All In On Gasoline – Chapter 2
Eric H. Karp, Esq., General Counsel TO NCASEF
The announcement by SEI’s parent company of its $21 billion acquisition of Marathon Petroleum Corporation’s Speedway business created quite a stir when it was publicly announced on August 3, 2020. I have written many times in this space of the impact on franchisees of SEI’s multi-year and multibillion-dollar expansion of its wholesale and retail gasoline business, but this acquisition takes those concerns to a new level.
Here are some takeaways based on publicly available information regarding the transaction.
- We have reviewed the parent company announcement of the transaction, as well as research reports written by some of the largest brokerage houses, including J.P. Morgan and Goldman Sachs. Seven & i Holdings told its shareholders that it strives to deliver best value to all stakeholders, including shareholders and customers. The brokerage houses engage in detailed analyses of the impact of this transaction on both the seller and the buyer. But what is conspicuously missing is any mention of how this acquisition strategy will affect the profitability and the value of existing franchise businesses in the United States. According to Goldman Sachs, SEI plans to progressively convert Speedway stores to franchise stores after strengthening merchandising and boosting daily sales. This is the only reference to franchisees that we find in these research reports. It is deeply disappointing that franchisees are effectively invisible to your franchisor, its parent company, as well as the financial community. Franchisees are indeed stakeholders, as they invest their financial and human capital in their franchise locations, and they should be treated and recognized as such.
- As was the case with the Sunoco stores purchased by SEI, Speedway stores sell more gasoline on average than do existing 7-Eleven stores. According to Goldman Sachs, gasoline sales account for 77 percent of Speedway’s total sales, compared with 20 percent for SEI.
- The Sunoco purchase materially changed the profile of the system, and the Speedway purchase, which involves nearly four times as many locations, will do the same but in an even more pronounced fashion. The number of 7-Eleven locations in the United States with gasoline will rise to nearly 8,300, increasing from about 46 percent of the total to just over 57 percent of the total. It will also increase a trend that began with the Sunoco transaction of at least temporarily reducing the percentage of the locations in the system that are franchised to an historical low of approximately 50 percent, down from 75 percent as of March 31, 2020.
- This transaction implements the parent company’s strategy of market concentration, which may be helpful for franchisees in terms of brand penetration and recognition, but can also produce serious anti-competitive effects as SEI acquires market power. When the transaction closes in the first quarter of next year, SEI will have approximately 14,000 stores and an estimated market share of 8.5 percent in a fragmented market.
- The financial community characterizes the transaction as part of a strategy to invest in growth businesses, noting that SEI’s operating profits have tripled over the last decade, driven in part by economies of scale driven by merger and acquisition. J.P. Morgan describes management’s expectations that this acquisition will more than double SEI’s operating profit and support a compound annual growth rate of better than 15 percent.
- The parent company’s overall strategy reflects its belief that its long-term growth and shareholder value are tied to the expansion of its North American convenience store portfolio. This may be a signal that further acquisitions will be in the making.
- In my most recent column, I noted the following: “In fiscal 2020, SEI’s operating income measured in yen increased by 10.5 percent, compared to an 8.8 percent increase for 7-Eleven Japan. And looking even deeper, in the same fiscal year, SEI accounted for 14.6 percent of sales to customers in the entire enterprise but it contributed fully 24 percent of the operating income for the year. The importance of this outsized influence that SEI yields in the business of its parent cannot be underestimated.” This confirms what franchisees have feared all along, which is that because SEI produces enormous cash flow for its parent company, it is willing to spend billions of dollars on acquisitions, but is not prepared to comparably invest in upgrades and renovations to existing stores, which have been starved of capital investment over many years.
- The entire transaction will be funded by debt, which will at least temporarily increase the debt to equity ratio of the company. This could put some pressure on the company to increase cash flow, which may come at the expense of franchisees.
- As you know from prior columns in this space, SEI has created a built-in conflict of interest because gasoline is consigned to its franchisees who receive a fixed commission based on the number of gallons pumped, rather than, as was the case historically, a percentage of the gross profit. Over the last several years, SEI has continued a massive run-up in gasoline profits. Even before this acquisition, nearly 46 percent of all the convenience stores operated by SEI or its franchisees in the United States had gasoline. Franchisees are legitimately concerned that this acquisition is all about amassing even more market power so as to be able to set retail gasoline prices with impunity.
- Examples of this trend can be found in public disclosures of SEI’s parent. It reported that for the three months ended March 31, 2020, revenue from gasoline sales compared to the same period in the previous year were down, the number of gallons pumped were down, crude oil prices were down, but SEI maintained the same average retail price per gallon ($2.45) year-over-year. As a result, its retail margin measured as cents per gallon rose from 19.5 cents to 29.13 cents.
This continues a trend we’ve seen over the last several years. For example, SEI’s average retail cents per gallon in 2015 was 19.8, in 2017 it was 22.62, and in 2019 it was 23.95. The parent of SEI touted to investors that these pricing policies created an increase in gasoline gross profit of $60 million for the first quarter of calendar year 2020, compared to the first calendar quarter of 2019. During that quarter, gasoline sales volume was down 9.9 percent, but cents per gallon were up 4.9 percent. According to a briefing held by Seven & i, SEI’s gasoline gross profits for April through June 2020 increased by 30 percent year-over-year. The artificially high gasoline prices not only hurt consumers but also franchisees, because high prices at the pump translate to less foot traffic in the store and thus lower merchandise sales.
- Goldman Sachs opines SEI will likely be able to maintain margins given what it characterizes as the low market penetration of electric vehicles, citing the U.S. Energy Administration forecast that electric vehicles sales, currently at 1.8 percent, will rise to just 11.2 percent in 2050.
It has been crystal clear for many years that both the short-term and long-term interests of franchisees are of little concern to management in both Dallas and Tokyo, and invisible to the financial services industry. For many concerned franchisees, this latest and massive acquisition only confirms these impressions. It is for this reason that now, perhaps more so than at any time in the history of this franchise system, franchisees need a strong, united and determined representative and advocate in the form of the National Coalition, the only franchisee body in the system whose leaders are democratically elected by their peers.