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Capital Markets Perspective We’Re Known by the Work We Do © Capital Markets Perspective We’re Known By The Work We Do. Volume 6 Issue 1 April 2017 Valuing Synergies in M&A Transactions Cedric C. Fortemps, CFA, Managing Director & Principal Stephen C. Lynch, CFA, CPA, Vice President Kyle A. Profilet, CPA, Analyst Introduction In Volume 4; Issue 1 of the Capital Markets Perspective (CMP) series, Taking a Closer Look at Transaction Multiples, published in February 2015, we sought to explain the reporting of EBITDA multiples paid for petroleum marketing and convenience store companies and clarify how and why these transaction multiples can vary significantly when compared across different transactions. We discussed how these metrics, collected from publicly available merger and acquisition (“M&A”) disclosures and widely disseminated by financial news outlets, could be misleading when the EBITDA that is being used to calculate the multiple is not made obvious to the reader. Unlike some industries where transactions are analyzed primarily based on the seller’s corporate EBITDA, experienced industry participants and analysts in the C&G industry typically focus on the price paid for an acquisition as a multiple of the seller’s store level EBITDA or the buyer’s projected corporate EBITDA (also referred to as synergistic EBITDA). The fact that the EBITDA used to calculate a transaction’s EBITDA multiple is not always the same EBITDA measurement has historically resulted in multiple confusion, which was discussed in depth in the previous CMP article mentioned earlier. The primary reason that the seller’s store level EBITDA or the buyer’s synergistic corporate EBITDA are the most meaningful EBITDA figures to focus on in analyzing deals in the C&G industry is that a strategic buyer can realize a significant amount of synergies when acquiring another company in the industry, which leads to a much lower imputed EBITDA multiple for them than a multiple of the seller’s corporate EBITDA. In this issue, we will analyze how significant these synergies can be and the impact they have on returns for a buyer. In addition, we will illustrate how, largely due to the enormous amount of synergies that strategic buyers can realize today, acquirers are able to generate significant returns for their shareholders even in cases when transactions are valued at EBITDA multiples that some observers may suggest to be extremely high or frothy. Potential Synergies in the Fuels Distribution, Petroleum Marketing & Convenience Retailing Sector of the Downstream Energy Industry One specific topic we highlighted in the previous issue was that in each transaction, a firm considering a potential acquisition will look closely at the existing operations of the company or assets for sale and begin to forecast the likely business improvements and cost efficiencies that the buyer could realize once the acquisition is complete. These synergies, which effectively increase the average per unit (or per store) EBITDA and can be achieved by increasing gross profits and/or by reducing expenses, are created primarily through the buyer’s ability to leverage economies of scale. Synergies can take many forms, but we will focus on the synergies that are most prevalent in M&A transactions taking place in the fuels distribution, petroleum marketing and convenience retailing sector of the downstream energy industry. Richmond • Baltimore • Chicago • Dallas | www.matrixcmg.com Securities offered by MCMG Capital Advisors, Inc., an affiliate of Matrix Capital Markets Group, Inc., Member FINRA & SIPC | Copyright © 2017 Matrix Capital Markets Group, Inc. All rights reserved. Volume 6 Issue 1 Capital Markets Perspective: Valuing Synergies in M&A Transactions Page 2 Synergies in M&A transactions typically fall into one of two broad categories – operating or financial. Operating synergies allow the buyer to increase the value of the combined entity by improving the profitability of its existing assets and/or the seller’s assets or by providing higher growth compared to what the two entities could achieve individually. Financial synergies are created by increasing shareholder value by doing things such as lowering an entity’s cost of capital, increasing its financial leverage or lowering its effective tax rate. While financial synergies can be significant in an acquisition, they typically are not discussed in detail in investor presentations or analyst calls when an M&A transaction is announced in the industry. Since publicly traded fuels distribution, petroleum marketing and convenience store companies often provide detailed data on the operating synergies that they expect to realize from significant acquisitions, we will primarily focus on analyzing the materiality of those operating synergies. Some of the most typical – and significant – operating synergies that can result from an acquisition are the cost savings negotiated by a buyer that can improve fuel and merchandise procurement costs due to the increase in scale from combining the buyer’s and seller’s operations. In addition, the resulting combined entity may have stronger negotiating power with non‐fuel and merchandise vendors that could allow them to reduce costs, such as credit card processing fees, utility costs, transportation costs and expenses associated with various service contracts. Economies of scale can also be experienced in the combined entity’s back‐office and middle management levels as duplicate functions, departments and systems can be eliminated. This allows for a reduced level of overhead costs to be spread across a wider asset base, resulting in lower overhead costs per store. Operating synergies can also come from top‐line growth. Acquirers will often leverage their brand‐name recognition, proprietary offerings, merchandising strategy, loyalty programs and larger networks to increase merchandise sales, fuel volumes, overall margins or all of the above. Other operating synergies can exist that are harder to quantify. For example, an acquirer may pursue an M&A opportunity in order to acquire a different set of functional strengths, organizational abilities or concepts. For example, in August 2014, Energy Transfer Partners, L.P. (NYSE: ETP) acquired Susser Holdings Corporation (NYSE: SUSS) partially in order to roll out Susser’s coveted, well‐developed and highly successful food service concept, Laredo Taco Company, to ETP’s existing stores. Within this difficult‐to‐quantify set of operating synergies, are those synergies that result from being able to access certain resources that are really only available in a larger organization. Examples include being able to leverage dedicated, specialized resources, such as merchandising, construction or procurement departments or working with ‘big data’ in order to find and exploit patterns, trends and associations that smaller organizations simply do not have the luxury of focusing on. Impact of Expected Operational Synergies on Recent Notable M&A Transactions Thanks to the amount of information that has been publicly disclosed by the public company acquirers listed below, we can analyze the materiality and impact of the expected operating synergies on the three most notable M&A transactions that have closed in the last few years in the fuels distribution, petroleum marketing & convenience retailing sector. These transactions are: 1. Energy Transfer Partners, L.P.’s (NYSE: ETP) (“ETP”) acquisition of Susser Holdings Corporation (formerly NASDAQ: SUSS) (“Susser”) 2. Marathon Petroleum Corporation’s (NYSE: MPC) (“Marathon”) acquisition of Hess Retail Holdings, LLC (“Hess Retail”), a wholly‐owned subsidiary of Hess Corporation (NYSE: HES) 3. Alimentation Couche‐Tard Inc.’s (TSX: ATD.A & ATD.B) (“Couche‐Tard”) acquisition of The Pantry, Inc. (formerly NASDAQ: PTRY) Richmond • Baltimore • Chicago • Dallas | www.matrixcmg.com Securities offered by MCMG Capital Advisors, Inc., an affiliate of Matrix Capital Markets Group, Inc., Member FINRA & SIPC | Copyright © 2017 Matrix Capital Markets Group, Inc. All rights reserved. Volume 6 Issue 1 Capital Markets Perspective: Valuing Synergies in M&A Transactions Page 3 Before we delve into the details of each transaction, Exhibit 1 provides a summary of each transaction and illustrates how significant of a factor expected operating synergies were on the acquirer’s projected corporate EBITDA within 12 ‐ 36 months of closing on the acquisition. On average, these three acquirers expected to be able to increase the seller’s corporate EBITDA by 68.9% through various operating synergies. Based on these acquirers’ EBITDA projections, the average synergistic corporate EBITDA multiple for the three transactions was 7.25x, which is 41.7% less than the 12.4x average corporate EBITDA multiple calculated when using the seller’s reported corporate EBITDA as the measurement for EBITDA. We believe the remarks about acquirers overpaying for acquisitions in the industry over the last few years would not be as prevalent if the focus wasn’t on the headline multiple that is based on the seller’s historical corporate level performance, but rather on the implied multiple after considering the operating synergies that the buyer expects to be able to achieve. If buyers are not focused on analyzing acquisitions with potential operating synergies when they are evaluating a possible acquisition, they could miss out on a unique opportunity to transform their business. Richmond • Baltimore • Chicago • Dallas | www.matrixcmg.com Securities offered by MCMG Capital Advisors, Inc., an affiliate of Matrix Capital Markets Group,
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