United+RSC: Jeff Eisenberg reports on the financial aspects of the transaction
By Jeff Eisenberg31 January 2012
Jeff Eisenberg, IRN's finance correspondent, looks at the financial aspects of United Rentals' proposed acquisition of RSC Equipment Rental and asks, is it a good deal?
For the equipment rental industry United Rentals' proposed acquisition of RSC is an enormous transaction, valued at US$ 4.2 billion including RSC's debt, but was it cheap or expensive?
Most equity investors, banks, and their advisers use an Enterprise Value method to value a rental company. This takes a multiple of cash flow (more specifically EBITDA - Earnings Before Interest Tax Depreciation and Amortization) and subtracts the company's debt to reach a value. This facilitates comparison between rental companies with different amounts of debt.
The 12 month trailing multiple paid by United Rentals was 3.8 times EBITDA (more on trailing multiples below). This seems low, and therefore a good deal, compared to the higher multiples that were seen up until 2007 and 2008. Often EBITDA multiples of 6 times, 7 times, or even higher were paid, including by United itself.
Why did companies previously pay higher multiples? One reason is that the high growth of the mid 2000s meant that an ‘expensive' acquisition became cheaper very quickly (continued rapid growth meant that whatever price was paid it seemed like a bargain after a few years.)
Banks were also happier to loan larger amounts before the current downturn; multiple bidders pushed rental company prices up; and everyone was more concerned with missing opportunities than paying down debt. Rapid company financial growth would fix anything.
Now, the banks are reluctant to lend at all. United's latest investor presentation mentioned that its new post-acquisition debt would be 4.5 times its 2011 EBITDA, just at the top of the range that its debt providers would deem acceptable.
It also said that this figure was "inclusive of year 1 run-rate cost savings". These costs savings total $200 million, 40% of which is corporate overheads, 14% is branch closures.
So, from United's debt providers' point of view, the acquisition is towards the top of what it can handle, even though proportionally cheaper than acquisitions used to be "in the good old days" of the mid 2000s.
However, that 2011 EBITDA is moving upwards quickly, and that 4.5 multiplier did not include the fourth quarter of 2011, usually the best quarter of the year for rental companies.
United's share price has increased slightly in the weeks since the proposed acquisition was announced, from $27 to just over $31 (Jan 10). RSC's share price increased from around $11 to just over $19 (Jan 10).
United's offer of $18 implied that RSC's previously relatively low share price undervalued the company, and United no doubt wanted to avoid a bidding war for RSC or speculation on RSC's share price.
The premium paid above RSC's share price was 58%: since RSC's share price was stable before the acquisition was announced, it is safe to say the news was kept quite quiet.
Several law firms have announced they are investigating RSC's board for, in effect, selling the company too cheaply. (Included in this is the charmingly named firm of Bull and Lifschitz. Yes, this is actually a real law firm in New York).
This, despite the fact that RSC's share price had not reached $18 per share since 2007. Remember the words of Bill Clinton (himself a lawyer before going into politics ), "No, the US does not have too many lawyers, some people still don't have one."
Valuations of companies, especially those traded on stock exchanges such as United and RSC, are made with limited amounts of publicly available information, most of it backward looking. Most stock markets require information to be distributed in a strictly regulated format, and detailed forecast information is particularly scarce.
Analysts that follow the larger publicly US traded companies publish recommendations and predictions on some figures, particularly earnings per share, and expected share price.
These are based, theoretically, on the same information which is available to all investors, plus data on the construction industry, general economic indicators, information from competitors, etc.
While the two companies together comprise 12 to 13% of the North American equipment rental industry, the share prices have closely followed each other since RSC floated on the stock exchange in 2007.
This implies that both companies' share price is moving in response to general industry situation, as well as the stock market conditions.
Therefore, it is not a surprise that investors like the further consolidation and savings that should be created by the combination of the two companies.
Should the acquirer pay a multiple of last year's EBITDA or next year's EBITDA? The financial markets refer to this as the ‘trailing' or ‘forward' multiple.
For publicly traded companies, we know last year's EBITDA, but companies don't publish a forecast for next year's EBITDA, the analysts have to make their best estimate.
RSC's rental revenue for the fourth quarter 2011 was up 26.9%. United's rental revenue for the third quarter 2011 increased 19.1%: URI's quarter ended September (versus November for RSC).
If a company grows quickly enough, and keeps growing, then the hope is it will wind up with last year's debt and next year's (better) profitability. The recession caught most of the rental industry the other way around, everyone woke up in 2008 and 2009 with last year's debt and this year's (recession) bottom line.
What does this mean for United Rentals' competitors, and their potential entry into Europe? Swallowing a 452 depot operation, which could mean closure of 100 depots, plus enough overhead reduction to save $200 million, is a time consuming, painful, expensive exercise, especially for the people involved.
United raised enough new debt for Standard and Poors to place its rating on CreditWatch, for a possible downgrade. The yield on the United bonds, however, which are also traded on exchanges in the US, has recently decreased, which reflects investor confidence.
This acquisition may be the first of a new wave in North America, where the rental industry began its slowdown before most of Europe (and some other continents avoided altogether).
However, Europe will likely have to wait at least another year due to uncertainty regarding the Euro and national debt situations, and still-weak banks. This uncertainty has left European banks still reluctant to lend to construction or equipment rental industries.
In conclusion, if United Rentals (and most of the rest of the industry ) is right and the North American rental industry will continue to improve, the acquisition price looks cheap at 3.8x last year's EBITDA, compared to "good times" company valuations that were seen before 2008.
The efficiencies of putting together two of the largest rental companies in the world should bring even more value; remember that 3.8 x the $200 million of savings is theoretically alone worth $760m.
However, the debt is probably as much as United can handle today, plus the complexities of the integration, so we may have to wait a while longer yet before we see them acquiring companies in Europe and elsewhere.
Jeff Eisenberg has spent 17 years in the rental industry. He started and led Genie Financial Services in Europe, providing finance for large and small rental companies all over the world.
Since 2000 he has held senior positions in a number of European rental companies, as well as his own consultancy for rental companies, financial institutions and equipment manufacturers. In July 2008 he joined Netherlands based Riwal working specifically with acquisitions and finance.
Contact Jeff at: firstname.lastname@example.org or Tel: +44 7900 916933.