Verra Mobility (VRRM) is an incredible business with a wide moat that is being overlooked due to its opaque financials and unglamorous entrance to public markets via a Special Purpose Acquisition Company (SPAC). The company was formed via multiple acquisitions in the traffic management space, incurring numerous transaction and transformation charges, as well as large goodwill amortization expenses. In addition, the company incurred sponsor fees via the process of going public using a SPAC. The depreciation and amortization charges on the income statement add up to a whopping $80 million per year, yet capital expenditures have stayed below $20 million per year for multiple years in row. When depreciation and amortization, transaction and transformation expenses, and nonrecurring sponsor fees are backed out of the income statement, and maintenance capital expenditures are assumed to be $20 million going forward, one can unearth a company with normalized operating margins north of 40% per year, which is on par with some of the greatest businesses of all time.
The large operating margins reflect the wide moat of the business. Verra has a virtual monopoly on managing red-light cameras and school zone speed enforcement cameras in the United States. It is also the leading provider of toll management, violation management, and title and registration services for fleet vehicles and rental car companies in the United States. The company offers parking management solutions in Europe and is looking to expand its toll management operations in Europe, with a pilot program in France ongoing and a recent acquisition of Pagatelia, a small toll management company based in Spain. The continued adoption of school zone speed enforcement cameras, continued growth in the number of toll roads, and conversion of toll roads to cashless payments should add tailwinds for growth for years to come, and additional opportunities for expansion in Europe and potential adoption of congestion charges by municipalities provide upside optionality.
The closest public comparator is Fleetcor, which offers fuel payment, lodging payment, and toll payment solutions to fleet vehicle companies. Fleetcor has an operating margin of 52% and is similarly levered with a debt to EBITDA of 3.15X. Fleetcor has been an incredible stock, with over a 1000% gain since going public in 2011, and it trades at 35X FCF. I believe the normalized free cash flow figure for Verra (assuming adequate working capital management) is around $100-120 million currently, with runway for growth in the low teens for many years to come. At the current stock price of $15.25 per share, and 163.7 fully diluted shares outstanding, Verra trades for 20-25X FCF, and is levered with a Debt-normalized EBITDA of 3.5X. This may seem like a lofty multiple, but companies with stable recurring revenue streams (like Verra’s long-term contracts with municipalities, rental car companies, and fleet vehicle companies) and high margins are trading at multiples in the 30X-40X range in the current environment. Assuming a similar multiple to Fleetcor of 35X FCF, Verra would trade at $22-26 per share, for upside of 44-72%. More importantly, the company has the prospect to continue to compound for many years at a 10-20% rate of return as it reinvests at a high rate of return and continues to gain operating leverage. As it delevers its balance sheet, the company may pursue additional acquisitions to realize further synergies (management appears to have a proven track record of integrating acquisitions prior to coming public) or buy back stock for additional returns.
As the company laps its 1-year anniversary as a public company, the incredible financial strength should become more and more apparent as investors buy in to the story and analysts deepen their understanding of the business. Moreover, a recent contract with New York city to install an additional 720 school zone speed enforcement cameras (on top of the 300 existing cameras) should add at least $32 million of high margin recurring revenue going forward (720 cameras * $3800 per camera per month * 12 months). Recent New York State legislation on school bus cameras may result in further upside if Verra can get the contract – a high probability given its level of involvement with New York City. Additional contracts are under negotiation in Georgia, and multiple municipalities are mulling the prospect of congestion pricing. Finally, investors will get a litmus test on pilot programs in France in 2020 as the company seeks to expand its toll management solutions throughout Southern Europe.
Risks include the prospect for public backlash against red light cameras and school zone speed enforcement cameras. Seven states have banned red light cameras, and Verra lost $11 million in annual recurring revenue when Texas banned red light cameras in 2019. I’d anticipate New Yorkers may take some umbrage when school zone speeding tickets begin to arrive in the mail throughout 2020. New York City has asked the company to target 60 school zone camera installations per month in 2020, a significant increase from its 40/month pace in 2019, and even management has expressed doubts they can hit that figure, so there are certainly execution risks in this program.
Competition from Fleetcor or new entrants may eat into the toll management business. One might argue the rental car business is in terminal decline, which will eat into growth rates in toll management. There are significant execution risks with the rollout of toll management in Europe, as Europe is a much more fragmented market than the United States and management has limited experience working with municipalities and toll operators in Europe.
It is worthwhile to note that working capital management has been lax in the first few quarters, with accounts receivable growing faster than revenue, and receivables will be a key figure to watch to ensure the company hits the normalized FCF figures above. It is also worth noting the complete flop of “Peasy”, Verra’s iPhone app designed to provide electronic, RFID-free toll-management to retail customers. The company has struggled to get adoption, and management has no experience marketing an app to the wider public. Lastly, I’d note that the private equity sponsor, PE Greenlight Holdings, has been selling out of the company. It offered shares at $12.50 in June, and recently reduced its stake from 25% to 15% of the company in another secondary offering in November at $14.25 per share. The offering price has acted as a congestion point for the stock, with the price consolidating in the $14-15 range for the last 6-7 months. The recent breakout from this range may be a good sign for the stock, but also note that the PE firm may seek to sell out the rest of its stake as the stock rises, adding overhead pressure.