Two representatives from financialadvisory firm Raymond James,which specializes in the conveniencestore and distribution channel,brought some good news to attendeesof the finance breakout at the summit.The focus of the session: “Capital MarketsUpdate and a Strategic Alternatives/ValuationCase Study.”
“Capital markets have improveddramatically since the downturn,” ScottGarfinkel, managing director of St. Petersburg,Fla.-based Raymond James, told thecrowd. Before everyone got too excited,though, he continued with this caveat:“But global economic concerns, domesticjob growth and the political landscapesurrounding tax increases and resolvingthe budget deficit continue to generateuncertainty and will likely contribute toongoing volatility.”
In spite of those realities, profitabilityfor many operators in the channel remainsstrong when compared to other sectors,and future prospects look good.
A Look Back
Yet to really see where we’re headed, weoften need to review the past. In 2009,companies and consumers alike focusedonly on weathering the economic storm.By 2010, a light at the end of the tunnelhad emerged as unemployment peakedand financial institutions regained somefooting. The following year broughta surge of confidence as corporationswere flush with cash unlike ever before,rates remained at historic lows and theeconomy gained steam. The economicengine continued to strengthen in 2012,but progress was crawling; gains were slowand the chance of risk remained.
Present day: The 2013 stock markethas started off well (so far) and M&Aactivity in the convenience store sector isextremely active, with valuations at heightenedlevels. In general, the capital is availablefor operators looking to fund strategicgrowth initiatives. “Could this be the yearwe’ve been waiting for?” Garfinkel asked.
Key market trends are also flavoringthe current environment, he said. Workingagainst the industry are headwindssuch as credit-card fees (reaching a recordbreaking$11.2 billion in 2012, accordingto NACS), the Affordable Care Act andcigarette pricing. On the positive sideare opportunities such as the growingacceptance and growth of foodservice inc-stores, the rise of master limited partnerships(MLPs) and M&A activity.
A review of both public and privateconvenience companies showed that 2012was a strong year for earnings, with lots ofcapital market activity. A $2.8 billion spinoffIPO from ConocoPhillips happenedin the spring, and by summer NorthernTier Energy had launched a $262 millionMLP IPO. Susser Holdings Corp. was spunoff in a $224 million MLP IPO.
More recently, market watchers wereanticipating the spinoff of Valero’s 1,880-site Corner Stores chain as a separate publiclytraded company, as well as the sale orspin-off of Hess’ retail gasoline and marketingsegment (by 2015). There’s also thepotential spinoff MLP of the retail divisionof Murphy USA, which includes 1,152retail outlets; and the possible spinoff MLPof the transportation and terminal divisionsof Phillips 66.
An overview of U.S. public equity offeringstrends shows there were 121 IPOs inthe past 12 months, which raised about$48.6 billion; also, 99 offerings totaling$20.4 billion are currently in IPO backlog.This year’s IPO market is already ahead oflast year’s, with 32 offerings raising $8.7billion in the first three months of 2013 vs.$6.7 billion over the same period in 2012.
On the M&A front, a difficult creditenvironment of unstable valuationsadversely affected M&A activity in 2008and 2009. In 2012, the number of M&Atransactions increased by 13.9% comparedto 2011; however, transaction dollar volumeincreased by only a modest 3.7%.As this year continues, M&A will likely bebolstered by unusually high levels of cashon corporate balance sheets; uninvestedequity capital from private-equity funds;and low interest rates, which are likely tocontinue for the near term.
An update on the debt capital marketsended the trip down memory lane. Garfinkeltold attendees that the middle-marketdebt volume has increased dramatically,and an increased number of large moneycenter and regional banks are activelylending to the convenience industry. Whilepricing has not yet returned to 2005-2007bull-market levels, it continues to trenddownward from the 2009 peak, with banksflush with cash and hungry for loans. Onthe flip side, debt covenants have becomemore attractive for borrowers.
Three Strategic Alternatives
In assessing strategic alternatives, businessowners at the outset must understandtheir own goals and objectives. The mosteasily defined concerns relate to financialgoals and objectives, but those relatingto the strategy of the business and other“soft” issues can be tougher to identify.Focusing on one particular case study,Roger Woodman, managing director ofRaymond James, discussed three strategicscenarios possible and viable for convenience-store owners today.
Strategic Merger: Companies cangrow externally through a strategic mergerwith another retailer operator or regionalfuel distributor in an existing or contiguousmarket. The pros: reduce duplicativeG&A and leverage fixed costs, increasebuying power and efficiency, consolidatebest practices and marketing strategies,optimize capital structure and competemore effectively against larger operators.The cons: Business owners may find itdifficult to share control, cultural andintegration issues may crop up, some jobsmight require downsizing, and the challengeof consolidating the company and/or the brand name looms large.
Equity Recapitalization: Withequity recapitalization, a portion of thecompany is sold to a private-equity sponsor.The benefits of this scenario includethe opportunity for certain shareholders tohave a liquidity event. Meanwhile, othersmay maintain ownership. Also, the managementteam may be awarded zero orlow-cost options, access to growth capitalis increased, and the process could runparallel with the sale to strategic buyers.
The downside of equity recapitalizationis that it likely does not yield thehigher valuation relative to other alternatives,and it includes active third-partyinvolvement and an uncertainty surroundingthe future tax and regulatoryenvironment. A leveraged balance sheetcan also cause a business to be vulnerableto industry competition and volatility.
Employee Stock Ownership Plan(ESOP): A qualified, defined contributionemployee benefit plan that investsprimarily in the stock of the employercompany can be a tax-advantaged wayto sell all or a portion of the business. Onthe plus side, there’s a certainty of closure,and the current management team staysin place. The ESOP means tax savings forboth the company and sellers and also createsa market for company stock.
ESOPsalso can provide a company with a greatsuccession-planning tool, as well as a tremendousemployee benefit.
ESOPs can be costly tools to implementand maintain, however, and the potentialfor overleveraging is something to watch.Also, be cognizant of the possibility of1042 rollover requirements. Significantplanning is also needed to meet potentialfuture repurchase obligations.
In closing, Woodman took a quicklook at valuation. Peer group analysiscomparison and sales leaseback analysiswere just a few of the tools he suggestedto use when focusing on the valuation ofa business.
Defining an MLP
A master limited partnership (MLP) is apublicly traded partnership. MLPs generallyown assets that produce relatively steadycash flows that can be distributed directlyto investors. MLPs must meet an IRS 90%qualifying income test. Qualifying incomefor fuel distributors includes wholesale fuelmargin and rental income.
An MLP provides a tax advantage; thestructure brings a higher valuation of 10 to15 times EBITDA vs. a traditional C-CorpEBITDA multiple of 5-9 times. In addition,MLPs have a lower cost of equity capitaland can grow the MLP to the benefit ofthe parent company, which retains the GPownership. Finally, MLPs provide the abilityto pay more and realize the same accretionas a C-Corp
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