Chances are you heard the news, but in case you haven’t, Hertz, one of the biggest rental companies in the world, has filed for Chapter 11 bankruptcy. Taking into consideration Hertz’s sheer size alone, the consequences of this event will ripple throughout. Yes, 2020 dealt a fatal blow, but you’ll see that it wasn’t the only reason. In fact, many of the wounds were self-inflicted. Plus, we’ll dive into the bankruptcy itself, and try to shed light on the ethics behind these processes.
In this episode of Company Forensics, let’s see why Hertz went bankrupt.
We go back to 1918. That’s right, 102 years ago; that’s how old this company is. Originally known as a Rent-A-Car Inc., it was the brainchild of Walter L. Jacobs, who started his venture with a dozen Model T Fords.
Within five years, his company had a fleet of 600 vehicles and turned in $1 million in revenue; these were fantastic numbers for 1923.
And this caught the attention of John Hertz, who owned a truck and coach company. He purchased Rent-A-Car and named it Hertz Drive-Ur-Self System. But get this, he kept Jacobs as president.
Jacobs even remained as president after General Motors became interested in the successful venture and purchased it in 1926.
GM went into an aggressive expansion plan, which included airports, such as Chicago Midway, as well as opening in Canada and, after World War II, their first European location, in France.
But John Hertz wasn’t done. In 1953, he repurchased the brand, through another of his successful companies, and created the Hertz corporation. Then he purchased a truck leasing company with 4000 trucks. So, by 1954, Hertz Corporation had 15500 trucks and 12900 cars.
In 1967, Hertz sold the corporation again, this time to Radio Corporation of America, which held on to it for almost 20 years. Then, in 1985, UAL corporation purchased it for $590 million only to sell it two years later, for $1.3 BN, to Park Ridge.
Just a detail: Park Ridge was owned and operated by Ford Motor Company. And, Hertz worked well for Ford. In some years, the rental business was up to 10% of Ford’s profits before tax.
Under Ford’s ownership, Hertz grew even more. In 2002, it even became the first international rental company to open in China, a very lucrative market.
But, though it had been lucrative for some years, Hertz was a bit of a headache for Ford, as they faced tough times of their own. So, it changed hands once more. And I really want you to remember this deal. In 2005, Ford sold Hertz to a private equity group composed of very big names, including Merrill Lynch, for $5.6 BN. That’s not pocket change.
It was under this new ownership that, in 2012, after two years of back and forth bidding, Hertz purchased Dollar-Thrifty, for $2.3 BN, and this gave Hertz 10400 locations and presence in 150 countries in total.
And if you are a fan of the show, you know how some big acquisitions end up.
But, before we get into that, let’s talk about what made Hertz special: they were good at what they did. They created membership programs, on-the-spot delivery and led the industry with innovations such as SiriusXM radio in 2000, carsharing in 2007, and photographic testing to ensure the state of rentals. Think of it as a before-and-after from when you rent the car and when you return it.
Why did they do all this? Hertz lost an average of $170 million a year in damages to its rentals.
There was also a culture around Hertz. Since the sixties, it made alliances with different brands to provide specialty cars. And some of these were very special: Jaguar XK-Es, Corvettes, and modified Shelby Mustangs.
They relaunched this program in 2016. Then, they had a “green” collection, with hybrids such as the Camry and Prius, making Hertz one of the first rentals to venture into this sector.
This made Hertz stand out and grow. A lot. By 2014, Hertz had over half-a-million cars in the U.S. alone, including specialty cars, hybrids, and luxury vehicles, and that’s what we want to talk about.
When you have half-a-million cars, chances are you don’t pay cash upfront for them, but rather, you lease most of them and you also lease locations, in places such as airports or hotels. Then you have to factor in fleet maintenance and the vehicles’ depreciation. So, this isn’t a cheap business. Not even close.
Hertz did what many rental companies do: use its own fleet to leverage credit in order to maintain it. With the profit coming from the operation, Hertz paid off the debt. Or at least tried to.
And, in recent years, the company was just barely coming up with payments. The reason? Competition, from other rentals, from Uber and Lyft, and global financial instability. Hertz’s big problem was that their debt reached about $18BN.
But Hertz knew the risks. In their 2014 report to the SEC (remember this one, it’s fun), Hertz Corporation recognized that their financial model relied mostly on asset-fronted debt.
A debt that depended on the vehicle’s value. This means that if the car’s value plummets, lenders can adjust the loan to better care for themselves. Basically, if cars are worthless, then lenders dish out less. This, in the automotive industry, one of the most competitive around.
So, relying on fleet value works as long as all the factors are in order: it’s a house of cards.
And what were the risks? Well, many. But one stands out, especially right now. Check out this bit of the SEC report.
Our car rental business, which provides the majority of our revenues, is particularly sensitive to reductions in the levels of airline passenger travel, and reductions in air travel could materially adversely impact our financial condition, results of operations, liquidity and cash flows.
Now that we understand the fragility of it all, we might say: oh, that’s why 2020 killed Hertz. Not quite, it gets more interesting: let’s go back to 2005 and that big acquisition.
The private equity group purchased Hertz for $5.6 billion in cash. But, they also had to take on around $10BN in debt.
So, what did the new owners do as soon as they purchased Hertz? They took out a $1 BN dividend almost immediately. Because, why not? And the contradictions kept coming.
Take, for example, CEO Mark Frissora, who shook the company to the core. He laid off employees and cut costs all around, which made sense when your facing debt. And then, he received a $19.2 million compensation package for it. Way to be austere.
And yes, CEOs are entitled to compensation packages, but should you take them when your company is knee-deep in debt? No.
Then, there’s the 2012 merger. The idea was to buy out the competition and expand operations, therefore having more income. It makes sense, but it meant another $2.3 BN to the tab.
Also, there were some conditions. For Hertz to be able to buy Dollar Thrifty, they first had to sell one of their companies, Advantage. They did, but four months later, Advantage went bankrupt.
Antitrust experts investigated the sudden bankruptcy and found it to be a failure on all sides, including authorities like the Federal Trade Commission, which was questioned for approving the deal in the first place.
To add fuel to the fire, the merger started acting up: the companies had two different computer systems that couldn’t be integrated. Hertz tried to join the Dollar, Hertz, and Thrifty physical locations in airports, but to do so meant more investment.
Then there were the cars themselves. Dollar and Thrifty allowed the tires on their cars to wear out thinner than Hertz did. So, to standardize the fleet, Hertz had to invest $30 million just in tire replacement.
The merger was supposed to save hertz $100 million but ended up costing them $70 million. By the end of 2012, Hertz had $20.2 billion in debt.
But this Frissora guy didn’t surrender. Perhaps he wanted another big compensation package. He kept cars for longer than usual so that the depreciation curve would soften in the accounting books. The older cars would go into the budget fleets like Dollar, Thrifty, and Firefly.
But this backfired because consumers and authorities alike took notice. That SEC report we spoke of? Well, in 2014, Hertz was charged with fraud, and Frissora was fired. But, he wasn’t found guilty.
Hertz had to settle with the SEC for $16 million. So, then they sued Frissora and another three managers. Then Frissora sued back. This was an all-out war.
And, right there and then, Carl Icahn comes in.
Icahn is a very successful businessman. But he’s known as a predator of sorts; a “corporate raider”. He takes advantage of flailing companies, buys them, then strips them bare of assets, then sells the scraps.
So, when Icahn heard, in 2014, that Hertz was a good brand in need of authority, it was right up his alley and he jumped in. He bought a total of 39% of the company and three seats on the board for $2.3 BN.
Almost immediately, he made some wrong moves. He placed John Tague, a former United Airlines COO, as CEO when there was a better candidate, Scott Thompson, the former Dollar CEO, with plenty of experience in the business. And Tague just didn’t do right. He renewed the fleet with sedans when the market was shifting to SUVs.
Customers fled, so Icahn pushed to raise prices. After all, the rental car business is pretty much an oligarchy and he believed Avis and Enterprise (the biggest competitors) would follow suit, but they didn’t. Instead, they stole Hertz’s customers with lower prices.
Let’s look at the clues. The market was shifting more towards SUVs, so fewer people bought sedans. Sedans lost their value faster. Remember, less fleet meant less money from the lenders: the circle begins to close.
In 2017, Tague left, and in came Kathryn Marinello. She shrunk the fleet, shifted to SUVs, and made good progress. The company had 9 quarters of earnings and growth. A possible recovery was in sight. Until 2020 came along.
The debt was just too high, and Hertz failed to make payments on their leasing operations. But, before hertz going out of business, they asked for a government bailout, which was rejected. One big reason was Icahn himself, who was worth $18 BN.
So, they had to file under Chapter 11.
Marinello jumped ship, and in came Paul Stone, just days before the company went under. And let’s talk about this Stone guy. Why would anyone want that job? Well, he made $700 000 in a single day as part of a retention program to keep executives from leaving.
In total, Hertz’s executives received $16.2 million. Great.
Meanwhile, if you have seen our show, you know what Chapter 11 means: reorganizing and shedding, to make a profit again. In Hertz’s case, this meant cars and people. Lots of people.
At the moment, 20,000 people and counting lost their jobs.
Then, there are the cars. In the U.S., Hertz had more than 500 000 cars and they will sell many of those for bottom dollar. Right now, the used car market is overstocked and with low demand.
So other rental companies, dealerships, and even manufacturers are affected. You see, manufacturers like GM and Nissan Motors don’t get much profit from selling to car rentals, but they sold in volume, which meant quick cash. Now, everything is paralyzed, and projections mention a possible recovery in 2022.
So, yes, 2020 did help in trampling Hertz. Even Icahn, usually a predator, lost billions, but the company might’ve survived if it had taken another path. Perhaps, one of less greed.