1.

What are the key cash flow improvements that Clayton Dubilier &
Rice (CDR) believes it can make as the owner of Hertz? How are
these improvements different from synergies & savings in
Conrail?
The key cash flow improvements that we see are the operational
Improvements that lead to higher margins for Hertz. They are:
U.S. RAC on airport operating expenses: CDR estimated that labor per
transaction, administrative, and other costs had increased 41 %, 65 %and 30
%. This lead to a decline in the operating margins despite the growth in
revenues. Also, the variation in margins across locations presented another
opportunity for improvement.
U.S. RAC off-airport strategy : Hertz expanded the number of its offairport locations but these locations were not able to generate enough profit
to justify the capital investment. CDR proposed to slow expansion, focus
selectively on profitable growth, and close locations that failed to achieve
positive contribution.
European operating SG&A expenses: Hertz operational SG&A expenses
as a percentage of revenue were nearly three times higher than those in the
U.S. CDR felt that European expense ratios reduced through consolidation of
some back-office and reservation systems.
U.S. RAC fleet costs: Despite its scale advantages, Hertz historically had
higher fleet costs than those of key competitors due to lack of multiyear
deals with OEMs. The move by major OEMs to move away from these deals
would put pressure on the prices for the competitors but Hertzs margins
would benefit from its steady fleet costs.
U.S. RAC nonfleet capital expenditures: As Hertz had outspent its
major competitors , it can reduce future capital spending while enjoying the
benefits of pas investments.
HERCs Return On Invested Capital (ROIC) : HERC managers earned
maximum bonuses year after year, despite the low returns on capital. CDR
expects to realize significant savings by changing managers incentives to
focus on ROIC.

2. What is it about Hertz that makes it a good candidate for an LBO?

What is the purpose of extreme levels of borrowing in an LBO like
Hertz? Does high leverage result in superior excess returns for
investors in LBOs? Can leverage have an impact on operating
performance in an LBO? If so, how

The following reasons make Hertz a good candidate for an LBO :

Hertz was undervalued.

Potential for increasing the operational efficiency: CDR
identified numerous areas where Hertz could save cost and increase its
efficiency leading to higher margins.
Strong Business Performance: Hertzs two principal operating
divisions: Hertz Rent-A-Car (RAC) and Hertz Equipment Rental
Corporation (HERC) had a strong brand name. Hertz RAC was the
worlds largest car rental company, and HERC was the third-largest
equipment rental company in North America. Hertz also enjoyed the
position of a market leader in on-airport business.
Potential for improving the capital structure: By increasing the
debt level through securitization of RAC fleets would lead to lower the
cost of capital.
Complacent Management: Hertz managers were overconfident and
convinced that they were running the business in the best possible
manner. Whereas the financial statements indicate that the operating
margins were way below the industry standards.

High Leverage has an impact on the operating performance by impacting

the paying capacity and liquidity needs of Hertz. Long term debt
agreements ensure stability and will enable Hertz to make large car
purchases and manage fluctuations in the rental activity in its fleet
management business. As the entire amount of debt was not withdrawn,
Hertz has the option of using the unused financing to take advantage of
future growth opportunities and needs. Hertz was able to lower its cost of
capital through the use of asset backed facilities.