Saturday, April 28, 2012

Biglari's Compensation Plan

So I understand that Biglari has pissed off a lot of people with renaming Steak N' Shake to Biglari Holdings and his hedge fund-like compensation package, which is of course unheard of for publicy listed restaurant companies. 

To be sure, Warren Buffett doesn't have anything like that, nor does the Tisch family or the folks at Leucadia and other value investing conglomerates.  I'm sure those folks would be opposed to Biglari's compensation plan too (as they are mostly opposed to the hedge fund structure in general; even though Buffett had one of his own early in his career).

Renaming to Biglari Holdings
First, let's look at this company name change for a second.  Yes, it seems so egotistical to name something for yourself.  I am one of those people that would have a problem putting my name on anything, but that's just me.  Some people name their fund companies after themselves, like Soros Fund Managment and others use another name, like Tiger (Greek Gods, mythical characters and highway signs are other sources of names).

I don't think there is anything inherently wrong with naming something after yourself, especially if you are going to change the business drastically into a holding company.  Of course, I would feel differently if Biglari changed the name (and store names) of Steak N' Shake to Biglari Burgers or some such and added new menu items like the Super Big Biglari Burger or Biglari Super Shakes etc... I would definitely roll my eyes on that (but then again, I live in NYC where at one point everything seemed to be named Trump, so maybe I am desensitized to super-egos).

But naming something to Biglari Holdings is partly meant to indicate that this company is no longer a burger restaurant and partly to indicate that this is now a jockey stock; not a burger company.

Also, when an ambitious, egotistical person puts their name on something, that can be a good thing.  They are going to really 'own' the business.  Nobody wants to put their name on something and see it flop; it's not good for their ego.  They are not going to rename something in their own name, do a big dividend recap and then let it go under.  Nobody wants to see their name on a $3.00 stock (OK, I heard someone say Trump again; I don't think Trump is a good analogy).

So even though there was a big uproar on the internet when this name change happened, I don't think it's a big deal.

Of course, Buffett did not rename Berkshire Hathway to Buffett Holdings to indicate a change in direction for the company.

I think part of the shock on this name change and compensation plan came from the fact that Buffett wouldn't do it this way.

I think some people were so happy that they found the next Warren Buffett, they really jumped on board emotionally as well as financially.  And when Biglari started doing things that Buffett wouldn't do, it was totally incomprehensible and unacceptable.

This is not to say that that's the only reason for the uproar.  But I think it contributed to the magnitude of it.

Compensation Plan
OK, I know this is going to be controversial and I will get hate mail for this but this compensation plan might actually be an interesting idea.  And I do know that both Buffett and Munger would not agree with me on this.

You have to think of this as a publicly listed hedge fund, not an industrial conglomerate.

Obviously, Biglari set up this compensation plan because he couldn't continue to run Lion Fund and SNS at the same time. He figured he will just put them together and run the whole thing like a hedge fund. 

If you look at it this way, this compensation plan is pretty normal and is actually better than deals you get in private equity and hedge funds.


First of all, Biglari's compensation plan doesn't have a catch up provision, meaning he only gets paid on growth above 6%.  So if book value grows 10%, he gets paid 25% of the 4% performance above the hurdle.  Hedge funds typically have some math in there so that even though they get paid nothing if they don't earn 6%, they will earn 20% of the total gain if they exceed the hurdle rate (so they will get paid 20% of 10%).

Also, Biglari is getting paid on book value growth which is after tax.  Hedge funds earn fees on pretax returns.  This is not as good as it sounds, though, because book value growth is after corporate taxes, but before any taxes stockholders will pay on dividends and capital gains.

But if BH focuses on growth and not dividend distribution, compounded returns may be taxed over time at the long term capital gains tax rate for the shareholders (when and if the sell).

So Why Is This Structure Interesting?
This may very well be innovative if it works out and I would be surprised if many hedge fund managers aren't looking at this carefully now.

One of the biggest issues in the hedge fund world has been the permanency of capital.  Investor funds rush into hedge funds (mutual funds too for that matter) in good times and then rush out in bad times.  I think Bill Ackman's first hedge fund blew up because of this; they invested in some illiquid, private equity-type deals and when redemptions came, they couldn't meet them.  That's probably why he is so focused on very large publicly listed corporations.

Private equity deals with this by having funds with fixed terms.  Oakmark (which I recently posted about) also has a lot of their funds as closed-end, fixed term funds.

This can be a problem too.  If you know you have to return capital in seven years, you might get into trouble if the market is not friendly at the time you have to liquidate.

Henry Kravis has mentioned how envious he is of Berkshire Hathaway's structure. 

The problem with these term funds is that they have to be out raising capital all the time; every time one of their large funds 'expire', their AUM goes down and they have to go out and raise capital for a new fund.

What about listed closed end funds?  Listed closed end funds are regulated under the Investment Company Act so is onerous to run and have many restrictions.

Some private equity structures are run as BDC's and there are a lot of those. But this has many restrictions too.

This capital problem is why guys like David Einhorn has set up Greenlight Capital Reinsurance (GLRE).  They set up an insurance company that will become permanent hedge fund clients of theirs.  Capital won't run away in bad times and rush in in good times.   (Of course, float can come and go according to insurance industry cycles and depending on well GLRE does).

So I think right now for hedge funds, this is the way to go to raise permanent capital.

What Biglari did was to convert this restaurant into a publicly listed hedge fund.  How can he get away with this as hedge funds are only to be sold to accredited investors and not the general public? 

Well, BH isn't actually a hedge fund.  It's a publicly listed corporation.  It only has a compensation package like a hedge fund and a capital allocator like a hedge fund.

Investment Company Act (ICA)?
How can this entity get around the Investment Company Act?   If the ICA is a pain in the butt, why don't people just set up a company like BRK, LUK, L and just do what they want?

Because even if you don't register as an Investment Company, you will be considered one if you look like one.  How do they determine if you look like one?  I think if more than 50% of your total assets is in investment securities and/or 90% of income is dividend and investment income or some such, you will be deemed an investment company.

BRK is not an investment company because it owns a large amount of wholly owned businesses.  Way back before they owned a lot of that, their investments were made either via Blue Chip Stamps or the insurance segment.  Obviously, insurance companies don't fall under the ICA, but are regulated as insurance companies. 

Loews too is not an investment company because their large holdings are consolidated; the large holdings are not investment securities but are consolidated subsidiaries.

Leucadia also looks like an investment business, but they too own a large amount of wholly owned businesses and consolidate some large holdings.

Biglari Holdings, too, would have to be careful going forward like the above companies to stay out of the ICA.  The fact that SNS is a wholly owned operating business gives Biglari some room, and this is probably another reason why Biglari wants an insurance company; not only to get the float, but to have an entity that can buy and hold investment securities without turning BH into an investment company.

So anyway, I know many people won't agree with me on this including many of my heros.  But I have to say that this is an interesting experiment.  Biglari gets a BRK, LUK, L-like structure (operating business and cash flows into investment securities) with a hedge fund-like compensation structure.

I have to say that I have never been against the hedge fund incentive compensation structure.  I know there was a lot of debate on that in the past few years all over the internet.  But for me, my view was always that if someone wants to pay 4%/50% management/incentive fee, let them pay it.  What matters at the end of the day is net performance to the investor.  If the manager earns 50%/year over time, then maybe the high fees are worth it.

I would rather pay that high fee than pay an equity mutual fund manager 1.5%/year with no incentive fee to underperform the S&P 500 index  (In fact, those mutual fund fees for underperformance and all those front-loads / back-end loads / 12b-1 fees and what not bother me way, way more than hedge fund/private equity fund fees).

So that's where I'm coming from and in this Occupy Wall Street age, I know this is not a common view, and that's OK.

BH's compensation plan is horrible and egregious for a restaurant chain or normal operating business or compared to other, older investment conglomerates like BRK, but not at all as a hedge fund (or private equity fund). 

If BH works out, I wouldn't be surprised if we see other hedge fund operators try to do something simliar.  If that happens, then Biglari would have turned out to be a pioneer.  (Although, again, I understand that most of the value investing community would not necessarily see that as a good thing).


  1. I remember reading the SEC filing on Biglari's compensation plan and it stated that he would be required to purchase BH stock with 50% of his compensation bonus. So, even though he created a hedge fund compensation system that many people do not like, at least he has to use half of his money every year to buy BH stock. I like this part of the compensation plan because it makes the leader continually have skin in the game.

  2. Why issue the stock indirectly like that? Why not just reduce the salary and grant stock? Is the accounting and taxes any more effecient doing it that way when paying payroll and federal taxes on the money.

  3. Cause Biglari can easily remove the requirement to buy stock and just keep the cash