Avis Budget Insiders Bet on Acceleration

For investors in Avis Budget Group (CAR), 2011 was a lost year. The company engaged a bitter battle with rival Hertz (HTZ) to snare a big prize: Dollar Thrifty (DTG). Both firms appeared likely to benefit from the industry-consolidating move. Fewer rental-car counters means fewer available cars and firmer rental-car prices. But the proposed purchase price climbed ever higher, quickly sapping any accretive possibilities for the winner. Moreover, the need to divest holdings to satisfy antitrust regulators mitigated some of the potential synergies from the proposed deal. So it's perhaps best that no deal was ultimately consummated by Avis Budget. Nevertheless, the failed bid had ramifications. Shares of Avis Budget were driven above $19 last year on hopes that all industry players would benefit from any deal that reduces competition. Now, the stock is back down to about where it was a year ago. Yet Avis still has clear upside. A $1 billion deal to reacquire its European franchise should boost profits. The combined entity will have more than $7 billion in annual revenue, and the deal should bring about $30 million in synergies. More importantly, the European combination helps the company compete for global contracts with multinational firms that had to stick with Hertz if they were to work with one vendor in the U.S. and Europe. Last September and October were news-heavy months for Avis Budget. On Sept. 12, 2011, the company pre-announced third-quarter sales of around $1.6 billion and third-quarter EBITDA of around $270 million. That represented about 8% sales growth and 20%-25% EBITDA growth from the third quarter of 2010. The timing was noteworthy: Two days later, the company formally scrapped its plans to pursue Dollar Thrifty. Management clearly wanted to say we're doing fine and don't need to do a deal anyway. Having seen Avis Budget fall from $17.50, to $13 over the prior two months, management may have expected its solid third-quarter pre-announcement to help boost the flagging stock. Instead, after the reacquisition of the European franchise was completed on Oct. 3, the stock slipped to $9. That was much too low for insiders to idly watch. During the first half of October, 14 insiders purchased a collective $887,000 worth of CAR for between $8.99 and $11.78 per share. The average purchase price was $9.18. For most of the insider buyers, their October purchases were their first open-market buys in over two years -- or ever. Five of those buyers showed a reversal of opinion -- they had flipped options for a risk-free profit back in February 2011 as CAR traded above $16. The significant insider-buying cluster at Avis Budget was impossible to miss in October. Nevertheless, I did not take advantage of the signal, given my overall pessimism on the market at that time. I absolutely did not foresee the remarkable 20% surge that the indices would experience last October -- a move that Avis Budget fully participated in. However, shares of Avis Budget also participated in the wimpy last two months of market performance in 2011, and renewed concerns about economic growth in the U.S. and Europe have pushed this stock back down to $11. I thought Avis Budget got ahead of itself last October. I'm also not assuming that insiders' actions imply a belief that fourth-quarter results (to be released in mid-February) will surprise on the upside. All indications point to roughly 5% revenue gains from a year earlier, mostly due to increased rental activity and not higher rental-car prices. Instead, I expect insiders' bullishness to be justified by several moderate, positive-leaning catalysts throughout 2012. Here in the U.S., recent improvements in employment should help management to predict sales growth of at least 10%, on the basis of a split between slightly higher volume and slightly firmer pricing. By my math, U.S. EBITDA could grow at twice the pace, as all car-rental firms are benefiting from very robust used-car prices, which in turn results in a better payback when cars are sold after 18 to 24 months of service. Yet developments at Avis Europe may be the strongest catalyst for Avis Budget this year, despite the debt-spawned turmoil in the region. While both the U.S. and European markets are arguably mature in terms of new sales growth opportunities, the acquired European division brings a high degree of exposure to China, India and Russia as well. And as management noted on the third-quarter conference call, growth in air travel outside of the United States both intra and international exceeds the U.S. domestic rate by a significant margin. Further upside from Europe also appears likely in coming years from operational synergies, along with an ability to start capturing high-margin global corporate account business -- the crown jewel of the Hertz business model. In terms of synergies, management expects to gain the equivalent of 40% of Avis Europe's net income. For now, that translates to roughly $30 million. But after applying the business processes deployed to save money at the U.S. operations, management believes it can ultimately derive another $50 million to $75 million in cost efficiencies. As an example, Avis Europe has five different fleet systems, five headquarters and five customer service centers. For a company that had $72 million in operating income in 2010, that's quite a number. Management cautions, however, that it will take two to three years to reap full synergy gains from Europe. The European opportunity did come with a cost, however, and it appears to be adding weight to Avis Budget's shares now. Though Avis ended its third quarter with $1.4 billion in cash, it still had to borrow $690 million to complete the deal, which was added to an already large $2.5 billion in existing debt. A potential catalyst for the stock is a 2012 framework for interest expense in relation to EBITDA. I estimate that 2012 EBITDA can reach $700 million. Synergy gains in Europe should push that figure to $800 million in 2013, even assuming zero sales growth. Once investors see that Avis has ample interest coverage and will be on a path to pay down debt over coming years, I expect some of the perceived risk to diminish from the stock. That risk is reflected in a very low P/E multiple of 6x projected 2012 earnings. As the risk premium diminishes, the multiple should expand. The next important event for shares of Avis Budget will likely be the firm's mid-February earnings conference call. For my bullishness to play out sooner rather than later, investors would need to hear positive forward-looking statements that Avis will be a solid cash-flow growth story, regardless of what the U.S. and European economies look like in 2012. The cost savings laid out by management and newly issued 2012 guidance should help this flagging stock finally move back into the mid to upper teens. For the potential 20%-40% upside I see in Avis Budget, I view the downside as limited because of the value multiple the stock is already sporting and the solid, EBITDA-generating global enterprise that is Avis Budget. Avis Budget may not be of interest to investors who are looking to swing for the fences in this difficult market, but given the past year's experience, solid 20%-plus upside potential in a lower-risk stock could be attractive.

Avis Budget Insiders Bet on Acceleration

The stock has a couple of catalysts that should put it in the passing lane this year.

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