Investing in Sponsor-Backed IPOs: The Case of Hertz

1. Why are the private equity sponsors pursuing an IPO of Hertz at this time – that is, what is the purpose of the IPO? The sponsors wanted cash in order fund another special dividend. They felt that even though they had only owned the company for short time, they were in the perfect position to sell it. There are several reasons why 2006 was an opportune time for the IPO of Hertz. The market was on the rise with the S&P up over 10% on the year.

The IPO market itself was incredibly strong, outperforming 2005 by November. As the case states “198 IPOs had price raisings approximately $41 billion. The pricing of IPOS also seemed solid. Of the 198 deals, the average first-day return (not annualized) was 8.8%. After four weeks, nearly 60% were trading above their offer prices”. Hertz was also recognized as one the top car rental brands in the world, it’s branding was dominant throughout North America, which in turn, gave it premium pricing power.

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At the time, Hertz also had the opportunity to expand in both the non-airport and equipment rental markets, which also has higher margins than general car rentals.

2. What are the differences between conventional IPOs and IPOs that arise from leveraged buyouts? First of all, it appears that private equity-led IPOs (RLBOs) are more successful than their non-buyout-backed counter parts. According to the case “a study which examined nearly 500 private equity-led IPOs from 1980 to 2002. For example, relative to $1 invested in the S&P, investors in RLBOs earned $1.05 on average over 36 months following the IPO compared to compared to $0..

81 in non-buyout-backed IPOs.” Sponsors also take it upon themselves to use debt in order to issue a special dividend and pay themselves for their work. This action typically raises concerns whether the sponsors are invested in the company over the long term. However, private equity firms claim that one of their advantages is their long-term perspective, a study by Moody’s involving 222 buyouts determined that this was not the case and that Special dividends resulted in a credit downgrade almost half of the time.

3. Should the sponsors have taken on additional debt and paid themselves a dividend from Hertz? No, the sponsors should not have taken on additional debt and paid themselves a dividend from Hertz. This pre-IPO action implemented by the sponsors shed negative light on themselves and the company as a whole. It portrayed entitlements of greed while hurting Hertz well established market reputation, it discouraged investors from potentially investing in the company, as well as throwing a negative persona over the future outlook for Hertz. The dividend payment also caused a media uproar with more negative externalities being portrayed against the sponsors, as they were seen as money hungry investors with no true intention of expanding the value of Hertz.

They were viewed as just wanting to receive their money and exit the company. Their actions were seen as selfish by the public and their peers, which was reflective by the demand for Hertz shares decreasing, along with the range of the IPO value falling from a stronger near $18 dollar range to a substantial decrease at around $15. The dividend payment provided doubt on the sponsors in how it was seemingly impossible to achieve value creation as well as significant management improvements in such a short time period, overall hurting the value of the company.

4. What are the pros and cons of public shareholders should consider when investing in sponsor-backed IPOs? This question boils down to the differences between investing in a sponsor backed IPO and investing in a non-sponsor backed IPO. During the time of this deal, the Great Recession was nearing its start, so the market took a big hit with that being said. Both sponsor and non-sponsor backed IPOs underwent price declines in their share-price valuation during this time, which should be viewed as a negative when considering investing in sponsor backed IPOs. To build on that with something that can be viewed as a positive, is that sponsor backed IPOs fell at a lesser rate than non-sponsor backed IPOs, decreasing at roughly 9% and 12% respectively.

Another positive of sponsor backed IPOs is that they tend to generate greater post IPO price appreciation than that of non-sponsor backed IPOs. All in all, PE sponsors, “create value from being able to invest and operate with a longer-term perspective than public companies.” This long term perspective leads sponsors to make tougher decisions in terms of operations and debt, as well as being able to, “hold managers more accountable for higher levels of performance than public companies.” The quick exit tactic often used by PE sponsors does however bring to debate whether these sponsors are, “in it for the long haul or only for themselves.”

5. At the $15 offer price, does the Hertz IPO represent a good investment opportunity for Berg? Would you invest in the Hertz IPO? After conducting our analysis of the value of Hertz, we believe that offer price of $15 is still too low. We believe the share price to be about $12.69. Therefore, Hertz would not be a good investment opportunity for Berg and I personally would not invest in the company either.

6. The sponsors invested $2.3 billion in equity (divided equally among them) to finance the $15 billion buyout of Hertz in December 2005. If the Hertz IPO is completed at the $15 offer price and the overallotment option (Greenshoe) is exercised, what is your estimate of the gross returns to the sponsors will earn on their $2.3 billion investment in Hertz (i.e. ignoring carried interest or management fees on the funds)?