A Look Around The Corner

By Eric H. Karp, ESQ., General Counsel To NCASEF

For several years, we have been observing that the investor community does not respect the earnings of the publicly held parent company of your franchisor. For a specific example, we can cite the fact that for the 12 months ended October 7, 2021, the stock of the parent company declined in value by about 2.5 percent while the S&P 500 rose approximately 30 percent. We see that as one of the main drivers for the opportunistic behavior of 7-Eleven, Inc. given the materiality of its cash flow to the parent company.

It therefore comes as little surprise that ValueAct Capital, a prominent activist investor firm, was reported in May to have amassed a $4.4 billion stake in Seven & i, amounting to about 4.4 percent of the company. You can read about ValueAct here: https://valueact.com. According to Bloomberg Law, ranked by market share, Seven & i is the 5th largest company to be targeted by activist shareholders. In a letter to its shareholders as reported in the financial media, ValueAct argued that management should focus much more of its attention on its core convenience store business, which it characterized as “high return” for shareholders. ValueAct argued that the company could be worth more than double its current market capitalization by making changes which might include spinning out the convenience store business into a separate company. While we have not seen the letter, none of the descriptions of it in the media indicate that it has any reference to the franchisees of 7-Eleven, and in particular their financial interests and concerns.

In what some will undoubtedly see as a related development, on July 1, 2021, Seven & i issued a 64-slide Medium Term Management Plan 2021-2025, which is publicly available in the Investor Relations section of the company’s website. This is a blueprint for where management intends to take the company and it is hardly coincidental that many of its goals respond to the points raised by ValueAct. Here are some specific examples.

  • The number one goal of the Plan is to concentrate management resources with the U.S.-Japan convenience store business as a pillar of growth. This is a signal that the company intends to devote the lion’s share of its attention to the convenience store business as a pathway to wealth creation for the company’s shareholders. The company is signaling that there is going to be a more formal alliance between U.S.-based and Japan-based convenience store management.
  • The financial metrics in the Plan are designed to communicate to the world that the company plans to grow materially, calling for a return on equity of 10 percent and an earnings per share growth rate of 15 percent or more.
  • The Plan calls for “business structural reform” by 2024, which includes “dealing with unprofitable stores” without specifying whether they intend to close them or invest capital in refurbishment and renovation. Seven & i has demonstrated that it is willing to spend tens of billions of dollars on acquisitions particularly focused on the gasoline segment but leave all too many franchised stores languishing in dire need of renovation, refurbishment, and improvement.
  • The group’s priority strategy includes “strengthening relationship with franchisees” without one word of how it will go about doing that. We have been representing franchisee associations throughout the United States for more than three decades. We have never seen, nor have we ever been informed about, less collaborative or a more contentious relationship between the company and its franchisees. It is indeed alarming that this off-balance sheet liability of the company receives so little attention generally, and specifically in the Plan.
  • Seven & i sees the United States convenience stores to be the main driver of growth in the convenience store group, aided by the recent acquisition and integration of the Speedway stores. This is seen as a way to increased shareholder value as a global brand. More specifically, the goal is that SEI, which currently accounts for 31 percent of the convenience store group’s cash flow, to generate 50 percent by 2026.
  • Goals for the U.S. network of stores include raising the store count to 15,000, increasing fresh food sales to 20 percent of revenue and raising delivery sales to 3 percent of total merchandise sales. As you know, delivery from U.S. stores is highly problematic for franchisees because the franchise agreement purports to give SEI unfettered discretion over how to divide the revenue and gross profit from that segment.
  • In order to expand delivery, the Plan is to drive the number of 7NOW Members to 55 million by 2025. Seven & i states that order-to-time delivery at 31 minutes is the fastest in the industry and that average spending per customer is $14.50, about 1.7 times the amount of in-store sales. There is no analysis of how these changes will affect franchisees.
  • Food Focused Growth is presented as another initiative based on collaboration with Warabeya dating to 2017 for 650 stores in the Dallas region. The aim is to build a highly efficient value chain involving a collaboration between SEI supply chain management, DHL and Warabeya. The plan involves a CDC commissary plant in Stafford, VA to supply approximately 1,300 stores and then to expand from there. How will this affect gross margin at the store level? The Plan does not say.
  • SEI will accelerate its goal of installing 250 electrical vehicle charging stations by 2027 to 500 stations by 2022, concentrating on California, Florida, Texas and Colorado. There is no indication of how the stores in these states will be chosen and it is not clear that this modest investment in electrical charging stations will meet consumer demands. General Motors touts its Path to an All Electric Future, predicting that it will have 30 new electrical vehicles on the road by 2025. https://www.gm.com/electric-vehicles.html
  • Another initiative is to roll out proprietary beverages, alcoholic beverages, in store cooking of croissants and cookies, and the Laredo Taco restaurant format to new and existing stores, including Speedway. The plan does not include any details regarding the number of stores or how much capital will be deployed. There is also no analysis about how these products will affect franchisee profitability.

With the acquisition of the Speedway stores, 7-Eleven is a remarkably different company than it was a year ago. At present, about 62 percent of all stores have gasoline and about 45 percent are company owned. Seven & i is projecting that systemwide merchandise gross margin for calendar year 2021 will be a disappointing 33.9 percent. But it is also projecting that SEI’s operating income for 2021will be up nearly 60 percent year-over-year.

Retail fuel margin (33.06 cents per gallon for the six months ended June 30, 2021) remains well above pre-pandemic levels (21.07 cents per gallon for the six months ended June 30, 2019).

If franchisees feel the ground shifting underneath them, it is not their imagination. At times like these, an activist, truth-telling, independent franchisee association that seeks to hold its franchisor accountable for its behavior is essential.