Private Equity and the Petroleum Marketing and Convenience Store Industry: History of Successes and Eager for More

September 14, 2022

David L. Corbett, CFA, Director and John T. Mickelinc, CFA, Associate
Downstream Energy & Convenience Retail Investment Banking Group

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History of Private Equity Investments in the Petroleum Marketing and Convenience Store Industry
Institutional private equity firms have been in existence since the 1940s and have since become a significant driver of merger and acquisition activity in the United States and around the globe. 2021 was a record year for the global private equity industry with nearly $1.2 trillion of investments made, an 111% increase over 2020. Private equity exits also set a record in 2021, with 3,895 investment exits at a total deal value of approximately $665 billion [1]. 2021 also set a new all-time high for global private capital fund raising at $1.2 trillion of inflows and as a result, firms at the end of the year were sitting on $3.4 trillion of “dry powder” available to invest [2], a more than 300% increase from 2010.

Despite the flurry of private equity activity in other industries, the first meaningful investment by a private equity fund in the petroleum marketing and convenience store industry (C&G) didn’t occur until the late 1980s, when Montrose Capital made a minority investment in The Pantry by acquiring co-founder Sam Wornom’s stake in the business and then subsequently purchased a portion of the ownership interest of his business partner, Truby Proctor, Jr. Since that time, there have been more than two dozen investments by private equity firms in the industry. A few of the more notable to date where the funds have already exited include:

Freeman Spogli’s investment in The Pantry
Wellspring Capital Management’s investment in Susser Holdings
Sun Capital Partners’ investment in VPS Convenience Store Group
American Infrastructure Funds’ investment in Empire Petroleum

Convenience store chains backed by private equity currently include:

United Pacific (Fortress Investment Group)
EG Group (TDR Capital)
Transit Energy Group (Energy Capital Partners)
Yesway (Brookwood Financial Partners)
Pilot Flying J (Berkshire Hathaway)
Refuel (First Reserve)

In addition, Davidson Kempner Capital Management, Harvest Partners and Ares Management have also retained their aggregate ~29% stake in Arko Holdings (GPM Investments) subsequent to the company becoming publicly traded in December 2020. A more comprehensive list of historical private equity investments in the C&G industry can be found in the following table:

Historical Constraints on Private Equity Investment in the Petroleum Marketing and Convenience Store Industry
Given the considerable size of the C&G industry, it still remains substantially underinvested by funds as compared to other industries such as technology, industrials and healthcare. These industries have attracted the lion’s share of capital, and technology on its own has grown from 15% of global buyout volume by deal count in 2005 to 31% in 2021 [3]. In addition to the multitude of reasons why those industries have been very attractive to private equity investors, there are also some historical factors that have contributed to limited private equity investment in the C&G industry.

Prior Limitations on Financing Sources. Going back a decade or more, there was a small universe of debt financing sources willing to lend money to companies in the C&G industry. This was in part predicated on concerns of financing institutions related to the potential environmental risks from petroleum spills or leaks from dispensers and underground storage tanks (UST) and the impact it could have on the collateral base. Over time, these concerns have been allayed in many cases by increased confidence with UST insurance funds in states that offer them, as well as improved compliance testing, UST monitoring and the expanded offering and use of private insurance products to cover remediation and legal liability. There is now a plethora of bank and non-bank lenders as well as sale-leaseback providers looking to put money to work in the industry and provide the leverage that private equity investors require to generate attractive returns on their investment.
Heavy Reliance on the Sale of Volatile & Low Margin Fuels. Some private equity investors have been hesitant to put capital to work in the industry due to concerns surrounding the heavy concentration of fuel sales at gross profit margins that can be extremely volatile and low on a percentage of sales basis. Ultimately, volatility in fuel margins can impact debt service capacity, and as noted above, debt is almost always utilized by private equity investors to enhance return on equity. Several factors have helped to alleviate this concern more recently, including the increased presence of high-margin foodservice offerings in convenience stores, which generate considerable customer traffic and help to buffer the impact of fuel margin volatility. In 2021, on a national average basis, foodservice made up 29.2% of total in-store gross profit, up from 27.6% in 2020 [4], as the negative impact of COVID-19 on in-store foodservice sales began to taper and convenience store foodservice offerings continued to expand. The expectation is that as the impact of the pandemic continues to fade, foodservice sales will continue what has been a long-term trend of expansion. Even though fuel margins remain volatile, the general trend in national fuel margins for the last decade has been positive. The average of 2009 – 2012 national average gasoline margin was 16.4 cents per gallon (CPG), while the 2018 – 2021 average gasoline margin was 28.6 CPG. Similarly, the average of 2009 – 2012 national average diesel margins was 23.7 CPG, while in 2018 – 2021 diesel margins averaged 40.8 CPG. While fuel margins in 2020 were at a record high, there is a common belief that margins may remain elevated for the foreseeable future as retailers focus on maximizing margins to help offset volume decline as well as higher operating costs such as labor and credit card fees.
Limited or No Synergies/Cost Savings. Financial buyers with no existing platform to absorb an acquisition have struggled to compete on valuation with strategic buyers in the industry that are able to extract very meaningful synergies in transactions or secure savings by leveraging their overhead structure and buying power with suppliers. Although this impediment for private equity firms remains a threat to their success in bidding processes, the firms that have been successful in acquiring a platform have reduced or eliminated this competitive disadvantage for future add-on acquisitions. In many cases, as a result of these synergies and cost savings, larger strategic acquirers have been able to improve an acquired company’s corporate EBITDA by 50-70% within the first few years of the transaction.

Current Petroleum Marketing and Convenience Store Industry Investment Drivers
Today, there is significant interest from private equity firms looking to invest capital in the C&G industry. While the existing sponsor-backed platforms in the industry continue to seek growth through additional acquisitions, there are a growing number of private equity firms that are seeking to make their first investment in the industry. There are a variety of reasons for the increased interest, with some of the primary points outlined below:

Recession Resistant. The C&G industry has proven time and again that it is recession resistant and that consumers have a relatively inelastic demand for the products sold at convenience stores. Ultimately, customers’ desire for convenience in both good times and bad has only increased over time. The industry performed well during The Great Recession of 2007 – 2009 and was deemed an essential service during the early days of the pandemic, providing key staples when customers were less willing to shop in larger format stores. As displayed in the charts below, industry inside sales grew 11.5% from 2006 – 2009, while pretax profit for 2007 – 2009 averaged $4.5 billion during a very challenging economic period as compared to $4.8 billion in 2006. In 2020, during the heart of the COVID-19 pandemic, industry inside sales increased 1.5% while pretax profit increased by 34.5%. Although fuel volumes were negatively impacted due to the reduction in miles driven, fuel margins more than offset the decline in volumes in many cases and in-store volumes generally remained strong and bounced back quickly in impacted areas. Both inside sales and pretax profit continued to increase to new record levels in 2021 as the impact of the COVID-19 pandemic began to wane.

“Amazon Resistant”. Amazon and other online retailers have crept into, and in some cases taken over, nearly every corner of retail and present a growing threat to many brick and mortar retail channels. This trend was exacerbated by the pandemic, which resulted in an increase in online shopping. Shrinking delivery times for online retailers present a threat, but the convenience customer’s demand for immediate fulfillment provides a unique competitive moat for convenience retail relative to nearly all other brick and mortar formats.
Real Estate. Although portfolios vary, many convenience store chains include a substantial fee-simple real estate component, which meaningfully increases the amount of debt that can be used to finance an acquisition. The use of leverage is a key driver of returns on equity for private equity firms and thus ownership of real estate is generally attractive for investors, whether traditional debt financing or sale-leaseback is employed. Fee real estate also enhances operational flexibility, provides an opportunity to realize enhanced returns from the appreciation of the real estate value, and provides a value backstop in the future if a convenience store is no longer the highest and best use for a location.

Expansion Opportunities. Despite the spate of consolidation that has occurred in the industry over the last decade, the C&G industry remains extremely fragmented, with approximately 75% of the ~150,000 total convenience stores in the U.S. being part of chains of 200 or fewer stores. The vast majority of the stores owned by companies with less than 200 stores are owned by 1 – 10 unit operators, which comprise 64% of the total site count [5]. As a result, there continues to be ample opportunity for growth through acquisition in addition to New-To-Industry locations.
Ability to Adapt. The C&G industry has a proven history of adapting and evolving to changing market conditions and consumer demands. In the 1980’s, the transition away from service stations began with a focus on convenience stores. That trend continued over subsequent decades to larger format stores with an emphasis on expanded merchandise and foodservice offerings and consumers ultimately became comfortable with eating “at a gas station.” In addition, the focus on in-store offerings and making the store a destination for customers is expected to continue as electric vehicle market share continues to escalate over the coming decades and increasingly stringent Corporate Average Fuel Economy (CAFE) standards puts pressure on fuel volumes. The industry will also continue to seek to serve as a destination for automotive refueling and adapt to whatever form that may take in the future.

Advantages of Private Equity Partnership for Petroleum Marketing and Convenience Store Business Owners
The previously outlined points cover why the C&G industry can be attractive to private equity investors, but what are the merits of partnering with private equity for an operator in the industry? It’s not for everyone, but there are a variety of reasons why it can be a symbiotic relationship for both parties and generate tremendous value for the business owner.

Availability of Capital and Investment Diversification. It goes without saying that capital is a key factor when deciding to partner with a private equity sponsor. Funding can take the form of a recapitalization whereby an owner takes the funds invested by the sponsor out of the business for net worth diversification or other purposes or growth capital where the capital is retained in the business for organic expansion or acquisitions. It is often the case that the use of proceeds is a combination of the two. With scale becoming an increasingly meaningful competitive advantage, and the cost of acquisitions and new builds being at an all-time high, outside capital could allow for a completely different growth curve for a business.
Continued Ownership and Operational Control. Retaining ownership with a private equity sponsor has a number of financial and non-financial benefits as opposed to an outright sale. The portion of capital that is retained or “rolled” into the business is typically not taxed at the time of the transaction and the equity would continue to grow along with the business. The gain on the retained equity is not taxed until the business is sold at some point in the future and this “second bite of the apple” often provides a substantial return on the owner’s retained equity in the business. A partnership with private equity is also a compelling option for owners that remain passionate about operating the business and are not ready to retire or seek alternative ventures, but would like to reduce the risk of ownership and diversify wealth. Depending on the level of investment and the private equity investor, there is typically a level of oversight from the financial sponsor, but the day-to-day operational control of the business can be retained by the owner.
Benefits for Employees. In many cases, the acquisition of a petroleum marketing and/or convenience store business by a strategic buyer can result in substantial reductions in corporate overhead staff due to duplication with the buyer’s overhead structure. Conversely, when a private equity firm makes a platform investment, it needs and values the senior leadership team and overhead staff and thus much, if not all, of the employee base remains intact. In most cases, key members of the senior management team are awarded a portion of equity in the company that serves as an incentive to grow the business and can be a meaningful windfall at the time of the private equity exit.
Operational Expertise and Cost Savings. While a private equity sponsor will rely heavily on the senior management team for its acumen and experience in operating a petroleum marketing and/or convenience store business, they often can introduce operational best practices gleaned from investments in other industries that can generate incremental value. This can include the introduction of management “dashboards” for key performance indicators, improved financial reporting and controls, marketing techniques and employee incentive programs, among others. In some cases, the private equity firm can procure cost savings for product inventory and services by leveraging the scale of purchases from vendors of similar products and services of other businesses in their portfolio and thus provide benefits from a level of synergies.

Outlook for Private Equity Investment in the Petroleum Marketing and Convenience Store Industry
Based on the increase in consummated private equity transactions in the C&G industry as well as the amount of interest in the sector from a variety of firms that are seeking their first investment in the industry, there appears to be a strong probability that private equity activity will continue to expand going forward. Likely players include firms that have historically invested in the retail, consumer, energy and industrial distribution segments. Groups that have historically invested further upstream in the energy sector and have had to manage through the volatility that exists in upstream sectors, could likely find the relative stability of retail/wholesale petroleum marketing attractive. Another factor that could make private equity more competitive in the space going forward is the growing impact of Hart Scott Rodino (HSR) regulations, which aim to curb transactions that the Federal Trade Commission (FTC) deems as anti-competitive. The FTC continues to review transactions in the industry with increased scrutiny and as the larger industry consolidators expand market presence in areas in which they currently operate, the door is opening to other buyers with limited or no operations in a given market, which could allow for a higher probability of successful transactions for private equity investors.

About Matrix Capital Markets Group, Inc.
Founded in 1988, Matrix Capital Markets Group, Inc. is an independent, advisory focused, privately-held investment bank headquartered in Richmond, VA, with an additional office in Baltimore, MD. Matrix provides merger & acquisition and financial advisory services for privately-held, private-equity owned, not-for-profit and publicly traded companies. Matrix’s advisory services include company sales, recapitalizations, capital raises of debt & equity, corporate carve outs, special situations, management buyouts, corporate valuations and fairness opinions. Matrix serves clients in a wide range of industries, including automotive aftermarket, building products, business services, consumer products, convenience retail, downstream energy, healthcare and industrial products.

Disclaimer
The contents of this publication are presented for informational purposes only by Matrix Capital Markets Group, Inc. and MCMG Capital Advisors, Inc. (“Matrix”), and nothing contained herein is an offer to sell or a solicitation to purchase any of the securities discussed. While Matrix believes the information presented in this publication is accurate, this publication is provided “AS IS” and without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranty of merchantability, fitness for a particular purpose, or non‐infringement. Matrix assumes no responsibility for errors or omissions in this presentation or other documents which may be contained in, referenced, or linked to this publication. Any recipient of this publication is expressly responsible to seek out its own professional advice with respect to the information contained herein.

[1] Harvard Law School Forum on Corporate Governance: Private Equity: 2021 Year in Review and 2022 Outlook

[2] Bain & Company Global Private Equity Report 2022

[3] Bain & Company Global Private Equity Report 2022

[4] NACS State of the Industry Report of 2021 Data

[5] NACS State of the Industry Report of 2021 Data