This interview with Lynton Kotzin
was published in the December 2010 issue of "Business Valuation Update," a publication of Business Valuation Resources, LLC.
BVU: What changes have you seen in the gas station/convenience store industry over the years?
Lynton Kotzin: No business can be valued in a vacuum, as the performance of a business and thus its value are impacted by economic conditions, industry trends and characteristics, and other external factors. To properly value a gas station/convenience store it is important to understand the significant changes in the industry over the past decade. The retail gas station industry began with a service orientation, providing routine and preventative maintenance. Convenience stores emerged as an outgrowth of the grocery store industry. These two types of retailers merged to create the gas stations with convenience stores industry.
The number of retail gas station-only sites declined as both consumers and the major oil companies developed a preference for larger, more modern sites that had a convenience store attached. Over the period 1997 to 2002, the number of gas stations with convenience stores rose by approximately 14% compared with a 38% reduction in gas-only sites. The industry became more consumer-driven as a way to attract a wider demographic that included women and upscale customers. Technological improvements and innovations, such as pay-at-pump technology, credit and debit card payment options, touch-screen monitors, remote payment systems, and automated fueling dispensers, also helped to increase efficiency and entice customers. Many locations also began offering prepared food and branded fast food options, expanded grocery selections, banking, money orders, self-service carwashes, and other ancillary services.
Large retailers such as Wal-Mart and Costco began selling gas in 1997. These companies had large buying power, which allowed them to operate on low-margin business models and to use fuel as a loss leader, which forced gas station/convenience stores to compete based on price and incur operating losses. This blurring of distinction among retail channels has increased competition and continues to pose a significant competitive threat to the industry.
There was also significant consolidation between the major oil companies, which resulted in a rationalization of gas stations, either as part of a regulatory requirement for the merger to proceed or because they wanted to focus on their refining and drilling operations. This resulted in significant transaction activity during this period.
Q: What are some of the unique issues involved in valuing a gas station/convenience store?
A: There are several issues. These stores are special purpose properties, and the underlying value includes the incremental value associated with the business enterprise, which is distinct from the value of the real estate. Bifurcating the real estate and business components is therefore a significant issue. Other important issues include:
- Fuel volumes
- Number and type of fuel dispensers and related payment technology
- Site location and visibility
- Condition and deferred maintenance
- Demographic and regional growth trends
- Branded versus unbranded
- Number and distance of competitors
- Traffic counts
- Diversification of revenue streams
- Ingress and egress
- Profitability and trends
It is important to conduct a site visit to properly understand the strengths and weaknesses of the subject location and ascertain the competitive threats. One issue that people don’t really consider, but it’s an important one, is ingress and egress and the barriers to access a location. The ease of being able to get in and out of the property is going to have an impact on the valuation because people want to get in and out quickly and don’t want to be inconvenienced by required turning maneuvers, crossing traffic lanes, or having to make a U-turn. They would rather access a station that’s in their direct path as opposed to maneuvering into another station.
Q: Does the brand of gas make a difference?
A: Gas station/convenience stores are considered convenience businesses rather than destination-type businesses, the implication being that motorists typically purchase gasoline based on the price and convenience of a particular location. Research indicates that most consumers see gasoline as an undifferentiated product and buy it based on convenience and price. There is effectively no brand loyalty, and the rise of self-service has also eliminated what site loyalty may have existed in the past. Motorists will typically drive into the station that’s most convenient for them and will not go out of their way and perform turning maneuvers or cross traffic lanes to purchase a specific brand of gas. A lot of companies have tried different customer loyalty programs and cards, but the research will tell you that convenience is still the most important aspect.
Q: How do you handle a gas station/convenience store with multiple revenue streams?
A: The diversification of revenue lowers the overall risk profile of the gas station/convenience store and reduces the dependence on the lower-margin gas sales. The inside sales or the convenience store aspect typically has much higher margins than gas sales. The more revenue sources there are, the more diversification there is in the business, which helps lower the overall risk profile and related discount rate. A lower discount rate typically will translate into a higher overall value. We typically do a weighting to determine what the weighted or blended discount rate is for the entire business, taking into account all these different revenue sources.
Q: What are some of the environmental issues that should be considered?
A: Traditional valuation techniques suggest that contingent liabilities be considered, and these frequently result from environmental regulations. The most significant in the area of gas station operations was the legislation passed in the late 1990s requiring all gasoline storage tanks to meet strict new guidelines for protection against corrosion, spills, and overfills. A number of gas stations went out of business or changed hands as a result. Continuing contingent liabilities in the industry affect the valuation process by reducing the indicated “clean” value by the cost of satisfying the liability. Additionally, environmental contamination often carries a stigma with it that may prevent or inhibit transferability of the convenience/gas station. Procedures may need to be performed with respect to identification and/or quantification of costs to clean up any environmental contamination, should any exist. The valuation should address the issue or disclose any expenditures necessary for remediation and/or compliance with other environmental standards.
Q: Does the real estate have to be appraised separately?
A: Yes. If the real estate is owned by the entity that you’re valuing, you would have to have a valuation methodology that would bifurcate the real estate and business value components, and then you would add the real estate and the business value component to arrive at the total value of the business. If you don’t do that properly, you could end up with a significant over- or understatement of the total value.
Real estate valuation methodologies should be developed to generate “standalone” business and realty value conclusions. Rent paid to the convenience and gas station owner/landlord is an operating expense to the business component and rental payments are income to the real estate component. Before estimating the value of the business component, rent must be explicitly considered and deducted from business cash flow. These assumed rental payments are the basis for the value of the real estate component.
Q: To what extent do you use public companies and guideline transactions?
A: The market approach attempts to establish value using direct comparison with sales of similar assets in the marketplace and the analysis of publicly traded securities of companies engaged in similar businesses. Because of significant differences between the subject location and guideline transactions and the guideline publicly traded companies, the valuation specialist should proceed with extreme caution and not blindly utilize these indications without a thorough analysis of the underlying data. Application of the market approach involves considerations and judgments concerning differences in financial and operating characteristics and other factors that would necessarily affect the value of the subject company versus the value of the companies to which it was compared. It is important to address differences in underlying business operations, size, growth, profitability, ownership of underlying real estate, timing of the actual transaction, and other qualitative and quantitative aspects. These indications may ultimately be useful only as a reasonableness check.