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 EnterprisesAssociate Dean of Research and Centers

MhcIntire School of CommerceUniversity of Virginia

Charlottesville, VA 22903gao5h@virginia.edu

434 242 7063 mobile/UVa434 985 4188 farm

Enhancing Petroleum Marketer Performance: Value

Driven Analysis and Practice

Enhancing Petroleum Marketer Performance: Value

Driven Analysis and Practice

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 incentives.

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

I. COMPETITIVE MARKET ANALYSIS

•CUSTOMER VALUE CHAIN AND FIRM’S RELATIVE POSITION•RELATIVE STRENGTHS AND WEAKNESSES OF COMPETITORS, INCLUDING FIRM•ENVIRONMENTAL TRENDS AND MARKET EVOLUTION

II. STRATEGIC VALUE ASSESSMENT

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

IV. EXECUTION OF STRATEGIC INITIATIVES AND ESTABLISH MONITORING/INCENTIVE SYSTEMS

•ESTABLISH OWNERSHIP PROGRAMS AND OPTIMAL FIRM STRUCTURE•DETERMINE BEST PRACTICES AND STRETCH GOALS/MEASURES•CREATE AND IMPLEMENT VALUE SCORECARD AND INCENTIVE SYSTEM

III. FORMULATION AND Strategic Value Mgt. (SVM) RANKING OF STRATEGIES/TACTICS

•FORMULATE VALUE ADDED STRATEGIES•ASSESS CORPORATE VALUE ADDED (NET PRESENT VALUE) AND SENSITIVITY TO KEY VALUE DRIVERS

•PRIORITIZE CAPITAL INVESTMENTS

ValueBased

Management

Questionaire on Performance Monitoring & Planning, Page 11. 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, describe__________________________________________________________________________________________________________________________

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? A.__________________________B._____________________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

performance? A.__________________________B._____________________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/unknownDoes 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 Management

I. COMPETITIVE MARKET ANALYSIS

•CUSTOMER VALUE CHAIN AND FIRM’S RELATIVE POSITION•RELATIVE STRENGTHS AND WEAKNESSES OF COMPETITORS, INCLUDING FIRM•ENVIRONMENTAL TRENDS AND MARKET EVOLUTION (PORTER’S 5 FORCES, ETC.

II. STRATEGIC VALUE ASSESSMENT

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

IV. EXECUTION OF STRATEGIC INITIATIVES AND ESTABLISH MONITORING/INCENTIVE SYSTEMS

•ESTABLISH OWNERSHIP PROGRAMS AND OPTIMAL FIRM STRUCTURE•DETERMINE BEST PRACTICES AND STRETCH GOALS/MEASURES•CREATE AND IMPLEMENT VALUE SCORECARD AND INCENTIVE SYSTEM

III. FORMULATION AND SVM RANKING OF STRATEGIES/TACTICS

•FORMULATE VALUE ADDED STRATEGIES•ASSESS CORPORATE VALUE ADDED (NET PRESENT VALUE) AND SENSITIVITY TO KEY VALUE DRIVERS

•PRIORITIZE CAPITAL INVESTMENTS, NTI, DEMOLISH/REBUILD, DIVESTMENTS

ValueBased

Management

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? PORTER’S FORCES GOVERNING COMPETITIVE POSITION

II. BARGAININGPOWER OFSUPPLIERS

III. BARGAININGPOWER OF

BUYERS

GOVERNMENTREGULATIONS

I. CURRENTCOMPETITORS

MARKET’SCOMPETITIVE

POSITION & PROFITABLITY

POTENTIALCOMPETITORS

IV. THREAT OF NEWENTRANTS

V. INDUSTRIES WITH PRODUCT

SUBSTITUTES

Entry Barriers

Exit Barriers

Low to Moderate barriers to entry Capital costs rising ($2.5 to $4 m.) new to industry units plus OH Low urban land availability with sprawl showing signs of slowing

Potential Entrants

Supplier Power

Substitutes

Buyer Power

Industry Competitors

Rivalry/Existing Firms

Very High Supplier Power Limited number of refineries hold lots of pricing power. Rising global demand & fixed Supply suggests potential long term price increases Moderate

High

Relevant Buyer Power Low switching costs due to public posting of gas prices leading to low switching costs; tired iron having hard time competing

Substitute Products Hyper marts & gas Drug store chains; grocery fresh movementElectric/hybrid vehicles

Ib. Porters Five Forces Model: C-Store IndustryFragmented 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 operators

Ic. Porters Five Forces Model Inputs Resulting Competitive Score

(3.5 being oligopoly and 5 being pure competition)Supplier Buyer Potential CompetitivePower 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 HighMod.

Assessing Competitive Advantage? Are Incumbent Advantages Identical to Barriers to Entry? Source: Competition Demystified, p. 56.

• If no, pursue operational efficiencies! If you are an ant, consider exiting!

• If yes, identify and manage competitive advantages.

1. Develop industry mapIdentify strategic value units having individual

market segmentsIdentify competitors in each segment

2. Test for existence of competitive advantages•Mkt-share stability, dominant firm, low entries & exits

•Sustained high profitability

3. Look for sources of competitive advantage•Proprietary technology

•Advantaged resources (locations)•Customer Captivity (Switching Costs)

•Economies of Scale•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.ShareStable?

Firm? Low entryExit?

Roic > Wacc? Pursue ? Notes

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

Industry

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 Tax40 Year Average through 2004, Koller, Valuation: Measurement and Management, Wylie, 2005, 141.

6.26.5

6.9

7.07.7

8.49.09.0

9.59.9

10.311.0

11.311.9

12.014.1

14.715.0

15.218.4

UtilitiesTelecommunications Services

Transportation

CSX Data 93- 06Energy

MaterialsRetailing

Total SampleConsumer Durables and Apparel

Automobiles and ComponentsTechnology Hardware and Equip.

Food, Beverage and TobaccoHealth Care Equipment and Services

Semiconductors and EquipmentTop Quartile, CSX Data 93-06

High Performing PM 01-07Media

Software and ServicesHousehold and Personal productsPharmaceuticals & Biotechnology

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 12%.

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

objective

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

OperatingDecisions EBIT(1-t)

OperatingDecisions EBIT(1-t)

InvestmentDecisions(Capital)

InvestmentDecisions(Capital)

FinancingDecisions

(Cost of Capital)

FinancingDecisions

(Cost of Capital)

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

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

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

Ec. Profit = Return on Invested Capital – Weighted Average 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

Capital

Cost ofCapital X Capital ($)

Operate - Improve the returnearned on existing Capital

Build - Invest as long as returns exceed the cost of capital

Harvest - Divest capital when returnsfail to achieve the cost of capital

[ ]

A Typical Financial Management System

PerformancePerformanceMeasurementMeasurement

PerformancePerformanceBenchmarkingBenchmarking

StrategicStrategicPlanningPlanning

CommunicateCommunicateResultsResults

CapitalCapitalBudgetingBudgeting

AcquisitionAcquisitionAnalysisAnalysis

GoalGoalSettingSetting

OperationalOperationalInitiativesInitiatives

IncentiveIncentiveCompensationCompensation

Earnings

Returns

MarginsBudgets

Cash Flow

Growth

?

The Financial Management System and Economic Profit

PerformancePerformanceMeasurementMeasurement

PerformancePerformanceBenchmarkingBenchmarking

StrategicStrategicPlanningPlanning

CommunicateCommunicateResultsResults

CapitalCapitalBudgetingBudgeting

AcquisitionAcquisitionAnalysisAnalysis

GoalGoalSettingSetting

OperationalOperationalInitiativesInitiatives

IncentiveIncentiveCompensationCompensation

ROIC less WACC = Ec. Profit

Decision-making(planning & resource allocation)

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

Performance Measurement

Accountability &Rewards

28

$0

$20,000,000

$40,000,000

$60,000,000

$80,000,000

$100,000,000

$120,000,000

$140,000,000

2001 2002 2003 2004 2005 2006 2007 2008

Fixed Assets Cap Rents Working Cap

Case #1: Looks are deceiving—Growth in Invested Capital

What Stage is the Firm?

29

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

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

2001 2002 2003 2004 2005 2006 2007 2008

Invested Capital Per GallonTotal Company: Implications?

$25,000,000

$30,000,000

$35,000,000

$40,000,000

$45,000,000

$50,000,000

$55,000,000

$60,000,000

2001 2002 2003 2004 2005 2006 2007 2008

Income Expense

Income and Expense GrowthTotal Company

31

Return on Invested Capital: Another Story

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

2001 2002 2003 2004 2005 2006 2007 2008

Retu

rn %

C 1 Ind Avg Top Qrt CP 8 Yr Avg

Return on Invested CapitalStrategic Value Unit (SVU No. 1)

-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%8.00%

10.00%12.00%14.00%16.00%

2001 2002 2003 2004 2005 2006 2007 2008

Retu

rn %

SVU Ind Avg Top Qrt

Return on Invested CapitalReturn on Invested CapitalSVU No. 1 and Comparable CompaniesSVU No. 1 and Comparable CompaniesDiscuss Recent Value Enhancing MovesDiscuss Recent Value Enhancing Moves

-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%8.00%

10.00%12.00%

2001 2002 2003 2004 2005 2006 2007 2008

Retu

rn %

Case Firm Firm B Firm C Firm D

Case # 2. Composite, High Performing SegmentAgain Note Growth in Capital Invested for Composite, High Performing Case Here we

also see its blended cost of capital (WACC)?

WA

CC

$162 $174

$215

$281

$400

$543

$0

$100

$200

$300

$400

$500

$600

2001 2002 2003 2004 2005 2006

Cap

ital

(in

Mil

lio

ns)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

Equity Debt Total Capital WACC

Case #2: Wealth Creation & Composite High Performing Firm EVA TrendNow, for the quiz: What does this suggest for its Return on Invested Capital? Greater

than or Less than its Cost of Capital (WACC)?

$3

$7

$13

$30

$38

$46

$0

$10

$20

$30

$40

$50

2001 2002 2003 2004 2005 2006

EV

A $

's

(in

mil

lio

ns)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

EV

A %

EVA $'s EVA %

What about the firm’s matrix

position?

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?

Tota

l V

alu

e

(in

Mill

ion

s)

$57 $66 $90

$381

$463

$508

$145 $199$254$105 $108 $125

$201

$288

$136$34 $91

$175

$0

$200

$400

$600

$800

$1,000

$1,200

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

BelowRec.Level

Above Inflationary Level

+0.7+0.7

So where are we now in the economic cycle? 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 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 www.chicagofed.org/digital_assets/publications/cfnai/background/cfnai_background.pdf.

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 DataEvery 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.

At Long Last, Trucking Data Utilized! Important!At Long Last, Trucking Data Utilized! Important!

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? 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

times? “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 news!

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 SlowlyU.S. Debt Shrinking Slowly

1x. Toward a More Balanced Global Economy

Challenge for China and Other

Asian Nations: Re-orient Growth Away from

Exports to Domestic Demand

The Coming Decade – Macro Outlook

56

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

The Federal budget is on an unsustainable path The Federal budget is on an unsustainable path – US Comptroller General– US Comptroller GeneralThe Federal budget is on an unsustainable path The Federal budget is on an unsustainable path – US Comptroller General– US Comptroller General

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

Growing Budget Competition from Mandatory & Interest

FY 2011 Request$3.8 Trillion

Social SecuritySocial Security19%19%

$730B$730B

Social SecuritySocial Security19%19%

$730B$730B

Non-security14%

$520B

Security23%

$895B

Interest7%

$254B

Social Security21%

$1,201B

Social Security21%

$1,201B

Interest15%

$845B

Non-security9%

$529B

Security17%

$955B

FY 2020 Projection$5.7 Trillion

Outlays in Current Dollars

Chart Sizes are proportional to total dollars

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

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

Structural changes to interest and mandatory spending squeeze discretionaryStructural changes to interest and mandatory spending squeeze discretionaryStructural changes to interest and mandatory spending squeeze discretionaryStructural changes to interest and mandatory spending squeeze discretionary57

Public Debt Increasing Far Above Normal

1958 – 2008 Average= 38%

58

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

Future debt rises to levels not seen since the end of World War IIFuture debt rises to levels not seen since the end of World War IIFuture debt rises to levels not seen since the end of World War IIFuture debt rises to levels not seen since the end of World War II

US General Government Gross Debt Projected To Exceed GDP by 2015

59

US General Government Gross Debt 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

General Government Gross Debt as a Percent of GDP

General Government Gross Debt as a Percent of GDP

Chronic federal deficits are putting US on a path to reach Chronic federal deficits are putting US on a path to reach European–style debt levels and slower economic growth European–style debt levels and slower economic growth Chronic federal deficits are putting US on a path to reach Chronic federal deficits are putting US on a path to reach

European–style debt levels and slower economic growth European–style debt levels and slower economic growth

Fiscal Restraint Already Evident in Non-Defense Discretionary Outlays

60

0

100

200

300

400

500

600

700Historical Actuals FY11-15 Plan

Non-Defense Discretionary SpendingFY 1962 – FY 2015

Real CAGRs:

60’s: 4.6%70’s: 6.1%80’s: -1.6%90’s: 1.5%00-08: 2.9%09-10: 18.1%11-15: -3.5%

62-15: 2.5%

Real CAGRs:

60’s: 4.6%70’s: 6.1%80’s: -1.6%90’s: 1.5%00-08: 2.9%09-10: 18.1%11-15: -3.5%

62-15: 2.5% Out

lays

in F

Y05

$B

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

Spike due toFY09 Stimulus

After decades long growth, expect a contraction in non-defense spendingAfter decades long growth, expect a contraction in non-defense spendingAfter decades long growth, expect a contraction in non-defense spendingAfter decades long growth, expect a contraction in non-defense spending

Afghanistan and Iraq Wars

Vietnam War Reagan Build-up

DoD Budget 1945-2015: Threat Driven, but Debt Constrained DoD Budget 1945-2015: Threat Driven, but Debt Constrained

61

Large debt levels will impair future US ability to increase Large debt levels will impair future US ability to increase defense spending as quickly as in the past defense spending as quickly as in the past

Large debt levels will impair future US ability to increase Large debt levels will impair future US ability to increase defense spending as quickly as in the past defense spending as quickly as in the past

Korean War

WW II

Missile GapCuban Missile Crisis

Pub

lic

Deb

t%

of G

DP

DoD

Bud

get

in C

onst

ant F

Y11

$B

Historic Budget Constraint Zone: Public Debt > 40% GDP

44% Decline 31% Decline19% Decline

Deficit Forecast: Bleak Without Major Entitlement Reforms or Revenue Growth

62

Fiscal Year

Percent of GDP

OMB February ’10OMB February ’10OMB February ’10OMB February ’10

CBO Mar ’10 Assessment of CBO Mar ’10 Assessment of FY11 BudgetFY11 Budget

CBO Mar ’10 Assessment of CBO Mar ’10 Assessment of FY11 BudgetFY11 Budget

TechAmerica ForecastTechAmerica Forecast

Changes from Mar 10 CBO:Changes from Mar 10 CBO:• Adjustments for DoD base Adjustments for DoD base

budget and OCO forecastsbudget and OCO forecasts• Higher assumption for health Higher assumption for health

care reform costscare reform costs• Reduced international affairs Reduced international affairs

spendingspending• Risk of higher interest ratesRisk of higher interest rates

TechAmerica ForecastTechAmerica Forecast

Changes from Mar 10 CBO:Changes from Mar 10 CBO:• Adjustments for DoD base Adjustments for DoD base

budget and OCO forecastsbudget and OCO forecasts• Higher assumption for health Higher assumption for health

care reform costscare reform costs• Reduced international affairs Reduced international affairs

spendingspending• Risk of higher interest ratesRisk of higher interest rates

Deficits stay above 4% through the forecast period; Deficits stay above 4% through the forecast period; the trend is toward larger, not smaller, deficits from FY14 through FY21 the trend is toward larger, not smaller, deficits from FY14 through FY21

Deficits stay above 4% through the forecast period; Deficits stay above 4% through the forecast period; the trend is toward larger, not smaller, deficits from FY14 through FY21 the trend is toward larger, not smaller, deficits from FY14 through FY21

OMB February ’09OMB February ’09OMB February ’09OMB February ’09Actual FY10 deficit is approximately 10% of GDP. CBO projects $1.3T deficit, $20.3T debt in 2020. Actual FY10 deficit is approximately 10% of GDP. CBO projects $1.3T deficit, $20.3T debt in 2020.

External Environment Summary

63

• 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.” The biggest threat we have to our national security is our debt.” Adm. Michael Mullen, Chairman of the JCS, June 2010Adm. Michael Mullen, Chairman of the JCS, June 2010

““The biggest threat we have to our national security is our debt.” The biggest threat we have to our national security is our debt.” Adm. Michael Mullen, Chairman of the JCS, June 2010Adm. Michael Mullen, Chairman of the JCS, June 2010

New World, Old Rules?

As Financial Markets Rallied & Global Economy Moved into Recovery

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

Sept. 08, space mkts. turn negative

Aug. 07Trends + to -

Source: RCA

Here We Show “Core” CRE Price Changes Broken Out Between Income (Space Markets) and Cap Rate (Capital Markets) Effects

$0

$20

$40

$60

$80

$100

$120

$140

$160

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10

CRE Sales CRE Prices

sources:CRE Sales: Real Capital Analytics, office, industrial, retail, multi-family properties $5mil+CRE Prices: Moody's/REAL CPPI National Aggregate Index

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 PricesDown 42%Peak to Trough

Private CRE Appreciation Decomposed—Two Market Downturns Last Year’s Overstreet Scenario Going Forward (2009-2010)

1991—1993• NCREIF Price Index -23.5%• NOI Effect - 3.2%• Cap Rate Effect -21.0%• Interaction Effect + 0.7%

2002—2004• NCREIF Price Index 12.4%• NOI Effect -16.4%• Cap Rate Effect +34.4%• Interaction Effect -5.6%

2007/2010

• NCREIF Price Index -- 40.0% •NOI Effect -- 15.0%•Cap Rate Effect -- 25.0%•Interaction Effect Ignore

2007/2010 C-Store Ostreet SWAG

• Pet Mkt. Price Index -- 20.0% •NOI Effect +5.0%•Cap Rate Effect -- 25.0% •Interaction Effect Ignore

Not over the Maturing CRE Mortgage Debt “hump” Yet!

Vacancy Trends, 1991 to 2010—Office, Industrial Retail Historically Weak, Apt. solid

Vacancy Trends, 1991 to 2010—Office, Industrial Retail Historically Weak, Apt. solid

REITs: A Leading Indicator--Good Omen?

Key Take-awayMonitor REITs in general and industry examplesGetty (gty) (hpt) (nnn)

Key Take-awayMonitor REITs in general and industry examplesGetty (gty) (hpt) (nnn)

73

Treasury and corporate bond yields are monthly through February 2011. Real estate cap rate is quarterly through 4Q10 and represents equally weighted average cap rates from institutional core property transactions.

Sources: Cornerstone Research, NCREIF, and Federal Reserve Board.

Core Property and Bond Pricing Relationship Linked

2%

3%

4%

5%

6%

7%

8%

9%

10%

2002.01 2003.01 2004.01 2005.01 2006.01 2007.01 2008.01 2009.01 2010:1

10 Year Treasury Baa Corporate Bond Real Estate (Cap Rate )

73

Feb. 2011

Feb. 2011

4Q10

Recently, Cap Rate Decline Has Lagged Bond Market Rally

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 standards;

• 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!

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 average

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 percent); 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 significantly; Risk takers will rarely have a better situation.

Bob White, RCA CEO, Market CRE ThesisContinued

• 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 ThesisContinued—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

•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 metros!

•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 metros!

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!

0

50

100

150

200

250

30019941

19951

19961

19971

19981

19991

20001

20011

20021

20031

20041

20051

20061

20071

20081

20091

20101

Dem

1994Q

1=100, S

up

set t

o =

avg

level

yyyyq

Retail Demand (Constant-Liquidity) & Supply Indexes

Demand

Supply

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%

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

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

Lessons Implied for Petroleum Distribution CRE

95

• 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? Discuss!

• 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

96

• 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 family

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 matrix) 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 effortsROE = 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!