8/27/2012
By David Urani

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Merger Monday brought a long-pursued acquisition of Dollar Thrifty (DTG) by Hertz (HTZ), who will pick up its rental car peer for $87.50 per share, or $2.6 billion. Hertz had been chasing this acquisition publicly for a couple of years and after finally coming to fruition both stocks surged. Surprisingly, Hertz was up even more than Dollar Thrifty, trading more than 11% higher mid-day versus 7% for DTG. Not only does Hertz get the added business from DTG, but also expected synergies. It's not all that often that the acquiring company spikes higher on a takeover, but in this case the market clearly feels HTZ got a good deal. But interestingly, Avis Budget (CAR) was also up on the news. To me, the HTZ/DTG deal seemed to spotlight an interesting value question on CAR.

Dollar Thrifty is being acquired for $2.6 billion while Avis is currently valued at approximately $2.0 billion (including dilution). That's notable because CAR generates a lot more revenue and earnings, while expected growth is higher as well:

• CAR 2Q revenue $1.87 billion versus $395.4 million for DTG
• CAR 2013 revenue growth estimate 3.5% versus 3.4% for DTG
• CAR EBITDA $254 million versus $88 million for DTG
• CAR 5-year EPS growth estimate 27.0% versus 15.0% for DTG

So what's going on here then? I think the main detraction from the company's value is the debt load, which stands at $11.3 billion (including vehicle financing program) along with $454 million of cash. DTG has CAR beat on its balance sheet, with $286 million of cash and $1.6 billion of debt. Yet, CAR's figures are similar to Hertz which holds $12.5 billion of debt and $619 million of cash (both companies finance their fleets with debt).

So perhaps DTG gets a strong valuation due to the fact that it looks to be more of a cash flow machine. Yet still, when it comes to size and scope, CAR dwarfs DTG and it's interesting to see such a smaller company command a higher value especially when its growth isn't very strong. On the basis of valuation multiples, HTZ may be a better comparison. While HTZ is expected to see modestly higher revenue and earnings growth next year, CAR's measly 6.3 P/E ratio versus HTZ's 9.3 looks deeply discounted.

But the thing is HTZ's new value as of Monday accounts for the addition DTG, so when comparing the companies, it's probably best that we combine the figures of HTZ and DTG. Therefore, I've added up a number of figures to see how the combined entity stacks up (earnings projections assume latest share counts; combined multiples use current HTZ share price).

Although CAR stood out as being very cheap on the surface, a deeper dig shows that it is probably fairly valued. While valuing DTG higher than CAR may have been a bit of a stretch, in HTZ's case it was a more fitting acquisition that can add cash flow and synergies. Now, in order to determine whether CAR is correctly valued it makes more sense to compare it to the combined company of HTZ and DTG. Looking at it that way we see a new HTZ that, compared to CAR, has greater sales, higher sales growth, higher expected earnings growth, and a somewhat sturdier balance sheet. Along with that, HTZ/DTG is now a materially bigger player than CAR, threatening to turn up the competitive heat. And notably, when taking into account added earnings from DTG, the new HTZ reveals a cheaper P/E of just 7.5.

Given these factors, it makes sense that the new-look HTZ would command modestly higher valuation multiples than CAR.

David Urani
Wall Street Strategies