Kirby Corporation (KEX) has been on an acquisition spree of late and completed its most recent acquisition just last Friday (December 14, 2012). Kirby operates a fleet of tugboats and barges throughout the United States' inland and coastal waterways. At first glance, Kirby's acquisitions look to be the workings of a normal company choosing to forego organic growth for growth via acquisitions. Upon closer examination, though, the company appears to be exploiting the US legal system to better position itself in the US domestic market.
Maritime transport in the United States is controlled by a complex web of laws rooted in the Progressive Era of the late 19th century and later influenced by protectionists in the early 1900s. Today, the Jones Act (passed as the Merchant Maritime Act in 1920 and last amended in 2006) governs the movement of cargoes between US ports. Among the provisions of the Jones Act is the requirement that all vessels involved in trade between US ports be US flagged and built in the US (see here for a creative evasion tactic). Proponents of the Act on the political right argue that it is essential for maintaining a merchant marine capability while those on the political left point to the jobs created in US shipyards, etc. by maintaining the requirements. Ultimately, the US consumer is the biggest victim of the Act's requirements as it makes the US domestic shipping market unable to quickly adapt to changes in the market.
The Jones Act prevents barges, tugboats and smaller coastal vessels from being built cheaper in the shipyards of Latin and South America or Asia. It also prevents shipping companies from bringing in foreign flagged or built vessels to operate on US coastal waters when demand for vessels is high. Periods of high demand for intracoastal traffic can lead to significantly higher shipping charges because of the limited supply of qualified vessels and the long lead time for new vessels. One notable example can be found in the federal government's response to Hurricane Sandy last month. The Act's requirements were waived for approximately two weeks in order to more quickly bring down the cost of gas in affected areas. The waiver was a tacit admission by the government that the Act does affect the price of goods and the effect of the waiver was that gas prices did indeed fall much faster as additional supplies were brought in by foreign flagged vessels from other US ports.
As a result of this distorted regulatory system, companies like Kirby have strong incentives to consolidate. Consolidating in a market where the supply of available vessels has been artificially limited makes it much more difficult for competitors to counter Kirby's increased power in the marketplace. In a normal market, a competitor could purchase or charter an idle foreign-flagged vessel from another market and plug it into their fleet; however, the Jones Act makes such action illegal. In light of this legal scheme, Kirby's acquisitions appear much shrewder than the typical strategic acquisition because it gives Kirby even more control of an artificially limited market.
Just because Kirby is engaging in a shrewd acquisition strategy, though, does not automatically make it a good stock, much less a great one. A horse whip manufacturer embarking on a shrewd consolidation of the horse whip market in 1920 wouldn't make it a great company, just the last horse whip manufacturer to enter bankruptcy. Thus an analysis of Kirby's business model and financial health is important to determine if the company is a good investment.
Many of Kirby's customers are petro-chemical and commodity companies whose only economically feasible method of transportation is by water. In a world where commodities are increasingly in demand, Kirby stands to profit significantly from shipping those commodities between parties. Kirby's other business unit - a diesel engine services unit - also stands to benefit from the continued boom of the oil and gas sector as many of the units it services are employed in the oil and gas sector. Thus Kirby is in an excellent position to profit from higher margins as high demand and limited supply allows the company to charge higher shipping rates for both short and long term contracts.
The structure of Kirby's acquisition of Penn Maritime last Friday provides investors with insight as to how management sees Kirby's stock price and the company's long term prospects. Out of a total transaction value of $299 million, only 10% was financed through the issuance of common stock at $58.16 per share. The remaining portion was paid in cash and retirement of Penn Maritime's debt. Kirby raised the funds for the cash and debt retirement portion by issuing $500 million in new unsecured senior notes which will also allow Kirby to retire $200 million in senior notes due February 28, 2013. That Kirby's management chose to only issue a limited amount of common stock is a strong signal to the market that management believes the stock's share price is fairly priced if not slightly undervalued. Kirby's management is also signaling that it has enough cash flow to service the debt and to either repay the principal from cash flow or be in a position to refinance the debt at or prior to its maturity. Overall, Kirby appears to be poised for further revenue growth and improved operating margins due to its recent acquisitions and should provide conservative investors with a healthy level of growth while protecting their investment.