Description

Hertz ("HTZ") is a short, so is the entire capital structure and Avis too. About 2.5 years ago, I had a 3 day business trip in Los Angeles where I had a full schedule up and down west LA. The friend I was staying with starting laughing when I talked about renting a car. In his words,”everyone Ubers here, its better and cheaper.” I was skeptical that 3 full days of Ubering would be cheaper as LA is a vast expanse to criss cross. I had no doubt that it would be a better experience as I hate driving in general and on the 405 specifically. My experience was awesome. Most if cars I got were Camrys, but the drivers were all locals who knew the backroads and knew when Waze was wrong. The 3 day tally came to about $150 all in. A Hertz (“HTZ”) rental car (usually pricier, but worth it on business with gold status) would have been at least $300 for a low end car, plus gas, parking and the stress of navigating an unfamiliar city on jammed freeways. Not to mention the hassle of returning the car and refilling the tank to avoid massive fuel charges. I vowed never to rent a car on a business trip again unless absolutely necessary and for longish family vacations. Which is what I have done.

I have followed the rental car companies for decades and their many changes of ownerships and LBOs and recent consolidation. One things to know for certain is that the industry is a high fixed cost business. They have to lease, service and track massive amounts of vehicles as well as manage unpredictable end demand that ebbs and flows massively with the economic cycle. Recessions cause business trips to be cancelled and per diems to be clipped. In addition, the types of customers that Uber/Lyft were poaching were and are the best customers for the rental car companies. They also have to lease expensive airport counter space and garages all over the world at every airport. Cars can end up mismatched as drivers pick up at one destination and drop off at another. For decades, business customers were viewed as captive between Avis and Hertz as they were the only companies with the scale, technology and efficiency to service time strapped business customers. Business customers were also the most price inelastic and profitable.

Municipalities used rental car companies and their customers as piggy banks charging massive sales, tourist, usage, convention, gas and other taxes and fees to the point where in some cities the fees could almost double the end bill. These fees are not going away soon if ever and they are a source of permanent competitive disadvantage for the rental car companies versus the Ubers of the world, which do not pay most if any of those taxes and surcharges. To provide rental cars requires servicing a massive fixed cost base, the margins have historically been only ok but steady to decent through a cycle and the OEMs until the financial crisis were virtually giving away their excess inventory (usually the worst unsalable cars which gave America’s highest end customers numerous opportunities to see how bad American cars were and buy German and Japanese cars instead, but that is a story for another day). I took a look at HTZ financials and was stunned by the large amount of financial leverage both vehicle related (typically ABL and non recourse in all but the most dire scenarios) and corporate debt. It seemed that small changes in volumes and revenue could lead to large declines in EBITDA and free cash flow as the incremental customers are highly profitable once the fixed costs are covered. Ironically, my friend in LA was long HTZ since it was so “cheap.” I walked him through the math on small changes in revenue and how they could lead quickly to negative EBITDA. I shorted the stock and eventually covered in the 10 range. Even though, I still think HTZ and eventually Avis are bagels, every dog has their day.

Flash forward to today, HTZ has tripled off the lows and I am short again. What I have written above is largely taken as gospel ex the tax/fee disadvantage that no one seems to talk about or realize. The bull case now is that HTZ will be the fleet management provider for our UBER/driverless car future. Uber has ended its leasing program that was losing $9,000 a car and that HTZ/CAR will own that business (not sure how the Uber eco system will cover $9,000 in losses? It does appear pricing will go up for Uber et al., so there will be some relief there).

These are small test programs and the issues that HTZ faces are in the here and now. It is not clear at all to me that rental car EBITDA dollars won’t turn into fleet management pennies. No credible business model has been provided, nor is it clear that the airport focused assets will be able to service a more far flung Uber driver and customer base. Even if some version of this dream becomes reality, it is years away and the revenue and cash flow losses are in the here and now as are the debt maturities. The debtholders may get to realize some version of this dream post bankruptcy. My gut is that Avis and Hertz both eventually file for bankruptcy and merge into a kind of last man standing ala BBY/COST/WMT vs. AMZN.

There is also the issue of management credibility, they just raised $1.2 billion of second lien debt to take out the 2018 maturity bonds (done) and the 2019 maturity bonds (rescinded). Extract research just published an interesting piece how this might put HTZ in technical default. Whether true or not, HTZ has raised a lot of cash to deal with both its current cash burn and 2019 maturities and any cash that might have been needed to true up ABL subordinated tranches that may not be covered due to declining auto used car pricing. They have been evasive about whether and when they will tender for the 2019 maturities, which was how they sold the priming second lien debt. They have fully drawn down on their revolver, a highly unusual move for a company with no liquidity issues. Actions speak louder than words so although on the last earnings call, they talked about having a month or two of better visibility (solar eclipse one time rentals?), they are acting like they know the gig is up and are battening down the hatches. They also talked about $300-500mm of incremental technology Capx to catch up for years of neglect. EBITDA is only estimated to range from $200-500m and could easily go negative. None of these moves inspires confidence.

Finally there is positive sentiment that Hurricane Harry will have destroyed enough vehicles to firm used car pricing. First, those who focuses on used car pricing are rearranging deck chairs on the Titanic as it hits the Uber and Lyft icebergs. There are a wide variety of estimates out there, but 500k of scrapped vehicles seems reasonable. That is a drop in the bucket on a 17mm SAAR (by comparison SAAR dropped to the 9-10mm range during the financial crisis). The bulls also make noises about how few rentals are really affected, which is the same thing the former CFO of Avis told me 2.5 years ago. He was just replaced. I beleive it coinided with poor operating performance.

The Numbers

In 2018 Bloomberg consensus is of $8.947 of Revenue and $493 of EBITDA. If you average out an incremental $100mm of Capx that the Company admits it has under invested for the past three years with the three year average non vehicle CapX of $150mm that is $250mm of CapX. Interest Expense should be roughly $680mm. That equates to $439mm of burn with no revenue declines. The bulls are betting on growth and margin expansion. I believe these numbers are as good as it gets and this does not even account for the $10,114 billion of net vehicle debt and assumes no cash needed to true up ABL residual values. I believe over the next 12-24 months, HTZ will experience somewhere between a 1-10% revenue decline, and that about 90% of that number will drop to the bottom line as expenses are largely fixed. Under those scenarios, EBITDA will range from $413mm to ($300mm). EBITDA is basically flat at the midpoint. None of these numbers is enough to cover interest and CapX and leaves the $4,492mm of net non vehicle debt deeply impaired. Even at the consensus and high end of my projections, you are looking at 10-12x Debt/EBITDA and 14-16x EV/EBITDA for the equity. Of course in more dire scenarios, the debt is deeply impaired and the equity is a zero. One analyst called this the directories business on wheels, I agree.

Catalyst

Technical or actual covenant violations. Cash burn. Defensive Chapter 11 to trap cash. Massive equity/convertible offerings to take advantage of this short squeeze.