Tony Kenney is expecting the question: How did Marathon Petroleum (MPC) and its retail subsidiary, Speedway, justify offering $2.874 billion for the Hess retail portfolio?
Granted, the convenience network is the fifth largest in the United States, with 1,256 stores in 16 states on the East Coast and Southeast, plus a transport fleet and pipeline shipper history.
With the Hess network tucked in, Speedway, the respected Midwestern powerhouse based in the sleepy town of Enon, Ohio, nearly doubled its store count to more than 2,700 across 22 states.
Yet analysts and industry observers are grappling with the multiple that Speedway paid. Was it too hefty a price to win a coveted prize?
Ken Shriber, managing director of Petroleum Equity Group, Chappaqua, N.Y., has described the price tag as “eye-popping, head-shaking, jaw-dropping.” That’s because it suggests a price of more than $2 million per site, or 12x to 14x EBITDA, at a time when East Coast prices are trending more in the range of $1 million to $1.5 million, or 6x to 8x EBITDA (earnings before interest, taxes, depreciation and amortization).
“Think about that—it’s double what analysts think Susser paid for Aloha Petroleum,” says Dennis Ruben, executive managing director of NRC Realty & Capital Advisors LLC, Scottsdale, Ariz., referring to Susser Petroleum Partners’ September acquisition of Hawaii’s largest independent marketer.
What remains unknown is the extent to which Aloha owned or leased its sites. “On the other hand,” says Ruben, “people are paying a lot of money.”
Alain Bouchard, recently retired president and CEO of Alimentation Couche-Tard, Laval, Quebec, which vied for the Hess assets, called the winning price “too high.”
“Marathon paid several million dollars more than the amount [Couche-Tard] was willing to offer,” he said at a financial meeting in May shortly after the deal was announced.
So why did MPC/Speedway spend so much?
In an exclusive in-person interview, Speedway president Kenney sat down with CSP one day after the Hess acquisition closed for an adjusted purchase price of $2.82 billion.
Yes, the price was high, but not for MPC/Speedway, not for the promises the Hess properties hold, not for the capabilities Speedway will bring to the equation. Specifically, Kenney points to the potential: additional merchandise margin. Speedway generates an incremental $17,300 per store per month compared to Hess. That is $250 million in annual incremental merchandise margin potential across all of Hess retail, with $70 million expected in the first three years.
How? By leveraging Speedy Rewards, the gold standard of loyalty programs; its operational discipline; and best practices among Speedway, Hess and the remaining retail legacy of WilcoHess.
“We wanted to be able to have the opportunity to enjoy the returns and the value that we create from the company by bidding the way we did on it. Many items came into play, including what we could achieve in just three short years with these assets. Based on our expected EBITDA in 2017, this transaction has a 7.7x multiple,” says Kenney. “Now, whether people choose to agree with that or not, the burden’s on us, obviously, and how our shareholders and investors will ultimately look at that.
“That’s really the heart of this thing: the opportunity this gives us to recognize the levels of this value and the longer-term value this transaction generates.”
CONTINUED: Making the Case
Making the Case
Going from a few percentage points in an integrated oil company’s revenues to a key driver of Marathon Petroleum’s downstream portfolio, Speedway has truly grown up.
Or, as Kenney likes to put it, “A little hidden gem within the company was being discovered.” He has led the retail business since 2005, when it still included SuperAmerica and was in shrink-to-grow mode, casting off its Southeast sites and focusing on driving operational efficiencies from an increasingly concentrated Midwest base.
After Marathon Oil spun off its downstream into MPC in 2011, Speedway’s profile rose. It soon ramped up again for expansion, snapping up nearly 130 sites in various transactions, including 30 Gas City sites in 2011 and 88 GasAmerica locations in 2012.
For those attending the Gas City auction, it seemed clear that Marathon got marching orders from headquarters: Don’t come home without most of the assets.
“Those are very good, strategic locations, really prime locations around Chicago they must have determined they wanted to control,” Ruben says.
Last year, Speedway entered Tennessee and Pennsylvania. The company also earned a three-year capital infusion of $925 million capital infusion even before plans to purchase Hess were announced.
All of these were signs that Speedway was preparing itself for bigger things and an endorsement from MPC president and CEO Gary Heminger, who believes in the potential of the refiner-marketer’s high-valued, stable cash-flow businesses. This includes the midstream operations—8,300 miles of pipelines and terminals—and Speedway.
Hess appeared to be a natural match for Speedway: Both have oil-company roots and represent an uncommon dedication to pure company-ops at a time when franchising is more attractive to giant retail chains such as Circle K and 7-Eleven, and to oil corporations such as Chevron that remain vested in the c-store sector. Hess will give Speedway a huge footprint on the East Coast, which has a high barrier to entry, and a chance to return to the Southeast.
It also would feed MPLX, marking yet another big deal with MLP fingerprints for 2014. And it would bring Speedway closer to its goal of being a $1 billion annual EBITDA business.
As Heminger would later say, the Hess retail network “really fits us like a glove.”
But the acquisition was never a sure thing. While Hess Corp. was shopping out its retail assets for bids, it also had a serious Plan B: spinning off the gas stations into a new retail entity, for which it filed documentation in January.
In formulating its bid, Speedway knew the price must be better than what Hess shareholders would receive under a spinoff scenario, and it must stay true to Hess’ desire to sell the sites in one transaction.
To size up the figure, Speedway considered the natural growth opportunities between the Hess sites in the Northeast and MPC’s refining, transport and storage infrastructure in the Southeast.
Shriber of Petroleum Equity Group sees a good case for the bid here. “It’s more of a flat-demand environment going forward; they want to have an outlet for their refining capacity, and this gives them that,” he says. “Having that refinery, terminal and logistics networks had a lot to do with their decision to overpay” in comparison to the going marketplace prices.
But central to making the case for the $2.8 billion bid was the growth potential inside the stores. In particular, Kenney points to the additional $17,300 in average merchandise margin per store per month that Speedway earns compared to Hess, and an additional $65,800 in merchandise sales per store. Both are driven by Speedway’s operational prowess and Speedy Rewards loyalty program, which has nearly 4 million active members.
Much like a job candidate advancing through rounds of interviews, the Speedway team sensed it was in the running based on the additional documentation Hess kept requesting, but Kenney contends they never sensed they were in the lead.
“You’re being challenged every bit of the way by the other side in terms of where your bid is, where your markups are on agreements, things that create value along the way,” says Kenney. “It wasn’t the sort of thing that you really knew for sure until they were ready to declare who they were going to go forward with.”
Hess ultimately signed a definitive agreement with Speedway in May, crowning it as the second-largest company-owned and -operated c-store chain in the country, leaping past Casey’s General Stores and The Pantry in site count and Couche-Tard and Murphy USA’s annual revenues with this one deal.
CONTINUED: Price of Loyalty
Price of Loyalty
In preparation for a spinoff, Hess essentially made the argument for Speedway’s bid, highlighting an area where the latter had a unique ability to make a difference.
Hess was a solid fuel retailer. Its volumes averaged more than 21,000 gallons per store per month greater than Speedway. This is partly a reflection of the population-dense markets of New England; it also reflects Hess retail’s ability to price aggressively thanks to cost synergies it enjoyed when its parent company was still in the refining and storage business. (Hess Corp. sold the last of its refineries in 2013.)
Through this price competitiveness, it built up a solid base of loyalty.
“They’ve been here since the 1960s, have a very strong brand name and brand recognition, good operations, and are pretty well-liked in the marketplace,” says Shriber, citing the company’s reputation for highly visible sites with big customer counts and competitive fuel pricing.
“Hess has, over a period of decades, forged a very strong and ubiquitous brand here in New York state that is in the mind of the consumer built on cleanliness, pricing and consistency,” concurs Jim Calvin, president of the New York Association of Convenience Stores, Albany, N.Y.
But one thing Hess did not have yet was a process to convert those strong fuel volumes and forecourt traffic into inside purchases. Indeed, in its spinoff documentation, the retail chain highlighted a focus on increasing its pump-to-store conversion ratio and purchase size.
In offering such a high bid, Speedway was making the case for its ability to transform the relatively average inside performance of the Hess stores into top-quartile material.
“We have a high degree of confidence in our ability to operate the business inside of the store,” says Kenney. “We know things we do to generate the sales and margin opportunities.”
One piece of this is Speedway’s operational acumen; all of its decisions—space allocation, SKU rationalization, placing new items, picking supplier partners for promotions—are based on whether they help profitability per square foot.
The other key piece is Speedy Rewards, which awards members points based on purchases in the store or at the pump. They can redeem these points for discounts on in-store items or fuel purchases. It also includes more than 25 category- and brand-specific clubs in which members earn a free item after so many purchases.
But these features are not what really give value to the program—it’s the 10 years of experience Speedway has in running and perfecting the program, argues Anton Bakker, loyalty expert and president and CEO of Outsite Networks Inc., Norfolk, Va., who consulted with Speedway on Speedy Rewards’ points-based architecture.
“You can do that with any technology, but having key performance indicators and holding store personnel to perform—that’s where the rubber hits the road,” Bakker says. “That’s the Speedy Rewards brand value.”
“Hess has done an outstanding job on the fuel side of the business,” says Kenney. “That’s what we think can also equate to the kinds of numbers we’re looking at inside.
“The first thing you’ve got to do is get a customer on your lot,” he continues. “Hess has had proven [success] on being able to do that through their fuel programs. Now, when you marry that with the loyalty program, which gives customers some offers and opportunities to shop inside the store, it’s good to start from the point where they are with the fuel business.”
There are three pieces to a vibrant loyalty program: the consumers’ demand for value, the vendors’ hunger for promotional opportunities, and the tested technology that acts as the delivery vehicle.
Outsite Networks research shows that a well-run, well-executed loyalty program can generate two additional inside sales and one additional fill-up per customer per month. Members of the nearly 30 loyalty clubs could be buying one to two more items per month.
Bakker suggests retailers in the Hess markets use the six to eight months it will take Speedway to introduce Speedy Rewards to figure out how to compete against a program that is entering a loyalty vacuum. “You have a consumer base that wants it and expects it, and a vendor base that wants to participate and didn’t have an infrastructure to do it,” he says.
“I believe that the price paid took into account the value of traffic and how much [Speedway] can lure away people to come into their stores,” he concludes. “That’s the value of loyalty.”
CONTINUED: Best of the Best
Best of the Best
While the acquisition appears as a merger of two giants, there is another chain in the mix: the nearly 400 WilcoHess c-stores and travel centers of which Hess acquired full ownership in January.
“They hadn’t really gotten into that business to start to look for efficiencies, and integrating Hess with WilcoHess,” Kenney says. “That’s now upon us; we’re going to look at both WilcoHess and Hess, to be able to look at the efficiencies there, as well as Speedway.”
Speedway has already identified about 400 of these potential efficiencies—or what Kenney describes as “best practices.”
These can exist in broad areas such as labor and marketing practices, the type of uniform store associates wear or the company vehicle policy. One clear area of opportunity: safety. Hess has a best-in-class safety performance, with two to three times fewer OSHA reportable incidents than Speedway, Kenney says. The team will focus on applying these best practices to the total Speedway business.
Sourcing is another area of potentially big savings. Hess has traditionally outsourced much of its support functions, while Speedway has insourced as a general rule. “When you start to do the analysis about bringing certain processes in-house vs. outsourcing, the numbers are compelling,” Kenney says. “That’s how you begin to develop some of your efficiencies.”
Foodservice is a reflection of these different philosophies. Hess was a committed quick-service restaurant (QSR) franchisee, with one of the largest—if not the largest—Dunkin’ Donuts franchises by number of sites, as well as Godfather’s Pizza, Dairy Queen and Wendy’s locations. Speedway has had some Subway locations, but its main foodservice offer is proprietary, including a made-to-order panini, sub and pizza program in pilot at 80 sites.
Here, Kenney says that Speedway is assuming all agreements Hess had in place. “To the extent any contract still had a term on it or the economics don’t hurdle the early cancellation of those agreements, we’ll abide by those agreements,” he says. “What will be done over time is those things will be evaluated against the better alternative, the best-practice approach.” For the 38 travel plazas, QSRs will be mandatory.
Similarly, Speedway will stay true to contracts with the three wholesalers in the mix: its own, Eby-Brown, as well as Hess’ McLane and WilcoHess’ H.T. Hackney.
Then there is the matter of rationalizing the Hess and WilcoHess store assets, which include many kiosk locations outside the norm of Speedway’s 3,900-square-foot ideal. This will happen over time, Kenney says, as the company evaluates the performance of each site based on its overall contribution to the portfolio, with cash flow being the leading indicator.
Under the deal terms, Speedway has three years to absorb the Hess sites and rebrand, investing $410 million from 2014 to 2017 in the process, not including about $50 million per year for maintenance alone. In that time, it will leap to the front of the line of company-owned and operated c-store chains. It’s a prospect that Kenney relishes.
“There are a lot of opportunities,” he says, “to bring what I think are three really good companies together and form an even better company.”
Room for Comparison
While Hess sites have enjoyed average fuel volumes nearly 12% greater than Speedway, their merchandise sales and margin average about 60% lower. With Speedway’s operational prowess laid over these sites, the room for growth is substantial.
| Metric | Hess | Speedway | Industry average |
| Fuel volumes* | 198,500 | 177,400 | 131,342 |
| Fuel margin | $0.137 | $0.144 | $0.187 |
| Merchandise sales* | $111,000 | $176,800 | $110,782 |
| Merchandise margin* | $29,200 | $46,500 | $31,670 |
* Per store per month
Source: Company reports, NACS
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