Can Anything Cool Down M&A in the C-Store Industry?

5/12/2015

The merger and acquisition (M&A) market in the convenience and gas station (C&G) industry is showing no signs of slowing down and the level of transactional activity in the first quarter of 2015 started where 2014 ended — red hot.

In the first quarter of 2015, several new acquisitions were announced or closed by some of the most active consolidators in the industry, such as:

GPM Investments’ plan to purchase the 163 sites remaining in Sun Capital’s convenience store portfolio;
CrossAmerica Partners LP acquisition of Erickson Oil Products Inc.’s 64 retail sites;
Petroleum Marketing Group Inc.’s purchase of Mid-Atlantic Petroleum Properties LLC’s retail assets in the metropolitan Washington, D.C. area;
TravelCenters of America’s acquisition of 26 retail sites from Best Oil; and
Alimentation Couche-Tard’s announcement of two new acquisitions in the United States shortly after finalizing its mega-merger with The Pantry.

The public announcements and post-closing industry analysis concerning these acquisitions contained the following themes:

The buyer was already an active, experienced and major player in the industry and M&A market.
The seller made the decision to exit the industry because of the “lofty” EBITDA purchase multiples currently being offered by some buyers (i.e., the purchase price was just “too good to turn down”).
The major players in the M&A market are still on the lookout for additional acquisition opportunities.

While all the market forces that have been fueling the merger mania in the industry over the past several years certainly still appear to be in place, we would like to use our crystal ball to briefly highlight several external events or market forces that could potentially slow down or severely inhibit the current pace of consolidation within the C&G industry and/or lower the purchase multiples.

These are a few of the items that our crystal ball produced when asked the question: What could potentially slow down this hot M&A market within the C&G industry?

INTEREST RATES RISE

Fed Chairwoman Janet Yellen ended the Fed’s two-day policy meeting in March by announcing the Federal Reserve was finally removing the “patient” wording from its official policy statement and was willing to consider raising short-term interest rates.

Most market experts now expect the Fed to raise its target federal funds rate for the first time in approximately seven years by no later than the third quarter of this year. The ultimate goal of the Fed will be to push interest rates higher across the market spectrum, from debt obligations maturing in 30 days to 30 years, to avoid the possibility of its current zero interest rate policy fueling economic and market bubbles throughout the economy. The Fed believes the economy is getting closer to where it can grow at a sustainable rate without the added incentive provided by historically low borrowing costs.

This low interest rate environment has certainly helped fuel the growth of M&A activity in the C&G industry. As the cost of capital starts to rise in 2015, this should have a suppressing impact on market multiplies that the major consolidators and master limited partnerships (MLPs) have been willing to pay for C&G assets. In addition, as the overall level of interest rates start to rise in the bond market, the ability of MLPs and real estate investment trusts (REITs) to quickly raise the capital needed to continue expanding could be negatively impacted. As rates continue to rise, fixed income investors that typically purchase bonds normally become less interested in higher risk/higher dividend paying classes of investments such as MLPs.

While most capital market participants are currently assuming the Fed will make all the correct policy adjustments over the next several years that are needed to wean the United States off this unprecedented period of accommodative monetary policy, not everyone is sure it can be done without triggering a sharp downturn in GDP and/or causing major convulsions in the capital markets.

Ray Dalio, founder of the $165-billion hedge fund group Bridgewater Associates and one of the most powerful and respected managers on Wall Street, recently warned his clients that the Fed’s actions run the risk of causing a 1937-style stock market slump and other dramatic unintended consequences.

Any major decline in share prices and the corresponding P/E (price to earnings) multiples of the most active public players in the M&A marketplace should reduce the purchase multiples this group of consolidators has been recently willing to pay for attractive C&G assets. In addition, if the Fed’s actions cause the U.S. economy to significantly slow down or slip into a recession, this will normally cause a company to pull back on its level and pace of acquisition activity.

SELLER EXPECTATIONS

As we mentioned in our earlier article (Convenience Store News, March 2015), most market experts are predicting the C&G industry will continue to consolidate for the foreseeable future and the marketplace will include a sufficient supply of petroleum distributors that are still willing to sell their businesses and exit the industry. However, the terms of a potential sale and the purchase price expectations of many sellers may be becoming too aggressive even for the largest and most active buyers.

Multiples are not the same in every market: Most sellers seem to believe any retail network should trade for approximately the same market multiple no matter where the retail assets are located from a geographic standpoint and/or the overall level of competitiveness of the network. Any rational buyer, no matter its size, has to take into consideration these market factors before making an offer and all acquisitions certainly do not offer the same potential upside opportunities and risks to a buyer.

Pro-forma EBITDA: Many businesses in the industry are now being marketed with numerous and, at times, very aggressive upside pro-for-ma adjustments to existing or “as-is” site-level EBITDA. As the M&A market in the C&G industry has become more dominated by public companies and as private equity players have also become active in the industry, this movement to a pro-forma EBITDA model commonly used for Wall Street-driven acquisitions is not unexpected.

However, for a fairly conservative industry that until recently had been historically dominated by private and family-operated companies, this movement in market expectations or pricing has caught many potential buyers by surprise. When a member of our firm meets with most privately held companies, the dominant view within senior management is still fairly universal: any rational buyer should not pay the seller for the acquisition’s upside EBITDA potential; the upside is the buyer’s incentive or risk premium for completing the transaction.

This type of reasoning certainly makes economic sense from a conservative buyer’s standpoint, but if seller expectations continue to shift to assume upside EBITDA potential will always be included in the final purchase price, this mismatch in expectations will make it harder to complete many transactions.

Misinterpreted public information: Sellers may misinterpret the high multiples paid by buyers based on historical EBITDA as reported in the media and apply them to their businesses.

Buyers are not the same in every market: Unless a seller’s assets are extremely attractive, such as the Hess Corp. retail network that was recently purchased by Speedway LLC, a seller cannot expect the final purchase multiple will be driven upward by the MLPs and other public consolidators. Unfortunately, most sellers initially assume their retail assets will attract the most aggressive market bidders and as such, their business will trade for a premium. If the perception does not turn into reality for many sellers, could the overall supply of potential sellers start to decline for the first time in many years?

A deal gone bad: How quickly has everyone forgotten about the Great Recession and the C&G companies that tried to grow too quickly before the economy turned sharply downward and as a result, failed during that stressful period of time. It could happen again. History normally repeats itself.

Many of the larger consolidators in the industry are certainly experiencing some growing pains and a few of them have recently slowed down their pace of acquisitions. One of these players could run into financial trouble, or a highly visible C&G acquisition may turn out to be a major disappointment from a financial standpoint. If the overall perceived risk profile for the C&G industry increases within the capital markets, this will typically result in higher interest rates on loans, stricter loan covenants and less capital allocation — and at the end, lower transactional volume.