[M&A Alssul Sinjab] Why Private Equity Firms Acquired Both No.1 and No.2 Rental Car Companies

Affinity Acquires Lotte Rental After SK Rent-a-Car Last Year
Rental Car Business Driven by Funding Rates and Used Car Sales
Higher Interest Rates Than Capital Firms, But Rate Cuts Provide Relief
Strengthening Used Car Sales, Which Account for Half of Profits

Global private equity firm Affinity Equity Partners announced on the 28th of last month that it will sign a Stock Purchase Agreement (SPA) with Lotte Group on the 11th to acquire Lotte Rental. Following the acquisition of SK Rent-a-Car, the second-largest car rental company, for 820 billion KRW last August, Affinity has now also acquired the industry leader Lotte Rental for 1.573 trillion KRW.

The market shares of Lotte Rental and SK Rent-a-Car are 20.8% and 15.7%, respectively. There is a noticeable gap compared to the third-ranked Hyundai Capital (12.8%) and fourth-ranked Hana Capital (6.2%) in the car rental sector. Why did Affinity rush to acquire the first and second largest car rental companies in less than a year? Here is an explanation of the background.

Private Equity Firms Naturally Favor the Rental Business

Private equity firms prioritize stable cash flow when buying and selling companies. Most limited partners (LPs) who invest hundreds of billions of KRW prefer businesses that generate steady profits with low risk. Therefore, private equity firms use EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) as a key indicator in company valuation.

The rental business’s success depends on relatively predictable factors such as borrowing interest rates, demographic structure, and consumer behavior. Due to the B2C (business-to-consumer) nature of the industry, market share rankings change very slowly. As a result, EBITDA forecasts tend to remain stable.

This makes the rental business an ideal model for private equity firms, which aim to increase EBITDA and then resell the company on the market. A representative example is MBK Partners, which bought Woongjin Coway for 1.19 trillion KRW in 2013 and sold it back to Woongjin Group for 1.68 trillion KRW in 2018. MBK reportedly earned about 1 trillion KRW in profit, including block deals and dividends during the holding period.

Car Rental Business Thrives on Low Interest Rates

Car rental companies borrow money by paying interest to purchase vehicles in bulk, then earn revenue by renting them to corporations or individuals. After 3 to 4 years, they sell the vehicles in the used car market to generate additional income. Therefore, the business’s success depends on how low the borrowing interest rate (cost of capital) is, how well the vehicles are maintained, and how effectively the used cars are sold in the secondary market.

Let’s first look at borrowing interest rates.

Most car rental companies have a debt-to-equity ratio exceeding 350%. Thus, higher interest rates significantly increase interest expenses, making profitability difficult. Indeed, the car rental market growth stagnated during the high-interest rate period of 2022?2023.

Moreover, Lotte Rental and SK Rent-a-Car, acquired by Affinity, have relatively higher corporate bond interest rates compared to capital companies like Hyundai Capital and Hana Capital.

However, due to the Bank of Korea’s interest rate cuts starting in October last year, the relative impact of interest rate variables on performance will diminish going forward. This is why the private equity industry is praising the acquisition timing as "perfect."

Used Car Sales Determine Profitability in the Car Rental Business

Vehicle maintenance and used car sales are directly linked to the profits that private equity firms value. Vehicle maintenance cannot be neglected in terms of attracting new customers and retaining existing ones. Additionally, well-maintained vehicles ensure a larger inventory of cars to sell in the used car market, which is crucial.

This is why Affinity repeatedly emphasized "modernizing car life management to comprehensively oversee the vehicle lifecycle" when acquiring the car rental companies. In fact, Lotte Rental has advanced expertise in this area through its 'Vehicle Visit Maintenance (Chabangjeong)' service.

Affinity announced it will operate the two companies independently. However, it is expected that the strengths of both companies will be integrated to achieve 'modernization of car life management.'

The profit from selling used cars after the rental period ends has a significant impact on the profitability of the car rental business. According to Hana Securities, used car sales accounted for 54% of Lotte Rental’s total operating profit in 2023.

In fact, Affinity is rapidly strengthening the used car sales business at SK Rent-a-Car, which it acquired last year. At the end of last year, SK Rent-a-Car purchased 'Cheonan Auto Arena' from Hyundai Elevator for 104 billion KRW. SK Rent-a-Car plans to transform Cheonan Auto Arena into a used car auction site and reopen it.