Car rental agency

Hertz rebirth delivers $ 3 billion windfall to two daring backers

As travelers face soaring prices for car rental this holiday season amid growing demand and a shortage of new vehicles, two little-known investment groups are reaping huge benefits from the one of the most lucrative trades in the hedge fund industry in 2021.

Certares Management and Knighthead Capital Management sit on paper earnings of nearly $ 3 billion after a daring $ 2 billion bet in May on Hertz as part of the centennial car rental pioneer’s exit from bankruptcy induced by the pandemic.

At the heart of their investment thesis, the pandemic blow to Hertz, when a collapse in global travel crushed demand for its vehicles, will be a blow overtaken by a longer-term opportunity.

New York investors believe the company’s fleet and site network can be redeployed as infrastructure for both the burgeoning electric car industry and the coming era of self-driving taxis.

“There is always one industry that is at the center of every struggling cycle,” said Tom Wagner, former managing director of Goldman Sachs who created Knighthead in 2008 to invest in distressed assets. “In this case, it was about travel and recreation. If we could do it right, we could do the whole portfolio right. “

With this in mind, Knighthead, which now manages $ 8.3 billion in assets, and Certares, which specializes in investing in the travel, tourism and hospitality sectors, raised $ 1.5 billion in spring 2020 to invest in the struggling travel sector.

They didn’t have to wait long to put the money to work. When Hertz filed for bankruptcy in May 2020, that was exactly the kind of opportunity they had in mind.

Together, the couple embarked on a marathon auction process to get the company out of the Chapter 11 administration. When they emerged victorious, they made a combined $ 2 billion investment in Hertz, fueled by through their previous fundraising and their existing funds.

The value of their investment increased 2.5 times over the next seven months – an exceptional return for distressed investors who had few good investment opportunities over an extended period in which central bank intervention supported stock markets.

In November, Knighthead and Certares re-floated Hertz on the Nasdaq and sold nearly $ 500 million of shares, but retained a 39% stake in the company, worth $ 4.5 billion. . Private equity group Apollo Global, which made a $ 1.5 billion preferred investment in Hertz as part of the bankruptcy auction, bought back its stake in the same month for nearly $ 1.9 billion. , that is to say a gain of more than 25% in just six months.

The pandemic continues, but the fortunes of the rental car industry have turned, giving a boost to the trade of Certares and Knighthead. Hertz is on track to generate more than $ 2 billion in operating cash flow this year, nearly four times its pre-pandemic profitability, despite a 43% drop in volumes, according to analysts’ estimates at Hertz. JPMorgan.

One of the main drivers of profits is the global semiconductor shortage which has reduced the production of new cars.

With limited ability to expand their fleets, brands such as Hertz and Avis Budget have raised their prices to meet growing demand. According to the online travel agency Kayak, average daily car rental prices during the holidays were well over $ 100 per day at beach destinations such as Hawaii and ski destinations in Colorado, Montana, Canada. Utah and Wyoming.

Meanwhile, supply chain constraints have caused used car prices to skyrocket, which also contributes to Hertz’s bottom line – car rental companies own huge fleets which they sell to companies. used car dealers as they age.

Although the group enjoys conditions that will eventually fade, Certares and Knighthead believe there is an opportunity to use the profits to turn Hertz, founded in 1918 to lease Ford Model T cars, into critical vehicle infrastructure. electric and autonomous taxis.

“For this to work, we decided that we needed to make a substantial effort in electrification,” Wagner said. “Hertz is located within 10 miles of 90 percent of the US population.”

With more than 12,000 locations around the world, including at most US airports, he added, Hertz could become an electric vehicle hub where travelers rent from automakers like Tesla that lack major dealer networks, presenting electric vehicles to potential new buyers.

Hertz revealed later that year that it had ordered 100,000 Teslas for delivery by the end of 2022, as part of a strategy to use its locations as charging infrastructure for electric vehicles. It has also entered into a partnership with the Uber carpooling group which is expected to make 50,000 Tesla available to Uber drivers by 2023.

Hertz’s existing locations are critical to the strategy, as building new rental car locations is expensive and time consuming. And its urban locations can be useful for Uber drivers who adopt electric vehicles, according to Greg O’Hara, founder of Certares.

O’Hara believes that Hertz outlets will eventually become service points for cleaning and recharging autonomous taxis, and plans to unveil new partnerships to install charging stations in hotel chain car parks.

“This is expected to be one of the best ESG investments on the market today,” he said, highlighting growing investor demand for environmental, social and governance investments. “It helps an internal combustion engine business grow into an electric vehicle business and a fleet service business for an autonomous driving business. “

The company’s windfall is controversial in Washington. In November, prominent Massachusetts Senator Elizabeth Warren sent a letter to Hertz criticizing the company for raising rental prices and authorizing a $ 2 billion share buyback program after the company sold cars and laid off thousands of employees when it went bankrupt, leading to complaints from customers.

“The company is happy to reward executives, company insiders and big shareholders while backing up consumers with record car rental costs and ignoring the recent history that nearly wiped out the company,” she wrote. “Hertz owes the public an explanation for this corporate greed. “

Wagner and O’Hara see their investment in Hertz not as corporate greed, but as funding for the auto industry of the future.

“We are committed to electrification,” said Wagner, referring to Hertz’s work with Tesla, Uber and online used car dealer Carvana. This “requires investments in vehicles, investments in charging networks and investments in used car partnerships. . . You can expect to see them expand and we’re going to be very creative in how we do it. “

Additional reporting by Sujeet Indap in New York