RERMAG

The Normal Cycle — Interrupted

Rental industry consultant and former HERC CEO Dan Kaplan talks about the impact of the credit crunch on funding, continued interest in rental by private equity, the importance of utilization analysis in an uncertain economy, and the anticipated rental growth in Europe.

RER: What kind of impact will the credit crunch have on the rental industry in 2008? Might some customers rent more and purchase equipment less?

Dan Kaplan: Rental is the preferred option during an economic slowdown. I predict the overall effect of renting more during a slowdown versus the economy will be negative. I predict the total rental revenue for the industry will be down in 2008 versus 2007.

A greater concern of the credit crunch is its impact on funding. The larger rental companies are funded by high-yield debt — “bonds.” Securing high-yield debt in 2008 will be expensive and difficult. Literally every rental company has seen its bonds discounted from 10 to 20 percent. You can now earn a yield of 22 percent on one rental company’s bonds. The lending institutions care about one thing — rental companies’ ability to make the interest payments on their debt. In order to assure debt repayment the lending institutions are forcing the rental companies to limit their capex spending. In other words, the rental companies will reduce their equipment purchases.

Another consequence of the credit crunch will be the lack of funding to support acquisitions. Acquisitions will occur, but on a restricted basis.

The housing construction slowdown is likely to continue for a while. What kind of impact is this likely to have on the rental industry?

In 2007 the housing slowdown had a negative effect on the utilization of earthmoving equipment. Earthmoving time utilizations dropped several percentage points. In 2008, rental companies will be buying less earthmoving equipment as a percent of their total spending. The manufacturers of earthmoving equipment such as Cat and Deere are experiencing and predicting significant declines in earthmoving in North America.

I expect the drop in housing starts to affect other categories of equipment in 2008 such as aerial work platforms. Not to the extent that housing starts affected earthmoving equipment but a slowdown is anticipated in other categories of equipment. Think of it for a minute. The normal cycle is that a track of homes is built, followed by a strip center, office buildings, banks, commercial establishments, etc. The housing start slowdown is causing the cycle to be broken. As the existing projects that utilize categories of equipment such as aerial work platforms complete, when will the next project begin?

As evidenced by the United/Cerberus situation, would you say the flow of private equity investment to the rental industry has slowed for the foreseeable future? Do you expect a slowdown in merger and acquisition activity in the rental market for a while?

Private equity has invested in the rental industry for one reason and only one reason, to make money. I believe the Cerberus situation was more of a reflection of the Cerberus investments in Chrysler and GMAC rather than the rental industry. I see the Carlyle investment in Coates in Australia as a positive.

I predict continued interest in the rental industry and would not be surprised to see more consolidation led by private equity in 2008.

What advice would you offer rental companies managing their companies in what appears to be a somewhat uncertain economy?

My advice is to analyze and live with the time utilization report on a daily basis. Every effort must be made to keep the time utilization of all categories of equipment with a value of $10,000 or more above 65 percent, and for equipment with a value of less than $10,000 above 50 percent.

If a rental company experiences poor time utilization after a considerable period of time, the following action items are needed in the following order:

1. Revisit your sales coverage and sales effort.
2. Transfer equipment to another rental location.
3. Reduce capex spending.
4. Sell off the excess or low time utilization equipment.
5. Last resort: reduce rental rates on a managed basis.

What kind of year do you expect for rental in 2008 and what are some of the unique challenges rental companies are currently facing?

The challenges in 2008 will be more of an effect of the economy than we faced in the period of 2003-2007 (great rental years). Profits will likely be down, business plans will be hard to exceed, and bonuses will likely diminish. Motivating and managing the branch managers will be a challenge.

2008 will be a greater challenge for the independents. Independents enjoy a significant amount of business from the local contractor building one or two homes, often on spec. This will happen less frequently in 2008.

It appears rental companies are less likely to acquire a lot of new equipment in 2008. Do you agree with that assessment and what impact will that have on manufacturers?

I track the capex spending of the 10 largest rental companies. I predict capex spending of the top 10 rental companies in North America will be down 18 percent for 2008 versus 2007. At the same time Europe will be experiencing a strong year in 2008. Europe will more than offset North America.

The equipment manufacturers are well aware of the reduction in spending in North America and the strength in Europe. The European Rental Association will hold its inaugural convention in June in Amsterdam. Look for strong participation of the manufacturers at the show.

Any other trends you expect to see in the next year or two, or any other points you’d like to add?

I expect to see more rental company consolidation in the next two years. From an operational point of view, look for increased usage of telemetrics and remote wireless devices.

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