Rental disagreement

(Fortune Magazine) -- In the months before its Nov. 15 IPO, Hertz hit the road. The company had an ambitious plan to pitch to investors: extend its dominance in airport car rentals to the leisure market while slashing costs. To do so, Hertz (Charts) must wrestle share away from privately held Enterprise Rent-a-Car--which has, in Hertz's own words, "historically dominated" the leisure business.

But evidently many buyers didn't like what they saw under Hertz's hood. When the rental giant's shares priced at $15 (down from its $17 estimate), the private-equity shops that bought Hertz from Ford (Charts) last year--Clayton Dubilier & Rice, the Carlyle Group, and Merrill Lynch--had to sell it for $1 billion less than planned.

For investors, one issue kept coming up: Hertz is facing a huge cost increase that Enterprise is not. Hertz has long had a sweetheart deal with Ford and GM (Charts). It buys no-frills cars at a discount, then sells them back to the automakers at a set price after several months. Enterprise pursues a riskier but potentially more profitable strategy. It buys fully loaded cars, then resells them on the market.

But last September, Ford and GM decided to cut back on inventory and repurchase fewer cars. The value of Hertz's fleet fell about 8% this year, since 65% of its cars are no longer assured a good resale price. Because Hertz is using its fleet as collateral, the costs of servicing its heavy debt load will rise.

The easy way to pay for the difference would be rental rate hikes, but Hertz's rates are already at a three-year high. Plus, 77% of its sales come from airports, where competition is fierce and corporate customers demand discounts.

That's why Hertz now covets the leisure market, where prices are flexible. But Enterprise has three times as many off-airport sites and as a private company can sacrifice earnings to lock out newcomers. "Being private gives it a lot of pricing leeway," says S&P analyst Betsy Snyder.

Hertz says it will explain its strategy after its quiet period ends in December. Consider it Hertz's turn to try harder.