Integral to the very foundations of economic theory is the idea of 'rent'. It, of course, relates to the external requirement and use of a capital good and embodies the very heart of limited resources made available for productive use within a market that distinctly presents a demand vs supply differential. Whether related to its agricultural origins or latter-day use as an enabling agent in financial arbitrage, the rental model has been with man from the outset of bartering to the sophisticated evolution of capital markets and loaned stock.
Beyond Wall Street and into Main Street, in the modern era the phrase 'rental' is perhaps most obviously associated with the the rental car, even if the income generation of domestic/commercial building usage far exceeds the revenue of temporarily loaned vehicles
Yet perhaps the greatest real-world, legendary example of 'rental for arbitrage' involved a 1960s rental company brazenly linked to 1960s youth-culture, the episode when Hertz touted for hire the muscular Shelby Mustang GT350H and testosterone fueled traffic-light-draggers rented the car for wagered suburban ¼ mile races. [NB the 'H' referred to , and history was re-lived with a 2007 Ford-Hertz concept ].
The episode was largely a PR stunt and ironically given the economic intent of its customers, in was a value-destructive exercise for Hertz (and indeed its insurers) which had to absorb the financial losses on wrecked, stolen and 'vandalised' cars which had performance parts pilfered.
The automotive rental market, as one can imagine, has been typically dependent upon the economic cycle, booming in its early positive rise stages, tailing-off as people and businesses become stable enough to buy their own vehicles yet with an event-driven need and suffering once again in the economic downturn. Having been out of favour in the west for nigh on 3 years, automotive rental numbers have started to pick-up once again with what appear green economic shoots.
To combat dependency on one customer group, the business development of what became the big rental firms soon recognised the advantage of multi-segment coverage, so expanded beyond cars to encompass self-drive vans and light/medium trucks, even 'AgCon' heavy equipment to maximise diversification (eg HERC) and latterly (in Hertz's case) into the used vehicle auction sector – so as to better control its released vehicle flow and values, aswell as benefiting from the sector's growth. Thus providing breadth aswell depth at the core rental service level, through the targeting different car-user types, businessmen of differing seniority, the general corporate fleet as well as the typical holiday-bound leisure user. In turn, service differentiation was installed giving preferential treatment to Gold level customers and the like.
In time the marketplace developed as new entrants joined – typically at the lower end. Companies consolidated, honed their business models relative to their needs (seen with the Hertz's 1994 absorption into Ford and later 2005 IPO) and so from the mid 1990s until 2007 stability reigned as all rental companies enjoyed a growing slices of a growing pie and sought out operational efficiencies via volume growth and proficiency goals via vertical and horizontal integration.
Moreover, to increase service differentiation and grow margin new service-product lines were established, Hertz as instigator with evolution of alternative 'Collection Cars' with innate orientations: starting with 'Fun', joined by 'Prestige' and latterly promoted 'Green' reflected by typically the Corvette ZHZ, Audi A6 and Toyota Prius amongst their other peer models and OEMs.
Thus until early 2009 the US set primarily consisted of: Hertz, Avis-Budget, Dollar-Thrifty, Enterprise, National, Alamo and Advantage – the latter bought out by Hertz at this time under Chapter 11 proceedings.[see later note]. The majority of names are recognisable the world over, with Europcar the largest foreigner in NA, whilst the likes of Ace, Kemwel and Payless operate at the smaller scale. With Hertz, Budget, Enterprise, Ryder, U-Haul and Penske.
The economic downturn hit the auto-rental arena hard and in a matter of months what were usually empty car lots over-flowed with unrequired stock. Moreover companies had to find additional lot space to store the cars or sell them at hefty discounts so adding to overhead costs, undermining innate capital-asset values and degrading the normative secondary revenue stream from its used fleet dealers. To add to the pressure, the plethora of indistinct, typically town/district-based small-time operators of cars and vans (typically bought on manufacturers captive finance house credit schemes) were able to under-cut given their owner-manager flexibility, recognising that price, not vehicle newness or quality service had become the determinant factor for many.
[NB Indeed the structural shift in the sector and changes in societal trends at large have tempted new start-up entrants such as City Car Club, ZipCar, WhipCar and many others to offer largely city-based services. These predominantly use company-owned vehicles, but the latter designed for privately/individual-owned cars, the latter to supposedly “sweat one's capital assets” - thus trying to make individuals act like car rental companies.
This daring approach that tries to turn-around what it considers irrationally 'in-built' perceptions regards car ownership, yet seemingly ignores the very real rationalities that lay under the surface of emotionality. From the basic that investment-auto-motives has learned it hopes to rent-out typically upmarket cars for mainstream or less rates, so seemingly setting out a high-risk yet low reward for the 3rd party renter. It seems to have the hallmarks of the modern '350H effect'].
Back to the sector incumbents, and from late 2007 it was the same bleak picture for all the large well known western multi-nationals, as with the auto-sector at industry at large. The rental arena was always set to undergo contraction, consolidation and renewal.
As the largest entities the likes of Hertz were always set to survive, its value on a relatively stable upward incline as the economic picture brightened. But such fundamentals-driven valuation appears not the case for all; the mid-size players like Dollar-Thrifty Auto Group benefiting greatly since seen as target prey by trade-buyers. And that has come to pass as Hertz's diversification strategy, striving further toward the leisure/holiday-maker segment and effectively adding 2 more brands to its Hertz and Advantage stable.
[NB Hertz out-bid Enterprise for the Advantage business in early 2009, having developed in-house the 'SimplyWheelz' sub-brand in 2007 with roll-out in Orlando's holiday-hub. SimplyWheelz's intention is as a low-cost operator, so mimics the 'low-service' IT reliant operational efficiency of the low-cost airlines model, able to marry a scant 'front-of-desk' with sizable behind the scenes group capabilities, itself 'synergised' by Hertz's backroom operations. Presently Advantage appears to be run at arms length to maintain customer loyalty but it is presumed its operations are being fully integrated, probably using SimplyWheelz's IT infrastructure, as it is imagined would Dollar-Thrifty if obtained].
In what at first glance appears a utility-type sector, one would expect listed competitors to be on a par, little movement difference between established players. Yet 2009/10 proved that market perception was all.
Hertz's stock price has lifted from an 18 month low of approximately $1.50 to a recent high of $15.60 or so, before settling at $13.35 at market close on 04.05.2010. This parallels the likes of Ford's performance in the same time-frame as a stock-floated large company having to undergo massive re-structuring yet with optimism regards riding the back of the turned consumption wave.
However, Dollar-Thrifty Auto Group makes that sound performance look positively vapid – even when by big picture standards it should not. As an sector peer comparator Dollar-Thrifty has in 14 months (3rd March 09 to 3rd May 2010 close) shot from $00.62 to $50.70 ! Its extreme price movement reflects the investment community's view of it from that of “dead-man walking” as expectant sector casualty to now the sector star since it proffered best ever Q1 results with a $27.3m Net Income (giving 91 cents per undiluted share) compared to a previous Q109 Net Loss of $-8.9m, and came under Hertz's $1.2bn gaze (at $41 plus stock per share).
Now buoyed by interest from Avis-Budget, apparently offering a “substantially higher offer”.
Typically the courting shenanigans has begun, with Avis-Budget Chairman & CEO Ronald Nelson publicly castigating Dollar-Thrifty's executives for not exploring his company's improved offer, and furthermore appearing to deter other offers. The letter sent to the financial press is obviously designed to have Dollar-Thrifty's shareholders take an active stance, which it seems they recently have done. As part of the aftermath, market speculators appear to have done him the favour and dis-favour of proving his higher valuation ultimately correct. The price climb though perhaps too steep for his liking. But at least it should theoretically open the ears of increasingly activist stock-holders – private and institutional.
[NB. especially so since many insurance companies themselves seek profitable portfolio company exit options amongst in the face of prevalent future pay-out funding gaps].
In answer, Dollar-Thrifty made a COMTEX statement stating that (under responsible fiduciary terms to shareholders that) it “would be willing to entertain a substantially higher offer”. Little surprise there then, as it tries to raise the stakes of a bidding war..
To give greater context, Avis-Budget has been in effectively a re-building mode since it was spun-out from Cedent group in 2006, a holding company that had strong inter-connected travel and hospitality sector interests. Today, although with greater autonomy Avis-Budget is having to fight harder than ever since the badly (corporately) timed 2007 recession, thus must react given its own growth ambitions and level of competitor threat from above in terms of Hertz financial muscle, from its mid-market peers, and from below in terms of the highly ambitious small-fry.
So inevitably, the question emerges, “is this the beginning of a 're-set' for the American and thus European and elsewhere car rental sectors?”
If the take-over of Dollar-Thrifty succeeds, as seems the intended case and so creating a new sector giant, how do the fundamentals of the picture alter? What does this mean for the remaining mid-sized corporations (ie Enterprise, National, Alamo)? Critically, what opportunity for additional investor excitement, generated via strategy changes, M&A or alliance formations? Is the natural reaction that of reactionary M&As in search of scale and geographic spread, or an emergence of sub-segment inter-peer linkages?
Given that Dollar-Thrifty has 1,558 company and franchise locations, if the victors, Hertz would immediately boost its world-wide locations from 8,100 to 9,658 (or so) whilst Avis Budget would grow from 6,700 or so to 8,250. Of course these numbers are only initial and largely operationally academic given the subsequent results of operational integration reducing site numbers to avoid overlap.
Beyond the scale issue of customer-facing geographic spread, is of course the issue of purchasing power from aut-makers. Unlike previous years when rental companies had long-term contractual allegiances with the Detroit 3, the advent of foreign motor company transplant factories on US soil and the increasing private purchase popularity of typically Japanese & S. Korean foreign cars, plus above all the need to create as broad a supply pool to allow inter-auto-maker bargaining (and arguably to cater to differing regional tastes) means that the rental companies are far more promiscuous in their buying habits than yesteryear.
That is bad news for the domestic Big 3 who had enjoyed a cosy relationship (especially so Chrysler with Dollar-Thrifty) but of course these days enables the foreign others to boost sales,, especially Hyundai-Kia given its own US & global growth plans.
Throughout history the car-makers and renters have had an on-off love affair, the former amiable counter-parts when private sales are low (as we see today) but less so in buoyant economic times when those long-term contracts mean a portion of their high-demand cars have been pre-ordered at low per unit profit margins. Historically a case of swings and roundabouts which is witnessed today.
[NB FIAT's Marchionne will undoubtedly try and have Dollar-Thrifty re-ignite their Chrysler relationship so as to boost US sales of its renewed & face-lifted Chrysler, Dodge & Jeep ranges – very probably providing sizable discount in NA and in Europe on FIAT products to help generate the production scale he seeks].
The correlate to the motor manufacturers is important, since all need to rebalance the lost volume from the retraction of (inter)national scrappage schemes.
And as such it could well be the right time in the economic cycle for typically competitive rental firms – especially in the mid and low tiers - to exploit the volume manufacturers own 'tight' times and inter-rivalry, by creating purchase consortiums – much in the same way that in the mining industry RioTinto and BHP Billiton are trying to do so as to effectively separate their upstream (input) activities for the benefit of their downstream (output) activities.
The saga between Hertz and Avis-Budget over Dollar-Thrifty will undoubtedly continue, and in the meantime, as ever broker-dealer houses and the remaining strong hedge-funds will be sizing up the victor and vanquished; seeking rent on any loaned-out stock. 'Deal Fever' may not be apparent yet given Hertz's self-proclaimed “comfort” in its position and offer, but it seems that as a precursor to the inevitable volume increase in purchased cars, there will continue to be frenetic trade movements on the trade volumes of all 3 vehicle renters.
But, beyond the mid-term sector re-shuffle, vehicle rental companies and their car-suppliers must keep and eye on the fringes of their domain. Just as Rent-a-Wreck slowly grew in its network and popularity over past decades, on a far more ambitious course appear to be the Chinese, the likes of the UK's Ling's (hire and lease) Cars undoubtedly a seedling for China's future vehicle export and foreign service ambitions. Hertz and Avis-Budget are concerned with their balance of power, whilst ultimately both may be hindered by China's desire to further buoy its balance of payments account.