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Icahn Doubles Investment in Hertz as Stock Plummets

After Hertz Global Holdings missed its earnings target by a long shot, investors dumped the rental-car company’s stock with one notable exception: Carl Icahn.

The 80-year-old billionaire, already Hertz’s biggest shareholder, more than doubled his stake in a show of support for the rental-car chain and by extension for the boss he helped bring to power two years ago. John Tague, a former executive of United Airlines, arrived as Hertz’s chief executive officer in late 2014, a few months after Icahn successfully fought to obtain three director seats.

Hertz’s split-adjusted shares have plummeted 70 per cent since then, including Tuesday’s 23-per-cent drop that erased $739 million (U.S.) in equity value. Tague is being vexed by some of the same problems as his predecessor; such as rising costs, changes in what travellers want to drive and lower used-car values.

He blamed rising depreciation costs and declining revenue for the third-quarter miss and told investors that 2016 earnings will be no more than a fifth of what it projected in August.

“I underestimated the depth and the breadths and the complexity of the transformation we are now undertaking at this company,” Tague told analysts on a conference call. “We are behind schedule and we are challenged earlier than we thought.”

Hertz shares fell $8.04 to $27.70 on Tuesday and in early trading Wednesday had slipped an additional 2.5 per cent to $27.01. After the market closed yesterday, Icahn said in a filing that he boosted his stake to 33.77 per cent from about 15.6 per cent. He’s also one of the biggest holders of Herc Holdings Inc., the equipment rental company that separated in June.

If Icahn’s latest investment is a show of faith, it isn’t universally shared.

“The problem is management,” said Maryann Keller, an independent consultant in Stamford, Conn., who sat on Dollar Thrifty Automotive Group Inc.’s board when it sold to Hertz in 2013. “The company was dysfunctional under previous management. It chose a CEO who has no experience in the rental industry. They were bound to stumble.”

Stumbling might be an understatement. Estero, Fla.-based Hertz reduced its full-year earnings outlook to a range of 51 cents to 88 cents a share, after saying in August that it expected $2.75 to $3.50.

“This management is in the midst of a transformation of the company,” Hertz spokesman Bill Masterson said. “The issues around vehicle values and pricing are industry issues” and are the same as those encountered two years ago, he said.

Bondholders are just as dismayed, with some questioning Hertz’s decision to go forward with bond sales in September without adjusting its forecasts. Investors who were reassured by earlier estimates clamoured for the notes, allowing Hertz to boost the U.S. deal to $800 million from a planned $500 million and get lower yields on both that sale and one for euro bonds.

After Hertz delivered the bad news, the dollar notes dropped 6.5 cents to 90 cents, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Investors “cannot help but ask why such a ‘plagues of Egypt’ backdrop would not have merited a guidance adjustment at the time of the bond deals,” Glenn Reynolds and Nathan Wenger of CreditSights wrote in a note on Tuesday. “At best, low style points for deal timing and disclosure.”

Analysts on the conference call hammered management on Hertz’s ratio of debt to Ebitda, which is close to levels that would violate a loan covenant, the first step to triggering a default. Hertz’s debt-to-equity ratio in the third-quarter was 4.5 times under the covenant’s definition, while the maximum permitted was 5.25. Hertz has little room for error going forward. It must stay below 4.75 times in the fourth quarter and first quarter of 2017, according to loan documents. Executives said they expect to comply with the restrictions.

“There’s a lot that happened here in a short amount of time when they were out in September affirming everything,” said Chris Langs, a taxable bond portfolio manager at GW&K Investment Management, which oversees $33 billion. “Management certainly gives us pause.”

Many of today’s issues sound familiar to Hertz shareholders. Before he stepped down, Tague predecessor Mark Frissora also cited higher-than-expected operating expenses in its U.S. rental business, as well as lower resale values and costs from fleet maintenance, damage and depreciation. Frissora is now CEO of casino operator Caesars Entertainment Corp.

In the most recent earnings release, Tague lowered guidance by $300 million in earnings before interest, taxes, depreciation and amortization. Part of that is failure to hit cost reduction targets on time, while $100 million is due to depreciation of cars in the fleet.

The adjustment came because the company looked at new data that showed resale values falling more than expected, spokesman Masterson said. Also, Hertz wants to rotate compact and mid-sized cars out of its fleet and replace them with larger vehicles that customers prefer. Since they plan to replace them faster, the company expects greater depreciation costs, he said.

Hertz also struggled with rental pricing. Two years ago, Frissora had been tracking revenue per day, which fell 2 per cent in his last year in the job. When Tague took over, he wanted to impose price increases the way airlines have jacked up fares in the wake of consolidation.

In May of last year, Tague initiated a plan to raise U.S. airport retail car rentals $5 per day and $20 per week. He also wanted to raise off-airport prices by $3 per day and $10 per week. While that worked in some markets in others Hertz either couldn’t get price increases to stick with consumers or hasn’t tried to raise rates. Revenue per day fell by 2 per cent in the third quarter to $45.41.

Regardless of explanations, investors don’t know if this is one bad quarter or a sign of a troubled business, Barclays analyst Brian Johnson said in an interview.

“The market is having a hard time digesting how much of the cut in guidance is a one-time occurrence and how much is a reduction in the company’s earnings power,” Johnson said.

Meanwhile, Icahn is barrelling ahead. He bought another 15.1 million shares.

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