The month of May has been full of spinoffs, and my Special Situations portfolio has been buying some of them. Today I'm back to buy shares of Hertz Global (NYSE:HTZ), which plans to spin off its equipment rental business in early 2015. Combined with a buyback that could see as much as 20% of the share count taken out and a consolidating car-rental market and the company's increased target leverage and the operating leverage of the business in a growing economy, I'm highly confident that Hertz is a great stock for the next few years. So I'm buying stock later this week.
The special situations
The special situations begin with Hertz's decision to spin off its equipment rental division HERC early next year. From both operational and financial standpoints, the decision makes a lot of sense. On the financial side, the cash flow drag from the equipment business will be eliminated, allowing the improving fundamentals of the car business to shine.
And that's important as the car-rental industry consolidates to three major players, including Avis Budget and Enterprise. That consolidation should help pricing across the industry, and rivals should slow efforts to gain share for its own sake, leading to earnings gains at Hertz.
As part of the spinoff, Hertz should receive cash proceeds of $2.5 billion. That's coming from an equivalent amount that the spinoff company will raise in debt and then pay to the parent. Some of that cash will be used to pay down debt, but Hertz is planning to also use some for a $1 billion buyback. That's in addition to $1 billion already authorized for repurchases. In total, the company estimates it might be able to buy as much as 20% of the outstanding shares. That's an excellent move, with shares trading at about 14 times this year's earnings and substantial earnings growth for 2015. A buyback will only accelerate any earnings-per-share growth.
Also positive is the news that Hertz has increased its target leverage ratio, to between 2.5 times and 3.5 times net debt/EBITDA. That increase may allow Hertz to "opportunistically look to return additional capital to shareholders on an ongoing basis." That's the kind of news a special-situations investor likes to hear.
As we approach the date of the spinoff, it will be interesting to see what valuation the market gives HERC, and that company -- which comprised just 15% of Hertz's combined total revenue -- could well be a buy in its own right.
Foolish bottom line
My Special Situations portfolio will buy $500 of Hertz now, and will look to add more as the special situation unfolds or as prices make it look particularly attractive. There are simply too many catalysts here for the stock not to appreciate over time. So we have lots of ways to win, and that's the kind of optionality I like to have. Like this idea? I have many more money-making ideas, and you can be the first to know them by following me on Twitter: @TMFRoyal. And check out my dedicated discussion board.
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Jim Royal has no position in any stocks mentioned. The Motley Fool owns shares of Hertz Global Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.