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NEW YORK -- A raging debate within the economic and financial communities concerns what will be the "New Normal" for the United States economy when the current recession ends and the economy once again begins to expand. Originally coined by Bill Gross and Mohamed El-Erian, co-chief investment officers for PIMCO, one of the largest investment firms in the country, the "New Normal" in their view will mean the:
-- Country's long term unemployment rate will hover around 8 percent;
-- Annual economic growth as measured by GDP will be below 2 percent;
-- Future annual stock market increases will be well below historical levels;
-- Availability of credit will continue to be constrained for the consumer and the business community; and,
-- Ultimately, there will be higher overall structural inflation.
While it is impossible to know if any of these troubling macroeconomic predictions will turn out to be true, it is obvious that the financial system is already evolving into the "New Normal." This process began in earnest after the bankruptcy filing by Lehman Brothers in 2008 and has had a major impact on the availability and cost of capital for all members of the retail petroleum industry. Unfortunately, this is especially true for those companies that would like to continue to grow by acquiring retail sites that are currently being sold by the major oil companies and distributors.
As any company that has recently tried to access the credit markets to complete a sizable acquisition already knows, all of the national and regional lenders have already adopted what most members of the petroleum industry feel are overly conservative lending standards for several reasons:
-- Lender's anticipate that the new federal regulatory environment will stress lower risk and less leverage.
-- Concerns over the declining health of the commercial real estate market in general and the economy as a whole.
-- The lender's primary focus is to survive the current financial and economic downturn.
While the current financial marketplace is very challenging, we would like to stress that it is possible to raise the funds required to complete a major retail acquisition. In 2009, our firm has been involved in several major acquisitions and we have been able to assist these clients in raising approximately $250 million from banks, private equity firms and other sources of capital. Listed below is a brief overview of the major issues all borrowers must be aware of before making an offer to buy a competitor, bid on a cluster of sites being sold by a major oil company and/or refinancing their existing debt:
-- All types of lenders (banks, private equity, sale leaseback, etc.) are primarily focused and will base their final funding decision on the cash flow or EBITDA (earnings before income taxes, depreciation and amortization) of the retail assets to be acquired, not the implied equity as indicated by a MAI (Member of the Appraisal Institute) appraisal. Lenders are not interested in owning additional distressed real estate assets and therefore, are only willing to lend money to established and creditworthy borrowers for transactions that have a strong and historical level of cash flow.
-- Banks are limiting the amount of senior debt they are willing to lend on a larger acquisition ($20-plus million) to 3.0 to 4.0 times EBITDA. The final loan amount offered by a bank within this EBITDA based matrix will be influenced by the lender's perception of the creditworthiness of the borrower and the quality of the assets to be acquired. Most lenders would also prefer to be involved in a transaction that is dominated by tangible assets -- i.e. fee simple sites -- and will be less aggressive or interested if the package includes numerous supply only sites and leased units.
-- A loan commitment in excess of $15 million from a regional or national bank will normally include a mandatory prepayment or cash flow recapture loan covenant that is based on a funded debt to EBITDA matrix. For example, most large loan commitments require the borrower on a quarterly basis to make additional principal payments equal to approximately 50 percent of the excess cash flow generated by the acquisition until the funded debt to EBITDA loan structure is below a 2.50 ratio. These additional principal payments are on top of the regular monthly loan payments and are obviously structured to rapidly lower the bank's loan default risk. This recapture mechanism will greatly impact the borrower's ability to arrange a capital structure that includes a mezzanine lender or equity partner.
-- The national and regional banks that are willing to lend in the retail petroleum space have adopted a single borrower loan limit of approximately $20 million to $30 million and therefore, a loan in excess of this amount will normally have to be syndicated. The syndication process can be costly, extra fees and higher loan spreads, and will take a longer period of time to complete than a single sourced transaction.
-- Generally speaking, the larger the loan, the lower the loan to value (LTV) covenant. For example, healthy community banks are still willing and eager to fund single-site transactions for creditworthy borrowers at a 70 percent to 75 percent LTV, but for much larger acquisitions, 55 percent to 65 percent is the norm. In addition, if the portfolio of sites appraises for a figure that indicates the borrower has more equity in the deal than originally assumed, do not expect the lender to increase its loan commitment or lower its cost of capital. Conversely, if the sites fail to appraise to the minimum LTV required in the loan commitment letter, most lenders will want to renegotiate the initial terms of the commitment.
-- Banks are increasingly looking for specific offers of ancillary business prior to making a commitment. A discussion of these potential business opportunities should be included in the loan solicitation package and can be used to attract potential lender interest.
-- The time between presenting a loan opportunity and completing the underwriting process continues to increase. Be prepared to present a complete loan package that includes information concerning all facets of the business to be acquired and your company's existing organization. Lenders are looking at risk from a global perspective and will not focus solely on the cash flow of an acquisition.
-- Be prepared to submit your loan package to numerous lenders and do not count on your existing relationships to fund a new acquisition. Unfortunately, over the last year our firm has spoken to many creditworthy borrowers who were completely surprised by their existing lenders' complete lack of interest in new loan opportunities and/or lack of candor in expressing the same until very late in the loan procurement process.
-- As the U.S. economy has started to stabilize and all classes of commercial real estate have declined significantly in value, private real estate investments trusts, dedicated debt funds, life insurance companies and sale-leaseback lenders have started to show an interest in deploying a limited amount of capital in the commercial real estate market. These sources of capital are seeking high quality, conservatively underwritten real estate loans, or the "best of the best" in both sponsorship and real estate assets.
On the positive side, retail petroleum businesses typically provide consistent cash flow based on its commodity business. In addition, many current and major oil assets are located within "High Barrier to Entry" areas of the country and include a high percentage of fee-simple locations. Our firm successfully negotiated structures that were accepted by equity investors and we continue to emphasize club deals to lower transaction costs.
Excess embedded equity will not be locked up forever and will eventually provide fuel for future growth and lower LTVs will translate into lower purchase multiples.
Institutional investors are becoming familiar with and are willing to lend into the convenience store/gas station industry.
The "New Normal" is already making its presence felt and the above guidelines should help any retail petroleum company achieve its future objectives when interacting with the financial markets.
John C. Flippen Jr. and John Sartory are managing directors of Petroleum Capital and Real Estate LLC. They have helped clients close more than $250 million in retail acquisitions via senior lenders, sale leaseback, mezzanine and private equity. For more information, go to www.PetroCapRE.com. The company also represents private equity groups that are willing to make opportunistic investments.
Editor's Note: The opinions expressed in this column are the authors', and do not necessarily reflect the views of Convenience Store News.