June 17, 2008

Recap Opprtunity

United rentals (URI) began a modified Dutch Auction today. A dutch auction is an auction in which an item is initially offered at a high price that is progressively lowered until a bid is made and the item sold. In this case URI indicated that they will buy back 27,160,000 shares out of their 86,000,000 outstanding shares at a price not less than $22 and not more than $25. Shareholders will tender their prices at a price they choose or they can elect to just tender and accept whatever price is finalized through the auction process. URI will look at all the tendered share prices and start to work their way up from the lowest tender price until they satisfy the required quantity of share buyback and the sum of that amount divided by the quantity of the shares to buyback will determine the auction buyback price.

I have not done any fundamental analysis on the company to determine its value because the way I looked at it is as follows: I do have an opportunity to make a quick profit with relatively little or no risk as I bought in below the the auction price range. However as I looked at the details of the auction and the financials of the company there is a good potential for a nice price appreciation after the buy back is completed. Moreover, insiders are buying heavily into the company, actually a big chunk of this company is owned by insiders. As I go through the owners list I see that Bruce Berkowitz have bought in at $18 a share. Mr Berkowitz is the founder and the Managing Member of the Fairholme Fund who boosts a stellar track record of value investing. That peaked my interest in the business.

URI has an Entp. Value(EV)/ EBITDA multiple of 5.5 on a TTM basis. After the recapitalization, if the market to apply the same multiple to URI's business, its shares should appreciate to high 30s. URI could use its $500 million cash to do the recap or borrow more either way their Enp. Value will not change, but shareholders will get a bigger piece of the company cash flows. If I reverse solve for URI price and market cap after the recap I should get $38 per share as per table below. Now the market may not keep the same multiple due to more debt added to the balance sheet but the potential for a run up in the price of URI have a high probability of occurring.

TTM Recap
Shares 86.406 59.246
EV $3,946 3,946
EBITDA $718 718
EV/EBITDA 5.5 5.5
Mkt Cap $1,902 2,404
Price $22 38
As for the business itself United Rentals is
... an equipment rental company. During the year ended December 31, 2007, excluding its traffic control operations, the Company’s network consisted of 697 rental locations in the United States, Canada and Mexico. It offers for rent over 2,900 classes of rental equipment, including heavy machines and hand tools, to customers that include construction and industrial companies, manufacturers, utilities, municipalities, homeowners and others. In February 2007, the Company completed the sale of its traffic control business to HTS Acquisition, Inc., an entity formed by affiliates of private equity investors, Wynn church Capital Partners and Oak Hill Special Opportunities Fund, L.P. In February 2007, the Company acquired High Reach Equipment Services, LLC (High Reach).
The company's customer base is commercial contractors that account for 70% of their business. The commercial construction is not dead and continue to do ok but may suffer in the near future, who knows. I am not a top down guy so I do not put a lot of emphasis on economy and sector outlook when analyzing a company.

The problem with an operation like URI is it will hardly generate any free cash flow, although they will have fantastic profitability margins. The business requires a steady and continuous capital investment to maintain operations. If you look at URI free cash flows for the past 10 years, it is highly variable. The company ends up blowing all of its cash flow from operations back to the business to buy more rental equipment. The company during the past 10 years have generated negative cumulative free cash flow in the tune of $1.4 billion.

Cash from Operations216.1421.4512.7696.7517.9342.3737.0643.0858.0868.0961.0
Cap Ex(564.2)(841.8)(962.0)(497.3)(709.4)(377.9)(649.0)(823.0)(965.0)(990.0)(845.0)
Free Cash Flow(348.0)(420.4)(449.3)199.4(191.5)(35.6)88.0(180.0)(107.0)(122.0)116.0

Some may argue to exclude capex in this situation as the company is still growing and need to add to its equipment fleet. Ok lets assume that the company will grow at the same rate forever, then what? They will never generate any free cash flow as they will need to add more to their assets to match fuel revenue growth.

The company, no doubt, has improved some of its metrics and profitability in recent years and its recent recapitalization may add more value to its shares. However, I am not in a hurry to hold it long term as I am not confident enough in my analysis, or more accurately the lack of, so i will tender my shares at $23.5. A price in the middle of the road and will yield me a nice return for couple weeks of holding, if it was tendered.


Ryan B said...

Hi Sami,

I have been reading the SEC Edgar fillings about the tender offer. I am not too familiar with tender offerings and I am wondering if you can answer a question for me. I have read that the expiry date to tender your shares is July 16th, but if I were to purchase shares before this date, for instance this week, would I be eligible to tender my shares. Or did I have to own the shares before June 9th?

Thanks Sami

Sami said...

Hi Ryan

No you still can buy the shares now and contact your broker and tender them for the auction.

There is a risk here that you may get a smaller price than what you ask for or if a lot of people tender, which is unlikely given the size of the offer, you may get locked out of the auction. If this happen there is a large probability, I believe, that you still can dumb your shares afterwards at much higher price than what it is trading for it now.

marc said...

One word, proration. Ford just did a tender offer (actually Kirk Kerkorian for F shares). 1.02 Billion shares were tendered as the price was way above prevailing market prices. 1% of those tendered shares were ulitmately purchased. So watch you proration, these transactions are not the risk-free propositions so many traders think they are.

Sami said...

Hi marc

Thanks for the comment. I agree there is nothing that is risk free in the market.

but I figured that there are good odds that with the number of shares being bought that my shares would get tendered. even if the shares did not get tendered odds are shares my trade a bit higher.

marc said...

Let me know how it goes. I will watch the results to see if it worked, most have not in the past year when traders see this as a win-win, no risk proposition.

Sami said...

I will post how it goes.

But I am not kidding myself, there is risk with this one, there is always risk in any position.

but I think the odds are favorable of making some return on the position.

marc said...

"I have not done any fundamental analysis on the company to determine its value because the way I looked at it is as follows: I do have an opportunity to make a quick profit with relatively little or no risk as I bought in below the the auction price range."

At what price did you purchase the stock and on what date, were you already an investor before the announcement? Thanks.

Sami said...


I have bought it on the day of the announcement of the auction and paid $21.4 a share.