Description

Gores Holdings II (GSHT) is a SPAC formed by The Gores Group, a Los Angeles-based private equity firm. The SPAC is acquiring Verra Mobility, formerly known as American Traffic Solutions, from Platinum Equity (the firms are incidentally led by brothers Alec and Tom Gores). The transaction should close within the next few weeks.

The Gores Group’s first SPAC, Gores Holdings I, formed Hostess Brands (TWNK). For those who dislike SPACs, like everything in life there are good ones and bad ones. Verra is private equity owned with a sophisticated public company type management team that has deep M&A experience.  

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We recommend purchase of Gores Holdings II (GSHT), as we believe that pro-forma for the completion of the transaction, Verra Mobility is currently valued at only 12x 2019e / 11x 2020e FCF per share.

• Virtually 100% transaction processing-type recurring revenue businesses with long-term contracts in place
• High single digit revenue growth with near 60% EBITDA margins and an EBITDA to free cash conversion of 55%
• Number one market share in virtually all its businesses - only national player in car rental vehicle toll management
• Multiple growth opportunities organically and via M&A. Replicating “toll management” in Europe a big opportunity

Verra Mobility operates in two segments:

Tolling & Fleet.  Pro-Forma 2018e Revenue and EBITDA of $230m and $150m – 65% margin

• Toll Management about $180m revenue and $125m in EBITDA – 70% margin
  • Within Toll Management – Hertz, Avis and Enterprise make up about $150m revenue and $105m EBITDA
• Violations / Title & Registration / European operation combined about $50m revenue and $25m EBITDA   
• Management expects “Tolling & Fleet” to grow revenues by 6-8% annually with flattish EBITDA margins  

The “Toll Management” business offers an elegant solution to what was a major hassle for the car rental companies.  

Before Verra:  

• Renter drives through a cashless toll. Toll authority issues a penalty to car owner (i.e. Hertz)
• Local Hertz offices flooded with tickets/fines, has to figure out who was driving each car through which toll
• Hertz then has to bill the customer for the entire fine…angry customers with some likely refusing to pay
• Hertz stuck with fines, administrative hassle and additional expense for this whole process

After Verra:

• No more penalties. Every car is registered at nearly every U.S. tollway. Each renter ultimately pays for tolls used
• Removes administrative hassle for Hertz….lucrative new ancillary revenue stream for Hertz
• Service fee revenue share provides Hertz with tens of millions of virtually 100% margin revenue

Verra enables car renters at Hertz, Enterprise, Avis and other car rental companies/fleets to use cashless toll lanes without penalty. Verra has relationships with virtually every tolling authority in the U.S. (which include prepaid tolls of 6.6 million). Verra captures rental car fleet license plate information in real time (Hertz alone has over 500k vehicles in its fleet), uploads that information to every tolling authority nightly, matches license plate information to tolls charged and bills customers for toll costs incurred – in total Verra processes 165 million toll transactions annually. Verra’s employees also manage the distribution and placement of transponders in cars at its many customer locations.

The rental car companies charge a service fee to their customers (i.e. Hertz charges $5.95 each day a toll charge occurs). Verra receives a piece of the service fee as its revenue and, in addition, keeps the spread between the undiscounted toll it charges the renter and the discounted rate made available by tolling authorities to anyone that prepays tolls. The vast majority of Verra’s tolling revenue comes from the service fee revenue share (not all tolling authorities offer discounts). While some are bearish on the rental car industry, “rental car days” have been flattish at Avis/Hertz for the past three years. Further, attach rates for Verra's service should continue to improve from the high teens/mid-twenties percent currently.

Post Verra’s acquisition of HTA (which provided toll management services to Enterprise and Avis), Verra now has all three major car rental companies under long-term contracts and is the only national player in the space. The Hertz and Enterprise contracts run through Q4 2021 while the Avis contract runs through 2024. The barrier to entry here would be Verra’s technological connection/implementation into every tolling authority in the country, something it claims would take a potential competitor many years to replicate.  

There’s good natural organic growth here as more toll roads go cashless and as the rental car companies do a better job educating their customers about the ability to use cashless tolling (Avis attach rate is nearly 25% while Hertz is less than 20%). While consumers might be surprised and unhappy about the subsequent credit card charges to their accounts – the fact is that without a tolling solution, a customer would pay a large fine to the tolling authority.

There has been some controversy about the rental car companies charging service fees every day of the rental regardless of whether a cashless toll has been utilized. Hertz has moved away from this model and now only charges a day of use service fee. Verra saw no impact from this move as it has minimum guarantees in its contract with Hertz (in addition volumes have continued to increase). Avis and Enterprise may well follow Hertz and begin to charge for toll usage days only. Either way, we don’t expect an impact to Verra – the Avis contract has minimum guarantees through 2024 and the Enterprise relationship is structured such that Verra receives a minimal transaction fee per rental agreement (rather than a share of service fee revenue). Regardless, increasing attach rates will drive greater and greater renter usage of cashless tolling which is very powerful – we estimate that Verra’s Hertz revenues will have grown from $52m in 2017 to $56m in 2018 despite Hertz going to a rental day charge only model in early 2018.

The obvious risk is what would happen upon expiration of the contracts (Hertz/Enterprise late 2021 – Avis 2024).  We would note the following:

• Our base case assumption is Verra continues to keep the big three as customers. Verra is the incumbent, they are the only national player, they created this business and have executed flawlessly. It’s worth noting that for a $21m payment, HTA (prior to its acquisition by Verra in 2018) extended its Avis agreement from 2021 to 2024
• The car rental companies are almost certain to push for a greater percentage of revenue share. Verra management would argue that with no other national player in the space, margins are unlikely to get squeezed much (if at all) and that any reduction in revenue share would come with lengthy contract renewals
• By 2022, we estimate that Hertz/Enterprise will likely account for 30% of company EBITDA. Even at half their previous profitability levels (seems extreme), between M&A contributions and general organic growth, we do not see 2022 FCF dipping below $1 per share.  If in return for sacrificing some margin, Verra gains long-term contracts – that security is deserving of a higher multiple. Avis on its own in 2024 would be less than 15% of EBITDA

In addition to the rental car business, the Tolling and Fleet segment includes a violations business ($28m 2017 revenue) where Verra processes violations issued to fleet/rental drivers as well as a title and registration business ($11m 2017 revenue) where Verra provides high volume automated title and registration services to the car rental companies.

Internationally, Verra just acquired EPC, a UK-based company with $12m revenue and $5m EBITDA. From EPC’s web site….”Euro Parking Collection plc (EPC) specializes in the identification, notification and collection of unpaid traffic and public transport related fees, charges and penalties issued to foreign registered vehicles (FRV) or persons across Europe…….”At present, EPC works on behalf of more than 450 issuing organizations in 15 European countries. These organizations are primarily made up of public and police authorities, councils, municipalities, national government agencies, road toll operators and private parking companies.”  

Management views Europe as a major opportunity to replicate its U.S. toll management business. Verra’s U.S. rental car customers have all asked Verra to provide the same service in Europe that it offers in the U.S. EPC, with its connection into many toll road municipalities in Europe, should enable this business to grow considerably.

Lastly, for this segment, Verra has developed an app called Peasy, which enables consumers to pass through any toll in the U.S by registering their license plates and credit card information online. The rental car companies are likely to block the use of their cars on the app since a user will likely forget to remove the license plate from the app upon completion of their rental.

Safety Automations.  

• Pro-Forma 2018e Revenue and EBITDA of $145m and $60m – 41% margins  
• Management expects this segment to grow revenue and EBITDA at about 2%-4% annually  

In this business, Verra offers enforcement technology for red lights (46% market share), speeding (55% market share), school buses (48% market share) and city bus lanes to local municipalities. Verra is number one in the space for red lights, speeding and school bus cameras. Verra’s cameras catch offenders and the company then tickets the offenders. The cameras are considered a safety tool – they of course produce revenue for local municipalities as well. Verra operates red light cameras in 16 states and speed cameras in 11 states. Once a state legalizes the cameras, Verra is able to offer their products to local municipalities. There are two revenue models, fixed contract (monthly fee) and variable contract (percentage of revenue generated). The company forecasts 2%-4% revenue/EBITDA growth driven by pricing and some additional installations in existing states. Management is not assuming adoption in any new states in the near term.

Valuation.  Pro-forma valuation is as follows

• 155m shares O/S.  40m SPAC, 39m PIPE buyers, 65m to Platinum, 11m Gores (6.5m founders + 4.6m PIPE)
• From its 10m founders shares, Gores gave up 3.5m to the PIPE buyers + it acquired 4.6m in the PIPE itself
• Balance sheet should show $900m debt and $50m cash at closing – Debt / 2018e EBITDA is 3.9x
• Market cap of $1.6 Billion (155m O/S * 10.40) plus net debt of $854m = EV of $2.47 Billion
• Earn out share schedule (10m shares) is as follows: 2.5m shares each at $13.00, $15.50, $18.00, $20.50
• Management projections are below: all pro-forma for the acquisitions of HTA (3/1/18 for $604m) and EPC (4/6/18 for $63m) and include $20m of synergies to be achieved in 2018 and 2019
• Cap-ex is low, cash interest is about $55m annually and the amortization step-up at HTA creates a low cash tax rate
• Keeping debt and interest cost flat we assume FCF of $130m in 2019 and $150m in 2020 prior to any M&A impact  

Unquestionably, management will do M&A to continue growing the business. Cash on the B/S + 2019/2020 FCF alone should total over $300 million. That level of M&A ought to produce an incremental $30m EBITDA / $20m FCF over and above the company’s projections by 2021.   

Summary. Verra is a unique, niche business with significant growth opportunities, enormous FCF and a low valuation. The rental car company contracts are long term in nature. Some reduction in margin on those contracts is possible but would likely come with a lengthening of long-term contracts – considering that there are no other national players and that Verra has executed flawlessly in its relationships with the big car rental companies we aren’t overly concerned. At $1 of 2020 FCF we’d expect at the very least a $13 to $15 share price. Leverage at 3.9x is reasonable. The Europe rental car opportunity seems quite significant and Peasy is an interesting option. Lastly, Platinum Equity (the seller) is retaining quite a bit of equity and the sponsor in addition to owning equity today gets warrants that pay off significantly at higher prices.

Catalyst

Completion of the SPAC transaction