Redflex picks up Albany OR contract

Don’t run any red lights in Albany.

You may recall that about 18 months ago I invested in an Australian company called Redflex. This company makes automated traffic control systems, and sends you a ticket in the mail if you get caught running a red light. Sue got caught by one of their systems in Minneapolis about 2 years ago. I was so impressed with the technology, I began researching it and really liked the business model. Redflex splits the fines with the city in return for installing and running the system (so the city pays nothing for enforcement). It was just getting started in America, so I got in early. This business model is the ultimate monopoly since the business is protected by a city contract, and people will continue to break laws, right?

Now, you get the benefits (as long as you don’t run a red light) of this technology. Safer streets and more police time to chase bad guys rather than monitoring intersections (or speeders, when you get the Redflex speed enforcement system down the road).

I see that Salem also just entered a contract with Redflex. Corvallis has not done so yet. California and Washington have many systems, as does Arizona. Redflex USA is based in Scottsdale.

If you want to buy the stock, you can buy on the Australian exchange, ASX, as RDF for about $3.19 per share. In the USA, you can buy OTC as a pink sheet stock: RFLXY for about $20 (there are 8 ASX shares to one OTC share, times the exchange rate difference of 1.30 to 1). The price is now just about where it was when I bought in, so you haven’t missed anything. It is a small / speculative stock, so I wouldn’t buy too much. But it will be fun to see their systems around town as a stock owner.

Here is the announcement and the website.

http://www.redflex.com.au/ASX_announcements/PDF/432390.pdf

Recommending Redflex Holdings

I would like to recommend a new stock for your research and perhaps purchase. If you follow my occasional investment newsletters (and upcoming Financial Planning website), you know I don’t recommend new ideas lightly. They have to be original to me, not some pass along idea. The company I am recommending is Redflex Holdings. This is a company we discovered the hard way: by getting a traffic ticket.

Redflex Holdings is a technology company with Australian originations. It has moved its USA HQ to Scottsdale, AZ (who can blame them!). Redflex has its roots in military communications. It continues a Communications Division that has contracts with Lockheed and the US Navy. In Australia, Redflex developed a “traffic enforcement” technology, using cameras mounted at intersections and high speed digital photo analysis to determine drivers who violate red lights (hence the name of the company). The technology is very precise and accurate and the results are great for the municipalities that contract with Redflex: they get better traffic control enforcement, leaving police to higher duties like fighting crime, and cities do not have any capital expense, but share the fines with Redflex. Redflex also offers a “speed limit enforcement” system that is gradually being deployed around the world.

My interest in this company is based on several factors: a contractual monopoly, or as Warren Buffet calls it, a “toll business with a wide moat”, recurring revenues due to its business model of sharing fines with the municipalities contracted to it, a small business base with a very large potential market, significant penetration and demonstrated success, an established business (defense contractor) that feeds capital into the new growth business (this provides dependable cash flow to finance growth reducing risk of growing faster than liquidity permits), provides a service that is very beneficial to society and not a fashion or fad.

Here are some of the metrics which are attractive: low awareness by the investing community (I had never heard of this company until we received a ticket), reasonable price compared to growth rate (40% revenue growth and 50% earnings growth year over year vs. a P/E of around 30), Positive Operating Cash Flow ($15M in 2005 vs. $5M in 2004, price ratio of less than 6 times cash flow), Reasonable price to sales ratio (about 1.8, very good for a fast growing tech company), solid return on equity (15% as calculated by $9M earnings per share divided by $60M net equity per share). Here is the Annual Report: http://www.redflex.com.au/ASX_announcements/PDF/274690.pdf

Many times, the financial metrics for a small growth company are not nearly as attractive as this. Often a lot of faith is required to purchase a small cap growth stock. They frequently are expected to lose money for several years (Amazon STILL is losing money!) That makes this story even better.

What can go wrong? There could be a backlash against automated traffic enforcement. In the Annual Report is a warning that the Ohio state legislature has a bill that would require manual (police officer) enforcement. I think that while this is the emotional response (BIG BROTHER), that eventually people will get used to the idea and accept it. The accuracy is undeniable as the ticket received in the mail has photos of your car with a closeup of the intersection traffic signals and your license plate. You cannot deny the light is Red as you are in the intersection. You can see its color in the photo. The timing of the infraction is to the 1/10th of a second along with indication of speed traveled (which is the basis for the future implementation of speed control).

There may be patent or other intellectual property challenges. Redflex won such a suit earlier this year (actually, it was dismissed). So, like all investments, this has some risk. But I think the upside is worth the risk in this case. Redflex trades as RDF on the OTC BB as RFLXY (20.50 USD on Nov. 11). It trades as 1 share to 8 on the ASX (Australian) exchange. Today (Nov. 11), the RDF.ASX closed at 3.54 AUD on 293K shares (about 3 times normal daily volume). The exchange rate is 1.34 AUD to the USD. So there is no difference between the two markets on converted price. The stock has been going up all year on increasing contracts for the Traffic systems (several signed this week). This could be a very large winner over the next 5 years based on the available market and the minimal penetration to date.