What at i is Fueling this Prolonged, Heightened M M&A &A - - PowerPoint PPT Presentation

What at i is Fueling this Prolonged, Heightened M M&A &A Cycle? Five Qu Questions We Get Asked F Frequently

Annual Conference November 7, 2018

Cedric Fortemps, CFA, Managing Director Spencer Cavalier, CFA, Managing Director Presented by: Aji Fadahunsi, Managing Director

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1. 1. What a are the macro and nd C& C&G G ind ndustry c cond nditions driving t this pr prolonged, heightened M&A cy cycl cle? 2. 2. How w is t tax ax law w impac acting g M&A A today? 3. 3. How w do I compete e agai against lar arge ger, b better er cap apital alized compan anies for ac acquisitions? 4. 4. Shou

• uld I

I be thinking of

• f growing or
• r selling, or
• r is r

remaining the same me s size ok

• k?

5. 5. Is Is t this t the peak of

• f t

the M M&A c cycle?

The e Five Mo e Most Popul ular Q Ques uestions

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Macro:

• : C

Con

• ndition
• ns f

for an A Active M M&A &A Market & & Com

• mpelli

lling V Valu luation

• ns
• Economic certainty & sentiment
• Deal spending firepower (i.e. cash reserves and credit facilities)

Business Confidence

• Multiple capital providers and low volatility
• Strong stock market
• Attractive cost of capital: interest rates, cap rates, ROE
• Liquidity: ability to monetize

Robust Financial Markets

• Capital gains rates
• Lower ordinary tax rates for C-corporations and most passthrough entities
• Ability to shield investment costs to enhance returns

Favorable Tax & Regulatory Environment

• Requirement to grow shareholder value and/or maintain distributions
• Need to scale operations to improve margins & free cash flow
• Activist shareholders

Corporate Imperative

• Young industries consolidating for intellectual property & market share
• Mature industries consolidating for scale and market share
• Industries being disrupted by new products, services, etc.

Industry Convergence

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Ma Macr cro: U U.S. B Bus usiness S Sent entiment i is Ver ery Strong

95 96 97 98 99 100 101 102 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Normalized (Normal = 100)

Business Tendency Surveys for Manufacturing: Confidence Indicator for US

Source: Organization for Economic Co-operation and Development (OECD)

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Ma Macr cro: 1 10 0 Yea ear U.S. Trea easury v

• vs. I

Int nter erbank L Lend ending ( (LIBOR) Ra Rates es

Source: S&P Capital IQ

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Ma Macr cro: S&P 500 P 500 Per erformance s e sinc nce J e Janua nuary 1 1, 2009 2009

500 1000 1500 2000 2500 3000 3500 4000 Source: Federal Reserve Bank of St. Louis

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Ma Macr cro: U U.S. R Rea eal GDP P Growth

Source: Federal Reserve Bank of St. Louis

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Ma Macr cro: U U.S. M& M&A Dea eal Value ( ue ($B $B) & & Dea eal Count unt 200 2007–2Q 2 2018

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C&G Ind ndustry: T Three M& ee M&A Waves es S Sinc nce 1 1995 & 995 & Ent Enter erprise V e Value/ ue/Corporate e EB EBITDA Mul Multiples es

Source: S&P Capital IQ

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C&G Ind ndustry: M& M&A W Waves es S Sinc nce 2000 & e 2000 & Cond nditions D Dur uring W Waves es

M&A Wave 1995 - 2000

• Business confidence
• Robust Financial

Markets

• Corporate imperative

M&A Wave 2005 – 2008

• Robust financial

markets

• Corporate imperative

M&A Wave 2012 - Present

• Business confidence
• Robust financial

markets

• Favorable tax &

regulatory environment

• Corporate imperative
• Industry convergence

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C& C&G Indust stry: Co Conditions P Prolonging g & Heigh ightening Cu g Current Cy Cycle

Condit ditio ion 201 012-2013 2014-2015 2016-2017 17 201 018

Business Confidence

• Low interest & cap rates
• High capital availability
• Low interest & cap rates
• High capital availability
• Low interest & cap rates
• High capital availability
• Low interest & cap rates
• High capital availability

Robust Financial Markets

• IPOs of 2 MLPs: Susser

Petroleum Partners (now Sunoco LP) & Lehigh Gas Partners (now CrossAmerica Partners).

• Other MLPs forming
• IPOs of CST Brands &

Murphy USA.

• Other MLPs still forming
• Federal Reserve ends QE
• Due to sale of PTRY and CST,

C&G industry public companies go from 8 to 6

• Federal Reserve shrinks

balance sheet & raises Fed Funds rate slowly

• Federal Reserve increases

Fed Fund rate by ¼ point 3x, but buyers and sellers continue to view interest rates & cap rates at historically low levels

Tax & Regulatory Environment

• Marketer electrification

concerns

• Marketer electrification

concerns

• Donald Trump elected 45th

U.S. President; lowers regs

• Tax Cuts & Jobs Act of 2017

(TCJA) Passed

• Marketer electrification

concerns

• TCJA goes into effect
• President Trump continues

to lower regulations

• Fed banking regulators lower

liquidity ratio, freeing up more assets to fund more loans and invest in higher yield assets

• Marketer electrification

concerns

Corporate Imperative

• Activist investment firm

invests in Hess Corporation

• Activist investment firms

invest PTRY, CST & TA

• PTRY sold to Couche-Tard
• Activist investment firm

invests in MPC

• CST sold to Couche-Tard
• Activist investment firm

invests in Casey’s General Store

Industry Convergence

• 24 privately held marketers

sold

• ETP buys Susser Holdings
• MPC buys Hess Retail

Holdings

• 25 privately held marketers

sold

• 30 privately held marketers

sold

• MPC acquires Andeavor
• 7-Eleven acquires Sunoco’s

retail assets

• 22 privately held marketers

sold year-to-date

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• Trans

nsaction

• n has c

closed

• At least 1

10 convenience s stores i inc ncluded o

• r 25 fue

uel sup upply accoun unts

• Co

Convenience stores and nd/or fue uels distribution bus usiness a a sub ubstantial compo ponent o

• f transaction
• US as

assets included ed as as par art of tran ansac action

• For stock t

transactions, m majority owne nership in c n compa pany was acqui uired b by buy uyer/investor

• Sal

ale/l e/leas asebac ack tran ansac actions not included ed

• Buy

uyer c cons nsidered pr private equi uity b buy uyer o

• nl

nly for its pl platform acqui uisition Cr Criteria f for Transactions Inc ncluded i in n Da Data

M& M&A Transact ction A Act ctivity: Conven enien ence e Retail & Fuel uels Distribution

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M&A Transac actio ion Activit ity: y: Convenie ience R Retai ail & & Fuels Distribution (cont’d)

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The e Five Mo e Most Popul ular Q Ques uestions

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1. 1. What a are the macro and nd C& C&G G ind ndustry c cond nditions driving t this pr prolonged, heightened M&A cy cycl cle? 2. 2. How w is t tax ax law w impac acting g M&A A today? 3. 3. How w do I compete e agai against lar arge ger, b better er cap apital alized compan anies for ac acquisitions? 4. 4. Shou

• uld I

I be thinking of

• f growing or
• r selling, or
• r is r

remaining the same me s size ok

• k?

5. 5. Is Is t this t the peak of

• f t

the M M&A c cycle?

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• Signed i

into l

• law on
• n Decemb

mber 2 22, , 2017

• Most s

sign gnifican ant as aspec ects t to t tax ax l law w chan anges es af affec ecting g M&A: A:

– Reduction in corporate income tax rate:

– Top marginal rate of 35% for C-Corps changed to flat 21% rate – Pass-through entities’ owners are eligible for up to 20% of Qualified Business Income (QBI) as tax deduction

– Immediate expensing for qualifying capital investments (i.e. accelerated depreciation) – Ability to depreciate 50% of “original use” value changed to 100% of buyers’ “first use” value – Limitation on business interest expense deduction

– 30% of Adjusted Taxable Income (ATI), which is similar to EBITDA, limit on deductibility of interest expenses

• The TCJ

CJA chang nges a are allowing buy uyers t to pa pay more for a acqui uisitions and nd/or get higher r retur urns and nd also results i in n less t taxes pa payable b by sellers o

• n

n transactions

The e Tax Cut uts J Jobs bs Act ct: H How I Is It Impact cting M& M&A?

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Example le of

• f the I

Impact o

• f TCJA on

A on a Hypothetical C l C&G &G M M&A &A Transaction

• n

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• In the

e exam xample, e, the e 3 tax ax law w chan ange ges w would al allow w a a buyer er to ge get the e sam ame e returns p paying $ g $147 mi million

• n (

(14.7 .7x Cor

• rporate E

EBIT ITDA) a as it wou

• uld have generated p

payi ying $ $120 m million

• n (12.0

.0x Co Corpo porate EBITDA) und under the pr previous t tax laws

• For t

those conc ncerned about ut the i impact that po potential f fut uture int nterest r rate i inc ncreases w woul uld h have o

• n

n M&A A mu multiples es, t the e tax ax law w chan ange ges in the e exam xample ab above e could offset inter erest r rat ate i e increas ases o

• f

ap approxima mately 2 250 bas asis points, as assuming al all other er f fac actors, including E g EBI BITDA, d do not c chan ange ge

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The e Five Mo e Most Popul ular Q Ques uestions

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1. 1. What a are the macro and nd C& C&G G ind ndustry c cond nditions driving t this pr prolonged, heightened M&A cy cycl cle? 2. 2. How w is t tax ax law w impac acting g M&A A today? 3. 3. How w do I compete e agai against lar arge ger, b better er cap apital alized compan anies for ac acquisitions? 4. 4. Shou

• uld I

I be thinking of

• f growing or
• r selling, or
• r is r

remaining the same me s size ok

• k?

5. 5. Is Is t this t the peak of

• f t

the M M&A c cycle?

19

• Deal volume was at an all time high 2017 with no signs of slowing in 2018. The U.S. leveraged loan market finished 2017 with a

record $646 billion of total volume—topping the $607 billion post-crisis high in 2013, beating prior year’s level by 33%, and beating the 2007 total by 21%

• The global M&A markets posted another strong year in 2017, as buyout value and exits showed healthy gains amid the strongest five-

year stretch for private equity fund-raising in history. PE Funds dry powder hitting a record high of $1.7 trillion in 2017.

• With deal volume down at traditional banks and nearly $250 billion of investable assets available to non-bank lenders, the debt

markets are red hot, offering buyers (often private equity firms) a golden opportunity to fund transactions with significant levels of low- cost leverage. The markets for leveraged loans are as robust as they’ve ever been, as banks and investors clamor for outstandings or higher yields to augment their positions in a sustained low-interest-rate environment

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Middle le M Market D Deal A l Activi vity b by Y Year

Mark rket U et Update

$225 $272 $164 $75 $183 $202 $237 $231 $326 $307 $284 $312 1,464 1,875 1,313 731 1,328 1,515 1,913 1,722 2,242 2,245 2,335 2,231 75 $0 $50 $100 $150 $200 $250 $300 $350 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 500 1000 1500 2000 2500 Deal Value ($B) Estimated Deal Value ($B) # of Deals Closed Estimated # of Deals Closed

• Significant investor/lender demand and short deal supply is creating

a supply/demand imbalance in the markets – intense competition for deal flow has led to a shift towards looser deal structures and, in certain markets, covenant-lite (or wide) executions, reduced restrictions on dividends or acquisitions, reduction or elimination of excess cash flow recaptures, and the further erosion of other structural protections

• As competition remains fierce and capital remains abundant,

transaction timelines for lenders continue to compress while requiring full underwriting support

• The competitive landscape in the broader leveraged loan market has

led to a disintermediation of traditional banks by non-banks in certain markets yielding a continued focus on markets like C&G by banks

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Leverag aged B d Buyout E Equit ity C Contrib ibutio ions

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Prima mary I Invest stor ( (Ba Banks v s vs.

• s. Non-Ba

Banks)

Lever eraged ed L Loan Ma Market S Statistics

Ave vera rage L Leve vera raged L Loan D Debt M Multiple les US Syndic dicat ated L d Loan V Volume ( (US $ $bil illio ion)

3.7 3.8 3.9 4.2 4.3 4.4 4.9 3.8 4.0 3.9 4.4 4.5 4.7 4.9 4.7 5.0 5.0 5.1 5.0 0x 1x 2x 3x 4x 5x 6x 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1H18 2Q18 FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA

20% 25% 30% 35% 40% 45% 50% 55% 1H04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 2008 1H10 4Q10 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16 2Q17 4Q17 2Q18 Equity contributions (%)

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1H18 2Q18 Banks Non-Banks Source: S&P Global Market Intelligence, Thomson Reuters LPC, PitchBook 0.0 200.0 400.0 600.0 800.0 1,000.0 1,200.0 1,400.0 1,600.0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018TD

Leveraged I-Grade Other

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Midd iddle M Mar arket U Use of Pr Proceeds

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Middle le M Market C Cove venant-Li Lite V Volume

US Mi Middle e Ma Market Loan n Statistics

Midd iddle M Mar arket L Loan an V Volume b by Y Year ar Mi Middle Ma Mark rket Loa Loan S Spre reads

0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1Q- 3Q18 Non-sponsored Sponsored L+0 L+100 L+200 L+300 L+400 L+500 L+600 L+700

2005 2007 2009 2011 2013 2015 2017 3Q18

0.0 25.0 50.0 75.0 100.0 125.0 150.0 175.0 200.0 225.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1Q- 3Q18 Refinancing New money (beg. 1Q03)

Source: S&P Global Market Intelligence, Thomson Reuters LPC, PitchBook

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Lever eraged ed L Loan D Dea eal Struc uctures es ( (Banks)

Pr Pre-Crisis Imme mmediately P Pos

• st-Cr

Crisis (2008-2009) To Toda day Leverage T Thresholds 5.00x 3.80x 5.00x+ Pr Prici cing Ra Range L + 275-350 L + 400-500 L + 300-400 Tenor ( (Average) 5.2 years 3.4 years 4.8 years Covena nant nts

• 29% of institutional loans were

covenant-lite

• Of the non-covenant-lite deals, 69%

had two or less covenants, 24% had three covenants and 7% had four or more covenants

• 4% of institutional loans were covenant-

lite

• Of the non-covenant-lite deals, 32% had

two or less covenants, 51% had three covenants and 17% had four or more covenants

• 75% of institutional loans are covenant-

lite

• Of the non-covenant-lite deals, 100%

had two or less covenants, 0% had three covenants and 0% had four or more covenants Ave verage LB LBO Mu Multiples 9.0x 7.4x 10.5x Equity ty C Contr tributi tion ~30% ~50% ~40-45%

Source: S&P Global Market Intelligence, Thomson Reuters LPC, PitchBook

(1) Pricing range depicted includes leveraged loans only. Estimated pricing for C&G industry is as follows: Pre Crisis: L + 200-300; Immediately Post-Crisis: L + 400; Today: L + 150-300

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Int ntroduction t to

• Direct

ect L Lend ending Pl Platforms

• Direct lending is a term meant to describe a transaction where a lending source directly provides a loan to the

borrower without the use of an intermediary. This type of “direct lending” is accomplished by going directly to private equity sponsors or owner/operators of large corporate or middle market companies, commercial projects or commercial real estate to originate loans that are ultimately provided by unregulated non-bank institutions

• Direct lending has emerged as an attractive asset class among institutional investors, generating solid risk-adjusted

returns that are primarily floating rate with high current income and lower volatility compared to other similar fixed income alternatives

• The market opportunity for direct lending has evolved over the last several decades as commercial banks have

temped their risk appetite and in many instances reduced their hold amounts of leveraged loans

• Supporting the growth of the direct lending market has been the increase in non-bank lenders funded by institutional

investors such as insurance companies, pension funds, endowments and sovereign wealth funds

• Some of the largest non-bank direct lenders include: Antares, Madison Capital, NXT Capital, Twin Brook Capital,

Golub Capital, Ares, etc.

• The proliferation of direct lending means that more banks and lenders are competing on price and terms, leading to

unprecedented levels of covenant-lite loans and the use of add-backs to make borrowers seem more creditworthy. This heightened competition continues to benefit borrowers while recalibrating the risk-return profile for lenders

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• The unitranche structure arose out of the desire to provide borrowers with a one-stop solution to their financing needs and
• ffer speed to execution, certainty of closing and, for the lenders, enhanced fundings and returns
• These facilities combine senior and subordinated tranches of debt into one facility with a blended rate of interest
• This blended rate of interest approximates the combined rate a borrower would pay for two separate facilities
• The unitranche loan may be divided into first-out and second-out components with priority issues handed through a

payment waterfall

• This type of financing operates under a single credit agreement, a single set of collateral documents, a single collateral

pool, and has one administrative agent

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Unitran anche he Introd

• duction
• n

Source: Thomson Reuters LPC Middle Market Quarterly Data as of Q4-17

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• Continued convergence between traditional banks and non-banks

 Split-lien structures, 1st out/last out structures  Jointly marketed funds between banks and private credit funds to provide certainty of close and

• ptimal cost of capital
• Markets remain robust with many Banks continuing to join the industry

 Leverage availability at all time high with evolving debt structures

• Stability in markets mean you don’t need rush to get things done… but market volatility will return

 Remember how good it felt to have four or five years on your deal when the crisis hit

• When that time comes, buyers will need underwriters with healthy balance sheets to support scalable

debt structures to finance their growth objectives

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Look

• king Ah

Ahead…

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The e Five Mo e Most Popul ular Q Ques uestions

26

1. 1. What a are the macro and nd C& C&G G ind ndustry c cond nditions driving t this pr prolonged, heightened M&A cy cycl cle? 2. 2. How w is t tax ax law w impac acting g M&A A today? 3. 3. How w do I compete e agai against lar arge ger, b better er cap apital alized compan anies for ac acquisitions? 4. 4. Shou

• uld I

I be thinking of

• f growing or
• r selling, or
• r is r

remaining the same me s size ok

• k?

5. 5. Is Is t this t the peak of

• f t

the M M&A c cycle?

27

Con

• nsiderations f

for

• r Growing or
• r Se

Selli lling or

• r Maintaining

27

• Real

eality i is that at it is mo more e than an a a finan ancial al dec ecision for most business o

• wn

wner ers. Own wnership al also me means:

– Employment, salary, distributions for owners and in some cases other family members – Future employment for next generation and potentially all future generations – Ownership provides owners with an identity and status in the community – Relationships and ability to “take care of” non-family employees important to many owners – Concerns about the legacy of the family business after a transaction

• For o
• wne

ners s serious about ut po potentially selling i in n the ne next few y years, i it i is i important to find a and nd wor

• rk with a team

m of

• f trusted a

advisors t to

• help achieve y

you

• ur goa
• als in a

a sale. . It Its n never too

• o early t

y to

• start p

planni ning ng

– Corporate tax advisor – Estate and trust advisor – Wealth management advisor – M&A advisor – Corporate legal advisor

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Obj bject ectivel ely W Wei eighing A All Fact ctors i in S n Sale e Deci ecision – Some e Step eps t to Take

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• Perform a SWOT ana

nalysis on n your ur bus usiness – be hone nest i in n your ur a ana nalysis. Ask for i input f from as ma many y memb mbers of

• f you
• ur or
• rganization
• n as you
• u’r

’re comf

• mfor
• rtable w

with. . In Include a as con

• nsiderations:

– Management team, strength and longevity – Ability to weather additional headwinds such as lower cigarette consumption, more fuel efficient vehicles, increases in labor costs – Current and future competition and ability to continue to compete in market given changes – Potential impact from electrification and/or changes in consumer trips behavior

• Bui

uild a detailed 5 year pr projection model based on n your ur pl plans ns f for the compa pany

– Make the model dynamic so that sensitivity analyses can be performed – Start with a base case, bullish case and bearing case – Include the capex that will be required to achieve the results in the projection case

• If

If the capital r required to

• ma

maintain or

• r grow the business is mor

more than y you

• u’r

’re comf

• mfor
• rtable

investing, s seeking a a capital partner ma may y be the a answer i if t there’s n no

• interest in a sale

– Currently a considerable amount of interest from private equity groups to invest in fuels distributors and petroleum marketers and convenience retailers. Investment structures can vary and certain groups are willing to have more flexibility around structure and control

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Pr Prep epare Y Your ursel elf – St Statistical An l Analysis on

• n Next Sli

Slide

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Decisi ision to Sell: Co Consi sidering D Div iversifi fication & & Risk isk-Adjusted ed R Retur urns

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• In

n cons nsidering a hold vs sell decision, risk and nd diversification m mus ust b be cons nsidered

• The Sharpe r

ratio i is us used t to help i p investors compa pare the likely return o

• n

n investment c compa pared to ris isk be being t taken

• Ca

Calcul ulations below b based on E n EBT margins as a a % o

• f b

book v value ue of equi uity to c calcul ulate annua nnual ret eturn

• The

he hi higher the he Sha harpe r ratio, t the he better the he i investment is o

• n a risk-adjusted r

ret eturn basis

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The e Five Mo e Most Popul ular Q Ques uestions

31

1. 1. What a are the macro and nd C& C&G G ind ndustry c cond nditions driving t this pr prolonged, heightened M&A cy cycl cle? 2. 2. How w is t tax ax law w impac acting g M&A A today? 3. 3. How w do I compete e agai against lar arge ger, b better er cap apital alized compan anies for ac acquisitions? 4. 4. Shou

• uld I

I be thinking of

• f growing or
• r selling, or
• r is r

remaining the same me s size ok

• k?

5. 5. Is Is t this t the peak of

• f t

the M M&A c cycle?

32

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