Updated from 1:26 p.m. ET to include closing share prices
NEW YORK (TheStreet) -- Hertz (HTZ - Get Report) said Tuesday it will spin off its equipment rental business, Hertz Equipment Rental, in an effort to refocus on the company's car rental business. The spinoff of Hertz' equipment rental business is expected to generate $2.5 billion in cash that will be used to pay down the company's debt and support a newly approved $1 billion share repurchase.
Overall, the spinoff may dramatically alter Hertz' capital structure, putting its leverage in line with competitors, while providing Wall Street with a far more straightforward car rental business. The move also comes as Hertz provided investors with a weaker-than-expected outlook for 2014.
Tuesday's decision to spin the equipment rental business may help Hertz weather a rough patch in the car rental market, while also insulating the company and its management from activist investors.
Hertz's newly announced share repurchase could allow the car rental chain to buy back 20% of its outstanding shares, the company said in a Tuesday statement. Hertz also raised the prospect of additional returns of capital to shareholders as a result of the company's targeted net debt ratio of 2.5-to-3.5 times earnings before interest, taxes, depreciation and amortization (EBITDA).
Those targets indicate Hertz could see its leverage rise from year-end net-debt of 2.9 times EBITDA, putting the company closer in line with Avis Budget (CAR - Get Report). Analysts had forecast Hertz net debt-to-EBITDA could fall in the coming year without a change to its capital planning.
"The actions announced today will create separate companies which we expect to benefit from improved financial profiles that include increased earnings stability and higher returns on capital," Mark P. Frissora, CEO of Hertz said in a statement.
Hertz Equipment Rental may be renamed and will have its own management team after the spinoff. The business generated annual revenues of over $1.5 billion in 2013, with 38% of those sales from construction market, 26% from industrial users, and a further 36% from other markets including niche markets like the energy sector.
At separation, the business is expected to have net debt of 3.5 times-to-4.0 times 2014 earnings before interest, taxes, depreciation and amortization (EBITDA).
Hertz will retain its Donlen fleet leasing business.
Hertz and Dollar Thrifty
For Hertz's more well-known car rental business, the spinoff may improve the company's cash flow, allowing the company to return capital to shareholders.
The spinoff may also give investors access to a pure-play car rental business that may be in recovery after the market was dramatically oversupplied in the years since the financial crisis. Consolidation such as Hertz takeover of Dollar Thrifty, and a recovering economy may also allow rental giants like Hertz, Avis Budget (CAR - Get Report) and Enterprise to regain their pricing power.
In December, Third Point Management and Corvex Management were reported as having taken stakes in Hertz, in an effort to unlock value at the car rental giant. Those reported investments came after company's weak third-quarter results, which caused shares to significantly underperform the S&P 500 in the second half of 2013.
Hertz enacted a so-called 'poison pill' in response to high trading volumes in the company's shares and around the time media reports of activist investors surfaced. Third Point repeatedly declined to comment on those reports, and on Tuesday declined to provide any statement.
In a late December note to clients reacting to those media reports, JPMorgan analyst Kevin Milota said Hertz investors were frustrated the company hadn't moved quicker with a sale or spinoff of its capital intensive equipment rental business. Such a transaction could unlock significant free cash flow for Hertz and increase the company's strategic focus on the rental car market, Milota said.
"In our view, if HTZ was to exit the equipment rental business, its free cash flow profile would dramatically increase," the analyst wrote. JPMorgan estimated Hertz would generate $693 million in 2014 free cash flow and $936 million in 2015.
On Tuesday, Milota said in a client note "we believe investors will receive the HERC spin announcement with open arms, offsetting what was otherwise a soft [quarter[ from an operating and full-year 2014 guidance perspective."
Hertz on Tuesday said it expected full-year 2014 revenue to be between $11.4-to-$11.7 billion, and EBITDA to be between $2.06 billion-to-$2.42 billion, generally a guidance that was below Wall Street consensus. Earnings per share guidance came in at between $1.70-to-$2.00 a share.
The lukewarm guidance provided by Hertz management underscores the strategic imperative of streamlining its operations and rejiggering the company's capital structure. Those initiatives could help Hertz navigate through supply issues in the car rental industry, for which it is the major culprit.
Hertz cited over-fleeting for an especially weak first quarter adjusted earnings per share guidance and said that the issue could be resolved by the end of the quarter, after dragging on earnings through the second half of 2013.
Hertz continues to integrate its acquisition of Dollar Thrifty and will use the equipment rental spin off to quickly pay down debt assumed in the deal. The acquisition culminated a multi-year effort by Hertz to buy its down-market competitor. It may also come to the forefront of Hertz strategy given the company's efforts to streamline business lines and re-configure its capital structure towards expanded returns of capital to investors.
Whether Hertz initiates a dividend is still to be seen. Hertz shares fell less than 1% in Tuesday trading, closing at $27.08. Shares have gained over 27% over the past 12-months.
-- Written by Antoine Gara in New York