Monday, August 9, 2010

Risk Arbitrage - Dollar Thrifty (DTG)

With hindsight, a nice place to have looked in March of 2009, when nearly every manager was facing redemptions and thought the sky was falling, was the rental car industry. Specifically, Dollar Thrifty Automotive Group Inc (DTG) went from $0.70/share 17 months ago to over $48/share now. Let's look at what is happening to the name right now. It is a very interesting risk arbitrage situation.

Hertz Global Holdings Inc (HTZ) announced on April 26 that they signed a definitive agreement to acquire DTG for $41/share, an 11% premium to DTG's prior close. The terms consist of exchange ratio of 0.6366, $25.92/share in cash, and a $6.88/share special cash dividend to be paid by DTG immediately prior to the transaction's closing. DTG, with more than 1,550 corporate and franchise rental locations, was assigned a value of $1.6 billion. HTZ estimated that a closing would take place within six months. The market interpreted the combination favorably, as HTZ rose 14% the day of the announcement. On the conference to discuss the merger, an analyst from large hedge fund with holdings in both DTG and HTZ expressed how he thought the acquisition was a "steal".

Another party who was not pleased with the announcement was Avis Budget Group Inc (CAR). On May 3, CAR CEO, Ronald Nelson, sent a letter to DTG CEO, Scott Thompson, to explain CAR's thoughts on the news. We will include it in full, because it has several important elements.
"I was very surprised by your April 26 announcement that you had signed a definitive agreement to be acquired by Hertz for approximately $41 per share, of which only about $34 is being funded by Hertz itself. This is particularly true given that, on April 19, a mere week before the Hertz announcement, Scott and I agreed to meet for dinner on April 28 to discuss a transaction between our companies, which you cancelled after the Hertz announcement.

As you know, we at Avis Budget have on several occasions in the past expressed interest in entering into a transaction with Dollar Thrifty, yet at no stage over the last several months did you or your financial advisor engage us in any discussions about a transaction or offer to provide us with information so that we might submit a bid. I spoke with your financial advisor in early April to reiterate our interest in a potential transaction between our companies and to try to arrange a meeting, yet neither they nor you engaged us in any substantive discussions or communicated your interest in Dollar Thrifty being acquired in the near term. It is hard to understand how your failure to engage in discussions with an interested strategic buyer, who you know also would be able to achieve significant synergies as a result of a combination, can be consistent with the fiduciary duties that you and your board carry to seek the best possible deal for your shareholders.

This failure is all the more surprising given that, at the time you signed a definitive agreement to be acquired at virtually no premium, you clearly had knowledge that published earnings estimates for Dollar Thrifty were well below the updated guidance that you were going to provide as part of your first-quarter earnings announcement after the signing. Given that the Hertz offer is primarily cash, your shareholders in addition to being offered virtually no premium to a stock price that did not reflect favorable non-public information, would have little opportunity to participate in the substantial upside associated with your improving results, the combination-related synergies or the substantial upside we all see as the industry recovers from its recent lows.

Now that we and our advisors have had access to the terms of the merger agreement, we are astonished that you have compounded these shortcomings by agreeing to aggressive lock-up provisions, such as unlimited recurring matching rights plus an unusually high break-up fee (more than 5.25% of the true transaction value, as described by your own financial advisor), as a deterrent to competing bids that could only serve to increase the value being offered to your shareholders. Given the complete failure to conduct a pre-signing market-check of the virtually no-premium deal with Hertz, such preclusive defensive measures are clearly not supportable in this situation.

We would like to make a substantially higher offer to acquire Dollar Thrifty, especially in light of your recent performance and the potential synergies associated with an acquisition of Dollar Thrifty by Avis Budget. We are confident that the antitrust analysis and clearance timetable for an Avis/Dollar Thrifty transaction are comparable to those associated with a Hertz/Dollar Thrifty transaction. We request access to legal, financial and business due diligence information relating to Dollar Thrifty, including access to management, so that we can formulate and submit such an offer. In that regard, we would be prepared to sign an appropriate non-disclosure agreement. We also request that the egregious provisions of the merger agreement be eliminated so that a level playing field can be created.

We look forward to the opportunity to engage in productive discussions with the board of directors of Dollar Thrifty to allow its shareholders the opportunity they deserve to realize the full value of their investments in Dollar Thrifty."
DTG closed at $50.70/share on May 3, up 15% for the day.

On May 6, CAR signed a confidentiality agreement with DTG to review financial data to evaluate a possible offer for DTG. HTZ CEO, Mark Frissora, repeatedly remarked how the HTZ offer for DTG is superior "on both financial and regulatory" grounds. That may be true, but what is the offer? Here is a helpful (facetious) note to management teams out there: if you want investors to evaluate your offer, and potentially agree with your "superior" argument, then providing terms of the offer is essential.

In mid-June, both HTZ and CAR received Second Requests (requests for additional information to conduct the antitrust review) from the Federal Trade Commission. From an antitrust perspective, it all depends on how the FTC will define markets. Law professor Steven Davidoff contributes valuable thoughts on the topic. He said that if the rental care market is segmented into the two categories, premium and travel/leisure, then both HTZ and CAR classify themselves as premium car rental companies serving those on business and those who are less sensitive to price changes. DTG categorizes itself as travel/leisure. However, you can also classify the market by airport and off-airport. In this manner, both HTZ and CAR compete with DTG. HTZ stated on the merger call that they have 26% of the airport market share and DTG has 11%. HTZ also said that the FTC will probably carve down market share if it is over 40% or 50%.

On July 6, DTG scheduled a shareholder vote on the HTZ deal to be held on August 18. Doing so effectively set a time frame within which CAR must operate if it wanted to bid for DTG. Yes, it could present an offer after the vote, but this could delay the merger, a move that shareholders would not happily accept. To further nudge CAR to make a superior offer, DTG announced on July 7 updated guidance of 2010 EBITDA of $200 to $220 million, versus the previous range of $170 to $190 million. The company also provided an updated outlook for fleet cost per unit per month for 2011, which was lowered to a range of $300 to $310/month, compared to previous guidance of $325/month.

On July 19, DTG rescheduled the shareholder vote for the HTZ merger from August 18 to September 16. No reason for the postponement was immediately provided, but the following day it was disclosed that the SEC stated that additional time was required for DTG shareholders to be notified of their rights in the merger.

On July 28, nearly three months after it publicly disclosed interest in DTG, CAR announced the terms of its offer. The offer was valued at $46.50/share ($39.25/share in cash and 0.6543 of CAR stock). CAR has fully committed financing for the cash portion. CAR said it was prepared to enter into a merger agreement with substantially the same terms as the HTZ agreement, but which includes removing the matching rights, eliminating the break-up fees, and increasing the commitment to secure antitrust approvals.

DTG responded to CAR's proposal on August 3 and gave some observations on the offer. DTG said that CAR's offer is more favorable, from a financial point of view, to its stockholders than the HTZ merger, and that it has fully committed financing to support the bid. Where DTG said it does not have sufficient information is in determining if the CAR transaction is reasonably expected to be consummated on a timely basis. The letter to CAR indicated:
"As you are aware, our respective advisors have had numerous discussions with respect to the antitrust risks attendant to a merger of our companies. Your legal advisors have stated clearly their position, based on their econometric and other analyses, that the divestitures to which you have committed in your proposal are sufficient to remediate any competitive issues. But citing our inability to enter into a joint defense agreement with you as well as our contractual obligations to cooperate with Hertz, your advisors have been unwilling to disclose details of their data and analyses beyond their general approach to the issues.

More problematic is Avis Budget's unwillingness to provide a reverse termination fee. As we have stated on several occasions, our Board accords substantial weight to the extent to which Avis Budget is willing to share the risk of the ultimate regulatory outcome. This is especially true where Avis Budget is unable to provide compelling objective evidence in favor of its antitrust position. Indeed, Avis Budget's unwillingness to offer a meaningful reverse termination fee can only represent to us, to the market and to any objective observer a lack of confidence by Avis Budget in its position. As you know, transaction certainty has consistently been a key criterion for Dollar Thrifty in evaluating possible transactions. We feel strongly that in order to merit favorable consideration by our Board, the relative magnitude of the reverse termination fee should be at least consistent with that of the Hertz transaction. Obviously, a fee of greater magnitude would demonstrate even greater confidence in your ability to procure antitrust approvals, as well as your willingness to take steps beyond your stated divestiture commitment to do so.

Your advisors have suggested that there is a natural trade-off between the transaction consideration and deal certainty. Unfortunately, the "Superior Proposal" determination simply does not work in that way. Each of the three prongs must be met, and a higher price cannot compensate for a deficiency in deal certainty. But even if we could blend the factors as you suggest, Avis Budget's unwillingness to provide a reverse termination fee, coupled with your disinclination to provide analytical data supporting your antitrust position, leaves us incapable of making such an assessment."
DTG's agreement with HTZ includes a reverse termination fee of $44.6 million if antitrust approval is not secured. CAR is not offering this fee, and DTG has expressed its disapproval. In hopes of addressing DTG's concern, CAR is willing to dispose of up to $250 million of revenue in the US and up to $325 million worldwide.

When DTG and CAR iron out their differences (which we expect to happen), then DTG will be obligated to accept CAR's superior offer. That will leave the next move to HTZ. This is one of those deals where it’s great if you had already put on the risk arb spread before CAR came around, but doing so now is dangerous. HTZ’s offer is about 19% below where DTG is currently trading and CAR’s bid carries a negative spread of roughly 5%. We would caution investors that the risk-reward of entering a position at these levels is unfavorable.

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About the Authors

Hunter is the founder of the Distressed Debt Investing Blog and the Distressed Debt Investors Club. He has worked on the buy side for the past 7 years in high yield and distressed debt investing.

Edward has been a professional investor for four years, focusing mainly on the event-driven space. His investment philosophy is value-based, and he spends the majority of his time identifying near-term catalyst based opportunities.

Email

hunter [at] distressed-debt-investing [dot] com