Small Operators Face Several Factors When Weighing M&A Options

NATIONAL REPORT — In the early 1980S, English punk rock band The Clash famously asked, "Should I stay or should I go?" Lately, many independents and operators of small convenience store chains are asking themselves the same thing. Although the real question may be: Should I grow or should I go?

Looking back on 2022, merger and acquisition (M&A) activity in the convenience channel didn't drum up as much excitement as in previous years — think headline-grabbing, billion-dollar deals.

That being said, M&A activity did not come to a halt in 2022; it just shifted to midsized and smaller operators. For example, Lawrenceville, Ga.-based Majors Management closed out the year with a flurry of deals, including the acquisition of 13 Maritime Farms stores from Rockland, Maine-based Maritime Energy, as well as the purchase of 10 Chevron-branded convenience stores, among other assets, from Morgan Oil Co. Inc.

In addition, Brunswick, Maine-based Rusty Lantern Markets picked up the Mallard Mart chain, adding four c-stores to its footprint in Maine when the Mallard Mart owners decided to retire. And moving west, the owners of Dino Stop Convenience Stores in the Green Bay, Wis., area exited the industry through a deal with 7E CO Holdings LLC, a Denver-based chain of 60 convenience stores with locations in Texas, Minnesota and Wisconsin.

More For-Sale Signs Expected

Can we expect the trend toward selling to continue? Absolutely, industry M&A experts say.

"Although operators are now enjoying sustained motor fuel margins at record levels, giving them perhaps less impetus to sell, the cycle can change quickly and without warning," noted Ken Shriber, managing director and CEO of Petroleum Equity Group (PEG).

PEG has managed seven such transactions in the past 15 months, from single sites to larger double-digit store portfolios. According to Shriber, motor fuel distributors and operators of all sizes — whether they have 30 sites or 300-plus sites — are looking to acquire more, "notwithstanding the increase in the cost of capital, so we have the buyers vetted for any size transaction," he said. "We are seeing multiples paid on deals holding at historically high levels. So, the time is now for small operators to consider a sale."

Buyer enthusiasm and corresponding deal values are still strong, especially for quality facilities with modern offerings and sufficient real estate, echoed Mark Radosevich, president of PetroActive Real Estate Services LLC.

The retail petroleum space has been constantly evolving from the early 2000s when the oil companies exited and sold their facilities to independent marketers, he explained. Over the years, these marketers have been forced to improve their operational standards or divest sites to independent dealers, while holding branded or unbranded fuel supply agreements.

"This was prompted by entry into numerous geographic areas by quality, highly successful independent store operators — for example, Wawa in Florida or QuikTrip in Atlanta and northern South Carolina — with large and modern facilities," Radosevich said, adding that market entry by larger players has rendered many of the former oil company sites with small stores on small sites obsolete. "Thus, store operators have been forced to adapt or die."

The factors at play in an operator's decision to sell are different for everyone, with Shriber pointing to business structure, geography, competition and asset stack as considerations.

The M&A Outlook for 2023

Considering the higher cost of capital, lower availability of capital, fear of a recession in 2023 and a tight labor market still negatively impacting the inflation outlook, it's hard to predict how 2023 is going to shake out in terms of M&A — especially until the Federal Reserve settles on an initial terminal federal funds interest rate. Once the Fed pauses on raising short-term rates (which have gone up approximately 4.5 points in the past 12 months), the capital markets should start to settle down, predicts John Sartory, managing director of Petroleum Capital & Real Estate LLC.

"I think the M&A market is going to stay somewhat muted given the Fed's ongoing monetary actions to raise interest rates and withdraw liquidity from the marketplace," he said. "In our industry, there is still a desire for companies to acquire and grow, but I do think it is going to be somewhat muted until we get better clarity as to where we are really going with the economy and what's the cost of capital going to be."

Another factor Sartory sees impacting the M&A marketplace is that the Federal Trade Commission (FTC) has taken a more aggressive stance in scrutinizing mergers and acquisitions in the convenience store industry and is taking more time to complete its review process.

The ability to raise the capital needed to acquire sites and keep them up to date with the more innovative marketers is probably small operators' biggest challenge, he continued.

If Exiting Is the Plan...

"I do think you will see smaller players having the opportunity to sell because some of the bigger players with access to capital are looking for nice, smaller fill-in acquisitions — as long as it is small enough not to garner too much FTC scrutiny, or where the assets are attractive in a new market that they planned to enter," Sartory explained.

However, sellers of sites that are in second-tier or third-tier markets and need improvements will have to be more flexible to get deals done — on terms and pricing. "They are not going to get the price and sale terms they would have gotten a year ago," he remarked.

Prudent sellers that do not necessarily need to sell right now, and want top dollar, may choose to "hold their powder for this year and see how it rides out. If we end up with a soft landing, history has shown the capital markets will recalibrate," Sartory pointed out.

Radosevich also noted that interest rates will negatively affect lease cap rates and reduce the value of credit-tenant leases held by investors. "If a small operator is growth-oriented, the key is to keep one's powder dry, as I believe that the level of available stores will increase in the event that some of the big guys exit," he said.

"Values will drop, helping to mitigate the rise in interest rates. Lenders will require sufficient amounts of equity to commit loans, and those that are ready to pull the trigger have a better chance of acquisition success," Radosevich added.

If the plan is to exit, though, now may be best time to do so before interest rates dampen the stable of buyers and deal values drop back down to traditional levels, he cautioned.