Fresh out of bankruptcy, Hertz is suddenly key to Tesla’s growth plans

October 28, 2021, 11:40 AM UTC

A formerly insolvent car rental agency has become an unlikely partner to guarantee Tesla’s future right when the EV brand is attempting to double in size practically overnight. 

As part of a plan to create a segregated “premium and differentiated rental experience,” Hertz placed an initial order to purchase 100,000 Model 3 sedans on Monday—only months after emerging from Chapter 11 bankruptcy. Tesla’s stock surged on the news, gaining over 10% to break through the $1 trillion market cap. 

“Now that Tesla is aggressively expanding its manufacturing capacity, it’s important for Tesla to make bigger headway in the fleet business, otherwise it won’t reach its growth targets,” said Ferdinand Dudenhöffer, director at CAR Center Automotive Research in Duisburg, Germany.

Elon Musk’s company is on the cusp of completing two factories, one in Texas and another in Germany, on top of its existing plants in Fremont, Calif., and Shanghai. Together the pair of new sites could push Tesla’s current rate of annual output from 1 million to at least 1.5 million vehicles by the end of next year, and possibly higher.

The centi-billionaire claims that Tesla is constrained only by the number of cars it can produce, implying the brand’s loyal fan base would have eagerly snapped up the cars otherwise sold to Hertz. Yet experts argue Musk will be greatly helped by a steady stream of orders if the rental agency can turn its luck around. 

“Hertz is an important lever to pull in this regard. It would be dumb to ignore this segment,” Dudenhöffer said.

Rental agencies can often be a pressure valve the industry abuses to unload mass numbers of cars that otherwise would sit around on showroom lots costing dealers money by the day. 

Typically this means steep discounts to the list price, although Tesla CEO Elon Musk denied he had offered any volume rebate. Given the acute global chip shortage has drained dealer stocks throughout the U.S. and pushed prices higher across the board, it would be foolish to do otherwise.

Courtesy of LMC Automotive

The Hertz deal still stands out as a milestone in Tesla’s history. The automaker has earned a reputation for being an iconoclast that relishes going against standard industry practice, and this mindset has extended all the way through its go-to-market strategy. 

Instead of advertising, for example, Tesla has turned to social media influencers to create and maintain buzz. Until last month it relied heavily on a customer referral reward scheme to boost sales, and it operates its own network of stores rather than professional third-party dealer groups. 

Thus far the strategy has worked like a charm, with investors valuing the company more than most rivals combined, despite its tiny size. A deal to sell what currently represents a tenth of its annual supply to a rental agency is about the most normal thing Tesla has ever done—and suggests underneath its bluster it may be concerned about excess capacity costing it money.

“The deal is a step toward conventional industry logic,” said Christoph Stürmer, partner and head of the automotive practice at Vindelici Advisors. “Having a steady customer base that is fully committed in fleet sales is something that everyone else has. Tesla is becoming more of a normal car company with a certain fraction of corporate buyers, which they haven’t had before.” 

Back from the grave

From one perspective, though, Tesla is defying expectations yet again, since it has other carmakers wondering why Musk is slumming it with a company in as much trouble as Hertz, precisely at a time when the chip crisis is boosting pricing power among consumers.  

“Even if you could, why would you want to?” said a source at one brand that offers both conventional cars and electric vehicles. Citing Hertz’s past solvency problems and the industry stigma of selling to rentals, he added, “I’m not sure excluding us is a bad thing at all.”

While Volkswagen aims to eventually offer EVs for Europcar customers once its acquisition of the company goes through next year, it told other rental agencies inquiring about ordering battery-powered cars like the VW ID.4 that it currently had other priorities.

“Since demand for our fully electric vehicles is currently so high, we prefer to first serve our private customers and corporate fleet buyers, which are our more margin-rich sales channels,” the group said in a statement sent to Fortune

The deal has been a PR coup for Hertz in particular, the only rental agency to file for Chapter 11 during the pandemic. The original meme stock, it attempted to sell new shares to retail investors while already in bankruptcy. Management nearly would have succeeded had regulators not intervened, given the clear risk to stockholders.

“Hertz is making a desperate leap to upgrade the average rental rates, the revenue they earn per hour, by being the only one where you can reliably get a Tesla because all other competitors cannot,” said Stürmer. “This deal was a statement, one that ensured the world would notice.”

There is arguably another reason why Hertz, run by a former Ford CEO, picked Tesla over other EV manufacturers. Musk’s focus on technology has helped it find alternative solutions to the outdated and obsolete semiconductors legacy carmakers traditionally source, allowing it to grow production while others are forced to halt assembly lines.

“Tesla is truly one of the only ones who could deliver 100,000 mass EVs to one customer in 2022,” wrote Evercore ISI analyst Chris McNally on Wednesday. “The Hertz order reminds us once again that Tesla is the only U.S. volume EV game in town currently.” 

More must-read business news and analysis from Fortune:

Subscribe to Fortune Daily to get essential business stories straight to your inbox each morning.