Car Rental Deal Stuck in Neutral

 | Nov 01, 2012 | 11:00 AM EDT
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On Aug. 27 of this year, Hertz Global Holdings (HTZ) announced that would acquire smaller auto-rental rival Dollar Thrifty Automotive Group (DTG) for $87.50 a share. News of the acquisition sent shares of Dollar Thrifty up from the pre-deal share price of $75 to $87, as the this was an acquisition that Hertz had wanted for a while and the market was confident the deal with go through. Hertz expected that it would clear all regulatory hurdles by Oct. 18. Yet around that time, the Federal Trade Commission (FTC) Bureau of Competition informed Hertz that the agency needed more time to review the deal. The market took this as a sign that the acquisition was no longer a given and DTG shares dropped 7% to $80.

Dollar Thrifty shares have fallen yet further and now trade for $77, which is nearly the same price they traded at before the deal was even announced. With a very attractive spread of nearly 15% to the acquisition price, this is a merger arbitrage trade that is well worth considering. My opinion (based on the initial information I have read but more importantly information on the history of this deal) is that it will go through. What matters with respect to a merger arbitrage trade is not when the actual acquisition is consummated but when (or if) the FTC grants its approval. FTC approval will most likely send shares right back over $87 a share. At the present time, Hertz extended the deadline for the FTC to rule to Nov. 16 from Oct. 31.

The first thing to know about this deal is that Hertz has been trying to buy Dollar Thrifty for over five years so Hertz is not going to walk away due to a regulatory hiccup. The FTC is now interviewing competitors about the impact of a HTZ/DTG combination. Obviously, your competitors don't want to go up against a bigger player, but a Hertz/DTG merger would hardly stifle the competition. According to an IBISWorld Study, Hertz currently commands a 19% share of the U.S. rental car market. Dollar Thrifty is smallest of the major four players with a 5% market share. The 800-pound gorilla in the room is privately held Enterprise, which holds nearly a 40% market share. No. 3 competitor is Avis (CAR), which has 18.5% of the market. Combined, the new Hertz would hold a 24% share, well behind Enterprise. What a HTZ/DTG combination essentially does is put 80% of the US car rental market in the hands of three players instead of four.

In 2007, Enterprise acquired Vanguard Car Rental Group, which gave the company the Alamo and National Car Rental brands. Hertz has already agreed to dispose of its Advantage brand to make the deal happen. Finally, under its merger agreement with Dollar Thrifty, Hertz has obligated itself  "to do everything it can to conclude the takeover, including litigating against any injunction or other attempt to block the deal." In other words, you can expect Hertz's full cooperation with the FTC to make sure this deal happens.

The FTC apparently wants more time so that a few years down the road they don't look back and realize they have made a huge mistake. But the reality is that a HTZ/DTG will not stifle competition. When you have three dominant players competing, consumers will benefit. The concern shouldn't be about consolidation but perhaps the future threat of collusion. But any such concern about a future threat of three companies violating a law is not a legitimate basis to impede a deal that will allow Hertz to better compete with Enterprise.

Still, we are dealing with a regulatory agency that has the power to delay or deny this deal. Given that Hertz has spent more than five years and significant financial resources to see this deal through, odds are high that it will happen. Whether approval is granted next month or next year is the biggest unknown. But you have a very cooperative buyer in Hertz and, if one assumes approval by year-end, the current 15% merger arbitration spread translates into a nearly 100% annualized rate of return. 

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