Leading car rental companies Hertz (NYSE: HTZ ) and Avis Budget Group (NASDAQ: CAR ) survived the unprecedented spate of consolidations in the industry that we witnessed last year. The other big player in the space is privately held Enterprise Rent-A-Car.
Hertz plans to separate its equipment rental segment from its core car rental segment. The car rental company will maintain the old company name, while the new unit will be known as Hertz Equipment Rental. Hertz will receive $2.5 billion cash from the spinoff.
Equipment rental is a bigger business for Hertz than many people might imagine. The segment finished fiscal 2013 with revenue of $1.54 billion, compared to $9.2 billion for the car rental arm. That's almost 17% of the revenue of the company's core business.
Generating massive shareholder value
The consensus from many studies is that spinoffs more often than not create substantial value for shareholders. A good case in point is the 2011 spinoff of TripAdvisor (NASDAQ: TRIP )
Since the spinoff, both stocks have shot up admirably, but TripAdvisor shares have gained 222% compared to a 146% for Expedia' shares. As a result, TripAdvisor now commands a market cap about 30% bigger than that of its parent company. That big gap remains even after the recent market correction for TripAdvisor shares, which traded at a frothy valuation.
Another notable case is the spinoff of Fortune Brands Home & Security (NYSE: FBHS ) from Beam (NYSE: BEAM ) in 2011. Fortune Brands Home & Security shares have climbed at a much faster clip than Beam's shares since then.
But the Expedia-TripAdvisor spinoff looks more remarkable than the Beam-Fortune Brands split, because Beam remains considerably bigger than Fortune Brands and commands more than twice its market cap.
Of course, not all spinoffs are so gilt-edged. Lands' End was spun off from Sears Holdings early this month. But the shares have been selling off, falling 17% in the space of little more than a week. Still, it's still too early to start judging the Lands' End spinoff as a failure.
According to Credit Suisse analyst Gary Balter, the sell-off can partly be attributed to technical forces. Investors might have sold Sears' shares short and purchased Lands' End shares in when-issued trading to avoid being short the stock, which drove up its price. The buying demand for this group of investors ceased when Lands' End shares started trading, and perhaps a sizable group of Sears' investors also sold their Lands' Ends shares. The result: falling share price for Lands' End.
Hertz shares, along with those of Hertz Rental Equipment, might receive a similar pop once the two companies part ways.
Another key reason why Hertz shares might rise considerably can be pinned on valuation matters. Once the spinoff is effected, Hertz will be viewed as a pure-play car-rental company in the league of Avis. Here is how shares of the two companies are currently valued:
Avis' shares trade at a considerable premium to Hertz stock. Assuming investors view Hertz favorably after the split and bid up its valuation to somewhere near Avis' valuation, that could mean an additional $8 to the current $26 share price. That implies a 30% upside potential.
The factors mentioned above may not amount to much if Hertz's business is faltering. The company posted weak fourth-quarter results, with 10.2% top-line growth but a worrying 12.9% decline in adjusted net income -- down from $139.1 million to $121.1 million, mainly due to swelling costs of fleet maintenance after the Dollar Thrifty acquisition last year. Lower than expected pricing also hurt profitability.
Hertz expects its domestic revenue to grow 6%-8% in the current fiscal year, while revenue from its international segment is projected to improve 5%-7%.
Perhaps the company's biggest Achilles' heel remains its massive debt.
Cutting down debt
Hertz is carrying a massive $16.3 billion of debt, with a mere $583 million in cash. The $2.5 billion cash proceed from the planned spinoff will be used to pare back that huge debt and for $1 billion in share buybacks. The IRS granted Hertz's request for a tax-free spinoff, which will go a long way to lowering spinoff costs for the company.
The company is keen on exploiting the opportunity in off-airport car rentals, by moving its cars to locations such as hotels, supermarkets, retailers, and auto body repair shops .where people might need to rent a car.
Hertz says only 34% of people in the U.S. use car rental services; it wants to exploit the 53% of the population, or 117 million people, with licenses who do not use the service.
The company says that nonairport rentals not only fetch higher margins than airport rentals, but cars in nonairport locations are often rented more frequently than cars in airport locations.
Hertz shareholders can expect a pop in the shares, and those of its spinoff, if recent spinoffs are any indication. It would probably be a good idea for investors to hold their shares of the spun-off unit in the long term, since there is good chance that the shares might even outperform those of its parent company.
3 stocks poised to be multi-baggers
The one sure way to get wealthy is to invest in a groundbreaking company that goes on to dominate a multibillion-dollar industry. Our analysts have found multi-bagger stocks time and again. And now they think they've done it again with three stock picks that they believe could generate the same type of phenomenal returns. They've revealed these picks in a new free report that you can download instantly by clicking here now.