2009-10-07
RA - RailAmerica

RA - RailAmerica plans on offering 21 million shares at a range of $16-$18. Majority owner Fortress 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.

That RA's railroads are often integrated into their customer's facilities meaning leading 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.

Financials

$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 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 freightcars hauling on their tracks than they do storing those unused freightcars so this is not an ideal trend.

Through 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 shareholder, 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 ear 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 does not 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 EDMC and SEP, RA is a former public company taken private 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

As always, piece was available to subscribers well before pricing and open.

VRSK - Verisk Analytics plans on offering 85.25 million shares in a range of $19-$21. Insiders will be selling all of the shares in this deal, VRSK will receive no monies. If over-allotments are exercised, insiders will be offering 12.75 million shares bringing the total deal size to 98 million shares. BofA/Merrill Lynch and Morgan Stanley are leading the deal, JP Morgan, Wells Fargo, William Blair, Fox-Pitt Kelton and KBW co-managing. Post-ipo VRSK will have 180 million shares outstanding for a market cap of $3.6 billion on a pricing of $20.

Travelers Insurance will own 15% of VRSK post-ipo, Berhshire Hathaway 10%. A number of insurance companies own a piece of VRSK stock. In addition VRSK's employee stock ownership plan will own 20% of VRSK post-ipo.

From the prospectus:
　
'We enable risk-bearing businesses to better understand and manage their risks. We provide value to our customers by supplying proprietary data that, combined with our analytic methods, creates embedded decision support solutions.'

VRSK is the largest aggregator and provider of detailed actuarial and underwriting data pertaining to U.S. property and casualty, or P&C, insurance risks. Insurers utilize VRSK to make better risk decisions and to price risk appropriately.

VRSK insurance risk management framework: 1)Prediction of Loss; 2)Selection and Pricing of Risk; 3)Detection and Prevention of Fraud, and 4)Quantification of Loss.

Two segments Risk Assessment and Decision Analytics.

Risk Assessment - The leading provider of statistical, actuarial and underwriting data for the U.S. P&C insurance industry. Largest P&C insurance database includes over 14 billion records, and, in each of the past three years, VRSK updated the database with over 2 billion validated new records. VRSK uses this data to create industry standard policy language and proprietary risk classifications and to generate prospective loss cost estimates used to price insurance policies. </p>
Decision Analytics - VRSK has a data set that includes over 600 million P&C insurance claims, historic natural catastrophe data covering more than 50 countries, data from more than 13 million applications for mortgage loans and over 312 million U.S. criminal records. Customers utilize this data, along with VRSK's proprietary algorithms, to predict potential loss events, ranging from hurricanes and earthquakes to unanticipated healthcare claims. VRSK is at the leading developer of catastrophe and extreme event models.

**Not only are nearly all the major US property & casualty insurers shareholders, VRSK's solutions are actually embedded into their customer's critical decision processes. VRSK is pretty much the only game in town when it comes to risk management for US property and casualty insurance firms. Would be an understatement here to state barriers to entry are high.

VRSK also has a large presence outside of property and casualty:</p>
U.S. customers included all of the top 100 P&C insurance providers, four of the 10 largest Blue Cross Blue Shield plans, four of the six leading mortgage insurers, 14 of the top 20 mortgage lenders, and the 10 largest global reinsurers. Over the past three years, VRSK has retained 98% of all customers.

97% of top 100 customers had been customers for each of the past five years. VRSK's revenue growth from these top 100 customers has averaged 12% annually the past five years.

72% of revenues are derived from annual subscriptions or long-term agreements, which are typically pre-paid. 60% of revenues are from the US P&C insurance industry.

Acquisitions - VRSK has made 9 acquisitions over the past three years, all in their Decisions Analytics segment. the acquired companies provide fraud identification and detection, loss prediction and selection solutions to the healthcare market. **VRSK's fraud identification and detection business is their fastest growing niche.

**Large, very successful insurance risk management operation embedded in the US P&C insurance sector with large proprietary databases, datasets and algorithms. Really the issue here is not whether VRSK is investable, it is 100% a matter of valuation on ipo. We'll take a look at this below.

Financials

Debt - There is a bit of net debt here post-ipo, $689 million. It appears much of the debt has been taken on as a result of the 9 acquisitions over the previous three years.

VRSK has steadily grown annually over the past five year. This has been a result of organic growth coupled with acquisitions. Revenues have grown quarterly for at least 8 Q's in a row.

Gross margins and operating expense ratios have remained steady the past 4 years. Result is VRSK is filtering revenue growth to the bottom line at roughly the same dollar for dollar amount over the years.

2008 - Revenues were $893 million. Gross margins were 57%. Operating expense ratio 22%. Operating margins a strong 35%, indicative of an automated/embedded type operation. Debt-servicing ate up 10% of operating profits. Plugging in taxes, net margins were 19%. Earnings per share were $0.92.

2009 - through first 1/2 of year, revenues appear on track for $1.04 billion, a strong 16% increase over 2008. Gross margins look to be 56%-57%, operating expense ratio 21%. Operating margins should once again be in the 35% ballpark. Debt servicing should eat up close to 9% of operating profits. After tax net margins should be 19.5%. Earnings per share should be approximately $1.10. On a pricing of $20, VRSK would trade 18 X's 2009 revenues.

Conclusion - Blue chip ipo coming at a very attractive valuation. Years of revenue growth, strong operating margins and extremely high barriers to entry. This is a large 98 million share deal(assuming over-allotments) with all shares coming from insiders. Because of this, VRSK may trade a bit heavy early on any opening pop. Anywhere near $19-$21 range however and this is a keeper. Strong recommend here in range for mid-term.