What next for United?

By Murray Pollok10 April 2008

The history of United Rentals is unique in the rental industry. Formed in 1997, it proceeded to raise large amounts of money on the New York stock exchange, and by merger and acquisition quickly became the world's largest equipment rental company, operating only in North America, with over US$3.6 billion (€2.3 billion) in 2006 revenue.

United's share price, however, has been a disappointment to investors. After an initial strong run from December 97 to July 98, nearly ten years later, it has not regained all of its lost share price. The company's revenue for the first nine months of 2007 grew by just 3.7%, although earnings were up 19%.

Perhaps then it was not surprising that Cerberus, a US-based private equity fund, made an offer to acquire the company and take it private in July of this year. Cerberus has invested in GMAC (formerly General Motors car leasing division) and Alamo/National Car Rental, so it's no stranger to leasing and rental. It is generally considered to be a positive investor, rather than a “locust” fund which acquires and asset strips companies.

On July 23rd, United and Cerberus agreed an acquisition price of $6.6 billion (€4.6 billion) including debt, which was a rather normal 25% premium to the share price at the time.

By the time the shareholders got around to approving the transaction in October, the landscape had changed drastically. On 14 September, customers started queuing outside branches of the Northern Rock (bank) in the UK, to withdraw their deposits, as part of an ever-deepening credit crunch. On 19 October, Caterpillar announced that the US economy will be “near to, or even in, recession” next year.

Then, on 15 November, United issued a press release saying that Cerberus was pulling out of the deal, and not due to any adverse information uncovered at United, or downturn in its financial performance.

United's share price went down by 30%, along with similar declines for RSC, Ashtead, Speedy, Hertz, Ramirent, (see chart) and Terex and Cat. It does not appear that the announcement of Cerberus' pullout caused the other rental company share prices to go down, but rather that investors are much more pessimistic about the sector than in July.

Then, as is often the case when US companies disagree, the lawsuits began. Customary with acquisition agreements are clauses stipulating if one party walks away from the deal, then they usually have to pay some kind of break fee or penalty, often above the legal and advisory costs for the other party. In this case, it seems that the original break penalty between Cerberus and United was agreed at $100 million (€70 million).

Due to the round nature of the sum, and remembering the business climate at the time, it appears that no one ever thought anyone would ever want to walk away. Remember, a rental company with revenue of $100 million is large enough to make it into the IRN 100, at about position 91. However, $100 million is still only 1.5% of $6.6 bn, a great deal less than the probable change in acquisition price.

The lawsuits by United against Cerberus are focused on whether even $100 million is enough, according to the small print in the contract. However, remember that today some 28% of United is already owned by Cerberus, so if they have to pay $100 million to the company for a break penalty, almost a third of that may be for Cerberus' own benefit.

Fundraising

So far, Cerberus has acquired 28.4% of United shares, today worth some $568 million (€398 million). Presumably this is Cerberus equity, for which one would expect an equity return of 15% or even 20% or more long term. Moody's credit rating for the acquisition debt is “investment grade” for the first $5.1 billion (Ba2 and B2). For over $5.1 billion, much more expensive unsecured “exchange notes” with Caa1 rating (sometimes called “junk” or, more courteously, “high yield” bonds) are required, which also usually give the exchange note holders some benefit of the equity appreciation.

So, if Cerberus, or anyone, can acquire United for somewhere closer to the “cheap money” $5.1 billion (€3.6 billion) debt financeable price rather than the previously agreed $6.6 billion, their equity return could go from that 15%+ to a great deal more.

Predictions

The general investor attitude for rental companies has changed since July, which is reflected in the share prices of the rental companies, with similar declines in equipment manufacturers.

I believe that United will be acquired, probably by Cerberus, for somewhere between $5.1 billion and the $6.6 billion original agreed price. The difference between the figures is just under 30%, while United's share price has fallen just over 30% since Cerberus pulled out; I doubt this is a coincidence. However, just as things have changed remarkably since July, anything can happen in today's rental industry!

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