A Railroad IPO Gets Derailed

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Real investors understand a tasty niche. Within the competitive realm of railroads, short rail and regional specialists operate in a niche that spares them from competing directly with smooth operators such as Norfolk Southern (NYSE: NSC) and Burlington Northern Santa Fe (NYSE: BNI).

But niche or no niche, investors had no appetite for the latest railroad IPO.

Just a couple of years after taking the company private for $1.1 billion, private equity firm Fortress Investment Group LLC (NYSE: FIG) returned short rail specialist RailAmerica (NYSE: RA) to the public arena with a $330 million IPO Tuesday. Priced at $15, shares traded in their debut for less than $14, well below initial expectations of $16 to $18 per share.

Under Fortress' stewardship, RailAmerica's debt ballooned from about $400 million at the end of 2006, to $714 million in the most recent filing. Even after using IPO net proceeds of $74 million to pay down debt, total indebtedness will have increased by about 60% while the company was out of investors' reach.

Furthermore, the timing of this particular IPO is highly problematic for prospective investors. Aside from what this Fool considers the mounting risks of a broader equity correction, red flags emerge from the railroad sector as well.

The pace of recovery in the sector's share prices appears to contradict both the explicitly cautious tone from industry CEOs, as well as persistently sluggish freight volumes, which are currently hovering about 15% below 2008 levels. When the broader market turns, I believe that shares of railroad operators will go along for the bumpy ride.

Since issuing the clarion call of bottom declarations that emerged from railroad operators after the second quarter, shares of CSX (NYSE: CSX) have surged another 20% atop a swift recovery from the worst levels of the year. Genesee & Wyoming (NYSE: GWR), RailAmerica's principal competitor in short line and regional services, has seen shares recover to the tune of 97% from their March lows.

With railroads facing a long and challenging incline of recovery, this Fool would rather see investors watching this latest offering from the sidelines than hopping aboard a potential train to nowhere. Once the dust settles, we will delve deeper into the company's operations and competitive landscape. For the moment, this IPO presents one more train that I'm content to watch from afar.