Under the Hood of Berkshire Hathaway’s Pilot/Flying J Purchase

Berkshire Hathaway announced last week that it is buying truck stop and gas station owner Pilot/Flying J in a multi-step transaction that will see Berkshire initially acquire 38.6% of the company and then up their ownership to 80% in 2023. After 2023, the Haslam family will continue to own the remaining 20%. The Knoxville, TN based company is the fifteenth largest private company in the United States, with revenue of about $20 billion.

Terms of the deal were not disclosed, forcing the curious to see if they can somehow reverse engineer aspects of the deal.

Pilot was founded in 1958 when Jim Haslam purchased a single gas station for $6,000. It dramatically increased in size when it purchased competitor Flying J out of bankruptcy. Because the bankruptcy proceedings are public, there’s valuable information within the filings made at the time, 2009. A value of $3.3 billion was placed on Pilot and Flying J was to be acquired for $300 million – $500 million in cash plus equity in the new company, valuing it in total at $1.8 billion. Post-merger, the combined entity had revenue in excess of $30 billion and would reasonably have an enterprise value of about $5.1 billion.

During 2013, Pilot Flying J offices were raided by the FBI. It was later alleged that the company engaged in a scheme to defraud truck drivers of rebates they had earned with the company. Pilot sales staff had sold larger volume customers on a program that rewarded them based upon volume, sometimes with discounts given at the pump and sometimes with rebate checks. According to the FBI, there was a premeditated strategy to cheat those customers on their rebates. Although revenue has fallen since the Flying J merger, from $30 billion to $20 billion, much of that is just the result of lower gas prices, so it is difficult to know what, if any, long-termĀ impact the episode has had.

It is also not immediately clear how much debt the company still has that needs to be repaid. In 2013, The Wall Street Journal reported that the company had $4 billion in debt, accrued from both the Flying J purchase and a dividend to help Jimmy Haslam (Founder Jim Haslam’s son) acquire the Cleveland Browns football franchise. Presuming most of the company’s excess cash has been used to deleverage, it very well could still have roughly $2.5 billion in debt today.

The segment of the North American gas station industry has three main competitors: Pilot/Flying J, Love’s, and TravelCenters of America. Pilot/Flying J is the largest with $20 billion in revenue and 750 locations, while family-owned Love’s is not far behind at 430 locations and $16 billion in revenue. Travel Centers of America is the only one of the three that’s publicly traded and has 250 locations and $6 billion in annual revenue.

The truck stop industry has seen challenges in recent years from technology that is allowing trucking companies and drivers to better optimize their diesel purchases. In the past, brand loyalty carried more value as drivers stopped at familar locations and tried to benefit from consolidating their purchases with a single provider. (This also made geographic diversity extremely valuable, which only a small number of companies had.) Now, they are more likely to use technology to tell them where and when to purchase fuel at the cheapest price.

That still leaves the question of how much Pilot is earning and what it’s worth. Margins are slim in this business – operating income is probably no more than 2% of sales, or maybe $500 million a year in total. Using a multiple of 12x operating income (a discount of about a third to the higher margin consumer gas stations of Couche-Tard and Casey’s) gives an enterprise value of $6 billion. That is roughly consistent with the value placed on the company in the Flying J bankruptcy filings in 2009. Subtracting $2.5 billion in estimated remaining debt would value the equity at about $3.5 billion.

For the Haslam family, there were likely numerous reasons to sell. The most obvious reason is the ability to monetize their family investment, while still maintaining 20% ownership in the long run. Berkshire Hathaway’s reputation also can give the family relief in knowing the company will be well-managed, they will still have a voice in decision making and that it will not leave Knoxville.

Most people were initially curious about what Warren Buffett thought about self-driving cars and whether it was a threat to the future of the business. When Bloomberg asked him this, Buffett responded simply, “I’m not going to lose sleep about it.” Should driverless trucks become a reality decades down the rode, it will certainly change the industry, but there is no reason that adaptation would not ensure Pilot’s survival.

What was truly interesting is that Buffett apparently is not bothered by the 2013 rebate scandal at Pilot. For a certainty, he does not consider it an issue any longer.

In any event, no one should expect this investment to soak up much of Berkshire’s $100 billion in cash. The cost of the initial 38.6% stake is likely around $1.4 billion. The remaining purchase in 2023 will likely be tied to a formula.

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