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    Digging for Dollars

    Ah, those heady days of 1999, when any college dropout armed with a bathrobe and a bad idea could make millions off of overeager daytraders.

    By Matthew Enis

    Ah, those heady days of 1999, when any college dropout armed with a bathrobe and a bad idea could make millions off of overeager daytraders.

    Many investors seemed to believe that Internet-based companies and new technology offerings would never succumb to traditional boom-and-bust cycles. In retrospect, though, Federal Reserve Chairman Alan Greenspan's concern about the "irrational exuberance" of the New Economy was legitimate — consumers, it turns out, occasionally like to leave their homes when making purchases.

    Yet despite the guilty pleasure that some observers have derived from watching dot-com and stock-option millionaires find new jobs, the economy and the surrounding investment landscape have been permanently altered.

    The Internet is here to stay, and many good ideas have endured the recent shakeout, surviving to teach valuable lessons to a second generation of innovators.

    The American public, which discovered Wall Street during the recent boom and invested in stocks and bonds at an unprecedented rate, has learned similar lessons and will likely return to the trading floor as its recent financial wounds begin to heal.

    In many ways, this broader economic climate precipitated the storm that many convenience store chains are currently weathering. The seemingly bottomless well of investment capital provided fertile ground for specialty lenders to grow quickly and aggressively market loans to c-store operators. Several chains sought to take advantage of these readily available monies to fund rapid expansion.

    And like the dot-com shakeout, this fast and furious growth has led to bankruptcies and fire sales for both petroleum marketers and their lenders.

    Although credit markets are constricting as recent bankruptcies and closings spook would-be industry suitors, the majority of retailers searching for financing may have some cause for concern, but little cause for alarm.

    "The lending and capital markets are always in a state of fluctuation," said Jeff Jones, CFO and executive vice president of Oak Brook, Ill.-based Clark Retail Enterprises Inc. "But well-thought-out deals will always find money to close."

    Unaffected chains should take advantage of this opportunity to witness the potential impact of several emergent difficulties that the c-store industry will be forced to face during the coming years.

    Companies such as Paducah, Ky.-based Duke & Long Distributing Co. Inc. and Mechanicsville, Va.-based Fas Mart Inc. gambled that healthy merchandise and gasoline sales could support rapid expansion.

    Unfortunately, thinning tobacco margins struck inside sales, and margins at the pump have declined since the price of fuel began its climb in the fall of 1999, choking cash flow and making it difficult for these operators to service debt.

    "When operators project the best- case scenario on everything, it causes problems," said Jones. "If, for whatever reason, that 'best case' doesn't happen, and a deal was closed on those terms, they're in trouble. It's important to make conservative assumptions regarding a potential acquisition's performance."

    The Jungle Out There

    With hypermarkets and grocers jockeying for position within the petroleum marketing fray, and drugstores paying top dollar for corner real estate, several new variables have been added to this "best case" equation.

    "Some chains have already stated an intent to operate at zero margin at the pump by the year 2004," said Betsi Lueth, president of Tuscon, Ariz.-based Meridian Associates. "If those chains continue to proliferate, marketers will have to figure out how to have profitability and cash flow without significant profits at the pump."

    Similarly, the Wall Street Journal recently predicted that hypermarkets and grocers will seize 15 percent of the petroleum market by 2005.

    Lenders will quickly become wise to this situation, and chains with their sights set on expansion should be prepared when examining prospective acquisitions or sites for new builds. In locations that will potentially be affected, marketers should be able to show lenders that they can exist without that fuel margin, said Lueth.

    In contrast, many of a chain's locations, particularly interstate and rural stores, will most likely be able to profit from more reasonable fuel margins for some time to come. For retailers expanding to new markets, this indicates that uniform business models and undifferentiated store designs are quickly becoming a thing of the past.

    "We really believe that there no longer is such a thing as a petroleum company or a convenience or grocery or foodservice company; these industries have all merged into a single entity," said Jones.

    "What we're trying to do, with our acquisitions of White Hen Pantry, Minit Mart and Wareco is to try to balance out our chain between fuel sales and convenience and foodservice sales. That's the best way to manage through volatility and fluctuations in the market."

    Rooted Sensibly

    If managed properly, growth and expansion are generally still visible signs of a healthy company.

    Zalman Vitenson, president of commercial finance at Houston-based Shell Capital Inc., said, "Consolidation is the answer when scale economics are key to the business. And the retail petroleum industry is a candidate for consolidation. So the strategy of rapid acquisition is not the culprit [in the recent bankruptcies] per se."

    However, Vitenson was quick to add that rapid growth could cause problems if a chain is not adequately prepared. Retailers should be ready to provide lenders with safeguards and answers addressing the following risks and associated questions.

    Integration: Do you have the right team in place to integrate quickly, and gain from the larger scale?

    Leverage: Do you have a capital base to help you through leaner times or when errors are made?

    Operational: Do you have the right merchandising/retailing concept, so that you are gaining additional margin, and taking advantage of scale?

    Adverse selection: Have you bought in the right markets?

    Jones agrees. "There has to be a sense of what the company will look like before and after an acquisition, and not make assumptions that aren't attainable.

    "It's important that your organization is capitalized appropriately to properly manage the new assets on your company's balance sheet. The company has to know what it's getting into and understand all facets of the acquisition target's business and surrounding market."

    Scott Morris, vice president of Hauppauge, N.Y.-based CreditAmerica Funding Corp., reminds operators that the same set of rules applies to site selection for new builds.

    "If you're building in a new area or taking on very large rebuilds, make sure that there is a good calling for the business, and that you can survive tight gas margins," said Morris. "Make sure you're in a location where the big-box retailers won't be able to hurt you.

    "It's good to make use of site studies and always have an exit plan. Lockout periods are a big problem facing a lot of operators who funded growth through securitized lenders. No one can get out when penalties range up to 20 or 30 percent."

    Ground-up leasing is another excellent way to carefully grow a chain; however, it is typically even more difficult to find lenders willing to finance deals without a real-estate investment component.

    "From our standpoint, we're operators — we aren't in the real estate business," explained Tom Horey, vice president of finance for Beaverton, Ore.-based Plaid Pantries Inc. "We look for a minimum 25-percent return on investment, and we're not going to get that in the real-estate business, so we like leasing.

    "Also, we have a niche; we can't outbid major oil companies for sites, but most major oil companies won't build on leased land. So, we have opportunities for good locations because the owners would rather lease their land than sell it." All of the chain's 105 stores are currently leased. "However, the fact that our stores are all leased makes it much more difficult to obtain financing," Horey said.

    Ear to the Ground

    Even if a chain is prepared for growth, it still may be difficult for operators to tap funding during a capital market drought. Although lenders are becoming more cautious, they are willing to take risks on good companies.

    "Even when you don't need money, you should continuously maintain relationships with a combination of banks and finance companies," said Horey. "Always keep networking. Then, when you need the contacts, they'll be available; it makes the transaction that much easier."

    When deciding exactly whom to network with, smart operators have always advised that borrowers request information about their lenders' own stability: In the case of securitized lenders, this would require researching the lender's bond issue managers, parent company or primary investors, and any portfolio backing. Morris also suggests that other factors may be equally important when determining a lender's long-term commitment to your business.

    "The investment bankers that market loan securitizations are often looking for 20-percent returns on their money — it's an impatient market," he said. "Banks are more patient, and are willing to take 8-percent to 12-percent returns. Know your lender's motivation and be able to gauge their long-term expectations. If they aren't getting the returns they are expecting, they might drop out of the industry."

    Loans are valuable assets and are generally sold to banks or other lending agencies when a lender goes bankrupt or exits the industry. Terms typically remain the same with the buyer, but this can cause headaches for retailers accustomed to dealing with the defunct lender.

    Despite the recent defaults and bankruptcies, the cloud hovering over c-store capital markets does have a silver lining. "Capital markets have tightened, especially for our industry," said Jones. "However, there has already been a shift from investment in the telecoms and dot-coms to more traditional industries, so money is still available if you have a good plan and good relationships with a variety of sources."


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    Sourceline: Standard and Poor's. Projection for 2001 based on first quarter defaults.


    By Matthew Enis
    • About Matthew Enis

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