Private equity wakes up: Jeff Eisenberg on investment in rental

In 2013 the equipment rental industry saw an increase in investments by private equity firms in rental companies. What does this mean for the industry, and how will the future be different from the past waves of acquisitions? Jeff Eisenberg reports.

In the boom times of the late 1990s and the up to 2008, the equipment rental industry saw an unprecedented amount of investment from private equity firms. This included investments in start-ups and very early stage companies as well as expansion finance, and even consolidations.

The logic of a consolidation was that in a fragmented industry with small players, achieving larger size, ‘critical mass’, would make companies more efficient. Larger market share would help ease pressure on rental rates; a larger product selection meant overheads would be spread; and larger companies had access to cheaper finance – and lower equipment prices from manufacturers.

Both the stock markets and private equity saw the opportunity, and often private equity investment was a stepping stone to stock markets, which paid very high earnings multiples.

In the crazy days of the late 1990s, when the US rental industry in particular was consolidating for the first time, a standard formula started to emerge for acquiring rental companies.

Before continuing, a quick digression on the definition of private equity is probably useful, because several different terms - ‘venture capital’, ‘private equity’ or ‘risk capital’ – are often used interchangeably for institutions that invest capital into companies.

It would be more precise to refer to the entire group of investors as private equity. Venture capital investors are a sub group of private equity, more often making investments in very young companies, sometimes before they make revenue, where the expected risks (and returns) are relatively high.

Private equity funds can indeed specialise in companies that have revenues of up to €10 million, or more than €100 million; some focus on ‘turnarounds’, often companies with some kind of financial challenge, of which there have been many in the post 2008 downturn.

Enterprise Valuation

In a previous IRN, back in the heady days of 2006, I wrote that rental companies were valued on the Enterprise Valuation model. This uses cashflow (EBITDA), multiplied by a factor, minus the company’s debt, to derive a valuation. At that time, many companies were bought at a multiplier of 5 or 6 times EBITDA (minus debt). This was an average of what was happening, rather than a how-to: sometimes 6 times EBITDA was larger than annual company revenue.

In the mid 2000s, multiple bidders were often fighting for an acquisition, either with private equity backing or, indeed, the acquirers were traded on stock exchanges. The logic was that even if the company acquisition prices seemed high, as long as the company continued to grow profitably, sooner or later it would grow out of the expensive price.

Banks were delighted to provide all or part of the finance for the acquisitions, even at high prices.

Part of the 6 times EBITDA multiple was the 3 or 4 times EBITDA cashflow bank loans that were often available. Again, that debt was not frightening: sooner or later the profitable growth would make everything OK, and it seemed like growth in rental would go on forever. We would have today’s debt with tomorrow’s revenue, the debt would shrink and the company would outgrow it.

Now, everything has changed. The banks no longer want to finance cash flow without extra support from assets, especially because growth can no longer be taken for granted. Or, perhaps the bank will do half as much cashflow loan as before, but not easily, and the companies for sale no longer have multiple bidders fighting for them.

The sellers still want 6 times EBITDA, but for companies that aren’t growing like 2006, and there is no bank rushing in with half the money. So very few deals are getting done…and at what pricing?

Secrecy and disclosure

When publicly traded companies such as Cramo, Ramirent and Lavendon were acquiring companies in Europe, and United Rentals and others in the US, they generally disclosed the prices and profitability of the target companies to their shareholders.

Some information was visible and either the EBITDA multiple was disclosed or could be estimated. Again, this has fundamentally changed. The buyers are quite often private equity funds which disclose very little information, except to their own shareholders, who are often also secretive. Even the stock market companies are disclosing less information than ever.

One UK private equity fund executive with multiple investments in equipment rental explained, on the condition of anonymity, that we should expect more secrecy in the future. He explained that disclosing high prices paid for the last acquisition works against you in the next negotiation.

Interestingly, this executive complained that the banks are as difficult as ever to work with, despite the supposed economic recovery. Indeed his fund had acquired companies without any bank finance; during the boom years before 2008 it would have been unusual or even unthinkable for a private equity company to undertake an acquisition without using leverage from a bank.

Another private equity fund director based in central Europe, also anonymously, said his fund had just made its first investment in the rental sector. Part of the sector’s appeal in central Europe is low penetration of rental, which points toward room for growth.

They like the cashflow of the industry, including the fact that rental fleet investment can be stopped, or even reversed, to produce cash relatively quickly in the event of a downturn, compared to other industries.

The same fund director said there are secondary buyouts and stock market quoted companies that help provide exit possibilities. All discussions with private equity investors sooner or later turn to the ease and availability of an exit; selling the company and realising the investment.

In the next few years the sector will certainly see more investment from private equity, but selectively. The past 12 months has already seen a number of high-profile deals (see table). These investments will be all over the world, which will help the industry develop and attract investment from banks and suppliers, as well as the private equity funds themselves.

Acquisition prices cannot be taken for granted, high multiples will be reserved for the best companies in the highest growth markets – and with those that have the best exit potential.

BOX STORY

Rental deals

The history of UK-based private equity company 3i is required reading for students of private equity in rental in Europe. Its origins go back to the UK government recovery plan after the 2nd World War, although it has since raised money on the London Stock Exchange and from other investors around the world. It was for a while the largest private equity fund in Europe.

3i is a shareholder in Loxam, and has been a shareholder in HSS, the Meek Group, Universal Aerial Platforms, Independent Access, Instant Access Centres, all in the UK, plus the Lavendon Group before it went to the stock market in 1996.

The old 3i model was to invest equity and debt into a company, even a young one, and wait until it was sold, even for a decade or more. Now, 3i is doing less young company ‘venture capital’ and more transactions where it buys and sells quickly. The most visible of these transactions was probably when Go Airlines, which 3i acquired from British Airways in June 2001 for £100 million and then sold to Easyjet in May 2002 for £374 million.

3i has also been involved with HSS, one of the best-known UK rental companies. In 2004 it acquired HSS from the Davis Service Group, then sold it in June 2007 to other private equity firms, Och-Ziff and Perry Capital, who in turn sold it to Exponent Private Equity in October 2012.

Platform specialist AFI in the UK (and now the Middle East as well) is also on its third private equity investor. NVM invested in May 2004, Barclays Private Equity in 2007, and Rutland Capital in June 2013. Each time the new investor took the old investor out, and the new investment was accompanied by an acquisition. AFI is now the second largest platform rental company in the UK.

Brazil saw a big investment in rental, with Southern Cross Group investing “over US$100 million” in Solaris. This followed Mill’s stock market flotation in 2010, and reinforced the ‘investability’ of the Brazilian rental market.

Ramirent sold its business Hungary to Danube SCA Sicar, a Hungarian private equity fund. Considering its size compared to Ramirent’s total business, it is not a surprise to see Ramirent concentrating on Northern Europe. But it is also good to see another private equity investment in the region, perhaps the first since Industrial Access in Romania received an investment from the Balkan Accession Fund in 2007.

The author: Jeff Eisenberg has spent 18 years in the equipment and rental industry. He started and led Genie Financial Services in Europe, providing finance for large and small rental companies all over the world. Since 2000 he has held senior positions in a number of European rental companies, as well as working with startups and acquisitions. He now provides consulting services to financial institutions, equipment manufacturers and rental companies. Tel: +44 7900 916933; E-mail: [email protected]