Inclusive Capital spots multiple opportunities for upside with an active ESG focus at Verra
Company: Verra Mobility (VRRM)
Business: Verra Mobility operates through two segments: (i) Commercial Services: the market-leading provider of automated toll and violations management and title and registration solutions to rental car companies, fleet management companies, municipalities, school districts and violation issuing authorities; and (ii) Government Solutions: works with local government agencies to help make cities and roadways safer for everyone through automated safety solutions, namely cameras that detect and process traffic violations for red lights, speed, school bus, and city bus lanes.
Stock Market Value: $2.2B ($14.03 per share)
Activist: Inclusive Capital Partners
Percentage Ownership: 6.66%
Average Cost: $14.11
Activist Commentary: Inclusive Capital Partners is a San Francisco-based investment firm focused on increasing shareholder value and promoting sound environmental, social and governance practices. It was formed in 2020 by ValueAct founder Jeff Ubben to leverage capitalism and governance in pursuit of a healthy planet and the health of its inhabitants. As a pioneering active ESG ("AESG™") investor, Inclusive seeks long-term shareholder value through active partnerships with companies whose core businesses contribute solutions to this pursuit. Inclusive is a returns-driven fund with a focus on environmental and social investing. The firm's primary focus is on environmental and social value creation, which in turn creates value for shareholders. Inclusive is so focused on environmental value that it has created a new metric to screen and value companies: enterprise value to carbon emissions abated.
Sarah Farrell, a partner at Inclusive Capital, was appointed to Verra's board on Dec. 30, 2021, just four months after Inclusive Capital filed a 13D, reporting its position in the company.
Behind the Scenes
Verra Mobility operates through two segments: (i) Commercial Services ("CS") and (ii) Government Solutions ("GS"). The CS business turned what was a major headache and large administrative cost for the rental car companies into an ancillary revenue stream at 100% margin. The company takes a cut of the daily service fee and a piece of the toll. The company has relationships with tolling authorities across the entire country, processes 250 million transactions per year and is really the only national provider of toll management across the country. The GS business is revenue generating for local governments and helps them increase their road safety mandates and identify problem zones.
The CS segment comprises approximately 60% of the company's revenue and has 63% EBITDA margins at the segment level and the GS segment comprises approximately 40% of the company's revenue with 40% EBITDA margins at the segment level. Both businesses are No. 1 in market share with the CS business covering 95% of U.S. toll roads and the GS business having 70% of U.S. market share. This results in a very high margin business with maintenance capex of only 6% of revenue and an approximate 50% return on invested capital.
Despite all of this, the company is undervalued because investors are not giving it credit for recovery from Covid, even though the CS segment is at 98% of 2019 revenue and the GS segment has exceeded 2019 revenue. Moreover, from 2015 through 2019, it grew EBITDA at 19% per year and is expected to grow EBITDA more than 25% per year in 2021 and 2022. This will result in internally generated cash flow of $500 million that can be used strategically or for stock buybacks representing approximately 20% of its present market cap.
Additionally, there could be future upside from three areas. First, the company could have a huge opportunity replicating what they currently have in the U.S. in Europe. Europe has even more tolls. If the company could find a way to manage the tolls for the European arms of the U.S. rental car agencies, there could be a $300 million to $350 million market opportunity, compared to $230 million in revenue generated from CS in the US in 2019. Second, there are attractive opportunities for strategic M&A. The company's management has shown they can be disciplined with acquisitions. The most recent acquisition, Redflex, is in the process of being fully integrated. Third, there are capital allocation opportunities with the company already announcing a $100 million stock repurchase plan.
As is customary with Inclusive investments, there is also a very strong ESG component to this business. Within CS, the company allows for more diversity in infrastructure funding. Most infrastructure costs are currently financed by gas taxes. However, with cars becoming more fuel efficient and the rise of electric vehicles, gas spending is in a secular decline, which is good for the environment. An increase in the amount of tolls collected will make up for this decline benefiting the environment while increasing VRRM's CS revenue.
In the GS segment, the ESG benefits are much clearer. Motor vehicle traffic accidents are the third leading cause of death in the U.S. in individuals ages 1-44, after drug overdoses and suicides. As of 2019, motor vehicle accidents accounted for 36,000 deaths in the U.S. and speeding and intersection-related accidents accounted for 55% of those fatalities. The GS business directly targets that problem. The Insurance Institute for Highway Safety found that red-light cameras reduced traffic fatalities by 21% in the U.S. and speed cameras reduced traffic fatalities by as much as 39%. The higher penetration that the GS business gets, the more profitable the business becomes for sure, but just as clear, the more lives are saved on U.S. roads each year.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving ESG practices of portfolio companies.