Description

I first wrote this idea up as part of my VIC application when the stock was at $6.35, the weekend prior to the J. Powell Pump of last week. Since then, VRRM shares are up ~25% to $8.02 as of market close today. Despite the move, I still believe the risk/reward here is interesting, hence the repost of my application. I have updated certain verbiage and figures in the writeup to reflect VRRM's current share price of $8.02. Note that this idea was previously written up regency435 in late 2018.

Thesis Summary

Verra Mobility (VRRM) is the leading outsourced toll management and traffic enforcement company in the US. VRRM shares have been hit by indiscriminate selling amidst the coronavirus scare as valuations of anything related to travel are being severely punished. I believe this selloff is overdone however and that VRRM is actually a high quality and high margin business with very attractive returns on capital which can emerge from this pandemic with its long-term growth algorithm fully intact. Additionally, while this business is somewhat levered (3.2x TTM net leverage), severe financial distress as a result of the pandemic seems unlikely as VRRM has enough liquidity to cover their cash burn for more than a year of no cash inflows or expense cuts and VRRM’s debt is well termed out (due 2025) and contains friendly debt-servicing covenants. I believe that VRRM stock is an attractive long at current levels and offers investors with at least a medium-term time horizon the opportunity to invest in a moated, secularly high-single/low-double-digit growing company with wonderful economics at only a 10x 2021 P/E multiple (0.7x the S&P 500’s multiple). As the coronavirus threat fades and people start traveling again, I believe VRRM shares can once again re-rate to a multiple at least in-line with the market, allowing investors to roughly double their money over the next few years.

Business Overview

The entity currently known as Verra Mobility is the result of a rebranding of the former American Traffic Solutions, following its acquisitions of Highway Toll Administration, LLC and Euro Parking Collection plc. In late 2018, Verra Mobility’s private equity owner, Platinum Equity, took part of the company public via a reverse IPO by selling a piece of its equity stake to the Gores Holdings II SPAC. VRRM did roughly $450m in revenue in 2019 and classifies its business into two segments – Commercial (60% of revenues) and Government Solutions (40% of revenues):

·       The Commercial business offers several solutions – primarily Toll Management – to customers including the Big 3 car rental players (Hertz, Enterprise and Avis) and other large fleet management companies. The Toll Management service was created to solve a problem that used to be a big headache for car rental companies. Before VRRM, car rental companies would be issued tons of penalties from local tolling authorities when car renters drove through cashless tolls for which they weren't registered. This would inundate the local car rental companies’ offices and create the additional administrative hassles of trying to track down who drove which car through which toll and then attempting to re-bill the customer. With VRRM’s Toll Management service, there are no more penalties issued as every car in a rental fleet is registered at almost every tollway in the US, thereby saving the car rental company a lot of time and inconvenience. In return, VRRM makes a spread per toll by paying the local tolling authority at the discounted electronic rate and charging the car rental company at the 10-15% higher cash toll rate, who can then turn around and immediately re-bill that fee to the appropriate car renter. VRRM is the only national provider of its Toll Management service in the US and one of the major growth opportunities for this business over the next 3-5+ years is replicating the success in the US in the EU.

·   The Government Solutions business contracts with cities, school districts and other governmental entities to provide the installation, maintenance and technological backbone of a traffic safety monitoring program. VRRM’s platform is customized to the rules of each client and its system captures and passes along any violations to the appropriate enforcement agency. VRRM makes money in this business by typically contracting on a fixed fee per camera basis and as well as by earning a share of the violations revenue. This business is the market share leader in the US with roughly 50% share of the US photo enforcement market (two other notable players are Conduent and Redflex, both with ~20% share).

Key Thesis Points

1.       VRRM is a high-quality and capital-light business with impressive returns on incrementally invested capital that will allow the business to compound value per share over time. While VRRM’s business is somewhat related to the infrastructure and travel industries which might conjure up associations with cyclicality and low margins, at its heart, VRRM is actually a payment processing company that enjoys phenomenal economics (gross margins are 95%+ and EBITDA margins are 50%+). Think about it this way – at the highest and most simplistic level, VRRM drives its revenues by earning a spread based on road traffic volumes plus any widening of that spread driven by the growing delta between cashless/electronic toll rates and cash toll rates. Neither of these two variables requires VRRM to invest any more money to earn that incremental revenue – every dollar they earn from incremental traffic volumes or incremental expansion of that cash/cashless toll rate delta drops down at essentially a 100% contribution margin to VRRM. These are great economics that one would typically associate with highly valued software companies that can keep selling their products to new users at virtually no incremental cost. We can see this attractive economic profile reflected in the return on incrementally invested tangible capital math below:

2.       Coronavirus will impact VRRM’s financial performance in the near-term but should have minimal, if any, impact to VRRM’s medium-to-longer term growth algorithm of at least 10% growth over the next decade. Road traffic is down and will continue to be down meaningfully over the next few quarters as most of the country remains in quarantine, but I think it is logical to assume that when things blow over, road traffic snaps back to normal levels relatively quickly versus gradually growing back to normalcy off of a low base. The IBTTA estimates US tolling revenue will reach $65-70Bn by 2030 which suggests an 11% CAGR from today, driven by the growing amount road-miles covered by tolls, increases in toll rates, and vehicle-miles-driven generally increasing over time. This, combined with gradual toll revenue mix shift from cash to cashless tolling and an increasing delta between cash and cashless toll rates should add another 1-2% to revenue growth for VRRM’s Commercial business, bringing total revenue growth for this business to roughly 12-13% over the next decade. With the Government business growing in the mid-to-high single-digits area, VRRM’s total revenue growth should approximate about 10% or so for the foreseeable future. I do not see coronavirus impacting the underlying factors driving this 10% growth and I think 10% may actually prove to be a pretty safe assumption as my math above gives no credit to the planned expansion into the EU over the next few years or to any other growth projects in the future. At current levels, VRRM stock seems to imply a permanent impairment to VRRM’s long term growth and earnings power when, in reality, this is likely not the case.

3.       VRRM has enough liquidity, well-termed out debt, and friendly debt covenants such that the business should be able to come out of the other side of coronavirus without coming under significant financial stress. VRRM generated ~$240m in EBITDA in 2019 and as of 4Q19 had ~$130m in cash and ~$900m in debt, bringing TTM gross and net leverage to 3.75x and 3.2x, respectively. Cash on hand and the ability to access an additional $275m from existing credit facilities gives VRRM near-term liquidity of up to roughly $400m. Even if we assume no money coming in and no expense offsets, this is still likely enough to cover at least a year’s worth of cash burn ($200m in cash opex which is likely mostly headcount, $60m in interest expense, and $30m in capex). Additionally, VRRM’s debt is not due until 2025 and the debt only requires mandatory prepayment in the event that VRRM is generating excess FCF – ie, if there’s no FCF being generated for a period of time, they will not be forced to pay down any debt.

4.       VRRM is very cheap on both a relative and absolute basis. Since the SPAC deal closed in late 2018 and VRRM’s shares became publicly listed, they have mostly traded in-line with the S&P 500’s forward P/E multiple. Since March however, that relative valuation gap widened significantly, with VRRM’s shares currently trading at only 0.7x the S&P 500’s forward P/E multiple. I would argue that VRRM shares should be valued at least in-line with the broader markets – the S&P 500 grows earnings ~7% on average and VRRM should be able to grow earnings at least 10%+ in a normalized environment for the foreseeable future.

On an absolute basis as well, VRRM looks cheap. For the sake of simplicity and in trying to avoid overcomplicating things, let’s assume VRRM’s 2021 numbers come out similar to management’s guidance for 2020 and that 2020 is a “lost year.” This would suggest 2021 EBITDA somewhere between $250-260m, or +5-8% growth vs 2019. Assuming earnings grow in-line with EBITDA, that would suggest 2021 EPS of around $0.75 vs $0.70 in 2019. Finally, I add about $0.05 to 2021 EPS from interest savings from mandatory debt prepayments resuming by 2021, which gets me to roughly $0.80 for 2021 EPS. If VRRM can once again trade at a market multiple (~17x) on the other side of coronavirus, that would get us to a $13.60 stock price (or ~70% upside from here).

Key Risks

·       Platinum Equity still owns roughly 30% of VRRM’s equity (49.5m shares), which could create an overhang on the stock if the sponsor decides to sell down their stake or exit the business entirely in the future.

·       A larger and longer-than-expected coronavirus-driven travel impact that lasts well into 2021.

·       VRRM’s important rental car customers (Hertz, Enterprise and Avis) undergoing significant financial distress or facing industry-wide insolvency. 

Catalyst

• Continued good execution and capital allocation decisions over the next 12-24 months
• The market re-recognizing the long term reasons to own the stock (secular high-single to low-double-digit growth in a normalized environment; attractive unit economics) and closing the valuation gap vs the broader market on the other side of coronavirus