When the Wheels Come Down

Pilot preps for smooth landing in Flying J acquisition; rest of industry braces for turbulence.

By  Steve Holtz, Online News Director & Beverage Editor

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With the filing of its plan of reorganization in U.S. Bankruptcy Court in February, Flying J Inc. took a step closer to its $1.17-billion buyout by the nation’s largest travel-center company, Pilot Travel Centers LLC.

And while the combination will create the largest truckstop chain in the country by more than double, the highly fragmented nature of the industry keeps its overall share relatively tiny.

“They still have a very small market share,” says stock analyst Ben Brownlow of Morgan Keegan, Memphis, Tenn. “There are roughly 6,000 truckstops in the U.S., and about 5,000 of them are the ‘mom and pop’ sites.” About 500 of the merged chains’ 570 sites will be operated by the company, and 318 will be owned by the company. The combined entity will reportedly have a 20% market share of the on-road diesel market.

THREATS AND OPPORTUNITIES

Still, there’s reason for the next-largest competitor, 233-store TravelCenters of America (TA), which Brownlow follows closely, and other truckstop chains to be concerned as the acquisition nears completion.

“Whenever you get No. 1 and No. 2 in the industry together, that’s never going to be good for No. 3 and the remaining sector. [They] are going to have more fuel and merchandising power,” Brownlow says. “Given that they pretty much had a national presence with Pilot and Flying J … [it’s even more so now], which will make it easier for them to win contracts from fleets.

“Combine that with improved buying power and more leverage, and it’s going to be a greater competitive force against TA and the remaining industry.”

Tom O’Brien, managing director, president and CEO of Westlake, Ohio-based TA, said largely the same thing in a second- quarter 2009 earnings conference call in August, about one month after the Pilot-Flying J merger was first announced.

“But I don’t think [those advantages are] the end of the world,” O’Brien said. “I think TA has always competed on the basis of having better facilities, better services. We think we’re still going to be able to do that successfully in the future.” O’Brien cited among TA’s strengths bigger parking lots, more full-service restaurants, a more robust truck-repair offering, more showers per facility, and “the industry’s best loyalty program.”

There is another possible bright spot of the merger for TA. “Pilot and Flying J have historically been the most competitive with us in pricing,” O’Brien said. “Maybe they won’t feel the need when they’ve got such a dominant position to be as aggressive as they have in the past. And that might give us an opening as well.”

Brownlow agrees: “Flying J has been more of a volume driver through lower fuel prices. … They’re very aggressive; they’ll sacrifice margin to drive volume.

“So,” he continues, “with Pilot taking over Flying J, there would be a more rational pricing environment across the industry because TA was, at some locations, losing volume to Flying J across the street and management was wondering how they were pricing so aggressively and not losing money.

 “Pilot is known for being a more rational pricer, so you shouldn’t see as much aggressive pricing.”

A spokesperson for Knoxville, Tenn.-based Pilot said the company could not comment on the acquisition until it is complete.

When the proposed purchase was first announced in July 2009, Pilot CEO Jimmy Haslam said, “By combining Flying J and Pilot, we will better serve our customers by more efficiently providing them with the products and services they need.”

Crystal Call Maggelet, chairman of the board of Flying J, added, “After a careful and exhaustive review of the alternatives available, we have concluded that a merger with Pilot represents the best possible outcome for Flying J, our creditors, our customers and our employees.”

Flying J, based in Ogden, Utah, filed for Chapter 11 bankruptcy protection in December 2008, citing a drop in oil prices and tighter credit markets. Brownlow says those changes were the tipping point for a company that historically had a troubled capital structure.

“For Flying J, it was purely because of their capital structure and on top of that the decline of oil prices,” Brownlow says. “The refinery margin environment has been extremely difficult, and they have that Big West refining operation, and that put pressure on the company as a whole. So it was more due to a decline in oil prices and the refinery margin being put on a capital structure that was already teetering.”

Former Flying J CEO J. Phillip Adams concurred, telling The Wall Street Journal in December 2008 that the company’s liquidity problems stemmed from loans that were secured with oil and refined-product inventories. The plunge in oil prices, which fell more than 70% from record-high levels in July 2008, lowered the value of the loan collateral and triggered additional payments, or margin calls, that led the company’s refining arm to default on a $200-million loan provided by a group of lenders led by Bank of America Corp.

Adams resigned in January 2009.

CLEARED FOR LANDING

The recent reorganization filing clears the way for the breakup of the company, including the sale of its approximately 250 travel centers, its Big West of California refinery and other assets for approximately $53 million. (See sidebar, left.)

It doesn’t, however, remove the fact that the travel-center industry continues to struggle. “The industry in general has been struggling because of a decline in fleet traffic and freight demand. That’s your biggest clientele,” Brownlow says. “It’s just been a tough environment. … TA has been struggling for almost two years, pretty much ever since they went public [when it was spun off from parent company Hospitality Properties in 2007]. They’ve been losing money year after year since they went public.”

With such struggles continuing, is it wise for Pilot to purchase Flying J?

“Apparently they have the capital. If you’re going to acquire someone, acquiring them out of bankruptcy or near bankruptcy is going to present your lowest multiple and you’re going to get the best deal out of that,” Brownlow says.

In the transaction, Pilot’s equity ownership by the Haslam family (52.5%) and CVC Capital Partners (47.5%), an international investment firm, will be diluted by an estimated 20% and possibly by another 7% if the Flying J shareholders exercise their option to purchase $200 million of new equity.

Flying J’s reorganization plan was still subject to a vote by stakeholders and creditors as this issue of CSP went to press. All business-unit sales also are subject to review by the Federal Trade Commission, a process expected to last well into this summer. 


Making Cuts Great and Small

As Pilot Travel Centers LLC works to purchase Flying J Inc.’s approximately 240 retailer sites, it also is acquiring Flying J’s corporate headquarters in Ogden, Utah, including the buildings and operations. Headquarters of the two companies are expected to be consolidated in Knoxville, Tenn.

However, since filing for Chapter 11 bankruptcy protection in December 2008, Flying J has taken several other measures to close or sell some of its other assets and cut costs.

In February, Alon USA Energy Inc. was selected as the “stalking horse” bidder for the Bakersfield, Calif., refinery from Big West of California LLC, a subsidiary of Flying J. The Bakersfield refinery is located in California’s Central Valley and has the capacity to refine up to 70,000 barrels per day (bpd) of crude oil.

In January, Flying J sold its insurance subsidiary—Flying J Insurance—for an undisclosed price to The Buckner Co., a Salt Lake City-based insurance brokerage firm. Flying J Insurance has been selling insurance policies to the trucking industry since 1997. Flying J Insurance gathers about $25 million of insurance premiums annually.

 In July, Magellan Midstream Partners LP purchased Flying J subsidiary Longhorn Partners Pipeline LP. The purchase price for the pipeline system was about $350 million. The 700-mile Longhorn common carrier pipeline system transports refined petroleum products from Houston to an El Paso, Texas, terminal serving local petroleum product demand and distribution to connecting third-party pipelines in Arizona, New Mexico and, in the future, northern Mexico.

In June, Flying J closed restaurants at seven of its locations in the United States to “sustain us through challenging times,” said a spokesperson.

In May 2009, Flying J execs turned to employees to help them dig out of the financial hole. In a company letter, executives requested that employees “be mindful of the company resources. If you see a way to be more efficient, bring it to the attention of a manager or supervisor. If 14,000 employees all help save $5 per day, it will add up to a large sum.”

Also in May 2009, Flying J trimmed hours on foodservice in its stores. In one travel plaza in Emporia, Kan., for example, the company cut back from 24-hours-a-day, seven-days-a-week foodservice to closing the restaurant from midnight to 5 a.m. Sunday through Thursday.

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