The buyout proposal for Seven & i Holdings ("Seven") by Couche-Tard, announced in 19th August 2024, might benefit from the current weak yen, but it appears to have primarily targeted the valuation gap, given Seven’s undervaluation relative to its rapid expansion of thier convenience stores in the US.
The "slow" reforms driven by Seven's management who warry about people's eyes and internal friction with employees have dissatisfied overseas impatient investors could promote Couche-Tard to make this proposal.
In any case, given that Couche-Tard made a large-scale buyout proposal for such a Tier 1 Japanese company in the range of 5 - 6 trillion yen (US$ 40bn), Couche-Tard have conducted thorough research and careful preparation before moving forward. On the other hand, Seven’s management now against a direct buyout offer from a competitor must be facing a tough decision.
If this proposal is successful, it could potentially trigger a domino effect of buyout bids from other global companies targeting Japanese firms. This is why I personally regard this as a highly noteworthy case.
Here are a few key points that I believe will be important to go forward.
1. What is the strategic goal?
(1) Expanding Market Share in the US
Couche-Tard's main goal is likely to expand its convenience store operations in the US. The key target is to acquire Seven's overseas convenience store business, which is primarily based in the US and generates 99% of its sales. Couche-Tard aims to secure the top market share in the U.S.
According to Seven's website, Seven holds the No.1 position with 8.5% market share, followed by Couche-Tard with 3.8% market share in the US. This acquisition would significantly leave the No. 3 player and below far behind. However, antitrust concerns could arise because the market shares are based on not sales amount but number of stores.
As a side note, in terms of Seven's domestic convenience stores, although Couche-Tard might be interested, there should be limited synergy potentials. Circle K, operated globally by Couche-Tard, no longer operates in Japan. However, Seven’s No. 1 position in the domestic convenience store market would still be beneficial for them. Despite potential future opportunities to leverage Seven’s high-quality products across Couche-Tard's stores globally, it’s unlikely that this would be included into Couche-Tard's valuation during the acquisition process.
In addition, Seven adapts a franchise model to manage convenience stores in Japan and establish an unique supply chain in Japan and offer diverse services from finanicals to payments. As a result, Couche-Tard would probably leave the domestic convenience store operations to Seven’s existing management and allow them to continue running the business.
(2) Advantage of Current Exchange Rate
The impact of exchange rates is significantly huge. It would not be an exaggeration to say that it was a key factor in triggering this acquisition proposal. While the influence of the "Guidelines for Corporate Takeovers" mentioned later also plays a role, the acquisition funding is the most challenging and the current favorable exchange rate certainly helps Couche-Tard.
Couche-Tard’s share price increased by 60% over three years on no considered exchange rate basis, but this rises to 103%,including exchange rate effects, representing a 40% boost.
In comparison, Seven’s share price increased by only 5% over the same period. Given that the exchange rate alone has provided a 30-40% discount, Couche-Tard could perceive that it can acquire Seven now without paying for premium.
In the future, in case that the Bank of Japan raises interest rates or concerns about an economic slowdown in North America grow, the exchange rate could shift towards yen appreciation. Hence, Couche-Tard might view this timing as a once-in-a-lifetime opportunity.
(3) Seven's Undervaluation
As mentioned above, Seven’s share price has only risen by 5% since its acquisition of Speedway in 2021. If inflation is considered, it might be argued that the actual performance is effectively negative.
Starting with the long-awaited sale of Seibu Department Stores in 2023, Seven has been rapidly restructuring its business portfolio, including the sales of FranFran (Furniture retailer), Senshukai (Mail-order company), Barneys (apparel company) and the closure and subsequent sale of 7 Ito-Yokado stores. Despite these efforts, the limited increase in Seven's share price reflects how investors have assessed these moves.
In hindsight, investors were watching closely whether Seven's management could take decisive actions on Ito-Yokado’s operations, followed by the sales of Seibu Department Stores rather than the piecemeal asset disposals and were likely waiting to see if they could break away from its past ties that Ito family, the founder of Seven established Ito-Yokado, struggling GMS in Japan.
As far as we see their investor materials, Seven has worked on rebuilding the Ito-Yokado business. However, while dealing with an activist which re-enters and puts pressure on Seven management, they ultimately couldn’t keep up with the pace that investors expected.
On the other hand, the exchange rate impact has also benefited Seven's expanded North American operations following the Speedway acquisition and contributed to a 40% increase in consolidated EBITDA. The North American convenience business now generates 60% of Seven's consolidated EBITDA.
However, this rapid growth in overseas earnings, when measured in yen, is a result of favorable currency conditions rather than synergy effects from the acquisition of Speedway. Given that this growth has not led to an increase in market capitalization, it’s hard to say that investors thinks highly of Seven’s management capabilities.
2. What Are the Chances of Success?
So, what are the chances? Here’s my analysis based on a few perspectives. I personally estimate at this point that the likelihood of Couche-Tard’s acquisition proposal would be accepted at 50% to 60%. The key factor lies in the special committee composed of independent directors of Seven who are tasked with evaluating the acquisition proposal.
The main point is whether they will recommend accepting the proposal to the Board of Directors (practically, this is submitted to the board in the form of a "report" in which the special committee presents its opinion; either in favor or against it.
I have never seen a case in Japanese M&A transactions that a listed company’s Board of Directors decides against the conclusion of its special committee in an M&A. Hence, the special committee’s decision effectively determines the outcome of the acquisition proposal.
In my view, the special committee’s likely conclusion will be: "while the strategic aspects of the acquisition proposal can be evaluated positively, it remains doubtful that Couche-Tard has financial capability to secure acquisition funding".
The ultimate decision will hinge on how much the "funding capability" factor is discounted.
As for Couche-Tard’s acquisition strategy,
i) Maximizing synergy effects in the convenience store Business post-acquisition
ii) Prompt divestment of non-convenience store businesses (including restructuring or withdrawal from unprofitable divisions if cannot be sold)
It is likely that Couche-Tard emphasizes its past M&A successes while showing the feasibility of executing i) and ii) above and presents a plan to "quickly improve the financial status after the acquisition."
In terms of Seven's domestic non-convenience store businesses, the divestment to a private equity fund would be the quickest approach. It is possible that a feasibility study has already been conducted to evaluate the potential of such sales.
(1) M&A guidelines: "Guidelines for Corporate Takeovers"
The M&A guidelines have created a significant tailwind for Couche-Tard. In the past, Japanese companies could essentially evade acquisition proposals from foreign companies, but with after the guideline is introduced in August 2023, such evasion has been practically hard. Specifically, decisions are no longer made by the management team but are effectively entrusted to independent directors. As a result, in a reasonable proposal, the likelihood that it has been accepted has greatly increased.
In the past, even special committees independent of the board of directors were often composed of professionals such as lawyers and accountants, and their decisions were largely based on technical considerations while being mindful of the management and public perception. However, since the Ministry of Economy, Trade and Industry (METI) introduced the so-called "Fair M&A Guidelines" in 2019 (Guidelines on Fair M&A Practices), the role of Special Committees has gradually become more significant, with a stronger emphasis on shareholder interests, particularly those of minority shareholders (as discussed in the M&A column: "Special Committees on M&A in Japan").
The turning point came last year when METI released the "Guidelines for Corporate Takeovers. The guidelines explicitly state that acquisition proposals should be evaluated based on whether they contribute to increasing corporate value and assessment and decision on the proposals should be made by independent directors.
As a result, because the role and responsibilities of independent directors in M&A have been clearly defined, the rising risk of shareholder derivative lawsuits makes it increasingly difficult for management to act out of self-preservation. (In the past, in case that foreign companies made acquisition proposals behind the scenes, the proposals were often buried by the chairman or president without report to the board and foreign companies were aware of the risk.)
The buyout proposal by Couche-Tard is a prime example of a case that Seven should align with the "Guidelines for Corporate Takeovers" As such, Seven’s management is obligated to proceed with M&A process in accordance with the guidelines. Couche-Tard also seems to be aware of this (particularly the "principle of transparency") or respond to media reports, as they announced their acquisition proposal to Seven on their website.
After confirming the composition of the independent directors, Couche-Tard likely concluded that they had a "reasonable chance of success" and proceeded with the acquisition proposal.
While the guidelines are not legally binding in the strict sense, if ignored, they could lead to backlash or even lawsuits from shareholders and investors. The practical effect of the guidelines is nearly equivalent to having legal force for large listed companies with a significant number of foreign investors. (however, some listed companies without activists might disregard them).
(2) Key Evaluation Points for the Acquisition Proposal
The special committee is likely to evaluate the proposal based on the following four key points:
Whether the proposal is sincere.
Whether it contributes to enhancing enterprise value.
Whether the acquisition price and conditions are reasonable.
The feasibility of securing financing.
Couche-Tard has propably engaged an investment bank and lawyers who are well-versed in the Japanese market and conducted before making this acquisition proposal thorough analysis of the key aspects including Seven’s businesses, management, and independent directors’ backgrounds, valuation, potential synergies and Japanese M&A regulations/guidelines.
Therefore, it is highly likely that the proposal includes the valuation and post-acquisition management plan to address the points above, especially for the special committee to evaluate points 1 to 4. Without such details, it would be impossible to evaluate point 2 in particular.
Even if these details are included in the proposal itself, the special committee will typically submit questionnaires or conduct interviews with Couche-Tard to obtain the necessary information for their evaluation.
My own assessment of the points 1 to 4 is as follows:
No issues and reasons => Ok.
Appears acceptable, but Couche-Tard's financial condition makes it difficult to judge definitively => 50% depends on 4.
Hard to say unless looking at the valuation. However, if the premium is 40% or more, it would likely be a pass => Ok with conditions.
Concerned. The sale of Seven’s non-core businesses, restructuring efforts and execution of synergy strategies will be crucial in order to improve Couche-Tard's finalical condition after the acquisition. Because the sum of the two companies would lead to increased debt, whether to secure financing depends on market conditions => currently a question mark
Point 1 can be skipped and point 3 depends on point 4. Let's focus on points 2 and 4.
(3) Whether it contributes to enhancing enterprise value
The evaluation surprisingly leans on qualitative factors. To speak frankly, it depends on the synergies that it can or appears to create. Specifically, the key evaluation point is whether the strategic scenario shows that sufficient synergies can be generated, outweighing any dis-synergies and lead to enhanced enterprise value.
Here is a breakdown by business segment:
Overseas Convenience Store Business: The acquisition is likely to be strategically reasonable and even attractive, resulting in a judgment that it contributes to enhancing corporate value in my opinion. Couche-Tard could find many ititiatives to generate synergies, including restructuring, store integration and supply chain consolidation for cost efficiencies. Although the risk of antitrust issues in the US could be reviewed given the current market share of the number of stores and the total sales amount. However, it's not an outright "No" scenario.
Domestic Convenience Store Business: As long as operations remain stable, it passes the evaluation. Couche-Tard without operations in Japan is unlikely to generate synergies from domestic operations, but would likely adopt a strategy of maintaining the status quo while leveraging Seven's product strength and know-how into their overseas convenience stores. Although potential dis-synergies such as talent outflow and decreased motivation are expected, the synergies are likely to outweigh these concerns.
In addition, common synergies across both domestic and international convenience store businesses would include streamlining administrative and shared functions.
As for non-convenience store businesses, Couche-Tard is likely to regard them as non-core and pursue exit strategies, likely through withdrawal or divestiture. While the treatment of employees could raise social and political concerns especially in Japan, unless legal risks pose a significant financial impact. However, from the perspective of enhancing corporate value, such actions would be considered reasonable and necessary.
Not only these non-convenience businesses have minimal synergy with the core convenience store operations, but also the divestiture of underperforming subsidiaries and focusing on the core business could lead to improved profits. Additionally, if these are disposed for higher valuation, it would contribute to enhancing corporate value.
Overall, it’s relatively easy to qualitatively argue that the proposal contributes to enhancing corporate value and identifying dis-synergies is likely to be more challenging. Therefore, it would be difficult for the specail committee to reject the proposal on the grounds that it fails to enhance corporate value.
Furthermore, the special committee would not only assess Couche-Tard’s proposal but also gather relevant information from Seven’s management. Seven’s counter-argument is that dis-synergies are likely to include: 1) The unique characteristics of the domestic convenience store market make synergies difficult to realize, 2) The risk of employee defection and decreased motivation due to restructuring and divestiture and 3) The potential cannibalization of existing markets in North America. However, when viewed holistically, I strongly believe the synergies still appear to outweigh these concerns.
(4) Feasibility of Financing = assessment on Couche-Tard’s Financial status
In conclusion, the situation is quite challenging. Based on recent data, Couche-Tard’s “interest-bearing debt / EBITDA (DE ratio)” is approximately “US$14bn / US$6.2bn” = 2.3x. In comparison, Seven’s DE ratio is “US$26.6bn / US$7.0bn” = 3.8x. Given that both companies carry significant debt and that their cash reserves appear to be fully allocated as operational funds, it is more practical to use the total amount of interest-bearing debt rather than net interest-bearing debt in this analysis.
In M&A transactions, a DE ratio of 4.0x is typically a benchmark (although under favorable market conditions or considering the target company’s past cash flow generation, a ratio of up to 5.0x-6.0x may be considered). Even if the acquisition were entirely financed through debt, Couche-Tard’s financial standing would significantly deteriorate. Assuming a 30% premium, the acquisition price would be JPY 5.9 trillion (US$ 39bn), resulting in a combined DE ratio for Couche-Tard and Seven of “US$ (14 + 26.6 + 39) bn / US$ (6.2 + 7.0) bn” = 6.0x, which is just barely feasible.
Even if Couche-Tard were to raise equity-like financing, creditors and investors would still demand the rapid realization of synergies, making asset divestitures, business sales and restructuring.
Therefore, the strong emphasis on asset divestitures, business sales and restructuring could paradoxically expose the potential dis-synergies that Seven’s management argues as risks, exposing a trade-off between these two factors of enhancing corporate value and financial feasibility. As such, how the special committee evaluates these aspects will be critical.
From Couche-Tard’s perspective, the plan would likely involve 1) incorporating non-core asset sales to promptly improve the DE ratio and 2) generating synergies in the North American business. Although it would take time to integrate supply chains and standardize products in the convenience store business, Couche-Tard’s established track record in PMI within the US market where they are well-versed makes this synergy scenario convincing.
Therefore, in terms of 1), the goal would be to swiftly sell off non-convenience store businesses to PE funds and realize the benefits as quickly as possible. Even if changes in market conditions push back the sale, Couche-Tard is likely to make a commitment to more promptly and decisively restructure the business portfolio than Seven’s current management does. This would enhance the credibility of their proposal in securing a rational judgment for both 2 and 4.
However, these are concerns that only come into play after financing is secured. The primary challenge is whether they can raise the necessary funds in an increasingly unstable market environment. Even if financing is theoretically feasible, it is unlikely that banks would issue loan commitments at the LOI stage where due diligence has not been completed, making it difficult for Couche-Tard to confidently claim that financing is secured at this point.
Moreover, if Couche-Tard's share price continues to decline, reducing its market cap to levels comparable to Seven’s, the prospect of raising equity-like funds becomes even more difficult, leaving little time to spare.
From Seven’s management’s perspective, if they have a strategy to defend against the proposal it would be to focus on these two points: “buying time” and “highlighting Couche-Tard’s financial challenges.” If we were an advisor as the sell-side, these would be our primary considerations.
(5) How much can the valuation (= financing) be raised?
I personally believe that the upper limit is a DE ratio of 6.0x, considering hybrid loans with equity characteristics.
The key point would be whether Couche-Tard can reduce it to around 4.0x within three years. Therefore, the maximum feasible acquisition premium would likely be around 30% to 40%, and even 50% would be a stretch. I believe that it would be very hard to go as high as over 50%.
If the acquisition premium is set at 30%, approximately US$ 5.0 billion in additional EBITDA would be required through organic growth and synergies post-acquisition. This is quite challenging. The higher the valuation, the greater the pressure to limit CAPEX and prioritize debt repayment, reducing the likelihood of completing the acquisition.
(6) Defensive strategies of Seven's management
To thwart the acquisition, I believe that the most effective strategy for Seven's management would be to push up the acquisition price by highlighting Couche-Tard's financial challenges. How might this be achieved?
First, they could bring in a white knight to drive up the acquisition price. For instance, if Seven collaborates with a PE fund to expedite the sale and restructuring of non-convenience store businesses, it can appeal to the market and possibly drive up share prices. Ideally, if they could announce the sale of non-convenience store businesses in bulk before the special committee reaches a conclusion, it would be optimal and likely lead to a rise in share prices. The success of this strategy depends on the decisiveness of Seven's management.
Other potential tactics include large dividend increases or significant share buybacks to inflate the share price. However, if overdone, these moves could be perceived as self-serving, leading independent directors to oppose them and then making this approach challenging although such actions were common in the past. Traditional defencive strategies like a Pac-Man defense (trying to acquire Couche-Tard instead) are outdated and unlikely to be effective.
The second tactic involves buying time. The purpose is to prolong special committee’s review period. Gradual progress on business divestitures or adding more items for consideration are subtle, but effective to increase the number of significant decisions that need to be made. This is a strategy of “running out the clock.”
Typically, a special committee would reach a conclusion within two to three months. In particular during the first half of the review, they would consider whether the proposal enhances the enterprise value and the latter half would be focused on assessing the reasobalibity of the valuation and the feasibility of the financing while independent directors of the committee possibly meet around ten times. Proceeding at a pace of one meeting per week, a decision generally takes around two to three months. However, given the high level of public attention, taking much time could be disadvantageous for Couche-Tard. They might be acting swiftly to make a decision within two months.
Hence, Seven likely considers to extend the review period by bringing in a white knight or launching various corporate actions. During this time, if Couche-Tard's share price declines, they might aim to have the acquisition proposal withdrawed.
A third option, if defensive measures fail and a full takeover becomes inevitable, is to propose an "equal merger" to avoid complete defeat (e.g., the entire current management resignation). Specifically, like the attempted merger of AMAT and Tokyo Electron, a holding company could be established in a third country as each side sends management members. Seven could keep its domestic convenience store business under their control, while would jointly manage the US business or give Couche-Tard its initiative. In case of the way to counter the acquisition they can also avoid the perception of a complete takeover.
(7) What will the special committee decide?
As mentioned earlier, the evaluation of this acquisition proposal will be conducted by the special committee, which is composed of independent directors, in accordance with M&A guidelines. Seven’s management would first appeal to the committee, arguing that they are better positioned than Couche-Tard to enhance its enterprise value. They might also propose various strategies to boost its share price in parallel.
On the other hand, if the committee concludes that Couche-Tard’s proposal is superior, they would likely also consider bringing in a white knight.
The committee would likely focus on evaluating Couche-Tard’s financing capability and the certainty of closing the deal. If Couche-Tard's financing is deemed difficult, the committee would likely say "No." Even if they decide to accept the proposal, financing would be a precondition, meaning that Couche-Tard would need to prepare a debt commitment letter. In this case, the committee might allow the deal to proceed, contingent on securing such financing (e.g., requesting Couche-Tard to move to the due diligence phase and present a legally binding acquisition proposal with financing in place).
*Note: Even though the special committee is composed of independent directors, some might think that they would be biased towards Seven’s management. However, modern special committees make decisions based strictly on whether the proposal is in the best interest of shareholders without any bias. During the deliberation period, there is generally no informal exchange of opinions on the matter between executive and independent directors, making the process very rigorous - much stricter than in the past.
(8) Antitrust Risks
There is a non-zero risk that the combination of the number one and number two companies in the industry could face antitrust issues in the US. While I am not familiar with the geographical distribution of the both stores, if there are regions where a monopoly would occur, a conditional approval, which allows the acquisition by excluding integration in certain areas, could be possible. In any case, the review process would take time, which could be disadvantageous for Couche-Tard.
(9) Political Risks
There is also a non-zero risk that the government could intervene to block the acquisition, similar to the Nippon Steel/US Steel case in the US. (certain
politics opposition party in Japan could raise objections). However, in this case, I believe it unlikely happens under the current ruling party for the following reasons:
1) Given that METI has issued M&A guidelines, they would be unlikely to take actions against the guidelines which were introduced last year by LDP, Leberal Democratic Party of Japan and a ruling party. As such, blocking the acquisition would be effectively counter-productive.
2) The government’s market reforms, including M&A guidelines, the governance code and the stewardship code have successfully attracted foreign investors which, significantly contribute to the current rise of the Nikkei Index. Blocking this acquisition could make foreign investors flee the Japanese market and be a touch decision for LDP.
3) While convenience stores are deeply integrated into Japanese society and economy, Seven itself originated in the US. Though Ito-Yokado introduced it to Japan and significantly expand the Japanese Seven business, the original US operations were eventually reacquired. Blocking the deal might seem odd given these historical facts.
Unless the acquisition results in significant societal harm, government intervention would be unlikely. Moreover, in the Nippon Steel/US Steel case, where I personally believe that Japanese govement led by LDP has helped Nippon Steel push for approval in the face of US resistance, opposing this deal would be inconsistent.
Given that non-core business divestiture to PE funds have become socially acceptable, Couche-Tard likely does not consider it as a major reputational risk in Japan.
In conclusion, as mentioned earlier, the possiblity of Couche-Tard's success stands at about 50/50, though I personally estimate it at 50-60% due to their strategic advantage. However, if Couche-Tard’s share price declines during this period, doubts about their financing capability could reduce the odd.
3. What will happen after the acquisition?
If the acquisition is accepted and Couche-Tard succeeds, what changes can be expected next?
(1) Accelerated divestiture of Seven’s businesses
If the acquisition is successful, all non-convenience store businesses both domestically and internationally will be swiftly sold off. In light of the urgency, sales to PE funds seem possible.
Even if Seven manages to defend against the acquisition, the speed of divestitures will likely increase. The notion that "slow reforms" triggered by the acquisition proposal will put pressure on Seven’s management to accelerate the pace as the situation provides a convenient justification for the reform.
(2) Relocation of headquarters to North America
Though Seven operates convenience stores in Southeast Asia, according to IR materials, those license fees are paid to SEI in North America. This suggests that Seven’s intellectual property is fundamentally based in North America. Moreover, since the North American business has grown larger than the Japanese operations, it would be more reasonable to move the headquarters to North America and to establish a global controlling office. Inevitably, this would result in quickly streamlining Japanese management functions and make it easier to generate cost synergies.
4. Future Implications
This is unprecedented situation that the top player in Japanese convenience store industry receives an acquisition proposal from a foreign competitor. Given that Seven originally started as an US company, the political motivation to protect a "Japanese brand" seems weak and it is unlikely that the Japanese government would step in to defend it. Moreover, the government has been rather promoting market reforms and introducing M&A guidelines to attract foreign investors. In that context, this acquisition proposal might even be welcomed.
Traditionally, unique corporate cultures and local unspoken regulations have made foreign companies hesitant to acquire Japanese firms, but if this cross-border deal involving the top domestic player goes through, it could spark a wave of In-out acquisitions by foreign companies. Though industries like automotive and heavy industries where Japan’s complex supply chains pose high barriers might still be difficult targets, sectors including beer, consumer goods, and pharmaceuticals similar to Seven, which grew through acquisitions and expanded overseas, appear easy to implement PMI (Post-Merger Integration) and to see a significant increase in acquisition risk.
In conclusion, it seems imperative for Japanese companies to accelerate the review and restructuring of their business portfolios, as Hitachi has done, to counter measures against potential acquisitions by large overseas competitors. The necessity for such preparation has not only increased but has been more apparent.
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