Assuming that the initial public offering of stock goes as planned later this month, the Hertz deal will become a Wall Street legend for quick profits and massive fees. The three investor groups that combined to buy Hertz from Ford last December will have made a paper profit of about 340 percent (before fees) on their investment in a mere 11 months. And Wall Street stands to make more than $1 billion in fees for helping buy Hertz and then convert it into a public company. All these numbers are based on my reading of documents that Hertz–now owned by buyout funds run by Clayton, Dubilier & Rice, the Carlyle Group and Merrill Lynch–has filed with the SEC. These firms all cited SEC rules that limit their ability to discuss pending stock offerings. But the numbers speak for themselves.
Making so much money so quickly seems impossible. But let me show you how Hertz’s owners can quadruple their investment even though the Street values the company at only about 25 percent more than they paid for it. It’s all about borrowing lots of money while taking your own money off the table. Ready for the ride? Fasten your seat belt.
The three firms’ clients paid $14.9 billion for Hertz last December. But they invested only about $2.3 billion of their own cash, with Hertz taking on $12.6 billion in debt. If Hertz sells stock in the IPO at $17 a share–the middle of the projected price range–the company would be valued at $18.4 billion: $12.9 billion in debt, plus stock valued at $5.5 billion. On the surface, this doesn’t produce anything like the profits I’ve talked about. But watch. As part of the wheeling and dealing, Hertz’s owners are paying themselves about $1.4 billion in cash dividends. (There’s been a fuss in the press over these payments, but I’m not taking a stand on them–today I’m just counting money.) Subtract that from the $2.3 billion initial investment, and they’ve got only about $900 million invested. At $17 a share, their Hertz stock will be valued at $3.9 billion–producing a $3 billion pre-fee paper profit.
Now to the fees. Each of the three private-equity firms took a $25 million fee when they bought Hertz from Ford. And there was $365 million in other fees, bringing the total to $440 million. I estimate the Hertz IPO will bring the Street another $75 million in fees: that’s based on the difference between the $1.5 billion the offering is projected to raise and the $1.425 billion Hertz expects to net. So now we have fees totaling $515 million. Then there’s the $5 million each firm is getting in return for giving up its right to a $1 million annual fee from Hertz. And more I’ve doubtless missed.
Finally, here’s the big fee kahuna: private-equity firms typically get 20 percent of their investors’ profits. So tack on another $600 million in fees for their piece of the $3 billion in paper profits, bringing the total to more than $1.1 billion. Sure, a potential $600 million in fees isn’t the same as having $600 million–the firms don’t get paid until their investors cash in their profits. But if Hertz performs well and the stock climbs–as the firms want us to believe it will–the firms’ ultimate take will total more than $600 million as they sell off their Hertz stakes over time. So valuing the fee at 20 percent of today’s paper profits seems reasonable to me.
A question that springs to mind–or should–is whether Ford feels foolish for having gotten only $14.5 billion for Hertz less than a year ago. The answer, the company says, is no. “We sold Hertz through a competitive-bid process that established market value,” Ford spokesman Becky Sanch told me. “The company received multiple bids during the bid process, and we feel we received the appropriate value of Hertz at the time of sale.”
I won’t presume to tell you whether to buy Hertz at $17 and go along for the ride with the big private-equity firms that will still control Hertz. Hertz’s owners have caught a tailwind, with the stock market rising since December, and airline traffic, which helps drive car rentals, soaring. Will future travel or economic headwinds crimp Hertz’s stock price and make it hard for the company to cover payments on its heavy debts? I just don’t know.
A final word: You’ve no doubt heard the Everly Brothers’ great romantic ballad “Love Hurts.” Barring the un-expected, you’ll soon hear Wall Street’s knockoff version. Its title: “Love Hertz.”
