Hertz So Good: The hidden costs of a “quick flip”

The Carlyle/Clayton Dubilier & Rice Buyout of Hertz Car Rental

Potential investors are told that one of the strengths of private equity investments is that they are not beholden to the tyranny of short-term returns like the public markets. “Private equity firms are not under public scrutiny … so they can focus on long-term business growth,” they are told. And so when a consortium of private equity firms, including industry giant the Carlyle Group, Clayton, Dubilier & Rice (CD&R), and Merrill Lynch, bought Hertz, the car rental company, from the Ford Motor Company in the autumn of 2005 for $15 billion, it was expected that they would formulate a long-term plan to build on the value of this household brand name.

But the firms had some short-term plans as well. Carlyle partner and fellow buyout firm CD&R realized that they could “push the boundaries of how much a rental fleet could be securitized by many billions of dollars.” By leveraging the company’s key asset with an eye on “flipping” or selling the company for a profit, the firms jeopardized the company’s credit rating: Standard & Poor’s downgraded the company’s bonds to junk status. Just six months after the deal was finalized, the new owners had Hertz take out another loan for nearly $1 billion in order to pay themselves a special dividend. 

A few weeks later—less than a year after buying out the company from Ford—Hertz announced that it would once again be going public. In its IPO filing, Hertz stated that money from the public offering would be used to pay off the loan for the special dividends.

The November IPO raised $1.3 billion, while the buyout group continued to own more than 70 percent of Hertz. The buyout firms used most of what was left after paying off Hertz’s $1 billion loan to pay themselves another $260 million in special dividends.

“Fast-buck artists” is the name that Business Week gave to the buyout consortium in their report on the Hertz IPO. But while the buyout firms were paying themselves special dividends, profits at the company fell sharply due to the increased debt. For 2006, Hertz reported an increase in revenue of nearly 8 percent but a decline in net income of two-thirds due to an 80 percent increase in total interest payments.

And what became of Hertz’s employees? Just a few days into 2007, Hertz announced it would be cutting jobs as part of its “productivity and efficiency” initiative. Altogether in the first two months of 2007, Hertz announced that it was eliminating 1,550 jobs, which represent close to 5 percent of the 31,500 workers Hertz employed at the end of 2006. In March 2007 , CEO Mark Frissora added that only one of every two workers who left the company was being replaced and that Hertz would be announcing more “layering and restructuring” initiatives later this year.