The Binding Process for Hertz - Case Study Example

Bidding for Hertz

Binding for Hertz

The binding process for is affected by different forces both within and without the company. The process of the dual-track used by Ford to initiate considerations for strategic alternatives affect the binding process as follows.  Firstly, the process by Ford is to initiate consideration of strategic alternatives complicates the process of binding. This is because the party bindings will have to use more time in order to get information needed to undertake the process. This implies that for one to be in a position to offer the accepted price, which gives the maximum value for Ford, the party is required to incur higher cost in order to initiate the buyout.

Secondly, because of the longer time duration required in order to collect the information is an implication that the participating party is likely to have lower ability to compete with its rivals because the information gathered is also known by them. Lastly, by getting the price of the IPO as the starting as the guidance in getting the value of the company, this strategy will offer Hertz additional choices of getting the required capital thus lowering the risk levels. By this method, Hertz has a foundation of the bid that can be equal or slightly more than the sum got from IPO.

There are ways in which hertz conform or does not conform to the definition of an ideal Leveraged Buyout, LBO and effects on Hertz as an appropriate buyout target. To start, there are ways in which Hertz is within the definitions of leveraged buyout. Firstly, is by considering the proven financial statements and its profit before tax since the year 1967. Secondly, between the years 1985 and 200, its sales had increased tremendously with an average of 7.6% per annum. Thirdly, Hertz has a management team that makes it an ideal candidate for LBO. The team possesses reasonable degree of knowledge regarding the industry. This helps in ensuring that the value of the company is determined professionally. Thus because of these characteristics, Hertz has a good track record thus making an excellent target for buyout.

Basically, there are only two value-creating opportunities that the sponsors exploit in this transaction. They are operating synergies and financial synergies. Financial synergies will occur when the two companies transacting complement each other how they generate finances. Operational synergies are the increased outputs as a result combining the two companies.

These assumptions were made to give direction on the amount of future the future revenue generated, expenses incurred, the proportion of debts to equity, the cost of the debt financing used and how it affects the company. The key assumptions were on the expected future sales, cost of sales and expenses. These assumptions are quite realistic because they relied on the current and past performances to arrive. We assumed that the operational environment will be quite similar and that the company will continue having the same resources. It is through these assumptions that we can be able to predict the company’s future performances. In making these assumptions, different items in the financial statements were varied differently based on the past experiences.

Estimating Terminal Values for Sponsors

My estimates of terminal value if the sponsors put up $2.3 billion in equity and return can they expect to earn. We compute total revenue from exhibit 7, 8, 9 and 10. This is given in the table below.

The expression for Terminal Value is given as,

Terminal Value = Final Projected Free Cash Flow*(1+g)/(WACC-g) where g is the perpetuity rate of growth that the free cash flows are expected to grow with and WACC is the Weighted Average Cost of Capital / discount rate.

Bidding for Hertz: Leveraged Buyout

Projected Cash Flows to Operating Company

($ millions)

2006

2007

2008

2009

2010

Net Income

$ 165.3

$ 252.4

$ 311.3

$ 403.6

$ 434.0

Add Back:

Increase in deferred taxes

$ 53.9

$ 49.5

$ 44.3

$ 38.4

$ 34.7

Fleet Dep - HERC

$ 249.5

$ 269.5

$ 285.7

$ 298.5

$ 307.5

Dep - Nonfleet

$ 196.2

$ 202.0

$ 206.0

$ 209.0

$ 212.0

Subtract

CAPEX HERO fleet

$ 410.7

$ 447.7

$ 430.0

$ 413.3

$ 387.4

Nonfleet CAPEX

$ 287.0

$ 219.8

$ 202.6

$ 223.2

$ 254.2

Increase in Net Working Cap

$ (115.8)

$ 46.3

$ 43.0

$ 38.3

$ 37.0

New fleet equity Equipment

$ 134.2

$ 79.5

$ 72.9

$ 64.4

$ 60.8

Cash Flow available for debt payment

$ (51.2)

$ (19.9)

$ 98.8

$ 210.3

$ 248.8

Add: Operating After Tax Interest

$ 309.9

$ 312.6

$ 313.6

$ 308.5

$ 297.8

Free Cash Flow

$ 258.7

$ 292.7

$ 412.4

$ 518.8

$ 546.6

Data as it is in exhibit 10

We compute WACC using the following express; WACC = RD (1 – TC)*(D/V) + RE* (E/V) where;

RD = current market rates for the company’s debt =

1 – TC = after tax cost of debt

D/V = Debt / Total Value

RE = cost of equity of the firm

E/V = Equity / Total Value

V = (D+E)

The proposed capital structure is as follows.

Amount ($ millions)

Kind of security

Rate

$4,300

U.S. ABS Secured notes

4.50%

$1,800

International ABS secured notes

4.90%

$600

Existing ABS Debt

$6,700

Total Estimated RAC Fleets / ABS Debt

$1,800

Term Loan Facility

8.000%

$400

Senior ABL Facility

7.000%

$200

Senior Euros Notes

7.880%

$2,000

Senior Unsecured Notes

8.875%

$800

Existing Senior Notes

7.000%

$600

Senior Subordinated Notes

10.500%

$5,800

Total Debt

Other Sources

$2,300

Sponsor Equity

$14,800

Total Payment for Assets

$17,100

Total

We then compute WACC from excel sheet as shown below

Debt / Equity Ratio

73.10%

WACC Calculations

Rd

7.33%

Assuming RE

13%

Using this equation

WACC = RD (1 – TC)*(D/V) + RE* (E/V)

7.25%

Computations

• Debt to equity ratio = Total Debt /Total Equity = ($6,700 + 5,800) /$17,000
• Return on debt us computed by getting the average value of the total returns of the debts, to get 7.33%
• Using these values to communicate WACC from its equation.

We then make use of this to compute the terminal value as follows,

Terminal Value = Final Projected Free Cash Flow*(1+g)/(WACC-g), assuming g = 3

To get = $2.3 million *(1.03)/(7.25%-3%) = $557,411.76

By assuming the growth rate of 20% we have terminal growth rate of 12% while the required rate of return for this investment which was used as discount rate was 7.25%.

If Carlyle desires a 20% target return on its equity investment, does your analysis suggest that $2.3 billion is too much to pay, or can it afford to pay more in either case, by how much?

The analysis method employed represents the net present value (NPV) of the expected future cash flows that all providers of capital can have after subtracting cash required to put into business to give the expected growth. This valuation method is based on the fact that the value of assets or businesses should be determined by its potential to generate cash flows to compensate those providing capital. The amount of $2.3 billion is too much to pay because the firm is now currently valued at $1.13 billion. By paying $2.3 billion one will have made a wrong decision because he has over paid to purchase the firm by more than $1 billion.

What is the market-required rate of return for this investment, and why might this differ from the sponsors target return?

Computed as follows

Thus the required rate of return is 11% to get the value of the firm as $2.3 billion. This differs from the sponsor target return because of failure to take into account all the debts. We get the value of Hertz using the equity residual method of valuation as;

The residual method of valuation of Hertz shares is as follows. Its computed as follows ER = FCF – (1-T) interest expense + change in debt principal

We are assessing the amount ford is likely to receive if it pursues its IPO alternative versus being bought by a private equity group. This is the minimum and maximum pricing for bidding Hertz. We make an assumption that there are million shares under issue. Using this information, I will compute the price per each share. The value of the equity is computed by multiplying share exchange ratio by acquirer’s share price.

From the instructions we are given one million shares on issue. Within the money options, we have 150,000. The exercise price will be = $15 / share

The company’s convertible debts with a face value of $1000, converted into 50 shares of common stock. The offer price per share will be $30. This is the target price that will be offered for each of the target shares outstanding. What factors would be considered in assessing whether the consortium bid is likely to beat that of a rival group? The prevailing interest rate in the money market. And the he exchange rate of the currencies under considerations. This is more so when the different consortium involved is using different currencies.