Description

Thesis Overview

Verra Mobility is a buy at $14/share or 10x 2022 EBITDA because the company is the dominant market share leader in two segments, electronic tolling for rental cars and video enforcement for traffic violation that have secular tailwinds, additionally the company's strong margins and low capital requirements allow for strong free cash flow conversion that Verra has used to buy back its own stock and make selective acquisitions. 

Returns

At 12x, our estimate of 2024 EBITDA, Verra would trade at $24/share or 70% higher than today's price. This also includes free cash flow generated along the way.

Business Overview

Verra's current business is comprised of the following segments. To get more background on the company, please refer to the two prior write-ups on Verra (2020 and 2018). The biggest change to the composure of the business is that Verra recently purchased a company called T2 Systems which provides parking solutions to colleges and cities.  

Investment Highlights

• Market leaderships leads to great economics and a strong competitive moat
  • Verra is the number 1 player in its two largest markets a) rental car cashless tolling and b) automated photo enforcement. There aren't really any other true rivals with any real scale that can compete with them. This has created a business that has 45% EBITDA margins and ROIC of >50%
• All three segments have secular tailwinds and large growth opportunities
  • Commercial Services
    • Secular: More and more toll roads are converting to cashless tolling. In 2019, 50% of toll roads used cashless tolling. By 2021, the number had grown to 64% (per Verra's 2021 Investor Day presentation). We expect this trend to continue so when you combine that with a return of business travel, Verra's commercial services business can grow high single digits over the next 5 years. 
    • Large growth: Verra has been working for years to recreate its business model for cashless tolling for rental car fleets in the United States in Europe. They are actively involved in pilots in a couple of European countries
  • Government Services:
    • Secular: Traffic stops are the leading cause of police / civilian conflict in the country. There is a strong desire by municipalities to add contactless enforcement programs because a) they reduce the potential for conflict and b) they capture more violations because they are running constantly. Verra offers a broad suite of contactless video enforcement solutions from school zone speeding to bus arm cameras. 
    • Large growth: There are rumors that another or multiple large US cities will put into place a NYC-type school zone speed enforcement program. New York is obviously the largest city in the country but it currently makes up 20% of VRRM's revenue. Winning a Los Angeles, Houston or Chicago would be a meaningful top-line and profit contribution. 
  • Parking
    • Secular/Opportunistic: Verra recently bought T2 Systems to add parking services as a third leg to their stool. T2 has leading market share (+40%) in the in the Tier 1 (>15k students) college sector for parking solutions but ~15% market share in the municipal sector. Verra has sized the municipal total available market at $1.2bln. Verra has +200 relationships with municipalities that T2 previously had no relationship with. We believe that there is a nice opportunity for Verra to cross-sell its new parking solution into their existing video enforcement customers.  
    • Large growth: Verra got into this business to fill out its urban mobility platform. In their view, there will be a movement to "monetize the curb" in the near future. That means managing access to who to can use the curb at any point in time, automating enforcement of those rules and aggregating/analyzing the date for their municipality partners to increase the yield from that highly sought after real estate. Verra has said that this is a potential $4blm TAM
• Strong economic model leads to >50% free cash flow conversion which leads to a lot of optionality when it comes to capital allocation and to grow free cash flow per share significantly
  • At their 2022 Investor Day, Verra put out some long term targets. As part of those targets they announced that they would generate $1.2bln of cash over the next four years or $8.00/share. They are also expecting to grow EBITDA by 40% over that time, so that if they relevered the business to 3.5x EBITDA during that period it would create another $500MM of capital available to deploy (~$3.25 per share). This gives the company a lot of opportunity to do either M&A or share buybacks (of which they have done both in the past). Either way, the result is that Verra expects to generate between $2.05 - $2.10 of FCF per share by 2026 which represents a 15% CAGR from 2021 actual free cash flow per share. I don't expect a business of this quality to be trading at 7x FCF.    
  • In the near term, management has said that they are going to focus their capital allocation on deleveraging the balance sheet given that 2/3rd of the current debt is variable rate (which will be a headwind to 2023 EPS)

Key Risks / Headwinds

• Customer Concentration Risk
  • New York City makes up 20% of VRRM's revenue
  • Hertz, Avis and Enterprise make up 37% of VRRM's revenue
  • Key mitigating factor: All of four of these relationships have been going on for years. Verra's is deeply embedded in not only the customer technology stack but the partner (toll agencies, DMVs etc.) technology stack. In late 2022, Verra renewed Hertz for 5 years, Avis is under contract through 2025 and Enterprise is up for renewal in the spring of 2023
• Interoperability among toll roads would reduce the value proposition VRRM provides to its customers
• Product revenue will likely drop in 2023
  •  The final installation of the NYC school speed zone cameras was completed in Q3 2022. This will cause a YoY decline in overall product revenue in 2023 (it looks like the sell side is modeling this correctly). But what will happen is that Verra's organic growth will slow this coming year vs. a more normalized year as they lap the final NYC camera installations 

Catalyst

Continued services growth in 2023 will lead investors to realize the strong secular trends that Verra has at its back and we can finally start lapping the one-time revenue and profits from the NYC school speed zone roll-out