Seven & I Holdings Co. Ltd. (TSE:3382, Financial) ("Seven & I") – During the quarter, the Fund initiated a position in Seven & I, a Tokyo-headquartered company that owns the 7-Eleven convenience store business globally, a network totaling approximately 72,000 stores. We think of Seven & I as operating three distinct business groups – 7-Eleven in the United States, 7-Eleven in Japan, and everything else. Everything else includes the licensing of 7-Eleven businesses to other operators across Asia, department and grocery stores in Japan, and a small bank in Japan and smattering of other Japanese businesses as well. While the licensing of Asian 7-Eleven operations has grown rapidly and could become quite meaningful to the company, the non-7-Eleven Japanese retail operations have been poor from an operating perspective, dragging in a small way on company performance and are currently the focus of restructuring efforts. In Japan, Seven & I operates 7-Eleven, the country's largest convenience store ("c-store") chain, with a dominant market share of approximately 45%. The Japanese c-store market in general is food-centric and, therefore, unusually high-margin. The company has established itself as the best-in-class operator and has been able to grow store count, revenue and profit well in excess of the market in total. Seven & I's Japanese c-store business is highly profitable and reliably produces an impressive amount of unencumbered free cash flow. In the United States, Seven & I operates 7-Eleven c-stores as well, albeit in a fundamentally different environment than Japan, one that is both food and fuel-centric and remains extremely fragmented in spite of considerable consolidation activity in recent years. 7-Eleven holds an approximate 6% market share in the U.S. and is the country's largest operator. Here too though, 7-Eleven has established itself as a very competent operator, in particular with a formula for success in higher-margin food offerings. In August of 2020, Seven & I announced an agreement to purchase the c-store operations of Marathon Petroleum, operating under the Speedway brand, which has an approximate 2.6% U.S. c-store market share. This transaction is expected to close in the first quarter of 2021. The transaction price is approximately $21 billion and, at the face of it, looks like a fairly full acquisition price. The announcement was received with trepidation in equity markets. Several facets of our thinking on the transaction are as follows; i) we believe that large anticipated cost synergies are reasonable and achievable, ii) Speedway is an atypically fuel-centric operation leaving substantial room to apply 7-Eleven's strategies in food to meaningfully enhance margin and operating performance, iii) a substantial sale leaseback of some of Speedway's owned properties will provide capital at very attractive rates (see comments above on selling reliable cash flow streams at outrageous multiples), and iv) Seven & I as a parent company is extremely well-financed with extraordinary access to capital, borrowing roughly USD 3.4 billion to finance the transaction at interest rates ranging between 0.06% and 0.28%. We expect that the U.S. operations of 7-Eleven will continue to play a consolidating role in a very attractive and fragmented market. We also expect that the restructuring of Seven & I's Japanese department store operations will proceed with increasing alacrity, reducing the drag on operating performance. All told, we believe we have paid a low multiple of normalized earnings for a very good business that can continue to grow long into the future. Finally, it is our view that if the U.S. 7-Eleven business were to be valued independently at a multiple similar to publicly-listed comparable companies, the undervaluation of Seven & I would become glaringly clear.
From the Third Avenue Value Fund (Trades, Portfolio)'s fourth-quarter 2020 portfolio manager commentary.
