Bidding Up RailAmerica at High Seen Bringing 30% Gain: Real M&A
RailAmerica Inc. (RA), the railroad operator controlled by Fortress Investment Group LLC (FIG) that reached an all-time high last week, is poised to reap about 30 percent more for investors as a takeover target.
Jacksonville, Florida-based RailAmerica on May 22 said it was in talks with third parties over a possible sale as part of a review of its options. While its shares have now more than doubled from last year’s low, the $1.2 billion short-line operator still trades at a 30 percent discount to rival Genesee & Wyoming Inc. (GWR), according to data compiled by Bloomberg.
Even after the company more than doubled operating earnings as Fortress trimmed expenses in the five years it owned the company, T. Rowe Price Group Inc. and Stephens Inc. said RailAmerica still could attract infrastructure funds and private-equity firms because there’s room to further cut costs. Berkshire (BRK/A) Hathaway Inc. may also be interested, Stephens said, as RailAmerica’s revenue from each carload of freight approaches a high and the company is projected to generate record free cash flow next year. RailAmerica could fetch as much as $31 a share, a premium of more than 30 percent, Sidoti & Co. said.
“It’s attractive to an acquirer because it’s in a pretty solid fundamental industry,” Robert Dunn, a New York-based analyst with Sidoti, said in a telephone interview. “It generates decent free cash. Certainly it’s a much better-managed company today” than when Fortress acquired it in 2007.
Donia Crime, a spokeswoman for RailAmerica, said the company declined to comment beyond its May 22 statement that said RailAmerica’s board is considering strategic alternatives and that it is in discussions with third parties regarding a potential sale.
Gordon Runte of New York-based Fortress, which had assets under management of $46.4 billion as of March 31, didn’t respond to a telephone call and e-mail seeking comment.
RailAmerica operates 44 short-line and regional railroads with about 7,400 miles (12,000 kilometers) of track in the U.S. and Canada, linking customers such as mine operators and factories with long-haul carriers that haul freight greater distances, according to an April regulatory filing. The U.S. industry’s deregulation in the 1980s buoyed short lines as major railroads such as Union Pacific Corp. opted to let smaller carriers handle traffic on less-traveled routes. In 2011, RailAmerica transported about 840,000 carloads of freight including farm and food products, lumber and metals, it said.
The company was taken private in February 2007 by Fortress, which paid $658 million, excluding net debt. The investment firm, which hired new management while initiating cost cuts at RailAmerica, then took the company public again in October 2009. Fortress held a 60 percent stake in the company as of March 31, according to data compiled by Bloomberg.
RailAmerica’s operating income rose to about $127 million last year from $47 million in 2006, the year before Fortress bought the company, as margins widened by 128 percent.
“This is one of the great private-equity stories of the past several years in my view,” Alexander Yaggy, New York-based manager of the Cortina Small Cap Value Fund (CRSVX) for Cortina Asset Management LLC, which oversees about $2 billion, said in a phone interview. “Fortress took an underperforming company, took it private, put in new management, repaired it, took it public again and it has exceeded expectations.”
Yaggy’s fund, which outpaced 99 percent of its competitors this year, owned RailAmerica shares as of March 31.
The stock touched a low last year of $11.14 in August before doubling through last week as the industry gained momentum. North American railroad operators generated $1,476 in revenue per carload of freight on average in the fourth quarter, within 1 percent of an all-time high, according to data compiled by Bloomberg.
RailAmerica’s stock had already climbed 49 percent this year to $22.13 as of May 22, when the company announced it was in talks about a possible sale. The shares rose further on the news, closing on May 25 at $23.75, 113 percent higher than its August low.
RailAmerica today advanced 1.7 percent to $24.15.
First-round bids are due on May 30, the Deal reported last week, citing a person familiar with the situation.
Even with the stock’s recent gains, RailAmerica was still cheaper than its closest rival last week. Its equity and net debt was valued at 9.5 times earnings before interest, taxes, depreciation and amortization in the last 12 months, a discount to the valuation of 13.5 times Ebitda for Greenwich, Connecticut-based short-line operator Genesee & Wyoming, data compiled by Bloomberg show.
“The stock is still attractively valued for somebody to come in” and acquire RailAmerica, Brad Delco, a Little Rock, Arkansas-based analyst with Stephens, said in a phone interview.
RailAmerica could attract infrastructure funds, which invest in everything from railroads and toll roads to airports and utilities, and other private-equity firms looking to squeeze out more expenses and further improve margins, Delco said.
The company’s ratio of expenses to sales, a benchmark for railroads, was about 78 percent last year, data compiled by Bloomberg show. That compares with an average operating ratio for companies in the Bloomberg Industries North American Rail Freight Transportation Index of about 73 percent, the data show.
Financial buyers would also be lured by RailAmerica’s free cash flow, said Andrew Davis, a Baltimore-based transportation analyst for T. Rowe Price Group Inc. The firm, which oversees about $550 billion, was RailAmerica’s second-largest shareholder behind Fortress as of March 31 with a 7.7 percent stake.
Analysts project RailAmerica’s cash from operations after deducting capital expenses will total $52 million this year and rise to a record $92 million next year, according to the average of estimates compiled by Bloomberg.
“It’s very likely, because of the high level of cash flow that these businesses generate relative to the amount of overall capital expenditures and maintenance that they require, a financial buyer like a private-equity firm would be interested,” T. Rowe Price’s Davis said in a phone interview.
Warren Buffett’s Berkshire is another potential buyer for RailAmerica, according to Stephens’ Delco. Buffett, who built Omaha, Nebraska-based Berkshire into a $197 billion holding company by acquiring firms that he deems to have durable competitive advantages, purchased Burlington Northern Santa Fe Corp., a Fort Worth, Texas-based railroad company, in 2010 for about $34 billion, his biggest deal ever.
Sidoti’s Dunn said he viewed Berkshire as more of a financial buyer who would run RailAmerica as a separate business rather than merge it with Burlington Northern.
Buffett didn’t respond to an e-mailed request for comment sent to his assistant, Carrie Kizer.
Dunn says RailAmerica may command $24 to $31 a share in a takeover based on Ebitda multiples typically paid in acquisitions of short-line railroads. At that price, RailAmerica investors would be getting a premium of as much as 31 percent to last week’s closing price, data compiled by Bloomberg show.
“If they’re going to sell it, I hope to get a very healthy price for it because I think the next several years should remain very good for the company,” Cortina’s Yaggy said. “As a stakeholder, I’d hate to see them sell at a low price just to get a deal done.”
Matt Troy, a New York-based analyst for Susquehanna International Group LLP, said Fortress may struggle to find buyers for the entire company and is more likely to sell its stake through a secondary offering. Long-haul carriers probably wouldn’t want RailAmerica’s short lines, and private-equity firms could struggle to find ways to further boost efficiency after Fortress already improved the business, he said.
For private equity, Fortress has “run the sponge dry,” leaving buyers with less incentive to pay up for the company, Troy said in a phone interview. For the larger railroads, “the strategic puzzle pieces don’t fit.”
Acquiring RailAmerica would allow any buyer to tap increasing demand for rail freight as the U.S. economy recovers and the company continues to focus on improving profitability, T. Rowe Price’s Davis said. RailAmerica said it is aiming to reduce its operating expenses to as low as 77 percent of its revenue this year, versus the almost 90 percent operating ratio it had in 2006 before Fortress took it private.
“It’s a story of a business that has much improved in quality since they went public and something that would be attractive to an acquirer because it gives them exposure to what I would consider a very solid industry,” Davis said. “They’d be acquiring a much better business with a lot less holes in it than it had previously.”