United Rentals’ Brad Jacobs

The late 1990s were rental’s heyday – news of a rental buyout or merger seemed to arrive daily. Even so, when United Rentals bought U.S. Rentals in 1998 it was the definition of Big News. In less than a year after it had been formed, United Rentals had shot to the top of the rental market and it has remained there ever since.

By the time the merger was finalized, the new number one rental firm had annual revenues of $1.5 billion and 404 branch locations. Several acquisitions later those numbers had increased in 2001 to $2.88 billion and 750 locations in 47 states, Canada and Mexico.

During the past two years, however, rental has fallen with the rest of the construction equipment industry. The $2.88 billion United Rentals reported in 2001 was down from the $2.91 billion in revenues it stated in 2000, and 2002 revenues seem certain to be down even further.

But take a further look at the numbers, says Brad Jacobs, United Rentals’ chairman and chief executive. “Non-residential building is down almost 20 percent on a year-to-year basis,” he says, “but our same-store rental revenue is down only 2.8 percent. We’ve been profitable throughout the whole construction recession and we were able to add more than 300,000 new customers in 2002.”

What can you expect from the rental market this year? Here’s what Jacobs thinks.

Q: What will happen to rental rates in 2003?

A: Rental rates are too low – ours were down more than 6 percent in the third quarter of 2002 compared to the same period in 2001. We have to get rates back up.

So we’re training our 2,000-plus sales professionals to let their customers know that in these times we need to fight for better rates. These men and women will be able to explain to our customers why renting from United Rentals is worth a few extra bucks. And they’ll negotiate a little more aggressively.

All of our branches are systematically analyzing who our best customers are and who is willing to pay the appropriate rate for our services. At the same time, we’re finding out who our borderline customers are, and having candid discussions with them. In order for those relationships to go forward, we need to have better rates. The long-term strength of the rental industry depends on the strength of rental rates.

Still, we have to be realistic. We can’t expect across-the-board raises in rates. Some markets still have excess fleet and declining demand. Rental rates in these markets are not going to go up no matter how much we try, but we can make efforts to stop them from going down even further. In other markets, however, especially where other rental companies have closed their doors and the demand is still there, you might see meaningful increases.

Q. Most rental companies have aged their equipment during this downturn. What have you done in this area?

A: We are going to age our fleet a few months more because we have the luxury to do so. We invested billions of dollars in our fleet during the past few years, so our fleet is young, about 36 months old on average. We plan to push that average out to 42 or 45 months by the end of 2003 and then keep it at that level or perhaps breakdown a little.

We’ve done extensive studies to correlate the age of our equipment with the amount of repair each type of machine requires and customer satisfaction issues. We’ve also done a number of focus groups with our customers to get their views on this important subject.

We’ve concluded while there is an appropriate age range for each type of equipment, there is also a kind of sweet spot around keeping the average age of the fleet to 3 1/2 years old. Up until that point you don’t see much customer notice about the machine’s age.

In hindsight, we’ve probably invested too much in our fleet over the years and ended up with a fleet that’s younger than it needs to be. At the same time, though, if we had not done that we wouldn’t have the luxury of being able to age our fleet without investing large amounts of capital into it.

We’ll still buy about $300 million in equipment this year. At the same time, we’ll sell between $150 million to $175 million in used equipment, so our net capital expenditures will be about $125 million to $150 million.

After this year we should spend between $500 million and $600 million a year, and we’ll generate about half of that in used equipment sales. All this will keep our average fleet age in the 42-month range.

When we got into this business five years ago, we were dealing with hundreds of equipment manufacturers. That number is down to 30 key strategic partners, with one to three main vendors for each equipment category. Our job is to make sure we buy the right types of equipment and place them in areas of greatest demand.

Q: What do you feel is the future of the small, medium and large players in the rental industry?

A: We have always said that there are two places to be in this industry if you want to make a good profit. You can be a small mom-and-pop outfit, keeping your costs low and giving tremendous service to your customers while finding a niche that is overlooked by the competition. This kind of rental business can make a good living for its owners, even though they may have to charge lower rates because they don’t have as high quality of equipment as we do.

On the other end of the spectrum are companies like ourselves, multi-billion dollar operations that can afford a sophisticated infrastructure, which gives us a superior cost structure. Our overhead is a small percentage of our total sales because our total sales are much higher.

Probably our biggest advantage, though, is our ability to share equipment between geographical clusters throughout our 750 stores. Each cluster, usually with 20 to 30 stores, is connected to a common computer system. Alone, this ability to share equipment within these clusters gives us more than $200 million per year in incremental rental revenue. It’s been the swing factor of whether we’re profitable or not. It also enhances our ability to go to Fortune 500 companies and get their rental business.

The biggest challenge, and this has been shown in this downturn, is faced by mid-size rental companies. These companies – even with good people and locations – tend to have two problems. They’ve financed their growth with too much debt instead of equity. And they can’t afford the organizational infrastructure to manage the size of the company they’ve built up. The verdict is still out on what will happen to these companies. Will they be sold to companies like ours, will they merge with other mid-size companies, will they restructure their debt and reemerge or will they be liquidated?

Q: Where will the rental industry go in terms of markets?

A: Most non-residential contractors have discovered rental, but I still don’t think they realize how much more they should be using it. They will in time, though. Residential builders, on the other hand, have not yet discovered rental and that’s going to change. I see a lot of possibility for growth in renting aerial lifts to homebuilders, who are now using ladders and scaffolding.

There really is no national presence of sophisticated rental operators in the rural markets. In fact, if I wasn’t at United Rentals, I would be rolling out hundreds of new stores in small towns all over the United States that either aren’t being served now or are being served poorly. These stores wouldn’t make money for the first few years, but after that they’d make a fortune. It’s a big opportunity.

Most of the foreseeable growth, however, will be in industrial. More than 98 percent of corporate America’s fleet is still owned. That doesn’t make any economic sense since most of it is just used occasionally. Economics will drive the change in that market

Q: Are there aspects of rental you think contractors need to be more aware of?

A: Even in 2003, I don’t think a lot of contractors are aware of the wide variety of equipment that is available for rent. It’s not just backhoes and skid steers and boom lifts. We have to do a lot more as an industry to expand the awareness of rental to the contractor. Contractors should be aware that our fleet is available as their virtual fleet, even though we technically own it.

Q. What’s in the future for rental?

A. Wall Street is no longer putting billions of dollars of capital into equipment rental companies so fleets are decreasing, which is a good thing. The excess equipment problem is dissipating, although it’s not over yet. If we had this level of fleet a few years ago when demand was 20 percent higher, we would have been able to significantly raise rates.

Of course, construction will not stay at this depressed level forever. Even now, there are hundreds of billions of dollars of construction projects going on all over the country. As the demand for construction increases over the next few years and rental fleets more or less stay at the same level, rental rates will increase and profitability will improve.

Unfortunately, most of our costs are fixed or semi fixed. Our typical store does between $2 million to $4 million in revenue. You still need branch managers, you still need to pay rent on the store and you still have depreciation every month. When revenues go down, your margins go down, and you can’t take the cost out fast enough to compensate for decreased revenue. While that’s bad right now, it’s going to be a blessing when the economy comes back, because we won’t need two branch managers nor will we have to pay two rents.

This means the coming good times will be even better than the previous good times. I believe this is an intermediate phase that will clean out some of the weaker players who had over-leveraged balance sheets and didn’t quite make it to the critical mass needed before the downturn came.

The rental industry will continue to expand. Nothing has changed about the attractiveness of renting.

Q: What do you now know to be true about the rental industry?

A: The same features that attracted us to this industry in the first place are still valid. It is large, growing, highly fragmented and in need of further consolidation. When construction activity rebounds our industry is going to do extremely well. The levels of profitability and cash flow generation will be greater in the next part of the expansionary cycle.

At the end of the day the rental industry is about helping customers solve their problems, and that gives us all a certain satisfaction.