Capital Is Key

Sept. 1, 1999
A company cannot grow or expand, or even tread water, without capital. In the capital-intensive rental industry, this is particularly true. Now more than

A company cannot grow or expand, or even tread water, without capital. In the capital-intensive rental industry, this is particularly true. Now more than ever, capital-and access to it-is a key ingredient in any recipe for survival. And few, if any, companies are better connected to a wide range of capital markets than United Rentals.

Nobody knows this better than its chief financial officer, Michael Nolan, who spends much of his time raising capital and maintaining a strong dialog with Wall Street investors. Nolan is constantly seeking new sources of capital, negotiating bank lines, and working with underwriters to develop equity proceeds.

"We try to maintain a balanced debt-to-equity ratio," Nolan says. "We started with a $55 million credit facility to match the $55 million in equity that we raised. In our IPO, we raised $100 million, so we increased the credit facility another $100 million. Then we raised it another $150 million and we raised about $200 million in equity with our second stock offering. There's always a enjoyable challenge for me to figure out the next source of capital."

Unlike what past generations of rental company controllers faced, there are far more sources of capital to choose from. "It's not like it was 20 years ago when all you had was straight common [stock] and the commercial banks," says chairman and CEO Brad Jacobs. "There's a half-dozen different forms of equity and a half-dozen forms of debt. You can do 'convertibles,' 'toppers,' 'ACES,' 'MIPS' - a lot of different sources of capital. Long-term debt, short-term debt, senior debt, junior debt.

"That's a big competitive advantage a public company has over a private company. If one capital market is not doing well, you have other options. They have a saying on Wall Street, 'You're supposed to feed the ducks when they're quacking.' So you have to find which capital market has an appetite for the financial instrument that you're pursuing."

Although being public is an advantage for United Rentals when it comes to raising capital, it also necessitates focused fiscal responsibility. "We have a report card every quarter," says Nolan. "It's not just what our bottom line or top line was. Are we improving margins? How much capital are we putting into the business? How are we using that capital? We are measuring each of our branch locations monthly. That way we can determine if something is out of whack and can fix it quickly. It's not like you find out about it three or six months later.

A private company can say, 'Let's spend a little more on this, business is good.' If a private company decides it wants to spend something, it's their money. With a public company, some of it is our money, but not all of it. We have a huge fiduciary responsibility

At that point, Jacobs and his team were financially secure, but still young and hungry. Over a period of several months, they began searching for another industry that was still relatively fragmented and ripe for consolidation. They hired consultants and researched dozens of potential industries. They read publications, attended industry trade shows, asked questions and consulted experts.

After narrowing the field down to a half-dozen industries, there was one that kept coming up ahead of the others - equipment rentals.

"The most important factor to us was the early stage of consolidation," Jacobs says. "It may appear, from all the activity that's going on, that consolidation is far along. But even if you look at last year, the amount of revenue that was acquired was far less than the amount of incremental revenue that was generated by the growth of the industry itself.

"The increase of the rental trend is far more attractive than [the trends in] most other industries. Rentals is not a fad - it's a trend based on the favorable economics of renting versus owning. This is a roughly $20 billion industry that could grow to be a $40 billion to $50 billion industry over the next five years.

"We were also very attracted to the rental industry because the typical owners of equipment rental companies are similar to the owners of solid waste companies - self-made individuals, who by their own wits and resourcefulness have made themselves multimillionaires. They are people with a lot of independence and entrepreneurial spirit, successful leaders in their communities. This industry has a lot of integrity. The average equipment rental company has a high level of ethics, a high regard for the law, and a high regard for treating its employees and its customers properly and with dignity. The quality of the people made us comfortable in this industry."

United put together $55 million in capital. Of that, $45 million came from its management team, including $35 million from Jacobs himself mostly taking the profits from the sale of United Waste Systems. Other investors - including quite a few former United Waste shareholders - contributed various sums to give United a total of $55 million in start-up equity, with which it made its first six platform acquisitions in October 1997. Since then, United has acquired 53 more companies (and, at press time, has another 19 companies signed up under letters of intent), culminating in its dramatic agreement in June to purchase U.S. Rentals, the industry's second-largest rental company.

That billion-dollar stock swap propelled United's annual revenue pro forma run rate to close to $1.5 billion and is likely to be considerably higher once that transaction closes this fall.

But United was well on its way to becoming the industry's leading company even before the acquisition of U.S. Rentals. Not including the U.S. Rentals branches, it now has outlets in 28 states and two Canadian provinces. United has acquired an extraordinary stable of RER 100 companies - including Oregon's Power Rents; East Coast-based aerial powerhouses Access Rentals and Equipment Supply Co.; leading Canadian rental players BNR Equipment and Reitzel Rentals in Ontario and Perco Ltd. in Quebec; Northern California's A&A Tool Rentals & Sales and A-1 Rents; Southern California's Able Equipment and ADCO; Houston's Gaedcke Equipment; and North Carolina's Mercer Equipment - and has arrived on the scene with an impact unprecedented in rental industry history.

With the startling purchase of U.S. Rentals, United captured the attention of the national media to a degree far beyond any previous exposure, with Jacobs appearing on CNN/FN and many stories appearing in newspapers and magazines.

The company's strategy is relatively simple: An acquisition team of eight specialists, led by vice chairman and chief acquisitions officer John Milne, is checking out hundreds of rental companies throughout the United States and Canada. United's game plan is to develop clusters of stores not more than an hour or two drive away where they can increase profitability by sharing equipment to drive utilization. Clusters also enable United to benefit from economies of scale by combining back office, accounts receivable, accounts payable, credit and collections functions.

Once United completes an acquisition, its operations team, led by former Xerox Corp. senior operations executive Wayland Hicks, takes over and works to establish stricter budgetary control and integration with the rest of the company through its management information system.

But part of the secret to United's success is that the "taking over" of newly acquired companies consists mostly of providing that company with capital to expand and grow while, generally, allowing the company to continue to do what made it successful in the first place, including keeping the company name. Unlike some national firms with a prominent name, the United management team believes that local name recognition is far more important.

United also, in most cases, keeps the existing management team intact, with the belief that its entrepreneurial spirit, hunger to succeed and knowledge of the local market are what made the company successful to begin with. In many cases, the selling owners stay with the company and continue to run it, often going on to manage a region or district. Many former owners work with United's acquisition team, helping it make contacts with successful rental companies in their particular areas as well as among industry friends in other geographic regions.

But the term "former" owners doesn't always apply. In addition to the cash payment they receive for their companies, most receive stock options as well. The United philosophy is to provide them former owners, who continue as shareholders as well as managers, with enough incentive to retain the motivation for success that inspired them as entrepreneurs.

United may seem to distant observers like a huge, almost monolithic corporation, coming out of the boardrooms to buy market share and take over the industry. The reality is that members of United's management team are highly committed entrepreneurs with personal stakes in the company's success. Jacobs, Milne, chief financial officer Michael Nolan and vice president of strategic planning Bob Miner, took the bulk of their earnings from the sale of United Waste and personally risked them by investing in a then-nonexistent rental company. Other United executives, such as acquisitions executives Joe Kondrup Jr. and Kai Nyby, did the same.

"We pay competitive salaries, but we provide incentive with stock options," says Miner. "So the people believe that their payoff will be building net worth in the company over the years as the stock appreciates. We're trying to align everybody's interests with the shareholders."

This philosophy, which developed at United Waste, does not exclude executive management. While CEO Jacobs was making about $200,000 a year in salary at United Waste, top officers of other major garbage companies were making close to or more than $1 million in annual salary. United Rentals is continuing this philosophy of keeping the financial present and future of executives tied to the company's success. Similarly, with United Rentals, Jacobs salary is $290,000 and the salaries of other executives are industry-competitive.

This philosophy is appreciated by investors. Although many in the industry perceive the original investors in United as Wall Street "suits" without identities, in reality many of the additional initial investors were relatives, friends and business associates of company executives who were also willing to risk their personal capital because they believe in the vision and plan. They were investing in a team with a proven track record.

"I'm an investor because there's no better consolidator than Brad Jacobs and his team," says Richard Heckmann, CEO of U.S. Filter Corp. and a member of United's board of directors. "In any business, you look at the team. Do they know how to consolidate? Do they know how to integrate? They have a wonderful track record and if anybody can do it, they can."

"The reason United Waste became such a success from a stock market perspective, and from a shareholder perspective, is that we've hit our numbers every quarter," says Miner. "We had 19 quarters as a public company and every quarter we met or exceeded what was expected of us. We understand that the way to create shareholder value is to continually deliver on what you promise. Meet your targets and meet your budgets - you do that by being highly focused from an operating point of view.

"People perceive United Rentals as an acquisitions-driven company, but we're really an operations-driven company in that we understand that our objective is to create value for shareholders. At United Waste we weren't just growing revenues. We were making sure that the growth we had on the top line was translated to growth on the bottom line. And that's the same strategy and philosophy we have here at United Rentals."

United made its first series of acquisitions last fall, when it purchased six platform companies. Although modest in scope compared to some of its later transactions, these initial acquisitions were the talk of the industry in October 1997. The first six - A & A Tool Rentals, Stockton, Calif.; A-1 Rents, Salinas, Calif.; Mercer Equipment Co., Charlotte, N.C.; J & J Rental Services, Houston; Bronco Hi-Lift, Denver; and Rent-It Center, Salt Lake City - totaled nearly $60 million in revenue and immediately established United as a major player in the industry. Its booth at the California Rental Association convention in Las Vegas last October attracted as much or more attention as any vendor on the show floor.

Two months after making its first series of acquisitions, United went public with its first stock offering, raising about $100 million. It followed with an additional $200 million offering in March, and completed a senior subordinated note $200 million bond offering in May. Last month, United obtained a $250 million senior secured seven-year term loan arranged by Bank of America to augment its existing $300 million revolving credit line.

What's next? United's capital foundation will allow it to continue making acquisitions. Although the U.S. Rentals deal presents the company with a logistical challenge to integrate such a large network of locations, the purchase brings significant competitive advantages.

"We're already buying equipment 10 percent to 20 percent cheaper than the predecessor owners were paying for the same equipment six months ago because of our larger size," says Jacobs. "With respect to used equipment, we don't have to rely just on the auction or broker channels to sell equipment. Instead, we have our own dedicated sales force that numbers more than 700 sales professionals coast to coast linked on the same MIS system so we can find the highest paying retail customer. We'll add to this sales force with the acquisition of U.S. Rentals.

"And another benefit to size in this industry is the ability to drive utilization of equipment while it's on rent. We're buying ... clusters of stores to build up dense operating regions with many locations within driving distance of each other. We'll also have access to cheaper capital; we'll have a lower cost of capital."

Although Jacobs is dedicated to growth, he emphasizes that being the largest company in the rental industry is not the goal in itself. "It's not our objective to be No. 1 on the RER 100," he says. "We may end up being No. 1, but that's not our mission. Our mission is to grow in profitability and quality, grow in our ability to service the customer in a high-quality way, and build up a world-class operating organization. If we do that and are the fourth- or fifth-largest, that's fine with us. With United Waste, what we were most proud of was being able to deliver to our shareholders exactly what we promised them, and that is our goal with United Rentals."

Still, acquisitions will continue full speed ahead, and the purchase of U.S. Rentals facilitates United's ability to play well in another arena - servicing national industrial accounts and Fortune 500 companies. "It will take some time to fully develop and train our sales force and have the services at the right level to penetrate that market with intensity," Jacobs says. "But that huge sector - manufacturing companies, factories, the petroleum and petrochemical sector - is just beginning to unfold for this industry."

Jacobs and his team believe the industry's largest potential for future growth is in servicing the industrial sector, which is also less subject to cyclical swings in the economy. And with the likelihood of an eventual economic slowdown or recession in the coming years, the United Rentals team believes that its size and geographic diversity will enable it to withstand a recession more easily. As the recent ads for the movie Godzilla proclaimed, size does matter. United Rentals has the size - more quickly than anyone expected.