Tax advantages, growth targets, incentive payouts, rising multiples and billion-dollar deals instantly creating networks of 2,000 to 5,000 stores.
Welcome to the world of the MLP.
As 2014 winds down, many downstream-based master limited partnerships are ramping up. At press time, the 6,400-store Energy Transfer Partners (ETP) had tucked into its portfolio Aloha Petroleum, one of Hawaii’s largest c-store operators with 100 locations. This came after a series of stunning ETP acquisitions, the 5,000-store Sunoco chain in 2012 and 640-store Texas jewel Susser Holdings just this past spring.
“This is just the beginning,” says Scott Garfinkel, managing partner with Raymond James Investment Banking, St. Petersburg, Fla. “You’re going to see more deals announced and folded underneath MLPs and … you’ll see other companies embrace the MLP structure as a new strategy.”
But as more companies latch onto the format—a fuel delivery and wholesale model that frees certain income from corporate tax—new questions arise. Will the temptation to grow for growth’s sake only fuel an unsustainable roll-up fervor?
The industry saw a similar frenzy in the late 1980s and 1990s, one that sparked an M&A madness that brought the likes of 7-Eleven and Circle K to bankruptcy. With current multiples going off the charts, will the balance of reasonable financing, cash flow, market value and retail savvy hold?
Or instead of built to last, is this a game of built to flip?
For those keeping score, two other major retail deals occurred this year in addition to ETP’s purchase of Susser. In August, Valero’s retail spinoff, CST Brands, San Antonio, engineered an $85 million deal to buy a controlling interest in MLP Lehigh Gas Partners (LGP), Allentown, Pa. While CST’s former parent was forming its own MLP, CST took an independent step to leverage its own opportunity.
The result brought CST’s store count into the 2,500 range and put the new firm into contention with ETP, especially after its expressed interest in becoming a major multi-regional, if not national, convenience operation.
Then in May, Enon, Ohio-based Speedway bought the retail assets of Hess Corp., New York, creating a Midwest-East Coast network of 2,700 stores. While neither chain is an MLP, Speedway’s parent, Marathon Corp., has an MLP within its structure. While executives have not said if a connection would occur, observers believe it is a strong possibility.
About a dozen other MLPs exist within fuel distribution and retail, but none that has taken aggressive steps the way ETP and CST have to consolidate c-stores.
Like any daring movement, MLPs have their pluses and minuses. On the plus side:
▶ Tax advantage: Above all else, eliminating corporate taxes on wholesale distribution of fuel to stores and rental income from those properties improves any financial scenario for running or growing a network.
▶ A sellers’ market: With a reimagined bottom line, multiples have risen from 5x-6x to 9x and into the double digits for higher-end properties.
▶ Consolidation: Creating synergies and scale in a fragmented industry can only help as cross-channel competition heats up.
On the minus side, the sheer size of these recent deals pose concerns:
▶ Too much, too fast?: Embedded in the MLP formula is the impetus to grow, but some say the pace is too fast and the price tag too high—in some cases with multiples at 10x EBITDA (earnings before interest, tax depreciation and amortization)—for the market to bear.
▶ Government pullback: If the IRS decides to rescind the MLP advantage, the whole structure could collapse.
▶ Integration, innovation speed bumps: With MLPs creating new mega-chains, the burden of integrating new buys along with the disappearance of any innovative spirit become real issues.
Those core competitive aspects may be what retailers eventually connect with beyond the confusing fiscal terminology of MLPs. Simply put, what would operating alongside a newly created MLP be like?
Texas retailer Sonja Hubbard sees two scenarios: The new MLP may emerge as an aggressive, improvement-oriented operator. Or it could be a larger, less nimble one.
With improved efficiencies, profits and cash flow, “this clearly makes them a more challenging competitor,” says Hubbard, former NACS chair and president of E-Z Marts, Texarkana, Texas. “But size also tends to make change more difficult.”
Other retailers have a similar take. “Using an MLP makes it easier to acquire another company, but MLPs need to grow, to constantly be fed to satisfy their owners,” says Tom Robinson, president of Robinson Oil Corp., Santa Clara, Calif., and also a former NACS chair. “That can be good and bad. It is easy to overpay if you have to grow, but MLPs certainly make it a better time to sell.”
CONTINUED: Built to Flip?
Built to Flip?
Anyone with a calculator and a pencil can see the mind-blowing sums these transactions can generate. Take the ETP-Susser deal: Savings on everything from improved buying power to shared general and administrative costs hit $70 million, investor reports show.
Additionally, there’s the MLP’s tax savings. While it may not improve the c-store’s bottom line (because c-store income is still taxed), the larger entity can free up capital once needed to pay the IRS.
Of course, beyond the savings are strong incentives to grow.
Growth can stave off demand declines for fuel that the industry as a whole is arduously charting. “One headwind we see for MLPs in this sector is the long-term [falling] demand trend in gasoline,” says Roger Woodman, managing director with Raymond James. “But you can offset that by successfully executing a growth strategy involving [not only] acquisitions, [but] remodels, new-store builds and improvements in operations—all of which require additional capital.”
The largest chains have only 2% or 3% of the industry’s portfolio of stores, so the kind of growth via acquisition Woodman speaks of is viable.
But that strategy raises eyebrows. An industry fuels expert, who asked to remain anonymous for this story, believes the dealer population that plays significantly into recent acquisitions is “particularly risky for this model.” Again, the original purpose of the MLP was to provide incentives for petroleum delivery investment, not necessarily the low-margin business of kiosk-style gasoline retail.
Also fueling the fervor of MLP growth are built-in financial incentives that go to general partners. They’re called incentive distribution rights (IDRs). Each quarter, as certain MLP metrics rise above predetermined thresholds, Woodman says, the general partner’s share of incremental cash flow (also called distributions) increases.
While he declined to say this is the major driver spurring MLP growth, he did say it was one of its many benefits for investors.
Others point to concerns about MLPs’ financial pillars. If an MLP’s future stands on interest rates and those rates rise, the same aggressive M&A calculations may stop adding up.
The current cost of capital is part of what’s fueling MLP activity, says Charley Jones, CEO of Stinker Stores, Boise, Idaho. “It’s never been cheaper in my lifetime,” he says. “But much like real estate, interest rates can turn instantly and go from a raging river to a dry creek bed incredibly fast. These [MLP] deals will go away when rates rise.”
“It is a treadmill that gets faster with increasing capitalization,” says a retailer in Texas who spoke to CSP on condition of anonymity. “Interest rates and the tax code are driving the MLP train. However, in my opinion, future investor enthusiasm will wane if interest rates go up significantly.”
Investors are happy to get into MLPs now because they have higher payouts than other options. But the market conditions won’t last forever. Rising interest rates will bump up the cost of future acquisitions, the accretive (or income above the cost of what’s paid) returns from a newly bought chain will evaporate, and the value of the company’s stock—also a way to improve leverage, or buying power—may ultimately fall.
“If interest rates rise high enough in the future to offer investors [other options with] equal returns and less risk, MLPs will see their stock price and their leverage drop,” the retailer says. “In this higher-interest-rate environment, MLPs have to distribute the bulk of their earnings, and there will be precious little to reinvest in upgrading their existing chain. They’ll also have less access to capital due to lower stock-price leverage.”
Chains don’t have to go the MLP route to succeed, the retailer says. He points to Framingham, Mass.-based Cumberland Farms, which focused on its retail offer in recent years and has seen healthy returns (CSP—Aug. ’14, p. 40). “This should demonstrate to others who choose not to roll up,” he says. “Success can be theirs by meeting their customers’ expectations.”
CONTINUED: Under the Hood
Under the Hood
While the two major MLP transactions—ETP-Susser and CST-LGP—were distinctive, many see similarities among the two, notably both being balanced debt-to-equity transactions.
The $1.8 billion ETP paid for Susser broke down to a 50-50 cash and ETP-unit basis, with ETP’s parent, Energy Transfer Equity, providing an annual IDR of $35 million for a 10-year period, subject to early termination.
It also played off Susser Holdings’ standing with creditors, which was very strong. In April, when the deal came to light, Susser’s annual yield was 5.3%. (Right now it’s 3.66% but still high compared to Casey’s at 1.1%, Couche-Tard at 0.45% and Pantry at 0%.) Susser’s distributable cash-flow coverage ratio—or a measure of a company’s ability to pay its debts—was at a multiple of 1.2, with the Farlex Financial Dictionary saying anything over one means a company is able to pay its debts using profits, a desirable quality.
In the CST-LGP deal, far less changed hands: only $85 million, or 2% of the Susser deal. But the connection gives CST access to the MLP structure.
The transaction itself was composed of $17 million in cash and 2.044 million shares of CST common stock. CST basically acquired LGP’s controlling parent or general partner and the IDRs.
While both deals are growth-centric, their financial backbone, at least with these initial deals, appear sound, says Steve Montgomery, president of b2b Solutions, Lake Forest, Ill. “The frenzy [of 30 years ago] was driven by financial institutions that were really in the business of bundling up large amounts of debt that they then sold in the securitized market,” he says. “They had no vested interest in the success of the actual retail operation.
“That is not the case with the MLPs,” Montgomery continues.
Garfinkel of Raymond James agrees: “It’s a much more stable, long-term financing play—one that works.”
Many of the assets also have real estate tied to them. Again, buying land that can undergo a sale-and-leaseback deal adds to the value and stability of the purchase.
Garfinkel even downplays the interest-rate argument, saying, “While MLPs typically have short-term fluctuations as a result of changing interest rates, MLPs offer a combination of yield and potential growth in unit price. [And historically], unit prices have shown little correlation to those changes in rates over the long term.”
Two Kinds of Buyers
Whether the MLP model endures, it has forced more traditional consolidators to rethink their response. Officials with Circle K parent Alimentation Couche-Tard, Laval, Quebec, have long played up their cautious buying strategy, something they’ve stuck to in recent investor calls.
Publicly traded Casey’s General Stores, Ankeny, Iowa, faces similar questions on investor calls. “We have the ability to continue to integrate acquisitions and certainly the financial capacity,” said CFO Bill Walljasper on a recent quarterly investment call, citing that Casey’s debt-to-EBITDA ratio is relatively low. “And we have sizable capacity on the balance sheet, if the right opportunity presents itself.”
He also acknowledged the recent big transactions roiling the industry and the higher multiples associated with them. “That’s something we’re keeping our eye on, especially with some of the larger chains. We are seeing a few higher expectations from a multiples standpoint,” said Walljasper. “But from the smaller acquisitions we traditionally do, multiples are still keeping in line with 5x-to-7x [EBITDA] trailing.
“We’re diligent about process; we won’t grow for growth’s sake,” he said. “We want to make sure it has some thought process behind it.” Casey’s ended the quarter with 1,835 stores in 14 Midwest states.
What’s evolved, according to Dennis Ruben, executive managing director of NRC Realty & Capital Advisors LLC, Scottsdale, Ariz., are “two worlds of buyers.” One is what he calls the “pure owner-operator” types, such as Dallas-based 7-Eleven and Circle K. This group of buyers is generally more selective. The deals they’ve seen of late “haven’t made as much sense in terms of the [financial] numbers and assets.
“The MLPs are looking at the world from a different set of eyes,” he says. “They’ve started to do things aggressively.”
After this year, nothing surprises Ruben. “I never dreamed that ETP-Susser would go to Hawaii,” he says. “The moral of the story: All bets are off. Everyone is looking everywhere. There are almost no geographic limitations anymore for the deals people look at. There don’t seem to be any price constraints, either. People pay multiples that are just beyond what anyone would imagine they would pay.”
CONTINUED: Getting Shut Out
Getting Shut Out
Challenges aside, the numbers today favor MLPs—and the big ones at that. It’s a problem Lehigh, itself an MLP, faced as its leadership team realized (prior to getting bought by CST) that it wasn’t big enough to compete with ETP.
“[ETP] paid a formidable price [for their deals], and the larger acquisitions get at that pricing; that will be a drag on us doing larger deals,” LGP president Dave Hrinak said during the company’s first-quarter 2014 earnings call.
Hrinak and Joe Topper, the CEO and entrepreneurial founder of LGP, experienced the full muscle of ETP, having bid on both Mid-Atlantic Convenience Stores (MACS) last year and Tigermarket earlier this year, only to watch ETP win both.
Seeing ETP stretch the multiples on those acquisitions, Topper said, “I think some buyers are trying to take advantage of interest rates at the level that they’re at to lock in some financing.”
“Irrational prices” are what Jones of Stinker Stores calls them, concerned that such activity may shut down an opportunity to grow his 68-store chain. “At some point, an asset is only worth ‘X’ amount of dollars,” he says. “If the big boys get in and throw their weight around, they can pay too [much] … and then the market moves based upon what somebody read.”
He openly questions whether a business can be profitable at the high prices he’s been seeing. “The only thing worse than not doing a deal is paying too much,” Jones says. “The negative impact is: If the MLP transaction sets the prices of the assets too high, then you’re a fool to buy at that point in time.”
That said, retailers of many sizes can find opportunity in a potential frenzy, according to Montgomery. Non-MLP players such as 7-Eleven and Couche-Tard “have been willing to make both large and small acquisitions,” he says. “This willingness to be an opportunistic buyer allows 7-Eleven and Couche-Tard [and others] the ability to grow by acquisition of smaller entities that may have escaped the attention of the MLPs.”
More Mitigating Factors
Looking past its basic design, inherent flaws and benefits, the MLP has a couple of key obstacles to overcome. One is integration. If the lessons of Cary, N.C.-based The Pantry are relevant, then integration of the acquired companies into a single identity can prove critical.
Operating under different brands and having multiple ways of going to business can take its toll on staff, says industry consultant Mike Scarpelli, who has worked in c-store and oil-company retailing for decades. “When you have 500 stores and five or six different store concepts—and I’m not talking just about store size—it’s a question of: What do you want to be when you grow up?” Scarpelli says.
In the case of Susser, Scarpelli believes the management team has a strong handle on that challenge: “Susser has [a process] when they picked up stores. ... It was, ‘Here’s what we are; it may be different, but let’s explain.’ ”
That type of culture-centric approach can make integration easier and allow the stronger concepts to permeate the new chain. “If someone does that with the money made available through an MLP, I’d keep an eye on that chain,” Scarpelli says.
One of the last, and most ominous, clouds hanging over MLPs is the government potentially ending the tax advantage. Woodman of Raymond James agrees that it’s a possibility, but he looks at the issue from a different perspective.
“It’s unlikely that the IRS will revise its current position on existing MLPs, [especially] involving proven asset classes,” Woodman says. “However, the agency is more likely to toughen its stance on new types of assets [submitted under] the MLP structure.” In other words, the concept of MLPs is likely to survive, but it will remain rigid in its definition.
Ultimately, true success lies not in the validity of the MLP structure itself but within each business, Garfinkel says.
“Companies with individual strategies are going to be successful or not based on their management team, the strategies they implement, people they hire and deals they do,” he says. “Nothing about MLPs has changed that.”
That said, business people are always drawn to opportunity. In this case, it’s about access to capital. Much of the opportunity for those at the helm of MLP firms is about just that. Either via tax code, low interest rates or stock value, it’s all about aggregating those financial opportunities, creating a formula that makes them think they’ll come out fine on the other end, make people money and—possibly—improve the channel.
In the words of another anonymous Texas retailer, who has experienced the swirl of MLPs firsthand: “If you can improve your access to capital, why wouldn’t you?”
MLP Density Across the United States
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