North Carolina Petroleum _ Convenience Marketers

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					            Enhancing Petroleum Marketer Performance: Value
                      Driven Analysis and Practice

I. How do we know how we are performing in the context of our environment? What are the
best indicators of our condition? What indeed are our objectives? II. Where are we headed?
Can we rely on economic forecasts? Our own firm’s? What techniques are useful? Are there
aids to optimizing our value creating abilities? Big picture vs focused picture: Economy-
Industry-Firm-Family ? II. Where are we headed? Can we forecast these forces are headed?
Economically? Industry-wise? Firm-wise?

                               George A. Overstreet, Jr.
                       Walker Professor of Growth Enterprises
                       Associate Dean of Research and Centers
                           MhcIntire School of Commerce
                                University of Virginia
                              Charlottesville, VA 22903
                              434 242 7063 mobile/UVa
                                  434 985 4188 farm
     Key Private Firm Managerial “Must-do’s”
• Private Firms are different than public firms!
  Unfortunately, most managerial research has
  addressed public firms—family firms are more
  complex than partnerships!
• Lacking market based value signals, private
  firms can use value based management
  signals or metrics to substitute for market
  based signals (daily equity price changes).
• This, however, requires a disciplined &
  knowledgeable path. Also, serious study and
  what Geoff Colvin refers to as “deliberate
  practice”. It is not in the domain knowledge
  sphere of most accountants and CEOs but
  requires their buy-in!
    Key Private Firm Managerial “Must-do’s”

I. Adopt value based management practices and
   systems based on the following principles:
   a. Establish accountability at each strategic
   value unit based on the value added principle
   that it must contribute positively to the firm’s
   value (yield a return on capital greater than its
   cost of capital (EBIT*(1-tax rate/(Debt +
   Equity) less Weighted Average Cost of Capital
   (% Debt*Cost of Debt*(1-tax rate) + (%
   Equity*Risk Adjusted Opportunity Cost of
   Equity)—naturally, this goes for new
   investments as well as existing ones.
           Key Managerial “Must-do’s”

II.  Develop a Business Council and Family Council—
     Study Groups can serve the former role if used
     appropriately. Study Generation to Generation.
III. Develop a living competitive market derived--value
     based–plan designed to identify, establish, and
     sustain competitive advantage for each Strategic
     Value Unit in your portfolio. Why competitive
     advantage? Returns on capital greater than the cost
     of capital are very rare without competitive
     advantages in highly competitive market
     economies. Discuss!
            Key Managerial “Must-do’s”
IV. Establish a Value Coach to get over the learning
    curve and “Firm Council” or Small Advisory Board of
    Wise, Experienced, Proven, Diverse Advisors to
    serve as a Sounding Board
V. With your team, develop a living strategic,
    competitive market derived--value based–plan
    designed to identify, establish, and sustain
    competitive advantages for each Strategic Value
    Unit in your portfolio. Why competitive advantage?
    It is the source of returns on capital greater than the
    cost of capital in competitive markets. Make sure it
    is considers your family’s life cycle and the need for
    diversification! And the need for appropriate
                 Key Managerial “Must-do’s”

VI. Establish Separate SVUs for Real Estate and
     Operations for Company Ops and Dealer Ops, Etc. If
     you don’t have balance sheet for each, develop
     market based valuation alternatives to establish
     your opportunity costs and capital allocations
VII. Treat the business as a business and the family as a
     family with a council for each. Devote time to
     making sure each is “healthy” and “value” oriented
Suggested Readings/Study: Talent is Overrated: What really Separates World-
      Class Performers from Everybody Else, Geoff Colvin, 2008, 2010, Portfolio.
      Competition Demystified: A Radically Simplified Approach to Business
      Strategy, Bruce Greenwald and Judd Kahn, 2005, Portfolio. Valuation:
      Measuring and Managing the Value of Companies, Tim Koller, et al, McKinsey
      and Company, 2010, University Edition, Wiley; Generation to Generation: Life
      Cycles of the Family Business, Kelin E. Gersick, et al, Harvard Business School
      Press, 1997.
   Strategic Value Management: A BALANCED APPROACH
                                                 II. STRATEGIC VALUE ASSESSMENT

                                                 •SOURCES OF COMPETITIVE ADVANTAGE
                                                 •ECONOMIC PROFIT/LOSS DYNAMICS
                                                 •FINANCIAL METRICS AND PERFORMANCE
                                                 •Strengths, Weaknesses, Opportunites, Threats (Swot)
                                                 •STATUS QUO VALUATION

    INITIATIVES AND ESTABLISH                    III. FORMULATION AND Strategic Value Mgt.

STRUCTURE                                        •ASSESS CORPORATE VALUE ADDED (NET PRESENT
         Questionaire on Performance Monitoring & Planning, Page 1
1.   Name: _____________________________________________________________
2.   Firm: _____________________________________________________________

1.    Does your firm formally engage in planning that should impact performance on a regular
      basis? Yes/no If yes, how often? Man/woman hours last two years?
2.    Has it been successful? Very 5………3 fair…….1 not at all
3.    Do you follow national economic trends? Yes/No If yes, what sources do you use?
4.   Regional and local economic trends? Yes/No If yes, what sources do you use?

5.   Do you analyze competitive trends in your marketplaces? Yes/No If yes, do you collect
     data? Yes/No If yes, what types?
6.   Do you feel that your firm has a competitive advantage? Yes/No If yes,
7.   If your firm has a competitive advantage, will it manifest itself in terms of performance?
     Yes/No If yes, describe how so?
     Questionaire on Performance Monitoring & Planning, Page 2

8.  Do you periodically value your firm? Yes/No If yes, do you use an outside
    source or do it internally? Outside/internal/Both? Do you measure the value of
    the firm’s profit centers or parts? Yes/no? If yes, how do you assess value?
    A. Market comparables? Yes/No If yes, market “comps”, what “comparable”
    benchmark/s do you use?
    ________________________________________________. B. Discounted cash
    flow valuation Yes/No C. Liquidation Value of Assets and Liabilities Yes/no
9. What key financial measures does your firm formally use to assess how your
    firm is performing?
    C.__________________________ D. _______________________________
    E.___________________________F. _______________________________
10. Were they used as an integral part of your valuation assessment? Yes/No
11. What key operating performance metrics do you use to assess unit
    C.__________________________ D. _______________________________
    E.___________________________F. _______________________________
     Questionaire on Performance Monitoring & Planning, Page 3

12. Let’s test your overall firm marketplace for competitive advantages: Does it
    exhibit market share stability? Yes/No/Unknown Does it exhibit low entries
    and exits? Yes/No/Unknown Does it exhibit high profitability? (return on
    capital employed over 10 percent after tax?) Yes/no/ unknown

13. Let’s test for competitive advantages? Does your firm have proprietary
    technology, supply contracts, or advantaged locations? Yes/no/unknown
    Does your firm have customer captivity? Yes/no/unknown Does your firm have
    economies of scale and hence is a low cost producer? Yes/No/Unknown
                           Strategic Value

                                                 II. STRATEGIC VALUE ASSESSMENT

                                                 •SOURCES OF COMPETITIVE ADVANTAGE
                                                 •ECONOMIC PROFIT/LOSS DYNAMICS
                                                 •LIFE CYCLE (PORTFOLIO ANALSIS)--MATRIX
                                                 •STATUS QUO VALUATION



STRUCTURE                                         •ASSESS CORPORATE VALUE ADDED (NET PRESENT
            I. The Playing Field
• How tough is the competitive state of our industry?
  Relative to “pure competition”?
• What does that suggest for our industry and its
  individual firm performances?
            Ia. The Playing Field: How Tough is the Industry?


II. BARGAINING                   MARKET’S                  III. BARGAINING
    POWER OF                    COMPETITIVE                    POWER OF
    SUPPLIERS             POSITION & PROFITABLITY                BUYERS

                               I. CURRENT
          Exit Barriers       COMPETITORS

                                                    Entry Barriers
 IV. THREAT OF NEW                                     V. INDUSTRIES WITH
      ENTRANTS                                              PRODUCT
                   Ib. Porters Five Forces Model: C-Store Industry
             Fragmented Nature With Each Neighborhood Market Differing
                                             Market fragmented with each being
                                             unique; consolidating with highly
                                             efficient price competitive chains on
                                             top of huge number of single store

    Low to Moderate barriers to entry                                                Relevant Buyer Power
 Capital costs rising ($2.5 to $4 m.) new                                            Low switching costs due
to industry units plus OH                             Potential Entrants             to public posting of gas
 Low urban land availability with sprawl                                            prices leading to low
showing signs of slowing                                                             switching costs; tired iron
                                                                                     having hard time competing

                                                   Industry Competitors

                  Supplier Power                                                         Buyer Power

                                                  Rivalry/Existing Firms
         Very High Supplier Power                                                           Substitute Products
  Limited number of refineries hold                                                   Hyper marts & gas
 lots of pricing power.                                                               Drug store chains; grocery
  Rising global demand & fixed Supply                                                fresh movement
 suggests potential long term price                     Substitutes                   Electric/hybrid vehicles
 increases                                                                                      Moderate
                           Ic. Porters Five Forces Model Inputs
                                Resulting Competitive Score
                  (3.5 being oligopoly and 5 being pure competition)

                Supplier    Buyer                                 Potential   Competitive
                 Power      Power    Competitors   Substitutes    Entrants    Score 3 to 5

C-Stores         High        High        High          High         High          4.75

Dealer           High        High        High           Mod         High          4.50

Space Heat        Mod        Mod         High          High         Mod           4.25

Card locks       High        High        High           Mod         Mod           4.25

Terminals         Mod        Low         High           Low         Low           4.25

Transports        Low        High        High           Low         High          4.75

* Force Level    High
Assessing Competitive Advantage? Are Incumbent Advantages
 Identical to Barriers to Entry? Source: Competition Demystified, p. 56.
                   1. Develop industry map
       Identify strategic value units having individual
                       market segments
            Identify competitors in each segment           • If no, pursue
                                                             efficiencies! If
   2. Test for existence of competitive advantages           you are an ant,
•Mkt-share stability, dominant firm, low entries & exits
             •Sustained high profitability                   consider

                                                           • If yes, identify
    3. Look for sources of competitive advantage
               •Proprietary technology                       and manage
          •Advantaged resources (locations)                  competitive
       •Customer Captivity (Switching Costs)
                 •Economies of Scale                         advantages.
             •Government Intervention
 Id. Barriers to Entry Model: Steps to Assessing the Competitive State of a Firm’s
                       Markets—Generic Strategy Implications

• Step 1: Develop an Industry Map with segments and
  competitors for Each Value Center
• Step 2: Test for Existence of Competitive Advantage
  (Mkt. Share Stability, Dominant Firm, Low Entries
  and Exits, Sustained High Profitability)
• IF No, Pursue Operational Efficiency
• IF No & Vulnerable, consider exiting to save assets
• IF Yes, Identify and Manage Sources of Competitive
  Advantage (Proprietary Technology, Cheap
  Resources, Economies of Scale, Barriers to Entry,
  Customer Captivity)
             Ie. Barrier to Entry Model and Strategy Implications:
                                  Case Example

             Market    Dom.
             Share     Firm?   Low entry   Roic > Wacc?   Pursue ?   Notes
             Stable?           Exit?
C-Stores      no       no         no           no          Op.Eff.

Dealer        no       no         no           no          Op.Eff.

Space Heat    yes      yes        yes          yes          CAdv

Card Locks    yes      no         yes          ???          CAdv

Terminals     yes      no         yes          yes          CAdv

Transports    no       no         no           no          Op Eff

              Operational Efficiency = (Op. Eff.)
              Identify and pursue Competitive Advantage = (CAdv)
 Implications of Structural Analysis
  Within the Petroleum Marketing
Analyzing the Competitive Landscape
What Return on Invested Capital Should
 We Expect for the Industry Given Its
       Competitive Structure?
            Ij. Long Term Industry Comparisons for ROIC After Tax
                                         40 Year Average through 2004, Koller, Valuation:
                                         Measurement and Management, Wylie, 2005, 141.
 Pharmaceuticals & Biotechnology                                                                                             18.4
 Household and Personal products                                                                                     15.2
             Software and Services                                                                                  15.0
                             Media                                                                                  14.7
      High Performing PM 01-07                                                                               14.1
 Top Quartile, CSX Data 93-06                                                                         12.0
    Semiconductors and Equipment                                                                  11.9
Health Care Equipment and Services                                                              11.3
       Food, Beverage and Tobacco                                                              11.0
  Technology Hardware and Equip.                                                             10.3
      Automobiles and Components                                                          9.9
   Consumer Durables and Apparel                                                         9.5
                      Total Sample                                                 9.0
                         Retailing                                                 9.0
                         Materials                                               8.4
                             Energy                                            7.7
                  CSX Data 93- 06                                        7.0
                  Transportation                                        6.9
      Telecommunications Services                                     6.5
                         Utilities                                   6.2

            CSX Entire Corp. Sample ROIC averaged 6 percent from 1993 to 2006 and 7% (including owner’s salary) and 6 %
            (excluding owner’s salary)—note this is not the same sample of firms for each year. Top quartile ROIC averaged
            If. The Playing Field
• How tough is our industry? Relative to “pure
  competition”? Close to pure competition; keep in
  mind there are huge differences market by market.
• What does that suggest for our industry and its
  individual firms’ performance? Low Return on
  Invested Capital versus Cost of Capital
• If so, how did we dodge the recession bullet?
Strategic Value Management (SVM) Has Three
Key Functions
   Enhancing firm value is the ultimate financial
   Key Question: Will the proposal raise the firm’s
    market value? Is its return on capital greater than
    its cost of capital? Does it have positive Economic
    Profit and NPV?
   Firms and their Strategic Value Units (SVUs) must
    identify and focus on the key drivers of value.
   The firm’s management options (SVM) must
    integrate strategy, action plans, targets,
    performance measurement and incentives across
    the organization.
  ROIC less Cost of Captial (EP) integrates performance measurement across
                                  key decisions


EP ($) or (%) = EBIT(1-t) - (Capital x Cost of Capital (%)

Ec. Profit = Return on Invested Capital – Weighted Average Cost of Capital

       Investment                                               Financing
        Decisions                                               Decisions
         (Capital)                                           (Cost of Capital)
  Ec. Profit (Value) Basics: What must management do to increase EP and
create firm value? Also, Minimize Cost of Capital – Optimal Use of Leverage

  EP ($) =    [  NOPLAT
                               Cost of
                                         ]   X    Capital ($)

               Operate - Improve the return
               earned on existing Capital

                      Build - Invest as long as
                      returns exceed the cost
                      of capital
                                  Harvest - Divest capital when returns
                                  fail to achieve the cost of capital
           A Typical Financial Management System

        Measurement                             Incentive

                      Returns        Growth             Capital

                  Margins      Cash Flow
   Initiatives                                     Communicate
                 Strategic            Goal
                 Planning             Setting
     The Financial Management System and Economic Profit

        Measurement                              Incentive

Benchmarking             ROIC less WACC                  Capital
                           = Ec. Profit                  Budgeting

   Initiatives                                      Communicate
                  Strategic            Goal
                  Planning             Setting
 Return on Invested Capital less the Cost of Capital or Economic Profit is the
key metric to for alignment and consistency in the organizational architecture

                             (planning &

 Accountability                                            Performance
 &                                                         Measurement
               Case #1: Looks are deceiving—Growth
                         in Invested Capital

$120,000,000         What Stage is the





               2001 2002 2003 2004 2005 2006 2007 2008

        Fixed Assets       Cap Rents     Working Cap
                      Invested Capital Per Gallon
                     Total Company: Implications?







              2001   2002   2003   2004   2005   2006   2007   2008
Working Cap 0.048 0.045 0.063 0.072 0.091 0.091 0.121 0.125
Cap Rents   0.204 0.256 0.24 0.219 0.207 0.208 0.211 0.241
Fixed Assets 0.142   0.18   0.168 0.148 0.169 0.196 0.225 0.222
                Income and Expense Growth
                      Total Company







              2001 2002 2003 2004 2005 2006 2007 2008

                       Income   Expense
                     Return on Invested Capital: Another


Return %





                    2001   2002   2003   2004      2005     2006    2007   2008

                    C1      Ind Avg      Top Qrt          CP 8 Yr Avg

                            Return on Invested Capital
                         Strategic Value Unit (SVU No. 1)
Return %

                      2001   2002   2003   2004   2005 2006   2007   2008

                              SVU    Ind Avg      Top Qrt
                    Return on Invested Capital
              SVU No. 1 and Comparable Companies
              Discuss Recent Value Enhancing Moves
Return %

                       2001     2002   2003   2004   2005   2006   2007   2008

                    Case Firm           Firm B        Firm C        Firm D
                 Case # 2. Composite, High Performing Segment
Again Note Growth in Capital Invested for Composite, High Performing Case Here we
                   also see its blended cost of capital (WACC)?

                                 $600                                                                      11.0%
                                 $500                                                                      9.0%

                                                                                      $400                 8.0%
         Capital (in Millions)


                                 $300                                 $281
                                 $200               $174

                                 $100                                                                      2.0%


                                  $0                                                                       0.0%
                                        2001     2002      2003     2004            2005       2006

                                                 Equity    Debt     Total Capital            WACC
      Case #2: Wealth Creation & Composite High Performing Firm EVA Trend
Now, for the quiz: What does this suggest for its Return on Invested Capital? Greater
                    than or Less than its Cost of Capital (WACC)?


                     $50                                                        11%
                                  What about the                                10%

                     $40           firm’s matrix                 $38

                                     position?                                  8%
     (in millions)

                                                          $30                   7%
        EVA $'s

                                                                                      EVA %

                     $10                                                        2%

                           $3                                                   1%

                     $0                                                         0%
                           2001        2002        2003   2004   2005    2006

                                               EVA $'s           EVA %
Case # 2. EVA Market Value Assuming Same Future Performance
          What is the EVA Based Value of Our Composite, High Performing Case Sector?
                       Moral: Growth plus Returns equal Huge Value Gains
          (Note: Enterprise Value equals Invested Capital & PV of EVA, with no growth)
                          Supported by market “comps”? Implication?


          (in Millions)
          Total Value

  $800                                                                      $508


  $400                                                                       $288
                                            $175                   $201
                          $34    $91                      $136
                                 $108       $125                             $254
                          $105                                     $199
                          $57    $66        $90
                          2001   2002       2003          2004     2005      2006

                                   Equity          Debt          EVA
                In summary,
•We can profit from the financial discipline
  that value based analysis and planning
provides—it is a form of deliberate practice
 similar to what Geoff Colvin describes in
            Talent is Overrated?

  Let’s not forget we need to monitor our
environment or “it’s all about the economy”
   Now for the Big Picture—A. Economic
Monitoring on the Cheap for Best Results—
  Two Free, Proven Monitoring Sources B.
   Where are the Commercial Real Estate
              Markets Headed?
  What do both suggest for our industry?
Business planning esp CRE is all about the Economy--Chicago Fed National Activity
Index (3 Mo. Moving Average) Shows U.S. Economy Went into Recession in Q4 2007

                                        Inflationary             +0.7

      So where are we now in the economic cycle?

The Chicago Fed National Activity Index
(CFNAI) is a monthly index designed to gauge
overall economic activity and related
inflationary pressure.
So where are we now in the economic cycle? CFNA-M3
                              CFNAI recently in a state of flux
• The index’s three-month moving average, CFNAI-MA3, increased to .11
  in February from .05 in January 2011. February 2011’s CFNAI-3 month
  moving average suggests that growth in national economic activity is
  approximately equal to its historical trend. With regard to inflation, the
  amount of economic slack reflected in the CFNAI-MA3 suggests subdued
  inflationary pressure from economic activity over the coming year.
• The index’s three-month moving average, CFAI-MA3 declined to -0.19
  from -0.15 in April suggesting that the economy is below its historical
  trend. It remained negative for the second month reaching its lowest
  point since November 2010. Keep in mind it also suggests low inflation
  despite all the market pundits!
•   On September 20, 2010, the National Bureau of Economic Research (NBER) determined that June 2009 marked the end of the recent
    recession. By comparison, the CFNAI indicated that the recession had ended in its October 26, 2009, release—almost a year earlier.
•   Stay tuned to the Chicago Fed’s email alerts on the Chicago Fed’s National Activity Index! Best “free” economic condition data
    available at any price. Know where you are before establishing where headed! Note: To compare the success of the CFNAI in tracking
    the dating of recessions established by the NBER, see
             At Long Last, Trucking Data Utilized! Important!

About the Ceridian-UCLA Pulse of Commerce Index™
In conjunction with economists at UCLA Anderson School of Management and Charles
River Associates, Ceridian has launched the groundbreaking Ceridian-UCLA Pulse of
Commerce Index™ by UCLA Anderson School of Management. It is a first of its kind
indicator of the state and possible future direction of the U.S. economy. The index is
issued monthly and has been proven to track closely to the Federal Reserve’s Industrial
Production number.
The Ceridian-UCLA Pulse of Commerce Index (PCI) is based on real-time fuel consumption
data for over the road trucking. By tracking the volume and location of diesel fuel being
purchased, the index closely monitors the over the road movement of raw materials,
goods-in-process and finished goods to U.S. factories, retailers and consumers.
Compiling and Analyzing the Data
Every day across the United States, over the road trucks are fueling up with diesel as they
move goods across the country, delivering everything from produce to raw materials to
finished goods. Through Ceridian’s electronic card payment services for the
transportation industry, Ceridian has been able to track this data and analyze the volume
of fuel being used by these vehicles on a yearly, monthly, weekly and daily basis. Ceridian
processes millions of these fuel transactions each year, and the data provides a
compelling story about the status and direction of the U.S. economy.
New Ceridian-UCLA Index: Trucking Based Ec. Index
Ceridian-UCLA Commerce Index and Industrial Production
Stalled Out?
Ceridian-UCLA Index: Longer View
Higher Fuel Prices Slowing the Economy?
Unfortunately, economic forecasts are notoriously deficit so the best we know is where we are at a point in
 time. Thus, it pays to know the long term history. How bad was the credit crisis relative to other rough
 “Below the Banking, Currency, Default, and Inflation Index (Rhinehart & Rhinehart, After the Fall,” 2010)
       Rhinehart and Rhinehart, “After the Fall,” 2010

• More than ample evidence that the decade of
  relative prosperity prior to the fall was fueled by an
  expansion in credit and rising leverage spanning
  approximately a decade;
• This is followed, in turn, by a lengthy period of
  retrenchment that most often only begins after the
  crisis and lasts almost as long as the credit surge.
• Clearly, not what one wants to hear on the morning
    Rhinehart and Rhinehart, “After the Fall,” 2010

• Paper examines 66 countries from 1900-2010 for 15 post WWII
  financial crises as well as the great depression, the 1973 oil shock
  and the current crisis;
• "After the Fall" predicts likely scenarios a decade after the crisis
  year of 2007;
• Their findings suggest a 90% probability that real house prices will
  be below 2006 prices in 2018;
• The chart illustrates that the “great recession” was not up to WWI
  hyperinflation, the great depression and WWII. So, things could be
  worse. Still, according to Peter Linneman’s comparative analysis—
  clearly the worst post WW II recession to date.
      Rhinehart and Rhinehart, Findings
• Rhinehart and Rhinehart go on to demonstrate that
  real per capita GDP growth rates are significantly
  lower during the decade that follows severe
  financial crises, particularly those characterized by
  synchronous world-wide shocks.
• Importantly, the median post-financial crisis GDP
  increased growth decline in advanced economies is
  approximately one percent.
• So, if the normal growth of the economy was 4—
  then 3; if 3.5—then 2.5 etc.
           Rhinehart and Rhinehart, Findings

• And, as we would also expect, during the decade following severe
  financial crises, unemployment rates are significantly higher than
  in the decade that preceded the crisis.
• The rise in unemployment is most marked for the five advanced
  economies studied, where the median unemployment rate was
  about five percent higher.
• In ten of the fifteen post-crisis episodes studied, unemployment
  never fell back to its pre-crisis level within the following decade.
• Clear implication—the recession has run true to form and will
  have a longer impact than a “normal” one with higher
  unemployment and lower economic growth! So, why is the press
  so surprised?
Summary of Economy Concerns: Jim Clayton, Cornerstone Real
              Estate Advisors, Feb. 13, 2001
U.S. Debt Shrinking Slowly
1x. Toward a More Balanced Global Economy

                                            for China
                                            and Other
                                            Exports to
              The Coming Decade – Macro Outlook
  US recovery from “Great Recession” is in flux, but its impact will be evident throughout
     the forecast period with slower growth & higher unemployment:
       – US & Europe’s weak economies threaten global recovery
       – Robust private sector growth is not yet occurring
       – Structural changes are occurring in the federal budget; mandatory and interest
         expenses are increasing faster than revenue

 Congressional Budget Office (CBO) projects deficits never under $700B
  through FY20
   – FY11 deficit is 9% of GDP & in 5% range through FY20
   – Deficits decline till FY14, then rise to $1.25 trillion by FY20
   – Public debt will reach 90% of GDP by 2020
   – Persistently high debt will constrain discretionary spending
 CBO estimates interest expense, $200B in FY10, reaches $900B by FY20,
  becoming an additional major budget driver

 The Federal budget is on an unsustainable path – US Comptroller General
   Growing Budget Competition from Mandatory & Interest
                                           Chart Sizes are proportional to total dollars

          FY 2011 Request                          Outlays in Current Dollars
                                                                                                        FY 2020 Projection
            $3.8 Trillion                                                                                  $5.7 Trillion

                                                                                                            Interest      Security
                                                                                                              15%           17%
                                                                                                             $845B         $955B
                 $254B          Security                                                                                             Non-security
                                  23%                                                                                                    9%
                                 $895B                                                                                                 $529B

                                 Non-security                                                                             Social Security
                                     14%                                                                                       21%
                    Social Security $520B                                                                                    $1,201B

Note: New “Security” category groups DoD, DoE Nuclear Wpns, DHS, VA, some of DoS and other security assistance programs

     Source: OMB, Budget of the U.S. Government, Fiscal Year 2011

 Structural changes to interest and mandatory spending squeeze discretionary
  Public Debt Increasing Far Above Normal

                                       1958 – 2008 Average= 38%

Note: FY10 – FY20 per CBO March 2010 Estimate of FY11 PB          Sources: OMB, Congressional Budget Office, March 2010

         Future debt rises to levels not seen since the end of World War II
US General Government Gross Debt Projected To Exceed GDP by
General Government Gross                US General Government Gross Debt
 Debt as a Percent of GDP                 is Projected to:
                                         Double between 2000 and 2015,
                                          exceeding 100% of GDP
                                         Surpass European countries such as UK,
                                          France, and Germany, and rival that of
                                          Greece and Italy
                                         Large public debt is slowing GDP
                                          growth in Japan and Euro-zone;
                                          could slow growth in US
                                         Japan’s GDP growth slowed in the ‘90s,
                                          averaging only 1.7%
                                         IMF reports GDP in Euro-zone countries
                                          will grow ~ 1% in 2010-2011
                                         UK to cut defense by up to 20%
                                        General Government Gross Debt Source: IMF Fiscal Monitor,
                                        “Navigating the Fiscal Challenges Ahead”, May 14, 2010,
                                        Statistical Table 6, p. 85
        Chronic federal deficits are putting US on a path to reach
        European–style debt levels and slower economic growth                                 59
     Fiscal Restraint Already Evident in Non-Defense Discretionary Outlays

                              Non-Defense Discretionary Spending
                                      FY 1962 – FY 2015
                                               Historical Actuals                        FY11-15 Plan
                                                                                                                         Real CAGRs:
                                                                    Spike due to
                                                                    FY09 Stimulus
                                                                                                                         60’s:     4.6%
           600                                                                                                           70’s:     6.1%
                                                                                                                         80’s:    -1.6%
                                                                                                                         90’s:     1.5%
           400                                                                                                           00-08:    2.9%
                                                                                                                         09-10:   18.1%
           300                                                                                                           11-15:   -3.5%
           200                                                                                                           62-15:   2.5%


Source: OMB Historical Tables, FY 2011 Budget, Table 8-8. Non-defense is all discretionary except budget function 050.

               After decades long growth, expect a contraction in non-defense spending
                      DoD Budget 1945-2015: Threat Driven, but Debt Constrained

Public Debt

 % of GDP

                       80                               Historic Budget Constraint Zone: Public Debt > 40% GDP

                            WW II                                                                                        Afghanistan and Iraq
                  800                                                                                                           Wars
                                    Korean War                                         Reagan Build-up
in Constant FY11 $B

                                                             Vietnam War
    DoD Budget


                  200                                Missile Gap
                                                  Cuban Missile Crisis                                                               19% Decline
                                    44% Decline                                                       31% Decline
                           1945     1950   1955      1960    1965        1970   1975    1980   1985      1990   1995   2000   2005    2010      2015

                                      Large debt levels will impair future US ability to increase
                                             defense spending as quickly as in the past                                                           61
Deficit Forecast: Bleak Without Major Entitlement Reforms or
                       Revenue Growth
                           Percent of GDP
                                                                     OMB February ’09
          Actual FY10 deficit is approximately 10% of GDP. CBO
          projects $1.3T deficit, $20.3T debt in 2020.
                                                                     OMB February ’10

                                                                 CBO Mar ’10 Assessment of
                                                                       FY11 Budget

                                                                       TechAmerica Forecast

                                                                 Changes from Mar 10 CBO:
                                                                 • Adjustments for DoD base
                                                                   budget and OCO forecasts
                                                                 • Higher assumption for health
                                                                   care reform costs
                                                                 • Reduced international affairs
                                                                 • Risk of higher interest rates

                         Fiscal Year
              Deficits stay above 4% through the forecast period;
    the trend is toward larger, not smaller, deficits from FY14 through FY21
                External Environment Summary
• Long-term growth of Social Security, Medicare and Medicaid has put the
  country on an “unsustainable fiscal path”
   – Rapidly growing health care costs are the most significant problem

• Huge deficits, growing national debt and an uncertain global economy will
  constrain the discretionary budget
   – Deficits of historic proportions projected for foreseeable future
   – Annual interest on debt projected to exceed DoD base budget by 2017;
     and earlier if interest rates rise

• The only practical way to reduce deficits & debt is via a combination of
  strong economic growth, increased revenues, and reduced spending
   – President froze non-security discretionary spending for FY11-13
   – Subsequently OMB directed non-security agencies to cut 5% in FY12
   – Presidential Commission reported recommendations in December 2010;
      but Congress must ultimately make the decisions—now in deadlock!

        “The biggest threat we have to our national security is our debt.”
                            Adm. Michael Mullen, Chairman of the JCS, June63
                     New World, Old Rules?

  As Financial Markets Rallied & Global Economy Moved into
Credit Crisis Revealed Many Mistaken Assumptions on How the
                        World Operates

Economies Cannot Grow Beyond Their Means in Perpetuity

Reasonable Probability of Reorienting Global Growth Away from
         US Consumer to Emerging Market Demand
           Uncertainty focused on two key factors:
      1. Fortunately, Developed World Growth Did Not Collapse
  2. Developing Nations Must Not Rely on Growing US Consumption
CRE Cycle Roller Derby: Development, Space, and Capital
Source: RCA                               Aug. 07
                                       Trends + to -
                                                       Sept. 08,
                                                       space mkts.
                                                       turn negative
Here We Show “Core” CRE Price Changes Broken Out Between Income
      (Space Markets) and Cap Rate (Capital Markets) Effects
Capital Markets: The Big Picture
   • Transaction activity has only recently revived
   • Prices starting to firm as credit crunch eases, but improvements selective

          Quarterly Commercial Real Estate Investment
                                 CRE Sales                         CRE Prices



  $100                                                                                              CRE Prices
                                                                                                    Down 42%
   $80                                                                                              Peak to Trough




         '01     '02       '03      '04      '05       '06      '07       '08      '09       '10
    CRE Sales: Real Capital Analytics, office, industrial, retail, multi-family properties $5mil+
    CRE Prices: Moody's/REAL CPPI National Aggregate Index
     Private CRE Appreciation Decomposed—Two Market Downturns
             Last Year’s Overstreet Scenario Going Forward (2009-2010)

             1991—1993                                 2002—2004
•   NCREIF Price Index -23.5%           •   NCREIF Price Index   12.4%
•   NOI Effect         - 3.2%           •   NOI Effect           -16.4%
•   Cap Rate Effect    -21.0%           •   Cap Rate Effect      +34.4%
•   Interaction Effect  + 0.7%          •   Interaction Effect    -5.6%

2007/2010                              2007/2010 C-Store Ostreet SWAG

• NCREIF Price Index       -- 40.0%    • Pet Mkt. Price Index     -- 20.0%
•NOI Effect                -- 15.0%    •NOI Effect                 +5.0%
•Cap Rate Effect           -- 25.0%    •Cap Rate Effect           -- 25.0%
•Interaction Effect Ignore             •Interaction Effect Ignore
Not over the Maturing CRE Mortgage
         Debt “hump” Yet!
Vacancy Trends, 1991 to 2010—Office, Industrial
      Retail Historically Weak, Apt. solid
REITs: A Leading Indicator--Good Omen?

                               Key Take-away
                           Monitor REITs in general
                           and industry examples
                            Getty (gty) (hpt) (nnn)
        Core Property and Bond Pricing Relationship Linked

       10 Year Treasury                   Baa Corporate Bond                  Real Estate (Cap Rate )
                                                                                           Recently, Cap Rate Decline Has
9%                                                                                           Lagged Bond Market Rally


7%                                                                                                       4Q10

6%                                                                                                        Feb.


  2002.01   2003.01   2004.01   2005.01   2006.01   2007.01   2008.01   2009.01   2010:1

   Reading the Cap Rate “Tea Leaves”

1. Cap rates on core real estate tend to be highly
   correlated with Baa corporate bond rates
2. Cap rates on core real estate tend to be slightly
   higher than Baa corporate bond rates Why? Less
   Liquid? Riskier?
3. Relationship “flipped” in 2006 as property prices
   hit new highs—then back to “normal” in 2009--
   but with a too robust a spread (back to chart)
4. Suggests future drop in cap rates and rise in
   property prices—which has been in process the
   past two quarters
          But…..make sure we look at all the evidence

• Yes, at the aggregate level, cap rates spreads to corporate
  bond and treasury rates remain relatively high by historical
• Yet “spreads” for high quality properties in select markets
  (DC, SF, and NYC for example) are much skinnier!
• Indeed, fierce competition for core properties in such
  markets has led to 6 percent and below cap rates on a
  number of transactions—a bifurcated to trifurcated market
  situation! It is the old “flight to quality” routine!
Com. Mortgage Interest Rates and Difference
 (Spread) to Risk Free Rate Has Normalized!
     **Interest rate data based on properties and portfolios valued at $2.5 million or greater and on loans with terms
     between 7 and 13 years.

     * CRE Industrial, Office, and Retail - 6 month
Post Bubble Cap Rate Spread Expansion
   Conclusion: Highly likely that CRE has bottomed out! But each local market
         is different which presents a Demand/supply puzzle. Analyze!

• Spreads to treasuries remain high which coincides
  with continued economic and property sector
  weakness—hence, risk and higher cap rate spreads
• Yet, historically, these same metric conditions have
  coincided with property value rises over a three to
  five year period.
• Chances are good that our “cap rate tea leaves” are
  pointing to a similar outcome this time around.
Time to buy—Time to Sell?
        Robert White (CEO, Real Capital Analytics)
     recently put forward the following thesis?
Core asset (office, retail, industrial, apt.) prices in
major markets up strongly in 2010 (approximately 30
Distressed assets still priced relatively well with
lenders ready to deal;
If you own stabilized properties or can manage to
stabilize one quickly—arbitrage opportunity exists to
sell high and buy low;
Buyers are paying up for high quality, well leased
properties while the vast majority are discounted
Risk takers will rarely have a better situation.
 Bob White, RCA CEO, Market CRE Thesis

• Time is NOW as distressed opportunities will
  evaporate within next two years
• Spike in major markets and assets driven by buyer
  demand as much as the return of debt markets;
• As CMBS conduits continue to expand and buyer
  pool deepens, they will be forced to expand into
  other markets—driving the markets up;
• Fundamentals improvement also factors in—with
  example of apartments last year up 30 percent.
Looking Back: Rich Rewards for Early Movers
Change in Investment Orientation, ’10 – ‘11
   Bob White, RCA CEO, Market CRE Thesis
    Continued—Concerns and Comforts?

• Rising interest rates? Oil prices? Japanese Disaster?
  Tax increases (capital gain or real estate specific)?
• Commercial real estate is still a relatively new asset
  class for institutional investors and allocations are
  not optimal from a percentage basis and, hence,
  should rise;
• Sell high—buy low or buy low and sell high—it
  appears to be a great time to do either!
• What do you think? How does the Convenience
  store product fit into this thesis? Discussion?
                    Other Pundits:
Prudential Real Estate Advisors positive at turn of year

•After a long period of fits and starts, conditions now
seem ripe for an extended recovery in CRE;

•Firmly established in multi-family and hotel;

•Office, retail, and industrial starting to turn after
hitting near-record vacancies;

•Caution required given that the turn is dependent on
what they view as a still “fragile” recovery
 RREEF’s Take on Retail—note for smaller and high growth
  metros—extreme selectivity! Does it apply to C-stores?

•Capital slow to return—distressed situation! Changing now as
surviving retailers stronger with store closings, etc.

•Consumers modestly increasing their wayward ways!
•Investors returning! Yields compressing here also;

•Prefer top quality although older properties with exceptional
locations if low-rent anchors are nearing the end of lease
renewal options

•Top investable properties found in a broad array of metro
situations but beware of smaller and high-growth, low barrier
Time to buy—Time to Sell? C’stores?
Here We Show “Core” CRE Price Changes Broken Out Between Income
      (Space Markets) and Cap Rate (Capital Markets) Effects
Industrial Still Struggling
Office Also Struggling
Multi-Family On a Different Track
Retail Still Struggling But Down Less than Office
                                          CRE All About S&D and Retail Has an Issue!
                                                       Retail Demand (Constant-Liquidity) & Supply Indexes

Dem 1994Q1=100, Sup set to = avg level





















                  Good Case Example: Appraisal vs. Mgr. Est. & Tax Assess.

          Description    2010 Tax Ass.      Mgr. Est. Value    Appraisal        App. Vs Ass.      App. Vs. Mgr. Est.    App./Ass      App/Est

                                                                                                                           %            %

Car Wash                         $410,700           $600,000        $460,000            $49,300             -$140,000          112%         77%

Service Station                  $575,000           $750,000        $551,000           -$24,000             -$199,000          96%          73%

Office                           $154,100           $250,000        $210,000            $55,900              -$40,000          136%         84%

Warehouse                        $159,600           $200,000        $206,000            $46,400                $6,000          129%         103%

C-store                          $378,776           $450,000        $419,500            $40,724              -$30,500          111%         93%

C-store                          $409,900           $300,000        $499,000            $89,100             $199,000           122%         166%

C-store                          $300,000           $250,000        $325,000            $25,000              $75,000           108%         130%

Service Station                  $336,364           $350,000        $438,000           $101,636              $88,000           130%         125%

C-Store                          $362,903           $350,000        $521,500           $158,597             $171,500           144%         149%

C-store and Garage               $653,968         $1,000,000        $750,000            $96,032             -$250,000          115%         75%

Building Lot                      $25,700            $50,000          $53,000           $27,300                $3,000          206%         106%

C-store                          $987,037         $1,050,000        $817,000          -$170,037             -$233,000          83%          78%

C-store                        $1,582,090         $2,250,000        $930,000          -$652,090           -$1,320,000          59%          41%

Total                          $6,336,138         $7,850,000       $6,180,000         -$156,138           -$1,670,000          98%          79%
         Lessons Implied for Petroleum Distribution CRE

•   Nourishing traditional banking relationships will pay large dividends in tough
    periods but should require keen assessment of the bank’s risk posture, etc.
•   Securitization and CMBS are not dead and they are beginning to recover—it has
    not been rapid—does continued scarce and pricier debt suggest liquidity build-
    up for petroleum marketing firms? What are the long term implications?
•   Alignment with equity & debt sources crucial to success during and post crisis;
    a great moment for creative partnering.
•   Operational excellence necessary for turnaround opportunities! Operational
    excellence is Rare! It is worth the price! Buy or lease A properties with
    B performance and turn into A properties.

           Lessons Implied for Petroleum Distribution CRE
•   Study history! These real estate banking crisis cycles are predictable although
    history repeats but never the same way. Banks are key element not because
    they create credit but because fractional reserves and mortgage based
    lending—a violent combination!
•   History suggests strongly that these banking based expansions and subsequent
    real estate (asset) bubble crashes are slightly less than two decades in duration
    (14 +/- years of build-up with a mid-term slow down followed by 4 +/- years of
    tough sledding)—Avoid the winner’s curse period (last 2+/- years of upturn);
    Don’t try to pick the top—be conservative! Sell in the 13th if you don’t ride it
    out! Never buy early in a falling market at the end of the cycle—they last years!
•   Value based strategic plans for real estate intensive firms should be based on
    this long cycle reality—fractional reserve banking systems and land inflation
    over a cycle lead to severe corrections!
•   Optimal long-term value route requires identifying the economic turning
    points—extreme points in the long term real estate cycle—and doing the
    opposite of the “herd” at these key points!
•   Extremes take years to develop & new technology will not alter this!
           Lessons relative to BEST PRACTICES

Essential Elements of Great CRE Investor/Managers have not
   changed: Confront the Brutal Facts; Get the right people on the bus
   and the wrong ones off; run the business as a business & the family as a
   1. Know Yourself, Your Firm, Its Parts, and Its Risk Tolerance
        Moreover, How Each Relates to Owner/s Personal Risk
        Tolerances and Financial Objectives—Analyze Deeply
   2. Determine Whether Each Unit is Adding Value: Analyze your firm’s
   portfolio of products, units, and strategic value parts with the best
   techniques available—Economic Value Added/Life Cycle Analysis (BCG
   2. Know Your Real Estate Markets—Establish a Information Network that
   Assures Your Team of Asymmetric Information
        Treat this as a necessary CRE business activity
Lessons relative to BEST PRACTICES Cont.
3. Understand subtleties of unit & firm value drivers--
formally analyze the market demand and supply
characteristics and build these assumptions into your
financial projections and discounted cash flow analyses
    • If you don’t practice DCF, review a value based analysis and see why not?
      Warren Buffet’s academic mentor can’t be wrong!
4. Understand the benefit/costs of leverage and build this
    into your modeling efforts
    ROE = ROIC + (ROIC less Cost of Debt) X D/E
    Moral: Unless you are making solid returns on invested
    capital (Debt + Equity), financial leverage won’t help
    & it can HURT
    Manage toward ROIC for each Value Center
    Lessons relative to Best Practices Cont.
5. Structure your real estate portfolio separately from your
operating business and account and manage it optimally using
best practice techniques to cull, revitalize, and add new to
industry units! Strategically establish fortress CRE positions!
6. Realize that managerial time and talent is your most critical
resource; capital can be creatively raised even in credit
constrained environments .
7. Management requires the focus achieved through applying
value based principles—unfortunately still not well understood
and used where needed most—in our private firm
environments. Return on Invested Capital less the Weighted
Average Cost of Capital =s Economic Profit ; Present Value of
Economic Profit =s Corporate Value Added! Grow Accordingly!
Lessons Confirmed by Credit Crisis
•   Debt contains a largely ignored risk (refinancing)
•   20 plus percent IRRs far easier to generate in spread sheets
    than in reality
•   Worst-case analyses rarely come close to potential worse
    cases and normally are too extreme—thanks to the
    limitations of our ability to forecast complex outcomes
•   Cheap and easy money portends expensive and scarce
    money in the future!

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