' Wizard reservations system to book rooms for its hotel chains.
So what's left for ARAC? It will be merely one of many Avis franchisees, albeit one with the right to run 414 high-volume outlets in the U.S.--and additional outlets abroad--that had been owned by Avis. Like any franchisee, ARAC will pay HFS for the use of the Avis name, initially at a rate of 4% of revenues. This year, that would work out to an estimated $80 million--double what all of Avis netted in 1996.
HFS also can charge ARAC for other services, such as reservations and computer work. But allocating those costs could be tough, since many of those expenditures will also benefit the Avis assets that HFS will continue to own. "Whatever HFS spends, they will rebill it to [ARAC]," says William Sider, Hertz's chief financial officer. ARAC will have its own management to look out for its interests, of course, but with a 25% stake and several directors on the board, HFS will have considerable influence.
These facts alone make shares in ARAC a sorry second to what investors got with Hertz (table, page 61). It remained intact when its majority owner, Ford Motor Co., sold shares to the public. Yet even on its own terms, stock in ARAC faces a cloudy future. That's because, judged several ways, the initial price HFS wants for ARAC seems inflated.
DO THE MATH. If the ARAC offering goes through as envisioned, Silverman's legerdemain would create $300 million in market value for a chunk of Avis representing just 16% of its fair asset value. The trouble is, HFS paid $806.5 million for the whole thing last fall. Do the math, and it implies a value today of nearly $1.9 billion for all of Avis--a billion-buck leap in less than a year. An HFS spokesman declined to discuss how HFS valued ARAC.
Had ARAC been public last year, the filing shows, it would have earned $5.8 million, implying a price-earnings ratio of 52. For Hertz, the figure is 23. Even if ARAC were to see earnings soar next year on rising rental rates and improvements made by HFS--to, say, $16 million, as a Lehman Brothers Inc. report suggests--it would sell for nearly 19 times earnings. Hertz shares go for 16 times estimates of 1998 profit.
Since ARAC's structure differs so much from Hertz's, it may make more sense to value it as a rental franchise. One way to do that is to take a multiple of operating income, adjusted for interest expense and nonvehicle debt. Another method is to multiply the number of cars in a fleet by $1,000. The first suggests a value for ARAC of $207 million; the second, no more than $196 million. Either way, concludes an executive at an Avis rival who has bought and sold many car-rental franchises, $300 million implies "a multiple [much] higher than we would feel comfortable paying."
Assigning a value to ARAC is even more difficult because it has a tangible net worth of negative $120 million. What happened? A huge slug of debt and goodwill (an intangible asset) swamped the balance sheet. ARAC's goodwill--accounting lingo for the premium HFS paid last year over the fair market value of Avis' assets--came to $197 million, or 59% of the total goodwill HFS created in buying Avis. Yet the new company got just $75 million, or 16%, of Avis' fair asset value. All that goodwill could cast a shadow over ARAC's future earnings, since it must be written off over 40 years. If the amount of goodwill turns out to be excessive, the company could have to accelerate the write-offs, hurting earnings even more. HFS notes that it follows generally accepted accounting principles.
Of course, one reason ARAC shares look expensive is because of the hard bargain Silverman drove when HFS bought the company last fall. The market values Hertz at about one times its sales. On that basis, an intact Avis really is worth about $1.9 billion, vastly more than HFS paid for it. The problem for investors is that they aren't getting an intact Avis. They're getting the part Silverman has chosen to slice off. Knowing that, Roland Ott and other investors may want to think twice before getting on the other side of a deal with HFS.