Friday, January 16, 2009

Short Line and Regional Perspective: It never ends, does it?

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By Tony Krugliski, Financial Editor

The other day, I asked a friend if he had seen a decline in home values in his town and if so, how much the values had declined. “Well,” he responded, “we really haven’t noticed much of a decline in values—but then again we haven’t seen any sales in my neighborhood for some time.”

 

The same thing holds true for sales of leased rolling stock in the secondary market. There haven’t been any significant sales that would put the present state of market values under a flood light. But there have been indicators as to what is actually going on.

Let’s explore the question of indicators as to the values of railcars and locomotives under lease that are being traded in the secondary market. Let’s stay with the real estate analogy. I doubt that I would get an argument from anyone reading this that a “professional” building that is fully tenanted by doctors, dentists, and law firms with long-term leases is obviously worth more than one standing empty. The same thing applies to equipment under lease when compared to equipment parked in the weeds. The cars or locos with leases attached are worth more. If the lease is particularly well priced from the potential buyer’s point of view, the equipment is worth even more than that.

But, as we said above, there haven’t been all that many recent fleet sales (involving leased or unleased rolling stock) to which we can look to estimate trends in values for railcars and locomotives. Why is this? In some cases, leased assets have been shopped (formally or informally), and the owner has come away from the process uninspired at the pricing that it has been offered for its equipment. The catchphrase that is being bandied around is that equipment owners are unwilling, even in this market, to sell leased railcars and locomotives at less than the “book value.” (Put another way, to take a loss on their equipment.) For this reason, sales offerings are withdrawn or are not even initiated by potential sellers who are unwilling to take a loss.

We currently know of at least two situations where informal sales activities are continuing without formal requests for proposals or the generation of broadly disseminated data from which a potential seller could make such a proposal. Apparently, these equipment owners are not hiring sales agents nor requesting proposals from market “players” in the hope that they can find someone (perhaps a new market entrant) who will pay them the book value or better for their equipment. In the absence of that kind of buyer being found … no formal offer of sale is being issued.

In this situation, what are the assets actually worth? We’ll take our cue from the real estate market. Any veteran homeowner will realize that eventually there will be sales in a down market and that these sales will probably evidence a dramatic decline in property values (at least for sales that actually occur under some kind of pressure like death or foreclosure.)

We’ve heard rumors of one sale in this market that involves a fleet in excess of 2,000 railcars that is supposedly to have been priced at approximately 85% of the value of those assets on the books of the seller. (We are told this sale occurred under some pressure to sell.) Our source also speculated that this sale price was due, in part, to an absence of buyers during the sales process.

If the above is true, it would indicate that there is presently a discount of 10% to 20% of book value built into potential railcar sales situations. The discount might be even greater for used locomotives not under lease, due to the fact that there are estimated to be more than 1,000 parked by lessors at the time this column is being written in December 2008.

In the past, we’ve had lessors tell us that their target for a return on investment in railcars or locomotives offered for lease is approximately 15% per annum. If our guess at the likely discount to book value is correct, buyers who can put together a deal with a (potentially pressured?) seller should be able to generate returns of between 15% and 20% if they can get appropriate financing.

Financing? Yes, there is that issue. There may be potential railcar and locomotive investors out there, but their ability to leverage their purchase 80% or 90% is probably long gone in this market. A 70% advance against value (assuming the buyer is looking for “non-recourse” financing) may be a better guess today. Perhaps this is the reason that there were so few buyers stepping up to the mark on the one small reported sale about which we heard rumors.

What does this all add up to? Perhaps if someone really has to sell, the big discounts on sales of existing fleets that some potential buyers have been seeking might become a reality. Or potential sellers could just decide to sit on assets until things improve. Then the question becomes, how long will that take?

It never ends, does it?