The two faces of Florida East Coast

Posted by Fred Frailey
on Wednesday, May 18, 2011

The Florida East Coast Railway that most people see looks to be doing fine. Intermodal business, which brings in 62 cents of each dollar of revenue, is at record levels. Almost four-fifths of the debt incurred at the time of its 2007 buyout by Fortress Investment Group was refinanced last January at lower rates. FEC is reviving its moribund spur to the Port of Miami as the port is dredged in expectation of Panamax container ships in 2014. What’s not to like about this picture? Nothing, and it’s the theme of my column in the forthcoming July issue of Trains.

But a filing with the Securities and Exchange Commission this month portrays a railroad that until recently was in far different — some would say dire — condition. Last year, interest expenses consumed one-third of FEC’s $200 million in revenues and virtually all of its free cash flow. The bottom line has bled red ink now for three consecutive years. And the aggregate business, which has traditionally paid for the railroad’s exemplary track structure, remains as dead as Florida’s construction industry. Carloadings of rock actually declined in this year’s first quarter from a year earlier.

The SEC filing can be read here. It’s the first glimpse outsiders have had of Florida East Coast finances since private equity funds managed by Fortress took the railroad private three and a half years ago. The reason for the filing is that FEC is offering to exchange the two issues of debt it and its holding company issued in January for identical notes that, unlike the first ones, can be traded easily on secondary markets.
The debt comes in two parts. One is $475 million of six-year notes at 8.125 percent, replacing short-term borrowings at rates of up to 11 percent. The other $130 million is more interesting. This so-called “payment in kind” debt would permit FEC to pay the interest rate of 10.5 percent or higher either in cash or by issuing even more of the PIK notes. Such notes, which are not secured by FEC’s assets and are subordinate to all other debt, are highly speculative. If management cannot make interest payments and instead issues more debt, the situation can quickly spiral out of control.
However, a source close to FEC tells Trains that the railroad plans to sell an initial public offering of stock, perhaps within the next year, the proceeds of which would be used to retire that $130 million of PIK notes. Until such time, the source adds, the railroad will probably opt to conserve cash by making interest payments on those notes in the form of more notes.
The refinancing has positive and negative implications for FEC. On the plus side, interest expense will decline from $66 million to $39 million annually, presuming the company issues stock in lieu of cash payments on its PIK notes. The savings give the railroad enough cash flow to try keeping its 60-mph track in good working order, essential if it is to provide dependable intermodal service on its 351-mile main line. But those payments in kind on the smaller debt issue will worsen the balance sheet and cause the company to look less attractive to would-be buyers of a stock offering.
In fact, it’s uncertain whether the company can be made to look like a silk purse to potential investors soon. Had today’s lower interest rates been in place during all of 2010, according to the SEC filing, the railroad would have made a profit of only $3 million or so. Plus, revenues last year were up sharply from their 2009 lows but remained down 28 percent from their 2006 peak and 17 percent from pre-recession 2008. The bright note is intermodal, but it comes with razor-thin profit margins. The railroad remains a barometer of the Florida economy, notorious for its ups and downs.
So which Florida East Coast Railway is real: the one described in my column you’ll soon read in Trains, or the one pictured in the SEC S-4 filing? They’re two snapshots of the same thing. The former is FEC seen through the prism of optimistic and down-to-earth Jim Hertwig, the railroad’s president since August 2010. The latter are the cold hard numbers that depict a company struggling to regain its footing. Hertwig is betting he can make intermodal revenues continue to climb until the Florida construction industry revives and those quarries near Miami begin to load rock again in big numbers. Those cold, hard numbers, in fact, give him six years for the Florida economy to recover. Chances are, it will. — Fred W. Frailey

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