The Hertz Corporation – Leveraged Buy Out

Key Inferences and Conclusions:
1. Hertz was attractive as a leverage buyout candidate, having:
• Relatively low existing debt loads with assets available to further leverage;
• A multi-year history of stable and recurring cash flows;
• Hard assets (Rental Fleet and Equipment) that may be used as collateral for lower cost secured debt;
• The potential for new management to make operational or other improvements to the firm to boost cash flows;
• Market conditions (9/11) that depress the valuation or stock price.

2. CD&R had the following advantages if this deal went through
• The use of debt increases (leverages) the financial return to the private equity sponsor. The total return of an asset to its owners, all else being equal and within strict restrictive assumptions, is unaffected by the structure of its financing. As the debt in an LBO has a relatively fixed, albeit high, cost of capital, any returns in excess of this cost of capital flow through to the equity.
• The tax shield of the acquisition debt increases the value of the firm. This enables the private equity sponsor to pay a higher price than would otherwise be possible. Because income flowing through to equity is taxed, while interest payments to debt are not, the capitalized value of cash flowing to debt is greater than the same cash stream flowing to equity.

Advantages of Private Equity LBOs:
1. One of the strengths of private equity investments is that they are not beholden to the short-term returns like the public markets. Private equity firms are not under public scrutiny so they can focus on long-term business growth.
2. In a typical deal a private equity shop would borrow about 70-95% of the purchase price (those loans go on the acquired company's balance sheet, often doubling or tripling its debt load). With that kind of leverage, even