United Rentals and Cerberus Get Ready to Rumble!

Guy Ramsey

November 19, 2007 • On July 22, Cerberus Capital Management, LP agreed to acquire Greenwich, Conn.-based United Rentals for $34.50 per share in cash. Additionally, the private equity firm also agreed to assume $2.6 billion of United Rentals' debt. In total, the deal was valued at about $7 billion.

Only two months earlier, this same investment group leveraged a deal to take an 80-percent stake in the new Chrysler organization for $7.8 billion. What shouldn't be lost in this ensuing dogfight between United and Cerberus is that a 10-year-old service-based company was valued at a number not far off from what was paid for an 83-year-old moniker doing something close to $48 billion in annual revenues. Granted, the automotive industry is struggling, but this is Chrysler we're talking about. We have come a long way, baby!

 

But late last week, Cerberus announced that it intends to back out of its plan to acquire United Rentals. It is reported that United Rentals views this move by Cerberus as unwarranted and incompatible with the covenants of the merger agreement, adding that the private equity firm did not cite a material adverse change, which is typically required for a buyer to back out of a deal. The end of the deal followed reports earlier in the week that Cerberus would pull out, causing shares of United Rentals to plunge early Wednesday morning. This plunge prompted the New York Stock Exchange to briefly halt trading, citing "unusual market activity" in the company's stock.

 

The timing for the buyout agreement for United couldn't have been worse, coming right as the credit market seized up from the sub-prime mortgage meltdown. Investment banks funding the deal are reported to be struggling with selling the associated debt offering. It has been reported that Cerberus is working with United's board to renegotiate certain terms of the deal, including cutting the price of the offer. The company was planning to sell about $2.55 billion of high-yield notes to help fund the takeover.

 

On Friday, United extended a debt tender offer after failing to secure enough buyers to cover all of the $2 billion it was obligated to sell to help finance the deal. The tender, which was scheduled to close last Tuesday, was extended until midnight Nov. 21. The extension of these tender offers demonstrates that United continues to work to fulfill all of its obligations under the merger agreement with Cerberus, no doubt hoping to force the issue. It appears that United stands ready to complete the merger transaction on the agreed-upon terms • even as it continues to consider all possible remedies, in light of Cerberus' repudiation of the transaction. The posturing begins.

 

Credit markets taking a further hit in recent weeks from large losses on Wall Street only exacerbates the situation. Banks are pressuring private equity buyers, like Cerberus, to renegotiate debt financing, so they aren't stuck with unwanted securities. 

 

The biggest question on the street now is, what did United Rentals know and when did it know it? That is the question many investors are asking after the news broke that Cerberus was trying to walk away from the agreement. It is clear in correspondence between the parties that surfaced last Wednesday that tension over the deal has been escalating since at least Aug. 31, which is when a Cerberus executive sent a letter to United Rentals' general counsel seeking a “discussion” about the terms of the deal. The Wall Street Journal reported that United Rentals responded six days later that any talks on a revision to the terms of the deal were out of the question.

 

The back-and-forth correspondence raises the question of whether United Rentals shareholders were entitled to know about the skirmish before Wednesday, when news of the crumbling deal sent United Rentals' stock down 31 percent.

The purchase agreement negotiated in July sought to limit liability to $100 million, "which was to be United Rentals' exclusive remedy" if the deal fell through, Cerberus said. Cerberus has offered "either to arrange for the payment of the $100 million termination fee, or to engage United Rentals in a constructive dialogue to negotiate a transaction on revised terms," according to documents filed late Wednesday. With all the posturing that has taken place, it was rather obvious that United intended to use any means possible to force this issue and it came as no surprise to me to read early this morning that United had indeed filed a lawsuit to force the completion of the transaction, depicting Cerberus' action a "naked ploy" to extract a lower price for the buyout.

 

Although it appears that the volatile credit market is a convenient excuse for unwinding this deal, there appear to be other underlying issues. Cerberus is concerned that United Rentals' financial future might not be as bright as previously thought. It is no secret that the housing market woes and tight credit are beginning to have an impact on utilization in many key markets. It is inevitable that rental revenues will be under pressure in 2008 and, for sure, 2009.

 

Before the collapse of the deal was announced, JPMorgan analyst Stephen Volkmann said in a note to investors that Cerberus paid "near the high end of the comparable transaction range," and that companies in United Rentals' peer group have traded significantly lower. In addition, "some of Cerberus' assumptions behind the deal were aggressive," Volkmann said.

 

United Rentals represented that it could achieve cumulative rental rate gains of 5.5 percent by 2009, even though third-quarter rates were down 2 percent, he said. United Rentals' free cash flow in the third quarter was $43 million, compared with $123 million in the year-ago period. The company said the drop in free cash was due to increased use of working capital. Private equity firms need strong cash flows to pay down debt used for leveraged buyouts, and cash flow is a big factor in debt rating. Of course, if the price paid were too high, it would force cash used for capital expenditures to be channeled away to service debt. If this happened, the result would mean that fleet replacement would be slowed and the ages of machines would inevitably be pushed out.

 

Pressure also would be put squarely on the shoulders of United's branch managers to keep revenue up. This is difficult to do when the economy is slowing, machines are aging, and you stop adding new fleet. Asking a manager to grow or even maintain revenue levels in a down economy with older machines is asking for trouble. In this case, trouble would be defined as rate erosion. United has worked long and hard for several years to reduce its fleet age, only recently attaining some of the benchmarks promised long ago by its founding executives.

 

I have to believe there are a lot of OEMs hoping the wheels come off and stay off this deal, a sentiment I personally share. As we enter a time of what some are projecting to be at least a mild recession, the producers of all types of lifting equipment, and the rental industry in general, do not need any added instability with the current status quo. The timing for turning the industry's biggest player into a debt servicing cash cow is not now.

 

Here's hoping that that Cerberus' $100 million break-up fee gets deposited in the United Rentals' checking account and that they • and the market • can remain stable.