Alimentation Couche-Tard Bid Places Seven & i's Investment Merits In The Spotlight

seekingalpha08-20

Couche-Tard could become a leading US convenience store player with its proposed acquisition of Seven & i.But the proposed transaction is less likely to be successful due to potential resistance to ...

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(OTCPK:SVNDY) (OTCPK:SVNDF) [3382:JP] stock as a Buy. Alimentation Couche-Tard (TSX:ATD:CA) (OTCPK:ANCTF) has made an offer to buy over Seven & i. My view is that this proposed deal has a low probability of being successful. But this transaction draws attention to Seven & i's key positives, like the stock's undervaluation and the company's portfolio optimization potential. Couche-Tard Could Become A Leading US Convenience Store Player With Potential Acquisition Seeking Alpha News reported on August 19 that SVNDY \"received a preliminary takeover offer\" from Alimentation Couche-Tard and highlighted that Seven & i \"formed a special committee, comprised solely of independent outside directors, to review the proposal.\" Couche-Tard has 7,131 convenience stores in the US market as disclosed on its corporate website, while Seven & i revealed in its 2023 management report that around 13,000 of its convenience stores are located in the US. As a comparison, the US boasted a total of 152,396 convenience stores at the end of last year, based on the National Association of Convenience Stores' annual survey. As such, Couche-Tard has the potential to become a leading company in the US convenience store industry with a combined network of 20,000 stores (including those from Seven & i) that translates into a significant market share of 13%. Couche-Tard has made no secret of its ambitions to gain market share and become a larger convenience store business. At its Q4 FY 2024 results briefing in June this year, the company referred to the convenience store market as \"a very fragmented industry.\" In its investor presentation slides, Couche-Tard stressed that the \"ability to leverage scale\" is critical for its \"growth model\" and indicated that \"scale\" is one of the \"bigger differentiators\" in the convenience store sector. According to National Association of Convenience Stores' 2023 State of the Industry Report cited in Couche-Tard's investor presentation, convenience store operators with at least 500 outlets in aggregate had a 22% share of the US convenience store market. In other words, Couche-Tard will most probably become the outright market leader in the US convenience store space, if it can expand its network to 20,000 stores equivalent to a 13% market share with the proposed purchase of SVNDY. Moreover, Couche-Tard has opportunities for further market share gains, as 60% of the convenience stores in the US are run by single-store operators that suffer from a lack of scale. In a nutshell, it will be good for Couche-Tard to acquire Seven & i, but I think that it might be tough for the deal to go through as detailed in the next section. But Proposed Transaction Is Unlikely To Be Successful My view is that the probability of Couche-Tard successfully concluding the takeover of Seven & i is low for two key reasons. One key reason is that Couche-Tard doesn't appear to be keen on a hostile deal, and SVNDY might possibly be resistant to foreign ownership. In Couche-Tard's press release announcing the acquisition offer, the company emphasized that it \"submitted a friendly (my emphasis), non-binding proposal to Seven & i\" and noted that it \"is focused on reaching a mutually agreeable (my emphasis) transaction.\" In other words, if Seven & i's special committee recommends rejecting the offer, it seems less likely that Couche-Tard will be considering a hostile acquisition. An August 20 Bloomberg report cited comments from research firm JapanConsuming's founder Michael Causton suggesting that SVNDY is \"part of Japan’s corporate establishment\" which implies that \"selling to a foreign company\" is \"extremely unlikely.\" In this Bloomberg commentary piece, it is also mentioned that the Ito family, Seven & i's second-biggest shareholder with an 8% equity interest, had previously said no to a prior takeover proposal in 2015. Also, it is worth highlighting that another Japanese company, Toshiba Corporation (OTCPK:TOSBF) (OTCPK:TOSYY), had chosen to be bought over by a Japanese consortium, rather than a group of US private equity investors, in the previous year. The other key reason is that there are financing-related hurdles to be crossed for the proposed buyout of Seven & i. Couche-Tard revealed in the company's investor presentation slides that its leverage metric was 2.21 times at the end of the most recent financial period, and highlighted that its \"leverage ratio comfort zone is 2.25\" times. LightStream Research's analyst Mio Kato was quoted in an August 19 The Japan Times news article saying that it is unlikely that SVNDY \"would want to sell and without an attractive cash offer (my emphasis)\" based on his understanding of the \"Seven & i management.\" As mentioned above, Couche-Tard's current financial leverage is already in the sweet spot, and it is difficult to imagine that Couche-Tard will be willing to gear up in a big way to support an all-cash offer for Seven & i's shares. Even though I think that the proposed transaction might not go through, this deal has put Seven & i's key investment merits in the spotlight, which I will elaborate on in the subsequent section. SVNDY's Investment Merits Draw Attention Seven & i is an attractive investment candidate, taking into account its valuations and portfolio optimization potential. The market currently values Seven & i at 8.0 times consensus next twelve months' EV/EBITDA as per S&P Capital IQ data, while Couche-Tard, SVNDY's peer and potential acquirer, is now trading at a relatively higher forward EV/EBITDA multiple of 11.3 times. It is likely the difference in valuations between the two would have influenced Couche-Tard's decision to make an offer for Seven & i which is attractively valued. Separately, I highlighted in my September 21, 2023 initiation piece that SVNDY recently \"concluded the sale of its department store business arm known as Sogo & Seibu\" as part of its actions to \"restructure the company's portfolio by divesting non-core assets.\" Since then, the company has continued to reshape its business portfolio. Couche-Tard would most likely have considered potential deal synergies associated with upside from portfolio reshaping when it chose to make a bid for Seven & i's shares. At the start of July, Seven & i Holdings announced that it has successfully divested its investment in Nissen Holdings, which is referred to as a \"mail order catalog operator\" in an old Bloomberg article. In the July 1, 2024 announcement, SVNDY emphasized that this latest divestiture will move the company closer to becoming a \"retail group centered around its food\" with \"Convenience Store businesses as our growth driver.\" It is clear that SVNDY has made another key move to simplify its portfolio. The optimization of SVNDY's business portfolio involves both divestments and investments. Apart from getting rid of non-core businesses, it is also equally important to strengthen Seven & i Holdings' core, involving food-related businesses and core convenience store operations. In Q2 2024 (calendar year), SVNDY bought over the \"convenience store business and gasoline retail business of U.S. company Sunoco LP (SUN)\" and an Australian \"convenience store and fuel retail business under the '7-Eleven' brand\" as per its April 17 announcement and April 1 press release, respectively. It is also encouraging to know that Seven & i has been very successful in allocating capital to inorganic growth investments in the past. At the Q&A session of its Q1 FY 2024 (YE February 28, 2025) analyst call on July 11, Seven & i Holdings disclosed that the average Return On Investment or ROI for its past 50 transactions was in excess of 14%. Seven & i Holdings' continued portfolio optimization efforts will likely enhance shareholder value and act as a catalyst to re-rate the stock's valuations in a favorable manner. On one hand, the sale of investments and assets will help to narrow the conglomerate valuation discount awarded to the company's shares. On the other hand, SVNDY's overall ROI at the company level can potentially improve with the acquisition of high-ROI businesses and the monetization of low-ROI assets. Risk Factors Investors should watch these two key risks for Seven & i. The first risk factor is that Couche-Tard subsequently withdraws its acquisition bid or that its offer price (yet to be disclosed) for Seven & i's shares is unattractive. The second risk factor is that Seven & i fails to create value with its future portfolio optimization initiatives, such as selling its assets on the cheap and acquiring businesses of inferior quality. Bottom Line I maintain my Buy rating for Seven & i. The stock's valuations are appealing considering its high-single digit EV/EBITDA multiple, and there are re-rating drivers like portfolio reshaping efforts. There could be a short-term catalyst in the form of a successful acquisition by Alimentation Couche-Tard, although I think this is less likely, as highlighted above. On the other hand, Couche-Tard is trading at a much more demanding EV/EBITDA multiple. While I am positive about Couche-Tard's US market share gain potential in the mid-to-long term, I am less optimistic about Couche-Tard's chances of closing this particular M&A deal, so I have a Neutral view of Couche-Tard.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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