Saturday, April 07, 2012

This Week at Amtrak

FEC Depot Boca NEFEC Depot Boca NE (Photo credit: Wikipedia)
From the United Rail Passenger Alliance:

This Week at Amtrak; Vol. 9 No. 2
Volume 9, Number 2

From the Editors…

When the parent company of a legendary railroad states its intention to operate passenger trains, it is bound to garner some attention. This week we try to find out what all the hubbub is about.

What’s all the fuss?

Last week the parent of the Florida East Coast Railway announced its intention to establish passenger train service between Orlando and South Florida. Suffice it to say, this set the world of rail travel advocacy aflutter, leading to numerous online articles, blog posts, and more than a palpitation or two. This is all the more remarkable since the FEC exited the passenger train business on July 31, 1968, thus never having become an Amtrak subscriber. Many find this hard to fathom. As historians like to point out, however, history does not repeat itself; but it does rhyme.

MORE, PERHAPS, than any other part of the United States, excepting the Great Northwest empire of James Jerome Hill, it is possible and, indeed, almost mandatory to think of Florida in terms of the personality of a truly imperial railroad builder whose equally imperial whim was the organization of a vast geography as his pleasure dome and lasting monument. Henry Morrison Flagler, a partner in Standard Oil with John D. Rockefeller who retired with an immense personal fortune in vigorous middle age and full possession not only of millions but the will to spend them grandly, was able before his death to claim Florida almost in its geographical, economic and social entirety as his own creation. Call it enterprise or call it megalomania, no Roman proconsul or magnifico of medieval Italy ever brought into being so grandiose a concept as railroading and its incidental and collateral expansion in Flagler’s Florida. - Lucius Beebe, The Trains We Rode, Volume One, Howell-North Books, 1965

The seeds of the modern era of the Florida East Coast Railway were sown toward the close of the Twentieth Century. With the loosening of Depression Era banking regulations, numerous private equity investment firms were established such as Goldman Sachs, The Carlyle Group, and The Blackstone Group. Their mission was simple: Invest their clients’ hard-earned dollars with an expectation of a return on that investment.

Fortress Investment Group was founded as a private equity firm in 1998, and is headquartered in New York City. Among their stated goals is to obtain “distressed and undervalued assets (some with limited current cash flows and long investment horizons) and tangible & intangible assets (real estate, capital assets, natural resources and intellectual property).” The expected life of these transactions is 3 to 25 years.

The Florida East Coast is much more than a railroad. There is the Florida East Coast Railway that operates 351 miles of mainline track between Jacksonville and Miami. The parent company, Florida East Coast Industries, also owned and operated Flagler Development Group, one of the premier developers in the state. Its portfolio of properties includes about 8.8 million square feet, primarily located in Jacksonville, Ft. Lauderdale, Orlando, and Miami. Flagler also provides construction, consulting, brokerage and property management services. The company also owns about 853 acres of entitled land in Florida and more than 3000 acres of Florida real estate in its land bank that are not yet entitled. It should be noted that of the listed Flagler prime property locations, Orlando is the only one NOT located on the railroad.

The FEC was acquired out of bankruptcy in 1961 by The St. Joe Paper Co., a legacy of the du Pont era. St. Joe controlled the FEC until 2000, when St. Joe distributed its Florida East Coast shares to St. Joe stockholders. The FEC became an independent public company, but this freedom would be short-lived.

The Staggers Act of 1980 removed much of the regulation overreach from earlier in the century, allowing the railroads to act as they were intended; as businesses. Since 1980, $480 billion has been invested by the nation’s railroads into their physical plant. With railroads now allowed to maximize the leverage of their franchise opportunities for growth became evident over the following two decades, especially to investment firms. All aspects of railroading, from manufacturers to railroads, themselves, have found favor once again with the money changers.

Fortress Investment Group’s initial foray into railroading was the acquisition of RailAmerica, a short line holding company, in February 2007. It would take RailAmerica public with an initial public stock offering in October 2009.

By 2007 the FEC was ripe and ready for a change. As a result of the protracted financial malaise gripping the entire state in the first quarter of that year, earnings suffered a drop of about 50%. Net income fell to $9.04 million compared to $18.7 million for the first three months of 2006. Revenue during the quarter dropped to $108 million from $136 million. This was attributed to a decline in revenue of $43.9 million in land sales, and a $7.3 million drop in railway revenue. To most, this would appear to be a distressed and undervalued asset; for Fortress, this was an opportunity.

On May 8, 2007, the Florida East Coast Industries Board of Directors unanimously agreed to a takeover by Fortress in a transaction valued at $3.5 billion. The Surface Transportation Board granted its blessing in September, 2007. Under the Fortress banner, the railroad and Flagler Development have been split apart; but remain as staples of their “Alternative Asset Management” portfolio.

So what’s next?

Flagler’s first hotel venture was The Ponce de Leon at St. Augustine, costing a then astronomical $1,250,000 and advertised as the finest resort hotel in the world. More investments followed in dizzying succession as Flagler, indifferent to considerations of profit or loss, began the realization of a vision which embraced all Florida as the playground of the nation with amenities of relaxation for every taste and purse. In 1893 he added a new dimension of splendor and costliness with the opening at Palm Beach of the incredible Royal Poinciana Hotel while the iron of the Florida East Coast was still sixty miles away at Fort Pierce. From then on resorts palatial and modest leapfrogged the railroad down the seacoast: Hobe Sound, Jupiter, Fort Lauderdale, Biscayne and Miami. - Lucius Beebe, The Trains We Rode, Volume One, Howell-North Books, 1965

The “playground of the nation” as left by Henry Flagler has grown up into an economic force within its own right, and is now the fourth most populous state in the union. The state’s Gross Domestic Product was $748 billion in 2010, also fourth in the nation. For Flagler, the goal was simple: the importation of vacationers (and their money) to enjoy the mild weather; but even Flagler realized that beautiful vistas and sandy beaches were worthless unless a means existed to transport people to them.

For Flagler’s successors at Fortress, the objective becomes a little more complicated. Certainly “considerations of profit or loss” weigh heavily on their minds. The true ultimate goal of Fortress (as with any similar investor) is to build the capital value of the investment to multiples of its original value; before selling out, either to a "buy-and-hold" investor (e.g., Berkshire Hathaway) or to the public in an IPO. Profits are merely the lever, not the goal.

Locked in the legacy of the FEC, Fortress has tangible and intangible assets, the value of which have always been dependant upon the ability or inability of access by the public. The future of publicly funded and maintained transportation is anemic, at best. As a property owner, Fortress has a unique advantage: It already owns a transportation company not dependant upon publicly-funded rights of way or traffic control systems.

How does one maximize leverage of the franchise to advance and tap into the state’s GDP? Port Everglades (Fort Lauderdale) and the Port of Miami are undertaking expansions which renew rail access. Even so, the fact remains that people really do live here. Flagler Development currently lists a nine-acre property consisting of five lots which “is currently entitled for 2.5 million square feet of mixed-use development.” Also from the listing:

Downtown Miami has become a vibrant urban center where a population of 71,000 swells to 194,000 during business hours. Within walking distance of Miami-Dade College, the New World School of Arts, American Airlines Arena, and the Adrienne Arsht Center for the Performing Arts, the property is also at the epicenter of Miami’s cultural district.

Ironically, this is the land which once was home to the FEC’s Miami passenger train station and tracks, which were razed in the autumn of 1963. With rail access being restored to the Port of Miami just north of this site, restoration of rail service to downtown becomes a real possibility. Could this factor into whatever Fortress has in mind for its modern-day version of the FEC?

Obviously, none of us here claim to know what the service proffered by the FEC will look like, or even if it will, indeed, transpire. That is not the point. What is relevant is that investors find railroads attractive again; and this adoration is growing. Generally, one needs to spend money to make money. Is a $1 billion investment of private capital justified to unlock the untapped/unrealized value of existing assets? The formula that made Flagler a success is still quite relevant. Fortress Investment Group may be just 14 years old, but perhaps it has figured this out.
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