A Railroad IPO Gets Derailed

By Christopher Barker | More Articles
October 14, 2009 | Comments (1)

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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.

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The Motley Fool CAPS community has shared its collective insight on 35 "Road and Rail" companies. Join the free CAPS community today and share your views on how the industry will fare.

Fool contributor Christopher Barker has never hopped a freight train, but he thinks it would be a fun place to learn the harmonica. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He also tweets. He owns no shares in the companies mentioned. Genesee & Wyoming is a Motley Fool Hidden Gems recommendation. Try any of our Foolish newsletters today, free for 30 days.The Motley Fool has a disclosure policy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

Report this Comment On February 23, 2010, at 12:20 PM, dausen6tas wrote:

This article is spot on target. RailAmerica is led by a former CSX management crew. Niche is right. Short lines and Regionals have a specific niche. They are not Class I's like the BNSF, UP, NS or CSX and therefore have to operate differently. Short lines are basically wooden axle railroads from years of deferred maintenance, so they usually do not have high speed rail or the best equipment to offer customers. What they do have to offer is service, customer partnerships, and reasonable accessorial charges. RailAmerica execs seem to think they are Class I's and price themselves accordingly without putting in the necessary dollars to maintain their railroads. As a result, this business plan will eventually fail just as it did for a similar short line company known as OmniTRAX INC. when some Class I execs tried the same model and failed miserably. The sooner RailAmerica realizes that they are not a Class I railroad the better off they will be. Then, maybe, they will actually experience some real growth. The saying goes as a rail customer, "If you are going to act like a Class I railroad, I might as well be dealing with a Class I and therefore, no longer need YOU, the Short Line!"

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