UV2534
April 20, 2009
BIDDING FOR HERTZ: LEVERAGED BUYOUT
Teaching Note
Synopsis and Objectives
In late summer 2005, Greg Ledford, managing director and head of automotive and
transportation buyouts at the Carlyle Group, a prominent private equity firm, must finalize the
terms of a bid to purchase the Hertz Corporation. Hertz, a wholly owned subsidiary of Ford
Motor Company, had been put up for sale in April 2005 when Ford announced plans to explore
“strategic alternatives” for Hertz. At the time, Ford was seeking to raise capital to shore up its
flagging automobile business. In June 2005, Ford filed for a possible initial public offering (IPO)
for Hertz, setting up a “dual-track process” that would result in an IPO should other sale
prospects fail. When no strategic buyer surfaced, the Carlyle Group joined forces with Clayton,
Dubilier & Rice (CD&R), and Merrill Lynch Global Private Equity (collectively, “Bidding
Group”) to bid on Hertz. At the same time, it faced competition from another buyout consortium
that included Texas Pacific Group, Blackstone, Thomas H. Lee Partners LP, and Bain Capital
LLC.
Under “The Decision” (p. 10 of case), the case outlines the three critical tests that the
Bidding Group believes are necessary to succeed in the bid. First, the bid must to provide the
sponsors adequate returns. Second, the bid must result in a higher value than Ford could achieve
from an IPO. Third, the bid has to best that of the rival bidding group. In essence, the bid must be
acceptable to both the sponsors and the seller, and win out over the rival consortium. Because the
valuation of Hertz requires that students have an understanding of how the fleet is valued relative
to the operating company, this teaching plan primarily addresses the first test the Bidding Group
applies for the success of its bid. For instructors planning to spend two days on the case or use it
in a case competition, the teaching outline for Day Two briefly touches on how the students
might qualitatively or quantitatively address the second and third tests.
The case is appropriate for use in classes on advanced corporate finance, private equity,
or deal valuation. It has been used successfully in an advanced undergraduate corporate finance
class and in a second-year corporate finance MBA elective. Because of the rich range of issues
, -2- UV2534
that can be considered, the case also works well as a capstone case or for use in a case
competition. To successfully handle the case, students should have had exposure to company
valuation prior to its being assigned, and they should be familiar with the concepts of equity
residual cash flows and internal rate of return.
For instructors wishing to provide students with a more comprehensive view of the role
and practices of private equity, we recommend combining this case with its companion case,
“Investing in Sponsor-Backed IPOs: The Case of Hertz” (UVA-F-1561). The Hertz IPO case
examines the sponsors’ announcement of the Hertz IPO in July 2006, just seven months after the
LBO was completed in December 2005. The speed with which the Hertz IPO was conducted and
the large special dividends paid to the sponsors are two controversial issues that were raised by
recent buyout transactions. The two cases cover a wide range of issues that arise over the course
of entry and exit of private equity investments.
The LBO case can be used for the following purposes:
• To familiarize students with the process of leveraged buyouts
• To discuss how private equity investors affect the options of firms, such as Ford, with
respect to the sale of assets (i.e., dual-track process)
• To help students understand the sources of value creation in leveraged buyouts
• To help students develop skills in valuing potential LBO targets
• To examine the relationship among the value paid for a target, the financing requirements
and the returns to buyout investors
• To assess how deal valuation and bidding strategy interact
• As a capstone case or for a case competition
Study Questions for Advance Preparation
The following questions are appropriate for a 90-minute class period. In this instance, it is
assumed that the valuation of Hertz will be conducted using market-based multiples.
Day One
1. How does the dual-track process used by Ford to initiate “consideration of strategic
alternatives” affect the bidding process for Hertz?
2. In what ways does Hertz conform or not conform to the definition of an “ideal LBO
target”? Do you believe Hertz is an appropriate buyout target?
3. Strategically, what value-creating opportunities can the sponsors exploit in this
transaction?
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4. How realistic are the key assumptions that underlie the Bidding Group’s projections in
case Exhibits 8, 9, and 10? Which assumptions are most likely to have the largest impact
on returns?
5. Based on the base-case estimates in case Exhibits 8, 9, and 10 and your estimate(s) of
terminal value if the sponsors put up $2.3 billion in equity, what return can they expect to
earn?
6. If Carlyle desires a 20% target return on its equity investment, does your analysis suggest
that $2.3 billion is too much to pay, or can it afford to pay more—in either case, by how
much?
If the case is used as a capstone exercise or in a case competition, students might be expected to
address the following questions. These questions can also be addressed if instructors wish to
spend two class periods on the case.
Day Two
1. What is the market-required rate of return for this investment, and why might this differ
from the sponsors’ target return?
2. What is the value of Hertz using the equity residual method of valuation?
3. Assess the amount Ford is likely to receive if it pursues its IPO alternative versus being
bought by a private equity group.
4. What factors would be considered in assessing whether the consortium’s bid is likely to
beat that of a rival group?
Materials Available
UVA-S-F-1560.xls is an Excel file of the case exhibits available for student use. A good
reference on the equity residual method of valuation that can be used in conjunction with the
case or assigned in advance is “Using the Equity Residual Approach to Valuation: An Example”
(UVA-F-1267) by Robert S. Harris.
Teaching Plan
1. How does the dual-track process used by Ford to initiate “consideration of strategic
alternatives” affect the bidding process for Hertz?
On April 20, 2005, as part of its revitalization plan, Ford announced it would evaluate a
number of strategic alternatives for Hertz, among them rationalizing headcount and plant
facilities and divesting of non-core assets. This announcement followed a period of steadily
deteriorating performance, especially in its North American operations, and as the case outlines,
April 20, 2009
BIDDING FOR HERTZ: LEVERAGED BUYOUT
Teaching Note
Synopsis and Objectives
In late summer 2005, Greg Ledford, managing director and head of automotive and
transportation buyouts at the Carlyle Group, a prominent private equity firm, must finalize the
terms of a bid to purchase the Hertz Corporation. Hertz, a wholly owned subsidiary of Ford
Motor Company, had been put up for sale in April 2005 when Ford announced plans to explore
“strategic alternatives” for Hertz. At the time, Ford was seeking to raise capital to shore up its
flagging automobile business. In June 2005, Ford filed for a possible initial public offering (IPO)
for Hertz, setting up a “dual-track process” that would result in an IPO should other sale
prospects fail. When no strategic buyer surfaced, the Carlyle Group joined forces with Clayton,
Dubilier & Rice (CD&R), and Merrill Lynch Global Private Equity (collectively, “Bidding
Group”) to bid on Hertz. At the same time, it faced competition from another buyout consortium
that included Texas Pacific Group, Blackstone, Thomas H. Lee Partners LP, and Bain Capital
LLC.
Under “The Decision” (p. 10 of case), the case outlines the three critical tests that the
Bidding Group believes are necessary to succeed in the bid. First, the bid must to provide the
sponsors adequate returns. Second, the bid must result in a higher value than Ford could achieve
from an IPO. Third, the bid has to best that of the rival bidding group. In essence, the bid must be
acceptable to both the sponsors and the seller, and win out over the rival consortium. Because the
valuation of Hertz requires that students have an understanding of how the fleet is valued relative
to the operating company, this teaching plan primarily addresses the first test the Bidding Group
applies for the success of its bid. For instructors planning to spend two days on the case or use it
in a case competition, the teaching outline for Day Two briefly touches on how the students
might qualitatively or quantitatively address the second and third tests.
The case is appropriate for use in classes on advanced corporate finance, private equity,
or deal valuation. It has been used successfully in an advanced undergraduate corporate finance
class and in a second-year corporate finance MBA elective. Because of the rich range of issues
, -2- UV2534
that can be considered, the case also works well as a capstone case or for use in a case
competition. To successfully handle the case, students should have had exposure to company
valuation prior to its being assigned, and they should be familiar with the concepts of equity
residual cash flows and internal rate of return.
For instructors wishing to provide students with a more comprehensive view of the role
and practices of private equity, we recommend combining this case with its companion case,
“Investing in Sponsor-Backed IPOs: The Case of Hertz” (UVA-F-1561). The Hertz IPO case
examines the sponsors’ announcement of the Hertz IPO in July 2006, just seven months after the
LBO was completed in December 2005. The speed with which the Hertz IPO was conducted and
the large special dividends paid to the sponsors are two controversial issues that were raised by
recent buyout transactions. The two cases cover a wide range of issues that arise over the course
of entry and exit of private equity investments.
The LBO case can be used for the following purposes:
• To familiarize students with the process of leveraged buyouts
• To discuss how private equity investors affect the options of firms, such as Ford, with
respect to the sale of assets (i.e., dual-track process)
• To help students understand the sources of value creation in leveraged buyouts
• To help students develop skills in valuing potential LBO targets
• To examine the relationship among the value paid for a target, the financing requirements
and the returns to buyout investors
• To assess how deal valuation and bidding strategy interact
• As a capstone case or for a case competition
Study Questions for Advance Preparation
The following questions are appropriate for a 90-minute class period. In this instance, it is
assumed that the valuation of Hertz will be conducted using market-based multiples.
Day One
1. How does the dual-track process used by Ford to initiate “consideration of strategic
alternatives” affect the bidding process for Hertz?
2. In what ways does Hertz conform or not conform to the definition of an “ideal LBO
target”? Do you believe Hertz is an appropriate buyout target?
3. Strategically, what value-creating opportunities can the sponsors exploit in this
transaction?
, -3- UV2534
4. How realistic are the key assumptions that underlie the Bidding Group’s projections in
case Exhibits 8, 9, and 10? Which assumptions are most likely to have the largest impact
on returns?
5. Based on the base-case estimates in case Exhibits 8, 9, and 10 and your estimate(s) of
terminal value if the sponsors put up $2.3 billion in equity, what return can they expect to
earn?
6. If Carlyle desires a 20% target return on its equity investment, does your analysis suggest
that $2.3 billion is too much to pay, or can it afford to pay more—in either case, by how
much?
If the case is used as a capstone exercise or in a case competition, students might be expected to
address the following questions. These questions can also be addressed if instructors wish to
spend two class periods on the case.
Day Two
1. What is the market-required rate of return for this investment, and why might this differ
from the sponsors’ target return?
2. What is the value of Hertz using the equity residual method of valuation?
3. Assess the amount Ford is likely to receive if it pursues its IPO alternative versus being
bought by a private equity group.
4. What factors would be considered in assessing whether the consortium’s bid is likely to
beat that of a rival group?
Materials Available
UVA-S-F-1560.xls is an Excel file of the case exhibits available for student use. A good
reference on the equity residual method of valuation that can be used in conjunction with the
case or assigned in advance is “Using the Equity Residual Approach to Valuation: An Example”
(UVA-F-1267) by Robert S. Harris.
Teaching Plan
1. How does the dual-track process used by Ford to initiate “consideration of strategic
alternatives” affect the bidding process for Hertz?
On April 20, 2005, as part of its revitalization plan, Ford announced it would evaluate a
number of strategic alternatives for Hertz, among them rationalizing headcount and plant
facilities and divesting of non-core assets. This announcement followed a period of steadily
deteriorating performance, especially in its North American operations, and as the case outlines,
