Bill Simpson wrote an analysis of RailAmerica (RA) to TradingIPOs subscribers on October 7. In their debut Wednesday, October 14, shares traded for less than $14, well below initial expectations of $16 to $18 per share.
The text of Mr. Simpson's original writeup follows:
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RailAmerica plans on offering 21 million shares at a range of $16-$18. Majority owner Fortress (FIG) will be selling 10.5 million shares in the deal. If over-allotments are exercised, the deal size will be 24.15 million shares. JP Morgan, Citi, Deutsche Bank, and Morgan Stanley are leading the deal, Wells Fargo, Dahlman Rose, Lazard, Stifel and Williams Trading co-managing. Post-ipo RA will have 56 million shares outstanding for a market cap of $952 million on a pricing of $17. IPO proceeds will be utilized primarily to repay debt.
Private equity firm Fortress will own 53% of RA post-ipo. Fortress purchased RA in a 2006 leveraged buyout of $1.1 billion. At the time RailAmerica was a publicly traded company. It appears the Fortress led buyout doubled RA's debt levels, par for the course during the LBO heydays of 2003-2007. As a result of that leveraged buyout frenzy, we are seeing solid businesses come public loaded with debt. RA is the latest.
Assuming RA utilizes all ipo proceeds to repay debt, there will be approximately $550 million in debt on the books post-ipo. Plugging in debt paid off on ipo, debt servicing the first 6 months of 2009 ate up a whopping 58% of operating profits.
From the prospectus:
'We believe that we are the largest owner and operator of short line and regional freight railroads in North America, measured in terms of total track-miles, operating a portfolio of 40 individual railroads with approximately 7,500 miles of track in 27 U.S. states and three Canadian provinces.'
In 2008, RA's railroads transported over one million carloads of freight for approximately 1,800 customers. For the six months ended June 30, 2009, coal, agricultural products and chemicals accounted for 22%, 14% and 10%, respectively, of RA carloads. RA's 40 railroads are located fairly evenly across all regions of the US.
Short-line railroad: railroads that transport freight between a customer’s facility or plant and a connection point with a Class I railroad. Essentially short lines are the connectors from a company to a long haul railroad. In North America there are 550 short line and regional railroads operating approximately 45,800 miles of track. Short line railroads make up just 4% of railroad revenues in the US.
The fact that RA's railroads are often integrated into their customers' facilities leads to a stable and predictable customer base. The only issue is volume. RA has seen a pretty significant dip in usage of their railroads the past year due to the economic slowdown.
Railroads carry more freight tonnage-wise than any other mode of transportation in North America. In 2006, railroads carried 43% of total ton-miles (one ton of freight shipped one mile) of freight transported in the U.S.
Freight revenues make up 87% of total revenues with non-freight revenues making up 13%. Non-freight revenues include switching (or managing and positioning railcars within a customer’s facility), storing customers’ excess or idle railcars on inactive portions of our rail lines, third party railcar repair, and car hire and demurrage.
$550 million in net debt post-ipo, assuming all ipo proceeds are utilized to pay down debt.
In the first six months of 2009, freight revenues decreased 25% from the first 6 months of 2008. This was primarily due to a decrease in carloads. Total carloads during the six month period ending June 30, 2009 decreased 25.6% to 414,303 in 2009, from 556,689 in the six months ended June 30, 2008. In contrast, non-freight revenues grew 25% the first 6 months of 2009, primarily as a result of storing customers' unused freight cars. RA makes a lot more off of freight cars hauling on their tracks than they do storing those unused freight cars, so this is not an ideal trend.
Through the first 6 months of 2009, fuel costs were 7% of revenues.
Slim margin operation as operational expense ratio was 83% in 2008 and 78% through the first 6 months of 2009. Combination of hefty debt and low margins is never ideal.
Taxes - RA has substantial tax loss carry-forward, $120 million not expiring until 2020-2027. RA also has $95 million in short line tax credits available through the next 20 years. RA's tax rate looks to be approximately 15%-20% for the foreseeable future.
RA does not plan on paying a dividend. This is a bit unusual as this is a classic low growth, predictable cash flow type business. RA, however, is not planning on returning any cash flows to shareholders, most likely due to the high debt levels. I would expect RA to use any cash flows to pay down debt levels.
2008 - Revenues were $508 million. Operating margins 17%. Debt servicing (adjusted for post-ipo) ate up over 50% of operating profits. Plugging in 15%-20% taxes, net margins were 7 1/2%. Earnings per share were $0.65-$0.70.
2009 - RA has had a difficult past 9 months. This is reflected in the '09 results through 6/30. Lower economic activity means less tonnage passing along rail lines. RA should pick up earnings per share in either 2010 or 2011, so the key here is not the high PE on ipo. The key here, unfortunately, is debt servicing eating up a very large portion of a fairly slim margins business to begin with. Revenues for the full year should be approximately $440 million, a 13% decrease from 2008. A portion of this decrease is due to lower fuel costs; however, as noted above, carloads decreased 25% year over year through 6/30/09. Operating margins should improve to 21%. A portion of this is due to lower pass-through of fuel costs, although RA management has created efficiencies to combat economic slowdown. After plugging in debt servicing and 20% taxes, net margins should be 9%. Earnings per share should be $0.70. On a pricing of $17, RA would trade 24 X's 2009 earnings.
Conclusion - Much like recent ipos Education Management (EDMC) and Spectra Energy Partners (SEP), RA is a former public company taken private in the past five years via a leveraged buyout. The newly public RA, much like SEP/EDMC, will simply have too much debt. Operationally, 2009 should be as bad a year as RA will have over the next few years. I would expect earnings per share to tick up in both 2010 and 2011. Even so, with debt servicing eating up so much operating profit here, RA looks fully valued to me in range. Skip this deal.