Hertz ( HTZ) may be spinning its wheels, but Merrill Lynch ( MER) is driving a timely investment in the rental car chain all the way to the bank. The early going has been tough for Hertz shares after this month's big IPO. The stock, which priced a dollar below the expected range at $15 a share, sank below its initial public offering price on Monday to close at $14.75. Yet Merrill Lynch's decision to participate last year's $15 billion leveraged buyout of Hertz still looks like a big winner. The Wall Street firm's $748 million cash investment in Hertz has doubled in value following the rental company's $1.32 billion offering two weeks ago. One brokerage analyst says the gain recorded by Merrill Lynch on the Hertz deal should add a dime a share to the firm's fourth-quarter earnings. Sanford Bernstein analyst Brad Hintz now expects Merrill Lynch to earn $1.95 a share in the fourth quarter -- some 15 cents more than the current Thomson Financial consensus estimate. Hintz says the big payoff on Hertz is more evidence of the wisdom of Merrill Lynch CEO Stanley O'Neal's decision to get into the red-hot private equity business. He notes that in just two years, Merrill Lynch has become a major force in the buyout world, with the value of its private equity portfolio rising three-fold to more than $6.3 billion.
This year, Merrill Lynch's private equity arm was a major investor in the $33 billion takeout of hospital chain HCA. It also is part of the private group seeking to buy Reader's Digest ( RDA) in a $2.4 billion deal. "It has clearly hit a home run with the Hertz equity offering last week," Hintz writes of Merrill. "With a number of its earlier deals maturing, we are beginning to see the impact that these private equity deals can have on Merrill's bottom line." In the past, private equity firms have typically held onto investments for several years, trying to make businesses more efficient before they looked to cash out. But that formula has been changing in recent years, as private equity firms are looking to score profits quicker than ever before unloading their past conquests. The Hertz deal has been real gravy train for Merrill Lynch and the other private equity firms that bought the company from Ford ( F) last December for a song. In all, the buyout team, which includes Carlyle Group and Clayton Dubilier, sank just $2.3 billion of their money into the transaction. The rest of the $15 billion deal was financed with debt, a move that has only further leveraged Hertz's balance sheet and dramatically increased the company's quarterly interest expense. This summer, the private equity team paid themselves a $1 billion special dividend. Hertz had to take out a loan from a group of banks to finance the dividend. In fact, the proceeds from the IPO went to pay off that loan and to fund a second $222 million dividend.
Hintz estimates that Merrill Lynch's share of the second dividend will add 3 cents to the firm's fourth-quarter earnings. The remaining 7 cents a share comes from the paper gain in the value of Merrill Lynch's equity stake in Hertz. With the two dividends, Merrill Lynch already has pocketed $400 million. That's not shabby, given Merrill Lynch's $748 million investment. Then again, private equity has proven to be an especially lucrative business -- especially for the firms that are funding the leveraged buyouts. Flush with a record sum of cash raised from institutional investors, private equity firms are fueling a merger bonanza this year. And along the way, the companies that are being acquired are taking out big loans to pay dividends to their private equity owners. To date, U.S. companies have taken out $26 billion in loans to finance the payment of special dividends to their private equity owners, according to Standard & Poor's Leveraged Commentary and Data. That's up 11% from the same time last year. And what's the biggest? The loan taken out by Hertz, of course.