A Close Look at the Sunoco Transaction
Eric H. Karp, Esq., General Counsel
On January 23, 2018, SEI announced it had closed on the acquisition of 1,030 Sunoco convenience stores located in 17 states. At $3.3 billion in cash, this was the largest acquisition in the history of the company, growing its United States and Canada store count to 9,700 locations. SEI now has about 4,300 gasoline stores, about 45 percent of the total.
The backdrop for this transaction is illustrated by the latest financial disclosures of SEI’s Japanese parent company. For the nine months ended September 30, 2017, revenue from gasoline sales increased by 29.7 percent over the same period the year before. And the revenue generated by retail sales at both corporate and franchise stores exceeded gasoline revenue by only ¥40,000. Moreover, SEI’s margin on retail gasoline sales continues to rise. For the same nine-month period ended September 30, 2017, gallons sold increased by 9 percent, but sales in U.S. dollars increased by 25.8 percent. Also, the cents per gallon margin rose from 20.36 cents to 22.8 cents, or an increase of 2.44 cents per gallon of gross profit. All of this, before the Sunoco transaction.
Last fall, the transaction hit a bump in the road when the holders of $1.6 billion of bonds in Sunoco balked at the transaction. That hurdle seems to have been overcome.
The Sunoco acquisition required the approval of the United States Federal Trade Commission in order to ensure that the transaction would be in the public interest. On January 18, 2018, the FTC filed a complaint against SEI, Sunoco and SEI’s parent corporation alleging that the transaction would have anticompetitive effects that could harm consumers. What the FTC was really saying was that to the extent SEI was concentrating its market power for gasoline, it would be acquiring the ability to raise prices because of a lack of effective competition. This is particularly ironic given the allegation by franchisees that SEI has been deliberately overpricing gasoline, sacrificing instore retail sales and its gross profit split. More information can be found at https://www.ftc.gov/news-events/pressreleases/ 2018/01/ftc-requires-divestiturescondition- 7-eleven-inc-parent-companys.
In its complaint, the FTC alleged that (a) the transaction would create a monopoly in 18 markets; (b) in 39 markets, the transaction would reduce the number of independent market participants from 3 to 2; (c) in 19 local markets, the transaction would reduce the number of independent market participants from 4 to 3; and (d) the acquisition would result in 76 highly concentrated markets in Boston, New York (Buffalo), Florida (Daytona Beach, Fort Meyers, Venice and Tampa), Virginia (Richmond), Texas (Corpus Christi, Killeeen, Laredo, Mission, San Antonio, Roma and Victoria), Pennsylvania (Gettysburg and Pittsburgh), and the District of Columbia.
The allegations by the FTC were in fact supported by SEI’s parent company public filings. Included in its filings made on January 11, 2018 was a statement that SEI intended to prove the store base and that the acquisition of the Sunoco stores was intended to “advance the market concentration strategy.” See http://www.7andi.com/en/ir/library/ks/201802.html.
Under a Consent Agreement, SEI agreed to sell 26 retail fuel outlets that it owns to Sunoco and Sunoco will retain 33 of the outlets that would otherwise have been sold to SEI. These outlets will be converted from Sunoco branded locations to independent operators. Firewalls will also be put in place to prevent SEI and Sunoco from collaborating on retail pricing strategies in the future, and for a period of 10 years SEI must notify the FTC of any plans to acquire additional gasoline outlets in any one of the 76 markets identified by the FTC in its complaint.
As for the 1,030 Sunoco of locations acquired with FTC approval, SEI’s parent company has disclosed its three-year strategy. These plans have a number of elements.
• Gasoline Sales. Given that those locations generate substantially more gasoline sales than typical 7-Eleven gasoline stores, the plan is to maintain gasoline sales of 5,500 gallons for the duration of the three-year post transaction period. Zero growth in gasoline sales is planned.
• Merchandise Sales and Gross Profit. The pre-transaction merchandise gross margin of the Sunoco stores is 31.5 percent. This is interesting because it is significantly above the consolidated gross margin of all SEI domestic stores, which for the ninemonth period ending September 30, 2017 was 34.6 percent, down from 34.9 percent for the same period the year before. The plan is to raise that gross margin to 34.5 percent in the first year, 34.6 percent in the second year and 34.7 percent in the third year. The apparent plan is to grow this margin in part by growing sales by 5 percent in each of the second and third years, which may be optimistic given that SEI existing store sales were up only 1.5 percent for the first nine months of 2017 over the same period in 2016.
• Brand Conversion. The Sunoco stores will not be “renovated” into the 7-Eleven brand until the second year after the acquisition. There is no indication as to whether or not this renovation will include anything more than changing the signs. This is consistent with SEI’s lack of appetite for capital expenditures in existing stores, which for the first nine months of 2017 was significantly below the levels in the previous year.
• Franchising. According to the publicly announced plans of SEI’s parent, there will be no franchising of any of the Sunoco stores during the three years following the acquisition.
Of course, the significance of the Sunoco transaction goes beyond its size and scale. It represents a long-term commitment to the gasoline business, many would say, at the expense of traditional merchandise sales. This transaction, along with many others that preceded it, shows that the company and its parent are willing to spend billions of dollars on acquisitions, but comparatively tiny amounts on the renovation of existing franchise stores. And SEI’s strategy for Improving the Store Base seems to rely more on closing unprofitable stores than it does on improving the existing store base. There is a big difference between improving the store base (SEI’s parent’s stated goal) and improving the existing store base. Indeed, in the first three quarters of its fiscal year 2018, SEI closed 156 stores and plans to reach 220 store closures by the end of its fiscal year on February 28, 2018.
The overall lesson is that these are perilous times for the franchisee community on a number of levels. It is vitally more important now, perhaps more so than at any time in the 40-year plus history of the National Coalition, for franchisees to remain highly organized, motivated, and united.