A 10-year relationship between “Harry” and a particular lender— a large national bank that, like Harry, shall remain anonymous— recently soured over a difference of opinion that could ultimately cost him a cherished store. When a loan on one of Harry’s gas stations recently came due for renewal, the bank demanded a property reappraisal, whose results implied the site had lost half its worth. In Harry’s eyes, despite a hiccup in volume caused by a temporary highway closing, the property has only increased in value.
“This is not a raw piece of land,” says Harry, the owner of a small chain with fewer than 10 stores in the Midwest, who spoke on condition that his real name not be used. “I bought it for $1.2 million and, with the improvements I’ve done, have invested a total of $1.6 million in it. I have debt of $900,000, and with the reappraisal they’re saying the site is worth $625,000 based on gallon sales. They want more equity [from me].”
The financial rabbit hole where Harry finds himself is more common than not. In this investigative study, CSP has examined the c-store industry’s health amid the nation’s prolonged economic recessions and snail’s-pace recovery. The report has uncovered a range of retailer fates—everything from foreclosure to expansion, litigation to takeover bids—with the common thread being the banking crisis’ effect on current lending relationships.
Among Harry’s options: Put up more of his own money to qualify for a renegotiated loan or part ways with a site in which he still sees tremendous potential.
“The banks are looking for new ways to make money,” he says. “They have written off a lot of these debts in the past and are now trying to call in these loans as cash money. … We’re good operators. If they think they can do better, be my guest.”
Whereas stories such as Harry’s suggest peril, the banks’ rekindled desire to make money has also meant signs of a revived lending climate but with a notable caveat to borrowers: The rules and expectations have changed.
Consider:
- Borrowers today are working harder to qualify for loans. Those who do, in many cases, must put up 10% to 15% more of their own equity than just a few years ago.
- Overleveraged retailers may hold a false sense of security; banks struggling to shore up their own assets have shown restraint in putting the screws to troubled borrowers. But as the economy mends and banks rediscover their health, instead of good news for borrowers, scrutiny and foreclosures are expected to accelerate.
- Private investors with deep pockets have shaken up the lending business, having acquired a taste for the industry’s strengths: resiliency, “good dirt” and solid cash flow—all traits that transcend the nation’s economic shifts.
- Inertia has bred anxiousness. After two years of stagnation, retailers and banks once again seem eager to grow, creating new levels of competition on both sides of the table.
“Companies can only stay so long without looking to the future,” says Jim Fisher, CEO of Houston-based IMST Corp., which specializes in site and sales analysis for all sectors of specialty retail. “When you start not doing anything for one to two years, and you’re extending the non-growth of the company, it leads to stagnation and that leads to market erosion. … The best way and fastest way to increase the bottom line is to improve what you’ve got.”
BANKING ON PROJECTIONS
The altered lending climate has its share of horror stories. By the close of 2009’s first quarter, default of commercial realestate assets at national and regional banks had soared to $16 billion, according to research from New York-based Real Capital Analytics Inc. One year later, approximately 70% of those assets remained in default, either operating under short-term forbearance or at some stage in the foreclosure process.
With summer’s approach, foreclosure activity had already begun to simmer in the c-store channel. Financial difficulties compelled Worcester, Mass.- based fuels distributor C.K. Smith & Co. Inc. to auction off 16 c-store locations in Massachusetts and New Hampshire, while Frankfort, Ill.-based Gas City Ltd. was contending with a foreclosure lawsuit regarding four of its southwest Chicago sites, in which its lending bank is trying to collect $16.8 million. Fundamentally, what has damned some retailers is the very structure in which they have long operated: salesand- profitability assumptions. As Tom Kelso, managing director of Richmond, Va.-based Matrix Capital Markets Group, suggests, “You may be running [a store] as well as you can, but you borrowed based on projections.”
Retailers base such projections not just on the value of the property but also on the promise of the business. Anderson, Ind.-based Ricker Oil Co. made public a grievance with London-based BP Plc, from which it purchased several ampm franchises in the fall of 2008. Ricker bought into the promise of the franchise and, in a lawsuit dated October 2009, said franchisees were “paying … fees on an untested business model that is failing and costing BP’s franchisees thousands of dollars per week.”
BP and Ricker Oil settled the suit earlier this year, but such actions underscore the importance of aligning cash flow with looming debt obligations.
For retailers who either purchased in the vulnerable period when the financial markets began to sink or simply overestimated their profits on an acquisition, banks have—so far—given borrowers a little bit of leash. “In most cases lenders are trying to ‘kick the can’ down the road to see if real estate corrects itself and if cash flow can catch up to service debt,” says Kelso. “Banks are not pushing as hard to get people to that point because banks don’t want to recognize loan losses,” he continues. “So, really, banks today are partners to a certain degree in keeping some companies afloat in a sense that it’s not in the bank’s interest to have a company fall apart.”
Sometimes, however, falling apart cannot be helped. Terry Monroe, president and COO of St. Louis-based American Business Brokers, has fielded numerous requests from banks that have foreclosed on c-store assets, asking him to broker fresh deals. A recent case of his concerned a six-store Midwest chain purchased three years ago by eager buyers, now mired in the foreclosure process.
“It wasn’t worth what they paid for it,” he says. “Those stores are soon going to be listed as ‘debtor in possession,’ and it’s not the first one I’ve worked on. In fact, we’re seeing that trend accelerate. They’ll probably sell for 25% to 30% less than what [the original buyer] paid for it, so the buyer is taking a haircut and the lender is taking a haircut.”
The six-store chain’s unraveling came about, rather familiarly, as a result of poor sales in a down economy and the inability to maintain the facilities, combined with excessive debt. Of the half-dozen stores, Monroe believes at least one should have been shuttered sooner due to underwhelming sales; had the owners done so, the store might not have such a toxic effect on total cash flow.
“It’s sad but true,” he says, “and there will be more to come.”
GETTING UGLY
Operator bankruptcies, on the other hand, could be a likelier byproduct of current lender-borrower discord, according to William Trefethen, managing director of Trefethen Advisors LLC, Scottsdale, Ariz.: “With bad fuel margins and maturing debt, when you combine those two it gets pretty ugly. It might come down to working out some sort of deal with the existing lender; the key is to start the dialogue early and get help.”
The nature of the problem has shifted dramatically and could afflict more than those who “bit off more than they could chew,” according to Michael Lederman, managing director and head of the “special situations” group for Memphis, Tenn.-based Morgan Keegan & Co. Inc.
“In the last decade the problem came from being overleveraged alone,” he says. “Today you have some that are overleveraged, but you’ve also got hits to cash flow due to the economy. Simultaneously, with the real-estate collapse, lenders are concerned and saying, ‘If things go bad, are we covered?’ ”
If the first half of the year is any indication, banks have reason to worry. By early June, 78 banks had closed—double the number that had closed this time last year, according to the Associated Press. Florida had the most closures at 14, followed by Illinois’ 10. Georgia, California and Minnesota rounded out the top five most-affected states.
Ironically, if the banking industry succeeds in pulling itself up off the mat, figuratively speaking, defaulting retailers could find themselves on even more tenuous footing.
“As banks get healthier, they will revert to treating weaker customers as they have in the past; they’re going to start recognizing losses,” says Kelso. “Today lenders are not forcing people to file [for bankruptcy]. But as banks become healthier ... watch out.”
In other words, be the ant rather than the grasshopper.
“[Retailers should] communicate with the bank and know where they stand, and not just with the relationship officer but with the credit and underwriting [departments],” says Scott Garfinkel, managing director of Morgan Keegan. “When you have relief periods that help fuel extra profit, that’s the time to think about being proactive about discussions with other lenders and where you’re going with the business.”
Others suggest joining share groups or similar business affiliations, which can help navigate the lending climate, especially during periods of choppiness.
“If you don’t know who the good banks are, shame on you, especially if you have your business there,” says Mike Zielinski, president and CEO of Royal Buying Group, Lisle, Ill. “The best thing is to be engaged with whomever you do business with, not only with bankers but also other people who are knowledgeable about banks.”
‘GOOD NEWS’
Proving the maxim that opportunities often arise in times of hardship, or perhaps because of it, seemingly countless good assets in multiple markets are now ripe for the plucking, according to Rick Mistretta, operating partner for Prairie State Energy, a Lake Geneva, Wis.-based operator of two stores and fuel supplier to 40 dealers in Illinois and Wisconsin.
“Mismanaged sites—that’s an opportunity,” he says. “Not all of these sites are shut down; some are still hanging on by a thread. … You have old Clarks out there that have very small stores and sell nothing but gas and cigarettes. Five years ago, when gas margins were 10 or 12 cents per gallon and credit-card fees averaged 2 cents, you could maybe make run of it with a site like that. The climate has changed for the worse.
“The good news is that you can buy [such sites] for significantly less, and you don’t have to pay for the profits it’s going to deliver,” he continues. “Before, you paid a premium for something like that, but today you pay on the P&L.”
Even if some traditional lenders— i.e., national and regional banks—have been scared off by a business they cannot or simply don’t want to understand, buyers now have more options in trying to scoop up these assets, according to Roger Woodman, managing director of Morgan Keegan. Earlier this year, for example, when Springfield, Va.-based Capital Petroleum Group purchased 29 ExxonMobil locations in northern Virginia, the company worked with Washington, D.C.-based Petroleum Capital & Real Estate LLC and financed the deal in an arrangement with a large private-equity real estate investment trust.
“With quality real estate and good operators, there’s an increased number of lenders looking to fund transactions,” Woodman says. “Banks were sidelined in 2009, but they have to make money, so there has to be an increased competition on divestitures. A year ago we’d have a problem getting a lender, but today three or four lenders are looking at the transactions and competing.”
Ed Holmes, president and CEO of Holmes Oil Co., a 42-store chain based in Chapel Hill, N.C., says he has two banks competing for a large loan of his that will mature in August 2011. Earlier this year, he contacted the original lender, which told him conditions were no better than they were six to eight months ago. Then a second bank took a look at the loan and offered him a more attractive deal, giving Holmes reason to check back with the original lender. He believes the industry has proven itself during tough economic times, so “when [banks] do have money to loan, they’ve seen that our industry has been profitable.”
Another source of potential capital: tapping funds from the divestment of sluggish assets. Put another way, as part of their growth strategy, some operators are realizing they simply cannot afford to hang onto underperforming stores.
“If you have someone with 25 stores, the old rule of thumb is that a third are cash cows, a third are good stores, and a third need a fire,” says Monroe, a former retailer who over time has divested himself of all his stores. “All too often you have operators who spend too much time trying to get that bottom third up off the floor. … Those that didn’t cull the herd are in trouble now.”
Although c-stores have drawn renewed investment interest, lenders are much stingier in helping borrowers meet their capital needs, according to Dennis Ruben, managing director of NRC Realty & Capital Advisors LLC, Chicago. “Before the credit problem you could get a mortgage for 80% of the purchase price,” he says. “Now it’s probably 65%, so there’s more equity that needs to be put into the deal. It’s a longer and harder deal to put together.” Furthermore, the “rules” for accessing this well-guarded treasure trove of capital have changed, and retailers need to work within the new confines.
“We see so many guys who say, ‘My cash flow is X,’ [but] until you can sit down and prove that your cash flow really is X, it’s kind of tough to qualify,” says Ray Cleeman, managing director of New York-based PrinceRidge Group LLC. “I think it’s about making sure your financials and the historical financials are all in order, and if you’ve done an acquisition in the recent past, show the improvements you’ve made and be able to identify how you’ve made them.
“Be prepared, because you don’t want to go there and get a homework assignment.”
A WIDENING GAP
Historically, it’s been especially difficult for independent operators to obtain the necessary credit to fund growth. The current level of borrowing success is significantly lower for small businesses than it was in the mid-2000s when up to 90% had their credit requests approved, according to the National Federation of Independent Business (NFIB), Washington, D.C. In comparison, a meager 40% of small-business owners attempting to borrow in 2009 had all of their credit needs met, NFIB research shows, while 23% had none of their credit needs met.
This lack of funds, paired with unkind competitive forces, means operators unable to spread mounting costs among multiple units are likely to go under.
“For the under-70,000-gallons-amonth dealer, the end may be in sight,” says Paul Tomaszewski, president of Pacer Fuels, an Austell, Ga.-based operator of seven stores that also supplies Chevron, Marathon, Texaco and unbranded motor fuels to 90 dealers in the greater Atlanta area. “It’s not going to be this year, and probably not next. But five years from now, we’ll have a lot fewer smaller dealers.”
The pruning has already begun; the number of U.S. c-stores fell 0.2% in 2009, to 144,541 stores, according to NACS’ year-end estimates. It was only the fourth time in the past 15 years and, perhaps more telling, the second straight year the store count has slimmed down. Industry experts suggest many of those who have departed are single-store owners who relied too heavily on categories with thinning margins, namely gas and tobacco, and couldn’t devote space to more profitable items such as foodservice.
Also, Tomaszewski believes, the continual escalation of marketing and operations costs, such as credit-card fees and expenses tied to payment-card industry compliance [CSP—May ’10, p. 40], has saddled cash-poor dealers with an insurmountably heavy burden.
Mistretta, whose jobbership does business in the Midwest, agrees: “In speaking with jobbers in the Chicago market and on up into Wisconsin, we’re experiencing the same problems. Many dealers are struggling to pay the bills and suppliers are chasing them for money. As creditors go, we’re probably the biggest one [for a dealer], considering a load of fuel costs $20,000 to $25,000.
“Unfortunately,” he continues, “a lot of operators don’t know how to promote, only discount. To generate sales they lower prices to move the product and then their competitors discount to match them. Soon all competitors have lowered their pricing and have done nothing more than give away margin. Then success becomes a function of the quality of your real estate and how well you manage your expenses. … For a long time, when it was a good industry, it didn’t matter.”
Being small in itself, however, isn’t necessarily a disadvantage. Growth is often dictated by one’s persistence in following through on opportunities— guts, plain and simple.
“I can think of one dealer who purchased one of our sites and has bought two more since then, and that was all since November [2009],” Mistretta says. “Buyers right now are looking for blood, and I don’t blame them.”
‘INTO THE FRAY’
Large chains rely on the availability of growth capital just as much as their smaller peers do. But the deals structured for larger, seemingly better-positioned companies also have become more difficult to align.
“You might need to put eight to 12 lenders on a deal because lenders want smaller exposures and nobody wants more than $10 million or $20 million loaned to one credit,” says Ruben of NRC. “For a $150-million deal, you’d need 10 or 12 lenders to put that together, particularly for new assets.”
There are exceptions to the rule. In May, three allied private-investment firms negotiated the rights to purchase a 74,000-barrel-per-day refinery in St. Paul, Minn., 166 SuperAmerica stores and other refining/retail assets from Houston- based Marathon Oil Corp. The price tag: in the neighborhood of $800 million, according to published reports.
“We’re seeing a lot of people jump back into the fray,” says Cleeman. “The market has thawed, and I think there’s a better realization between buyers and sellers of what can and cannot be done. … Lenders just want to make sure their capital is safe, and conservative underwriting is what’s getting this done.”
“Clearly there is another wave of financial investors who want to consolidate the industry,” says Ruben. “People who are big probably need to get bigger. … In the 25- to 75-store range, you have situations like a second- generation business, where the son inherited it from his father but doesn’t have the same passion, or maybe you see someone getting beat up by the bigger guys.
“In that situation,” he continues, “you either buy somebody or you sell; there’s no standing still. A lot of people … are growing out of cash flow at a pace of one to two stores per year, but it’s hard to compete with the big guys who are growing by 100 to 200. That gap is only going to get wider.”
IT’S OUT THERE
Independent business owner Harinder Singh has had past success getting traditional banks to back his growth projects, yet he recently tapped into the private-equity market to fund the addition of a seventh store. Although he couldn’t share a precise dollar amount, he is now scouting additional sites to feed “the next phase of expansion,” also funded solely through private equity.
“You can get five investors together, but I haven’t heard of anyone getting a traditional loan,” says Singh, president of St. Louis-based Gateway Petrol Inc., whose portfolio also includes an upscale Indian restaurant and a food-manufacturing plant. “The banks are really not interested anymore, but private money is a great idea. There is a glut of property people need, and it can be bought at a discounted price today.”
Regardless of the equity source, industry experts suggest a renewed period of expansion and consolidation is on the horizon, if not already under way. Major sales recently have involved assets from stalwarts Speedway SuperAmerica and ExxonMobil, as well as the planned sale of more than 70 sites by Southeast consolidator The Pantry Inc. Finally, underscoring the point in dramatic fashion, there’s the ongoing tug-of-war between Alimentation Couche-Tard and Casey’s General Stores, in which the price and value of assets are a prime concern (see story, p. 12).
“Whether it’s private equity or a larger high-yield bond, or even something a little more unusual like a term B loan, so many options are available to retailers and downstream management teams,” says Cleeman. “For anyone with 50 sites or more, the amount of capital available to them is almost silly.
“I don’t know what the gap is between the people who need capital and those who can provide it,” he continues. “[Retailers’] frustration is that they can’t reach these lenders. Maybe they’re looking for a certain size transaction that doesn’t exist. … I think there is going to be a lot more deals going on, because the money’s out there.”
Numbers Game
$16 billion Amount of national and regional banks’ commercial real-estate assets in default for the first quarter of 2009
70% Percentage of those assets that remain in default one year later
23% Percentage of small-business owners attempting to borrow money in 2009 who had none of their credit needs met, compared to 40% who had all their credit needs met
65% Approximate percentage of the purchase price most lenders are willing to fund, compared with 80% prior to the credit crisis, meaning borrowers now have to contribute more equity when making acquisitions
SIGNS OF DISTRESS
Amid a return to industry growth, there remains an undercurrent of distress caused by retailers who overbought at the wrong time or failed to live up to loan requirements. From the mid-2000s to mid-2008, lenders became more and more aggressive with lending terms, resulting in higher advance rates and less onerous covenants, according to William Trefethen, managing director of Trefethen Advisors LLC.
“The economy has impacted volumes and margins and the resulting profitability, which in turn can trigger covenants related to debt-service coverage and funded debt ratios,” he says. “Declining real-estate values have also impacted loan-to-value covenants. … The current conservative lending environment has left very few options available to borrowers wishing to refinance maturing debt that was originally funded in the more aggressive lending environment [prior to 2008].”
As a result, some banks are trying to make up for lost time. “Say a dealer financed $800,000 of a $1-million purchase,” says Rick Mistretta, operating partner for Midwest jobbership Prairie State Energy. “The five-year balloon comes up and the bank-required appraisal comes through at only $800,000. Most banks are no longer financing 80%; instead, we typically see 70%. The dealer now must come up with $240,000 cash to keep his location or put it up for sale.
“At that point, if you don’t have the money, what are you going to do?”
STAYING IN CIRCULATION
The next wave of industry consolidation will likely involve some unexpected new market entrants: first-time owner/operators who have a white-collar pedigree. The gutted U.S. jobs market has left many workers—among them, onetime executives with ample nest eggs and inflated salaries—suddenly jobless and in need of something to do. In the process, they turn to the c-store industry and, essentially, buy themselves a job.
“Six to eight months ago we noticed this shift,” says Terry Monroe, president and COO of American Business Brokers. “[These people] have got some capital, or they’ve got access to capital, so it’s easier to get these deals financed. A guy can buy himself a job, maybe making $50,000 to $100,000 a year.
“For the higher-ticket [assets], meaning anything over $1 million, those will have a tough time selling,” he continues. “Where we do see an explosion is stores of $700,000 and under, especially $500,000 and less.”
These assets might have been better served by their owners taking them out of circulation, according to Jim Fisher, CEO of IMST Corp. “For an operating company of c-stores with fuel, they can say, ‘This store no longer fits my model,’ ” he says. “Rather than flipping it to the next generation of operators, take it out of the industry. If it’s a bad site and it doesn’t work for you, it doesn’t work for anyone else.”
Buy Low, Sell Now
It’s an “interesting” time for retailers wrestling with the idea of selling their stores, according to Dennis Ruben, managing director of NRC Realty & Capital Advisors.
“Some people want to sit on the sidelines, but it’s not bad enough to not go forward if you’re really interested in selling,” he says. “I’m not sure things are going to be that much better down the line.”
Similarly, Terry Monroe thinks sellers will remember this period as “the good ol’ days.”
“The values are not going to be reset to where they were three years ago, no more than residential real estate popping back to what it was three years ago,” says Monroe, president and COO of American Business Brokers. “The multiples are reduced and more in line with where they should be: an average of 5 times EBITDA (earnings before income tax, depreciation and amortization) whereas it used to be in the 6-times range.”
Some two-year-old deals, experts suggest, were done at 7 to 9 times EBITDA.
“Even if we see a strong rebound in the economy, it would take a long time to get back to where we were three to five years ago,” Monroe says. “If you procrastinate, you’ll get less.
HOW TO THRIVE IN A TOUGH LENDING CLIMATE
DIVERSIFY. “The problem is putting all your eggs in one basket,” says Roger Woodman, managing director of Morgan Keegan & Co. “Incumbent lending relationships are getting nervous and want to force a refinance. We advise multiple lending relationships.”
RETAIN YOUR OPTIMISM. “The past two years have been a great time of selfreflecting and self-evaluation of sites,” says Jim Fisher, CEO of IMST Corp. “It’s time to stay positive.”
TAKE INITIATIVE. “Be more proactive in getting out in front of any potential problem coming from your bank,” says Scott Garfinkel, managing director of Morgan Keegan & Co. “Proactive thinking can allow you take advantage of opportunities in any capital market.”
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