Private equity and equipment rental

Private equity (PE) has a long history of involvement in the equipment rental sector, and continues to be active in doing deals.

Although I lack access to any statistics to prove it (and as if that would stop me having an opinion!), my guess is that the participation of private equity in equipment rental is higher, as a proportion of the total size of the sector, than in almost any other industry.

This leads me to ponder why that should be so.

Why private equity investment is so high in rental

I think the answer is partly related to the make-up of the sector, partly to the characteristics of rental companies in general and partly to where PE houses see their areas of strength.

The largest rental companies still have a low market share 

The rental sector across the world is still relatively fragmented, with even ‘dominant’ players typically having less than 30% shares of their national markets, and often substantially less.

This is in part a measure of sectoral maturity (it’s a relatively young industry compared to, say, retailing or car manufacturing) and so the big companies haven’t had time yet to be even more dominant.

Fragmented customer base = less investment competition

However, it’s also a reflection of the end customer base. Over 70% of rental equipment is estimated to go into construction, which is a market, at its smaller end, that is still hugely fragmented with many, many one-person businesses.

At this end of the market relationships are still critically important, and there will therefore always be a home for the quality local player.

For the PE investor this fragmentation means that there is less likelihood in ending up in bidding wars with major trade investors for a particular target company, as the major, cash-rich trade investor is still pretty thin on the ground.

The rental sector has one company in Europe approaching €1 billion in turnover, and not many more than that in the USA, whereas there are dozens of retailers and manufacturers above this level and having substantial cash reserves.

So deals can be done more easily and with less competitive tension compared to other industries.

Investing in equipment offers more financial security 

Second, rental companies have great defensive characteristics for a financial investor.

Unless the market suffers massive trauma, (as it did in 2008, with >30% falls in demand in many countries) the fact that 15% to 30% of rental company P&l costs are related to depreciation of equipment means that cash can be generated for some time simply by turning off capital expenditure on new equipment.

For a PE investor this means that their base investment, and that of their banking supporters, is at least likely to be safe, even if it doesn’t yield great returns and profits are poor, or even non-existent.

Of course, the limiting of capital expenditure on new equipment can only be sustained for a limited number of years, but it will see most businesses through a “normal” downturn.

Finally, the great skill of the best PE houses is picking the timing of their investments.

Short term investments 

There are few businesses better than rental businesses for converting sales growth into profit growth when times are good and the market is on an upward curve.

We shouldn’t therefore be surprised to see quite some PE activity in the market right now.

Many rental companies have been running themselves to generate cash for a few years and find themselves well-positioned for an upturn (although there is often an initial ‘catch-up’ in equipment investment required) but their current owners have maybe tired of the investment.

For the PE house, getting into a business which is well positioned, where investment requirements are not ridiculous and where there may be an opportunity to ride four to five years of growth before cashing out is the perfect scenario.

Is PE investment good for the industry?

Well, it could be argued that explicitly financial ownership contributes to making the cycle of growth and bust a little more extreme, as it has an interest in investing into growth maybe more aggressively than if it was a long-term owner of the business.

In any event it doesn’t really matter whether it’s good or not, because it’s here to stay.

*This article was first published under the title ‘Cash machine’ in the August 2013 issue of IRN magazine. 

About the author Kevin Appleton is a former CEO of Lavendon Group and now executive chairman of Travis Perkins’ £1.5 billion builders merchants division in the UK. Mr Appleton writes a column in every issue of IRN.