Description

I realize there is a very similar VRRM write up just below this. I actually wrote this the morning that was posted, but Wright13 beat me to the punch on submitting. I guess this won’t fulfill my club requirement, but I’ll post it anyway- I already wrote it and goes a bit deeper into the businesses.

Verra Mobility is a near-monopoly business with a ~50% EBITDA margins and a 70% return on tangible capital. The company should grow revenue organically at a mid to upper single digit rate and FCF at an upper single digit to lower double digit rate, but is priced for a 2023E FCF yield of 6.5% and a 15%+ total return. A slug of floating rate debt provides additional upside to FCF in the event of lower rates.

Business

VRRM has three segments, two of which account for ~90% of the company’s revenue.

Commercial Services: ~45% of revenue, ~65% EBITDA margin

The Commercial Services business primarily provides tolling services to the domestic rental car agencies (RACs) and small fleet operators. VRRM is essentially a monopoly in this business with 100% market share of the rental car industry. The three RACs make up ~75% of this segment’s revenue.

VRRM is responsible for maintaining the registration of every car in a customer’s fleet with each of the 50 or so independent tolling operators in the US. When a fleet car drives through a toll gantry, VRRM immediately pays the toll to the tolling agency, and in the case of the RACs, bills the renter for the toll. This requires a back-and-forth integration with each tolling operator to accept VRRM’s large volume of ever-changing registrations. These tolling integrations involve operating agreements, payment processing setups, and information sharing protocols to ensure synchronization of data.

VRRM also reaches into the RAC’s internal systems to pull out the info about who was in the car at that specific time as well as into the RAC’s internal billing system to pull the renters payment info on file. Finally, VRRM is responsible for all of the services in between, including managing and matching the physical transponders in each car, training the RAC’s sales desks on how to deal with tolling issues, and operating a calling center to provide customer support to the RAC’s customers.

The RACs usually charge their renters a per diem fee to enroll in the tolling program (it occurs automatically if the driver goes through an electronic gantry). Two of the three major RACs offer an all inclusive flat rate option too. VRRM has a revenue share agreement on the fee, and also earns a spread on the tolls by paying the electronic rate while charging the driver the cash rate (or unregistered rate).

The company offers a similar service for violations (speeding/parking tickets) and a titling and registration service that’s responsible for keeping the RAC’s fleets in compliance. The violation and title/registration products aren’t fully deployed into the customer base.

Management projects a 6-8% long-term growth rate for this segment driven by expansion into Europe (there is no VRRM equivalent product in Europe yet), increased penetration of the non-tolling products, increased penetration of cashless tolling lanes on existing toll roads (64% of lanes in the US are cashless as of 2021), more toll roads (newbuilds and conversions), and the normalization of travel volumes and rental day volumes:

The most realistic threats to VRRM’s dominant position in this segment are the RACs building the capability in-house and a private competitor called BestPass.

BestPass is a smaller company (~500k transponders in 2019 vs. VRRM at 5.8m+ today) that also maintains a similar sized network of integrations with tolling authorities. BestPass targets trucking fleets and doesn’t have an RAC-focused product, which would require the integration with RAC internal systems as well as the customer service and transponder management capabilities. Given the whitespace in trucking, it seems unlikely that BestPass is going to concern itself with competing against VRRM, particularly when the RAC market consists of three customers who are locked up with VRRM via multi-year contracts.

The difficulty of displacing VRRM, whether by in-sourcing or using a competitor, is compounded by the logistical issues of operating a fleet of cars with constantly changing geographic locations. For example, using VRRM for Florida and a competitor for New York is not feasible because a car that’s in New York on one day is often in Florida a couple days later. VRRM would have to be talking to the competitor to track who was registering what car with which authority, and which transponder in which car was registered where, etc. Add in regular changes to the fleet and the result would undoubtedly be an awful customer experience. If an RAC switches from VRRM, it must be done all at once. An RAC could theoretically build up the capabilities in-house, but the integrations with tolling authorities took many years for VRRM to develop. Dropping the service risks tolling violations, penalties, and customer confusion. The fixed cost nature of the service reduces the financial incentive to any one RAC.

VRRM is contracted with HTZ and Avis through 2026 and 2025, respectively. The contract with Enterprise has historically been 2-3 years in length, and it’s up for renewal in May.

Government Solutions: ~45% of revenue, ~35% EBITDA margin

The Government Solutions segment owns and operates red light/speed cameras. Red light cameras are a flat to declining business due to their unpopularity. Speed cameras are a growing business due to their efficacy in improving safety in specific areas such as school zones, bus lanes, work zones, and on school bus arms.

VRRM has ~70% market share in N. America with Conduent’s (CNDT) transportation segment being the largest single competitor. The typical model here is for VRRM to purchase the camera equipment for a municipality which pays a fee for VRRM to provide the equipment and manage the operation. A more accurate representation of this segment’s earnings should subtract the depreciation on company owned cameras.

The exception to this arrangement is VRRM’s contract with New York, which was ~27% of the consolidated company’s revenue in 2021. Unlike every other municipality, NY owns its own cameras, which it purchased from VRRM. These one-time purchases are now complete, and I expect revenue from NY to drop to ~$125 million in 2023.

The contract with NY expires in December of 2024, but there’s little chance that VRRM is displaced by a competitor. For one, the deployment is the largest on the continent and multiple times larger than anything a competitor is currently managing. VRRM sells Jenoptik cameras, a German company for which VRRM holds the N. American distribution rights. A competitor taking over the contract would need to build up the maintenance infrastructure from scratch and make a large investment into working capital because of NY’s awful payable cycle. NY and Verra have a 20 year relationship, and it would be shocking for the company to lose the contract after the city just made a huge capex investment into the program.

Management guides this segment to a mid-single digit long-term growth rate, but I believe it’s more realistic to expect a low single digit growth rate in the near term punctuated by growth spurts when new states adopt favorable legislation.

Parking Solutions: ~10% of revenue, ~20% EBITDA margin

The Parking Solutions segment is the result of VRRM’s acquisition of T2 Systems from Thoma Bravo in 2021 for $350 million. This segment sells hardware, software, and associated services for the operation of parking lots (think the systems where you enter your parking space number and pay with a credit card at a kiosk).

This segment primarily serves universities but has been branching out into smaller municipalities.

Management is forecasting high single digit growth, where EBITDA grows faster than revenue due to a mix shift away from hardware towards software/services.

Valuation

I believe VRRM will do ~$160 million of FCF in ’23 for a FCF yield of 6.5% on today’s diluted market cap. With 6% top line growth, 50bp of EBITDA margin expansion from mix, and leverage on a flat interest expense, FCF can grow organically at a high single digit to low double digit rate for a 15%+ total return.

VRRM is levered ~3.4x net debt. 30% of the gross debt is fixed at 5.5%, but 70% is variable at L + 325. The company exited 2021 at a 4.1% effective rate. That’s ballooned to ~8%! Few stocks today are priced for a higher for longer rate regime- I see no reason why VRRM should be priced differently. If/when rates come down, FCF will increase materially providing additional upside to the total return calc.

Catalyst

Lower rates, Enterprise contract renewal, deleveraging...