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Audit Integrity Responds To Hertz' Lawsuit About Bankruptcy Probability, Hilarity Ensues
The simply idiotic lawsuit recently commenced by Hertz against Audit Integrity for daring to put the company which was on the verge of bankruptcy numerous times over the past year on its list of top bankruptcy candidates, has been the butt of all jokes within the analyst community. The kind of unwarranted retaliation by a firm against someone who dares to point out its flaws is not only comic, but a practical infringement of the First Amendment, especially if substantiated qualitatively. And for substantiation, maybe Hertz' legal counsel can also go after all those sell side and 3rd party analysts who over the past year have claimed the firm will likely not survive more than 12 months (hint: there are many of those around).
Today, James Kaplan, Chairman and CEO of Audit Integrity has provided his must read response, which one hopes should put to rest Hertz' simply sad and silly attempt to prove its "viability" by going after its critics.
The response is a delightfully sarcastic must read (highlights ours), and needs no additional commentary.
“Bankruptcy?” Ouch!!! We Touched a Sore Spot
James A. Kaplan, Chairman and CEO, Audit Integrity
Audit Integrity recently released a new Bankruptcy Risk model. The model was developed at the request of our clients, which include D&O insurance companies, institutional investors, and other interested stakeholders.
At Audit Integrity, we deal with some unpleasant truths. Some companies go bankrupt. Some corporate managers commit fraud. So it has been, so it will continue. What is equally true is that traditional, accepted measures of fraud and bankruptcy risk have failed time and again to identify companies at risk. Audit Integrity ratings and rankings are based on documented instances of bankruptcies and fraud (SEC Accounting and Auditing Enforcement Releases.) Our intent is to provide a valuable indicator of critical corporate risks.
The purpose of the Bankruptcy Risk Model is to predict the likelihood of bankruptcy among publicly-held companies over a rolling 12-month period. The model combines traditional quantitative inputs, including financial solvency measures and market valuation (option) models, with our own proprietary AGR®, which quantifies accounting transparency – in other words, whether the company’s published numbers can be trusted.
Each of these components uses historical data and tests that include in- and out-of-sample accuracy measures. Our statistical approach produces some very positive results, as noted in the White Paper available for review at http://www.auditintegrity.com/.
From my personal perspective, I was surprised to note that the impact of the U.S. Government “carpet-bombing” the world with liquidity had substantially reduced the rate of bankruptcy since the first Quarter of 2009, when overall probabilities were as much as three times higher than the September results.
I was also surprised by the reaction to our announcement. For the past six years Audit Integrity has identified corporations most at risk of litigation, earnings restatement, and SEC enforcement actions, but apparently the term “bankruptcy” is more incendiary than all of these combined.
Clearly, the word “fraud” has a similar effect. Audit Integrity did not state that companies with higher bankruptcy risk are committing fraud, but rather, that fraud risk metrics are part of our statistical process because these indicators of aggressive accounting have proven to be predictive of bankruptcy. Time will tell which of today’s companies are actually committing fraud.
In our bankruptcy model announcement we mentioned a number of large companies that had the highest probability of filing for bankruptcy over the coming year. Notwithstanding our report that the probability of bankruptcy was actually very low, a few of the companies listed were totally outraged at being identified as most likely to file. In one case, Hertz Global Holdings, Inc. (HTZ) filed action against us. In another case, CBS Corporation (CBS) publicly declared that our Bankruptcy Risk report was based on “flawed pseudo-analysis”.
Both CBS and Hertz complained that we had ignored numerous qualitative issues including analysts’ opinions. This seems odd, since by definition, quantitative analysis is purely statistical and deliberately excludes any and all subjective evaluation.
Statistical analysis, a branch of applied mathematics concerned with collecting and interpreting data to be used in estimating the probability of a particular outcome, is, and has been, widely used in a host of applications. I would guess that CBS collects and analyzes statistical information regarding their consumers; if they do not, this might be contributing to their poor performance.
As independent publishers of information, we pride ourselves on the use of applied mathematics to generate objective results. We are beholden to no one. Our job is to ferret out the truth in an environment where companies are incented to obfuscate.
However, since Hertz and CBS both objected to the lack of qualitative opinion in Audit Integrity’s report, I am prepared to offer my own personal perspective as a CFA and investor. I have highlighted the qualitative elements in the statements below to differentiate them from the statistical.
I must warn our readers that this will be the first and last time I depart from the “pseudo-analysis” we call “statistical.”
Hertz Global Holdings, Inc.
- Hertz Global Holdings is a highly overleveraged business whose revenues are dependent on business and leisure travel.
- I doubt that we will see a meaningful rebound in Hertz revenues over the coming year.
- A good portion of their assets are tied up in Goodwill/Intangibles, which represents a low-quality asset and poor collateral.
- Their primary tangible asset is their fleet of autos, which may or may not be fairly valued, since used auto prices have dropped significantly over the last two years.
- In my opinion the likelihood of a bankruptcy filing, as rated by Audit Integrity’s model, seems very conservative.
CBS Corporation
- I believe CBS has a broken business model.
- Revenues have not grown for many years.
- CBS’s media dominance is being eaten away by a host of competitors including cable and Internet providers as additional sources of entertainment and information.
- CBS struggles with the high cost of operation while new entrants in the space are far leaner.
- Goodwill/Intangibles represent more than 60% of assets. There is a possibility of an impairment charge if revenues and earnings continue to slip.
- Interest on long-term debt of approximately $7 billion is eating up operating income.
- Unless CBS can substantially reduce its cost structure while continually restructuring its debt, I believe trouble lies ahead, and it could be sooner rather than later.
I hope both Hertz and CBS will be satisfied with the qualitative opinion I have provided to complement Audit Integrity’s quantitative analysis. Please note, “This essay reflects the opinion of the author and not necessarily the opinion of Audit Integrity, Inc.”
Just beautiful.
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Hertz's private equity sponsors include: the Carlyle Group, Clayton, Dubilier & Rice and an investment arm ML (BAC)
Perhaps the lawsuit should attempt to pierce the veil right on down to the sponsors who looted the balance sheet
This is a really good point. The defendant should use the discovery process to really give them an "internal exam".
I don't know why Hertz cares what Audit Integrity says.
Investors don't read documents anyway. To wit:
-- investors in trust preferred securities are SHOCKED to find that bright boys and girls like ZH's Andy and Lizzy (except working at TPG) can buy trust assets at bargain prices and preferred shareholders don't have claims for fraudulent conveyance because the trups investors bought EQUITY and not DEBT.
-- investors in first lien mortgages are SHOCKED to find that mortgage servicers can do mods without getting sued because banks pushed through legislation giving them a servicer safe harbor that lets them put other folks interests ahead of the first lien holders.
-- investors in mortgages are placing ZERO probability on the chance that residential cramdown legislation will be passed by congress once the banks sell enough of their mortgage holdings to FNM, FRE, FHA, SWFs, PPIP funds, mutual funds, etc that the Bernanke and Geithner show can tank mortgage prices withouth killing the banks.
If investors don't read documents, don't watch the news, and don't think they will make bad decisions no matter what Audit Integrity says.
James Kaplan responds.. So, you thought we would be ascared of your silly suit. Now it will cost you what is left to settle ... STUPID
Didn't CBS issue shares tdy?
Technically James just committed a CFA Institute no-no by referencing himself as a CFA and not a CFA Charterholder.
Priceless.
Almost as good as the gem at 1530 on Ran news by ol Trip T
'US Recovery better than expected'
the latest from Grayson
http://www.unmaskthefed.com/
The Hertz transaction was a classic PE rip-off.
1) Ivy League boys at Carlyle, CDR etc. pickup the asset, leverage the guts out of it, and get it to a point of "performance" in order to sell back to the public.
2) Ivy League boys at Fidelity, Vanguard etc. managing 401k money buy the IPO stock from their mates at Carlyle, CDR etc. as a "solid investment" to add to their portfolios.
3) All of "the boys" cash out on the transaction, while the public is stuck with the swill, without any say (except by ticking the box on their 401k selection paper that says "Growth Fund") at all.
Nice job if you can get it.
Now that's good comedy
"3) All of "the boys" cash out on the transaction, while the public is stuck with the swill, without any say (except by ticking the box on their 401k selection paper that says "Growth Fund") at all. "
How do the boys at Fidelity, Vanguard, etc cash out if the stock is worth shit now?
A point of clarification and perhaps correction on the HTZ information presented here.
The value of the vehicle fleet at Hertz, and most rental car companies, is supported by guaranteed repurchase agreements with the car companies that supply the vehicles. You can argue that the car companies might default on such agreements, but that did not happen during the bankruptcies at GM and Chrysler to the best of my knowledge. And since those agreements allow car manufacturers to sell vehicles that retail will not buy (as ZH has eloquently written about) it seems unlikely they will default in the next year.
If the BK argument for HTZ rests on the assumption that the fleet value is overstated, there are a series of events that have to occur prior to that eventual come-to-Jesus moment. In my experience firms like AI rarely delve that deeply into the fundamentals of the company to accurately analyze such contingencies.
In my opinion - and I am sure others with have a different and equally well informed point of view - Hertz is right to address this issue in the courts. Bearish analysis on any company has a valuable role in capital markets. But sloppy analysis with inflammatory conclusions should be held up for scrutiny in exactly the same way that ZH so competently waves the flag on senselessly bullish nonsense.
with news censors like you it is no wonder that
companies like moody's, s&p, fitch and other
raters issue vapid and deceitful ratings to please
the sellers and others with upside biases....
their eternally rosy ratings are always good for
public consumption while ai and others with a
less sanguine view need to be taken to court
for silencing....
hertz is a public company and should have no
protection from adverse publicity....let the
two parties have a public discussion about their
views so that investors can have an informed view
of the company's prospects....
if ai is full of crap it will come out through
an airing of the facts....however, it sounds
like hertz and its emissary (that would be you)
are inconventienced by facts and math....
however you missed the point about the fleet argument
since it is doubtful not present in ai's analysis
since their analysis is statistical rather than
qualitative...such confusion is an intentional
act of muddying the waters....
time will tell what hertz's fate is....however
i believe that more sunshine is helpful to markets
rather that fear uncertainty and doubt....thanks
for helping us to keep our heads in the sand...
I hope Carlyle didn't pay too much for your lousy analysis and/or writing ability. This sentence makes no sense, "...those agreements allow car manufacturers to sell vehicles that retail will not buy..." Even ignoring the strangeness of believing that GM(or other manufacturer) reselling (I think you mean buying) Hertz's used car inventory would be successful, you conveniently ignore the probable fact that the manufacturer would be repurchasing at a discount not at a premium to the value of those assets on the balance sheets. This is THE problem with overlevered companies, the effect of small decreases in asset values are magnified. And when combined with decreasing revenues, the company is a bankruptcy waiting to happen.
And to delve deeply into fundamentals, if you rent cars with any sort of frequency, you would notice that Hertz is now keeping cars much longer than it did previously (>15k miles). Consequently, Hertz's business model of charging a premium for premium (condition and style) vehicles has obviously been adjusted downwards towards its competitors.
One could argue that these asset impairment and decreasing revenue problems are affecting the industry as a whole, which is fine, but as history has shown time and again, the overlevered always suffer the worst.
Putting aside your needless slight that I work for Carlyle, or anyone associated with HTZ or PE or rental cars or any company in the industry. I do not, but that is besides the point. I simply know more about it that you do. Do not mistake superior knowledge for a hidden agenda.
GM and every other car company that sells to rental car fleets does, in fact, repurchase the cars at the end of what is usually a 6 month rental window. They then resell them through used car auctions that are attended by only that company's dealers.
The repurchase price is set at the time of the original sale, so the depreciation associated with the car is known. The rental company then depreciates the car at that rate until it is time to hand it back.
Further, the longer the rental company keeps the car, the lower the monthly depreciation tends to be. That makes the 15K car you note - which is entirely accurate - a higher margin vehicle to rent versus the daily charge.
All of this information is available in the company's financial disclosures.
While I have not tracked the subject Hertz facts and story, Audit Integrity does come up with some strange (i.e., POOR) "ratings" on companies. It is a sign of what is coming where they cram some company numbers in a matrix / template and spit out a bunch of ratings. That might get you close to the right answer two-thirds of the time, but many times it will lead you astray. XBRL is going to make this a more popular exercise despite its weak results.
It is unclear how Audit Integrity survives with their poor work product.
improper use of the CFA Charterholder designation, it cannot be used as a noun. "as a CFA Charter holder" would be correct.
FYI
Repurchase or GDP vehicles are the normal manner in which fleet is purchased. However, all rental car companies are moving towards a higher percentage of "risk" units in their fleets, in which the company incurs the risk of resale at auction rather than the guaranteed repurchase you mentioned previously.
Repurchase or GDP vehicles are the normal manner in which fleet is purchased. However, all rental car companies are moving towards a higher percentage of "risk" units in their fleets, in which the company incurs the risk of resale at auction rather than the guaranteed repurchase you mentioned previously.
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