The Age of Private Equity

Feb. 1, 2007
Consultant and former rental company CEO Dan Kaplan talks about the impact of private equity, the sophistication of software and and why the advent of

Consultant and former rental company CEO Dan Kaplan talks about the impact of private equity, the sophistication of software and “telemetrics,” and why the advent of the $10 billion rental company will come sooner than you think.

RER: What are the implications of private equity coming into the rental industry?

Kaplan: Private equity has only one goal, and that is to make money for its investors. Its primary goal is not necessarily to grow market share and grow the business unless that happens to coincide with the goal of increasing return on capital and returns to investors. Today you have a situation where private equity owns two of the larger equipment rental companies in the world — Hertz and RSC. In my opinion, both of these rental companies enjoyed in the year 2006 the best year in their entire history in terms of both revenue and profit. Both firms are reducing their capex spending budgets for 2007. The result will be more positive cash flow versus taking a business that's doing incredibly well and growing it further.

So that's the basic difference between a private-equity-owned company versus a company owned by, let's say, strategic sources interested in growing the business for future market share.

It's a different environment than when you came into the industry.

When I came into the business in 1982, my goal was to get equipment out on rent. If the equipment operated and didn't break down, you had a successful rental company. People were running older fleets and basically trying to operate effectively. It was operations oriented. Hertz, for example, was owned by Hertz Corp., which was interested in growing the business for strategic reasons.

Today's CEO probably spends more time addressing investors and investor conference calls, significant shareholders, SEC issues and quarterly earnings releases than anybody ever has in the past in the industry.

Today's CEO has to be articulate and much more financially astute. He has to be both financially and operationally astute. In the past you primarily had to be operationally astute. Now you have to be able to make presentations, be articulate, and be responsible and accountable for all information dispensed. Most of the major players are either public or they are borrowing money and therefore are public in another way, where they have to disclose the most intimate detail of their businesses. And that requires not only having your competition understand what you are doing, but making sure that whatever you are saying is factually accurate. You face personal liability if the information is anything but that.

I would doubt most of the instrumental people in the history of the industry, even though they were entrepreneurs and people of vision, would be the people they would need to be to lead their companies today.

Does the entry of private-equity money put more pressure on smaller independents to improve their systems? How best to do this lacking the capital of the larger, better-funded companies?

The larger rental companies have done an incredible job in the past five years of improving operations. They are doing Six Sigmas on every aspect of the business. EBITDA returns have increased significantly, because they have gone to every area possible that can be measured, and they have taken steps to improve them and become more efficient. You have to look no further than the operating results that these companies are reporting quarterly to see that occurring. Time utilizations are high, the fleets are utilized greatly, rental rates are improving, expenses are being reduced, downtime is being reduced, fleet ages are lower.

There is professional management at the highest level in the larger rental companies. A lot of the independents are still operating as I did in the early 80s. Their basic goal is to get equipment out on rent and satisfy the customer. They are using their software for utilization measurement, but not to the extent the larger companies are managing that business and driving the profitability.

Will larger companies get much bigger in the coming years?

There are larger and larger rental entities that I predict will be significantly larger in years to come. For instance, look at Sunbelt buying NationsRent. I predict there will be more consolidation in the top 10, the consolidators will further consolidate, and you're going to see more efficiencies, more pressure on vendors for pricing as they get larger, and a greater, larger rental industry with bigger players.

United Rentals now has revenue at $4 billion. I predict we'll see a number of companies in years to come with revenues from $5 billion to $10 billion, and it's possible that the largest rental company could in fact get to $8 billion to $10 billion in 2010, and there will probably be more than one of these large players.

We'll see more intense management by professionals. For instance, the CFO of United Rentals is a professional who came from outside the rental industry with significant financial wherewithal. So the professionals are being brought in to help accelerate the growth and professionalism of our industry.

Can independents still compete?

Independents compete at the local level with everybody, but basically the customer base of the larger rental companies is different from the customer base of the independents. We're talking about different customers. The independents are serving a 15- to 20-mile radius in the city in which they operate, they are not calling on national accounts, their fleet is not of the size that can take care of these larger customers. The typical fleet size of an independent is less than $1 million, where the fleet size of these larger companies are $2 billion to $4 billion, so it's a totally different customer base. There is still a need for the independent at the local level. They do provide a service, they will be there; they are just reaching a different customer.

There may be exceptions, but for the most part the independents are not calling on the oil refineries, large chemical plants or automobile manufacturers. They are calling on do-it-yourselfers, homeowners, and small businesses in the geographies in which they operate.

Will use of telematics (or telemetrics) continue to grow and become standard practice in the industry?

Telemetrics is the next big breakthrough in, basically, computerization of the rental industry. Once upon a time there was no software. Then software came in and became incredibly sophisticated, and it has brought the big guys especially to a very enhanced level of operation and knowledge. Telemetrics is the next step on top of that. I'm going to call it enhanced software. I'm talking about very sophisticated software. For example, Rentalman is a very sophisticated system running off an AS400 that only bigger companies can use.

Bigger, more sophisticated rental companies are not only using that software, they might be employing six to 10 people taking that software and bringing it further and managing it, using that data. So it's a department within the rental company taking that sophisticated software and making it work. I doubt independents can afford the kind of people investment to take their software and then invest on top of it. They utilize the software to get by day by day but the bigger companies are using that software to tear into the business and analyze it.

I would say that every one of the major rental companies is at least testing telemetrics and some are utilizing it. And it's going to do two things: it's going to make the rental companies more profitable, and at the same time the suppliers of that equipment will bring the cost down. The result is increased utilization, decreased downtime, and more diagnostic data that will reduce major repairs, lower thefts, improve delivery time, and overall improve operating efficiency.

It's not standard now, but it's being more than tested, it's being implemented at various stages, and I would say by 2010, not too far away, it will probably be standard. There are two costs involved here. The first is putting the unit into the piece of equipment and the second cost is the monthly carrying charge for the unit. Companies such as Qualcomm are working with manufacturers to pre-install the basic chip or whatever goes in there, and to the extent that they can do that they will be lowering the cost. In other words, the customer may buy the equipment, and if telemetrics systems are standard, the customer can decide if they want to activate it or not, but the cost will go down dramatically if it's preinstalled versus coming to the rental company afterwards and going to each unit one at a time and putting it in.

I foresee that increasingly those telemetric units will be included standard in the equipment that the manufacturer builds, so the people who manufacture them will bring down the cost substantially to the equipment manufacturer that will install it as a benefit for the customer. And then as more people utilize it, the monthly carrying charges will be further diminished. That seems inevitable and it's occurring at a rapid rate.

What kind of year should we expect in rentals in 2007?

I expect 2007 to be a great year but not as great as 2006. I expect that revenues will be up, the fleet investment will be somewhat smaller than in 2006, rental rates will increase in low single-digit numbers, and inflation will take some effect. But I don't expect it to be like 2006, which was the all-time barnburner where the industry grew incredibly, the fleets grew, the rental rates increased a lot, and profitability was incredibly high. There's nothing wrong with 2007, it's just hard to measure against 2006.

Independents will have a good year in 2007, but they will probably be hit harder by the slowdown in housing than the larger rental companies. Major rental companies derive 5 or 6 percent of their business from residential construction. I would guess that the independents probably get 10 to 20 percent or greater from residential. Non-residential construction looks like it will have a good year in 2007 and that's where the major rental companies are deriving their business. The smaller independents are not deriving the majority of their business from non-residential construction.

It appears as though most rental companies plan to acquire less equipment in 2007. What can you say about that? How will that affect manufacturers?

Larger rental companies buy fleet for two purposes. First, they buy fleet for maintenance capex, which means to bring the fleet age down. And they buy fleet for growth capex, to grow the fleet. My sense is they will buy fleet for growth capex and cut down on maintenance capex and thereby grow the fleet age. So fleet age will grow and fleet sizes will grow but the overall spending will decrease compared to 2006.

How will that affect manufacturers?

Manufacturers have a double-edged problem. They have put in capacity during the past year and a half, so they have more capacity to sell, but the buyer is pulling back a little bit. So the manufacturer has a double problem — increased capacity and I'm going to say minimally reduced capex spending, so the capex spending could be down 5 to 10 percent for the larger rental companies. That, coupled with increased capacity, makes the problem greater than 5 or 10 percent for the manufacturers. So manufacturers will probably be happy to have low single-digit price increases for their equipment, where they have enjoyed 10- to 12-percent price increases the past couple of years.

By the same token, the manufacturers have improved their processes the past couple of years also, so not only have they reduced some of their cost, but they have the ability to produce more equipment in their factory. So they have the ability, not only because they put capacity in but because they improved the processes, to produce more. So I would say manufacturers have a greater concern in '07 than the equipment rental industry.

Also the customer is changing increasingly from the operator to the rental company. So if a manufacturer sells 100 units and more of those units are sold to rental companies than the independent, and the larger rental company is a disciplined buyer, the manufacturer is effectively selling it to a rental company at a lower price than to a dealer who is selling at dealer net plus.

Do you expect national U.S. rental companies to go more international in the next few years?

I predicted in the past it would have occurred already. Hertz is in France and Spain, and you have Ashtead in the U.S. I don't think we'll see it in 2007, but I think we could see it in 2008. It really depends on who is the owner of the rental company and what their goals are. It would be impossible for me to predict what private equity is going to do with two of the larger companies going forward, but I absolutely see U.S. companies operating in Europe as early as 2008, not earlier than that.

It's possible that more Europeans could be here, and vice versa.

How do you see rentals advancing around the world: Middle East, India, China, Japan, other Asian countries, Latin America, Europe, Russia?

I don't care what country or continent you are talking about, there is a movement from ownership to rental. It's moving at various rates all over the world, and there is no place that it's not moving. There is significant movement in Latin America, off a small base, but moving. I would say Europe is strengthening, they follow the U.S.; as the U.S. is slowing down a little bit, Europe is becoming stronger. In India and China, the rental industry is small today in those markets but the change is going to be so dramatically rapid. So they are going to have the greatest growth potential, but off a very small base. It's just the way the world is moving, it's just moving toward rental. It's a more efficient use of capital for those who need the equipment.

Is penetration still growing in the U.S.?

My guess is that between 2005 and 2006 penetration increased 2 more percent, and that penetration is now at 40 percent. I'm predicting it goes to 50 percent by 2010. It's moving. The bigger rental companies, and even companies like Home Depot, are moving it. So as these rental companies have bigger and more varied fleets, and become more professional and give a higher level of service, offer total geographic coverage, and have the sales teams to go out there and convert the people, they are moving it.

How must rental companies train their people — management, service, sales, branch managers — to compete in today's rental economy?

Training is a massive effort. In addition to training mechanics, companies need to train drivers in skills such as how to communicate with customers because a driver can have a big effect on getting business. They need to train coordinators how to answer the phone, train sales people how to make sales calls, train counter people and sales people how to overcome the price negotiations, train people how to utilize software to improve rental operations, train branch managers how to be financially astute. It's a training task at every level and position within the rental company that's forever ongoing.

When rental companies hire, they should look to hire trainable people. Going back to my old theme, I believe you should hire people for the next level position, don't hire for yesterday's position. Hire people that are trainable, that are capable of getting your company to a higher level.

Do you expect to see any significant breakthroughs in equipment manufacturing?

I'm not expecting any particular breakthroughs. I expect to see continual consolidation of the manufacturing process and then the manufacturers, as I said earlier, will become more efficient in the way they build equipment and reduce the lead times to get the equipment to market. I am not close enough to have a good enough vision to see, from the manufacturing end, something that would be as dramatically changing as the rental industry has changed in the past five years. The change in rental has been dramatic.

What about on the software side? What kind of advances do you expect to see in the coming years?

Software is advancing, but the ability to utilize the software and understand it is advancing faster. The software is there, but now it is a matter of unleashing the total capability of what the software can do.