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.
Why?
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.
Conclusion
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).
Showing posts with label BH. Show all posts
Showing posts with label BH. Show all posts
Saturday, April 28, 2012
Tuesday, April 24, 2012
Biglari Holdings Annual Meeting
So I did something unusual and went to an annual meeting last week. I am usually not interested in annual meetings as they seem to be sort of love fests or promotional events and most of them seem to be rubber stamp events with no real substance. Of course, the glaring exception is the Berkshire Hathaway (BRK) annual meeting.
I have been following Biglari Holdings (BH) recently and heard that he sits there and answers shareholders' questions for four or five hours. I thought this would be an interesting event to attend. So I did and it was interesting.
I didn't take detailed notes like BRK shareholders do, trying to capture every question and answer. I just jotted down things I heard that I thought were interesting and here it is.
First of all, I should mention that this took place at the St. Regis Hotel in midtown and started at 1:00 pm and went on until a little before 6:00 pm.
Here are some random notes (some of it is off the top of my head so it may be off):
Intrinsic Value Growth Goal of 15%/year
BH seeks to grow intrinsic value by 15%/year. This was mentioned in the annual report, but I don't know if that is before or after his incentive compensation. It's not that important to me as this is just a number that people have to come up with; high enough to be interesting but not so high as to be silly.
Value of Activism
One chart Biglari showed at the beginning of the annual meeting was what happens to an investment if bought for 50 cents on the dollar and comparing that to what happens to this investment if they can participate on the board of a company and help it grow value to $2.00. Now you are talking about turning $0.50 into $2.00 instead of $1.00.
So if they can buy $1.00 of assets for $0.50, the return in 5 years would be 15%/year. But if they can participate in value enhancement to get the value up to $2.00, that would boost the return to 32%/year instead of 15%/year.
A key point is that even if the activism doesn't work out, they should do well.
SNS Doing Well
Biglari announced at the annual meeting that SNS had same store sales and traffic growth of 4.8% and 5.2% in the first quarter of 2012 continuing the trend in improvement. The Signature store in Times Square is doing very well. He showed a video of the opening and a couple of clips when the Steak N' Shake Signature store was featured on the Letterman show. Letterman did spend a lot of time talking about how it was an important thing in his early life to be able to go to the SNS on his bicycle to get shakes.
Sales are doing well at the Times Square store but he said that they do need some work on operations; there is room for improvement. Someone asked him what lesson he learned or is learning from the Time Square store and he said they need more space (the Time Square store is only 1300 or 1400 square feet; it's a nice store but tiny).
He also said that SNS is the only national hamburger chain (or national fast food chain, not sure which one he said) that offers an organic hamburger, even though it's just in one store (Times Square). He did say it is selling well and they are working on getting it to more stores.
Why Not Sell/Lease Back or Spin Off the SNS Real Estate?
Someone mentioned that SNS owns the land under many stores; why not sell the real estate and lease it back or split/spin off the real estate? This would free up capital and improve returns.
Biglari's response was that if you sell the real estate, you lose optionality. When you own the real estate, you have choice. When you sell the real estate, the landlord can raise rent or decide it can be more profitable as something other than an SNS restaurant. You lose control. If you own the real estate, rent can't rise and a landlord can't kick you out.
He said the cost of a sale-leaseback would be 8%, so after taxes and expenses, they would have to earn 10% with the proceeds of a sale-leaseback for it to make sense.
Biglari mentioned that they actually went backwards; they BOUGHT real estate recently. They bought $9 million of real estate and lowered rent expense by $900,000 for a 10% return.
He also mentioned that a lot of this financial engineering stuff is done by managements that can't or don't turn around the operations. They shuffle assets but things don't improve because they don't turn the operations around. So turning the operations around is more important than financial engineering.
Why Not Refranchise Stores to Free Up Capital and Boost Returns?
Someone asked why BH wouldn't want to sell and refranchise SNS restaurants. Biglari had an interesting response. He said they are working on franchising the business, but it is taking time because they want to do it right. They don't want to sign up a bunch of franchisees and open up a bunch of stores only to have to close them. They want to do it right and that takes time. They want to find the right partners, set up the infrastructure and systems etc...
As for selling/refranchising stores, Biglari says that there is so much room for improvement in the existing, owned store base that it makes no sense to refranchise at this time. For example, the average sales now is around $1.6 million. If there is a clear path to get that to $2.0 million, then it makes much more sense to work on getting that to $2.0 million rather than selling the store and franchising it.
If sales moves up to $2.0 million from $1.6 million, Bigari says that they can earn conservatively a 40% incremental margin. That means the $400,000 increase in sales per restaurant would increase pretax profits by $160,000/store.
If the store were franchised, they would earn 5.5% royalty on sales. So at the current $1.6 million, BH would earn $88,000 in royalty fees. He said that at best, the franchise business would have a margin of 50%, so that implies pretax profits of only $44,000.
(He didn't mention what the cash generated from the sale of the restaurant sale would earn, so this may not be apples to apples (because we don't know what price the restaurant would fetch either)).
Anyway, it is an interesting response and compelling as it does seem that there is nice returns to be earned going forward in the existing restaurant base.
I have mixed feelings about franchising as I personally tend to think that the best businesses are owned (Starbucks, Chipotle Mexican Grill) and franchised operations are 'trashy' (YUM Brands U.S. operations and countless others; MCD being the notable exception that has really gotten the franchising thing down to perfection)).
In any case, at this point I don't have any strong feelings about whether any of this financial engineering is a good idea or not. Biglari seemed really passionate and serious about turning SNS into a great business; better products, lower prices etc...
(Just as a note, he said maintenance capex for SNS in 2011 was $6 million and won't change much in 2012)
Cracker Barrel
Not surprisingly, he made some comments about Cracker Barrel. Most of the comments were similar to what he said in his letters to CBRL shareholders.
He offered two examples of the waste and mismanagement at CBRL. He said that he spends a lot of money on billboards. I forgot why he knows this, but he said that CBRL spends $1,400 per billboard per month (that's what I think he said, but again, this is off the top of my head so I may be wrong), and he said that is way too high a price. He said that he pays for a lot of billboards so knows the market and this level is just way too high.
He also mentioned that CBRL restaurants have a separate bathroom for employees. He said this is incredibly wasteful as space is very important in the restaurant business. Why do employees need their own bathroom?
He said this is just two examples and he is sure there are many, many more. But he will need access to information to find more waste and that can only be done by getting on the board.
He insisted that he is at CBRL for the long term and is not there for a quick profit, and that contrary to claims by the CBRL board (that don't stock in CBRL), BH's interest is aligned with the shareholders of CBRL. BH owns so much CBRL, how can the interest not be aligned?
He said more than once, as if speaking to the CBRL moles in the audience that he is not going to go away. It may take years and he will be there. One failed proxy contest is not going to make him go away. What's right will prevail.
Anyway, Biglari really seemed determined and serious about this.
Questions were asked about the opportunity cost of owning so much CBRL without making much headway in terms of getting board seats. He said that they are long term investors and they are concentrated investors. This is the way they work.
If you look back to what Biglari said in the beginning about the difference between turning $0.50 into $1.00 and $2.00, having it turn to $1.00 is not bad at all. So BH will presumably do well even if nothing happens on the proxy contest.
He reiterated the value that can be realized at CBRL if they can get store productivity back up to where it was when the founder ran it.
Biglari sent a letter to CBRL shareholders on the day of the annual meeting and he said that CBRL should be able to grow traffic by at least 3%/year and should be able to target 5%. Someone asked where that number came from. The answer was that after years of traffic declines, it shouldn't be too difficult to turn traffic around. He mentioned SNS. He mentioned that it was getting harder for SNS to grow traffic as they have been growing for many quarters in a row. But after declining for so long, Biglari insists that it won't take much to turn it around a modest amount.
Incentive Compensation
So someone stepped up to the microphone and asked Biglari about his compensation. He said that if Biglari cared about the shareholders, why not reduce his $900,000 salary and incentive compensation and use it to invest and enhance value for shareholders?
Biglari mentioned that the compensation was overwhelmingly approved by shareholders. He said that if he didn't like the compensation package, he shouldn't own BH stock. Biglari asked that if you invested in a hedge fund, would you ask the hedge fund manager to lower his management and incentive fees? (my comment: a lot of investors *are* actually asking hedge funds, private equity funds etc... to lower fees!).
But I understand Biglari's point.
At some point, Biglari said that this is an unintelligent question so he doesn't want to respond any more to it or some such thing (I'm pretty sure "unintelligent" was the word he actually used). Of course, Biglari is not known for, say, the folksy charm, wit and humor of Warren Buffett. I thought to myself, hmmm... I would not answer a shareholder question like that even if I did think it wasn't the best question (you know what he's gonna say).
Of course, it only took seconds for someone to notice the 'hypocrisy' of the comment "if you don't like it, don't own the stock". So someone jumped up and said, hey, that's not a stupid question and you can't tell people not to own the stock when BH also owns shares in CBRL and complains about compensation there. Why not just sell CBRL stock if you don't like it?
I knew this sort of question would come right when Biglari said "if you don't like it...".
But Biglari's response made sense too. This is different because you are looking at a compensation package at BH that is based on results. If BH doesn't succeed and make money for shareholders, it will cease to exist.
At CBRL, management is failing and trailing the industry on many measures. The complaint against CBRL is not so much the compensation but the (non) performance of the business.
So that is a fair distinction; he's not trying to get on the board of CBRL to cut compensation (even though that may be part of the plan), but to create value for shareholders by improving the operations of the business.
I agree with Biglari that this is a different thing altogether.
This is not to say that people shouldn't complain about what bothers them. They could bring it up and leave it up to other shareholders.
Other Things
Someone asked him what he's learned from other financiers taking over businesses and trying to run them. What has he learned from watching Eddie Lampert, for example? His answer was that he learned that retail is a hard business.
He went on to talk about how the restaurant business is full of horrible operators that make really bad decisions all the time. He made it sound like an easy business to do well for that reason.
He talked about Sam Walton and Walmart and about Henry Singleton/Teledyne and knew the important metrics of his management tenure (book value growth, sales, earnings or whatever it was... he just threw out a bunch of numbers off the top of his head).
Conclusion
It is clear that Biglari loves business and is deeply passionate about it. He is no fool. You can tell he is a voracious reader and knows what he is talking about. He seemed to answer questions well. I didn't have any problems with anything he said that I remember.
He doesn't have any of the charm that you see from a Buffett, of course. There aren't many of those. He does have this intensity about him, though, which give you the feeling that Biglari will be spectacularly successful or flop miserably. But my sense is that he won't flop miserably.
He does have an incredibly arrogant vibe about him. He is definitely not the warm and friendly type. But you know, that's OK. When I look at investments, I look for people who are passionate about succeeding, works hard and loves to do what they do; I'm not looking for friends. I really did get that sense from him after watching him for five hours. He is there for the money, of course. But it seems to me that he really loves it too (unlike many highly paid people I've known on Wall Street over the years).
I think this is an interesting situation. I understand many people don't like Biglari for many reasons but I think it would be a mistake to write him off. I think there is a bit more substance there than people seem to think.
But then again, I could be totally wrong! If I am, I apologize in advance.
I have been following Biglari Holdings (BH) recently and heard that he sits there and answers shareholders' questions for four or five hours. I thought this would be an interesting event to attend. So I did and it was interesting.
I didn't take detailed notes like BRK shareholders do, trying to capture every question and answer. I just jotted down things I heard that I thought were interesting and here it is.
First of all, I should mention that this took place at the St. Regis Hotel in midtown and started at 1:00 pm and went on until a little before 6:00 pm.
Here are some random notes (some of it is off the top of my head so it may be off):
Intrinsic Value Growth Goal of 15%/year
BH seeks to grow intrinsic value by 15%/year. This was mentioned in the annual report, but I don't know if that is before or after his incentive compensation. It's not that important to me as this is just a number that people have to come up with; high enough to be interesting but not so high as to be silly.
Value of Activism
One chart Biglari showed at the beginning of the annual meeting was what happens to an investment if bought for 50 cents on the dollar and comparing that to what happens to this investment if they can participate on the board of a company and help it grow value to $2.00. Now you are talking about turning $0.50 into $2.00 instead of $1.00.
So if they can buy $1.00 of assets for $0.50, the return in 5 years would be 15%/year. But if they can participate in value enhancement to get the value up to $2.00, that would boost the return to 32%/year instead of 15%/year.
A key point is that even if the activism doesn't work out, they should do well.
SNS Doing Well
Biglari announced at the annual meeting that SNS had same store sales and traffic growth of 4.8% and 5.2% in the first quarter of 2012 continuing the trend in improvement. The Signature store in Times Square is doing very well. He showed a video of the opening and a couple of clips when the Steak N' Shake Signature store was featured on the Letterman show. Letterman did spend a lot of time talking about how it was an important thing in his early life to be able to go to the SNS on his bicycle to get shakes.
Sales are doing well at the Times Square store but he said that they do need some work on operations; there is room for improvement. Someone asked him what lesson he learned or is learning from the Time Square store and he said they need more space (the Time Square store is only 1300 or 1400 square feet; it's a nice store but tiny).
He also said that SNS is the only national hamburger chain (or national fast food chain, not sure which one he said) that offers an organic hamburger, even though it's just in one store (Times Square). He did say it is selling well and they are working on getting it to more stores.
Why Not Sell/Lease Back or Spin Off the SNS Real Estate?
Someone mentioned that SNS owns the land under many stores; why not sell the real estate and lease it back or split/spin off the real estate? This would free up capital and improve returns.
Biglari's response was that if you sell the real estate, you lose optionality. When you own the real estate, you have choice. When you sell the real estate, the landlord can raise rent or decide it can be more profitable as something other than an SNS restaurant. You lose control. If you own the real estate, rent can't rise and a landlord can't kick you out.
He said the cost of a sale-leaseback would be 8%, so after taxes and expenses, they would have to earn 10% with the proceeds of a sale-leaseback for it to make sense.
Biglari mentioned that they actually went backwards; they BOUGHT real estate recently. They bought $9 million of real estate and lowered rent expense by $900,000 for a 10% return.
He also mentioned that a lot of this financial engineering stuff is done by managements that can't or don't turn around the operations. They shuffle assets but things don't improve because they don't turn the operations around. So turning the operations around is more important than financial engineering.
Why Not Refranchise Stores to Free Up Capital and Boost Returns?
Someone asked why BH wouldn't want to sell and refranchise SNS restaurants. Biglari had an interesting response. He said they are working on franchising the business, but it is taking time because they want to do it right. They don't want to sign up a bunch of franchisees and open up a bunch of stores only to have to close them. They want to do it right and that takes time. They want to find the right partners, set up the infrastructure and systems etc...
As for selling/refranchising stores, Biglari says that there is so much room for improvement in the existing, owned store base that it makes no sense to refranchise at this time. For example, the average sales now is around $1.6 million. If there is a clear path to get that to $2.0 million, then it makes much more sense to work on getting that to $2.0 million rather than selling the store and franchising it.
If sales moves up to $2.0 million from $1.6 million, Bigari says that they can earn conservatively a 40% incremental margin. That means the $400,000 increase in sales per restaurant would increase pretax profits by $160,000/store.
If the store were franchised, they would earn 5.5% royalty on sales. So at the current $1.6 million, BH would earn $88,000 in royalty fees. He said that at best, the franchise business would have a margin of 50%, so that implies pretax profits of only $44,000.
(He didn't mention what the cash generated from the sale of the restaurant sale would earn, so this may not be apples to apples (because we don't know what price the restaurant would fetch either)).
Anyway, it is an interesting response and compelling as it does seem that there is nice returns to be earned going forward in the existing restaurant base.
I have mixed feelings about franchising as I personally tend to think that the best businesses are owned (Starbucks, Chipotle Mexican Grill) and franchised operations are 'trashy' (YUM Brands U.S. operations and countless others; MCD being the notable exception that has really gotten the franchising thing down to perfection)).
In any case, at this point I don't have any strong feelings about whether any of this financial engineering is a good idea or not. Biglari seemed really passionate and serious about turning SNS into a great business; better products, lower prices etc...
(Just as a note, he said maintenance capex for SNS in 2011 was $6 million and won't change much in 2012)
Cracker Barrel
Not surprisingly, he made some comments about Cracker Barrel. Most of the comments were similar to what he said in his letters to CBRL shareholders.
He offered two examples of the waste and mismanagement at CBRL. He said that he spends a lot of money on billboards. I forgot why he knows this, but he said that CBRL spends $1,400 per billboard per month (that's what I think he said, but again, this is off the top of my head so I may be wrong), and he said that is way too high a price. He said that he pays for a lot of billboards so knows the market and this level is just way too high.
He also mentioned that CBRL restaurants have a separate bathroom for employees. He said this is incredibly wasteful as space is very important in the restaurant business. Why do employees need their own bathroom?
He said this is just two examples and he is sure there are many, many more. But he will need access to information to find more waste and that can only be done by getting on the board.
He insisted that he is at CBRL for the long term and is not there for a quick profit, and that contrary to claims by the CBRL board (that don't stock in CBRL), BH's interest is aligned with the shareholders of CBRL. BH owns so much CBRL, how can the interest not be aligned?
He said more than once, as if speaking to the CBRL moles in the audience that he is not going to go away. It may take years and he will be there. One failed proxy contest is not going to make him go away. What's right will prevail.
Anyway, Biglari really seemed determined and serious about this.
Questions were asked about the opportunity cost of owning so much CBRL without making much headway in terms of getting board seats. He said that they are long term investors and they are concentrated investors. This is the way they work.
If you look back to what Biglari said in the beginning about the difference between turning $0.50 into $1.00 and $2.00, having it turn to $1.00 is not bad at all. So BH will presumably do well even if nothing happens on the proxy contest.
He reiterated the value that can be realized at CBRL if they can get store productivity back up to where it was when the founder ran it.
Biglari sent a letter to CBRL shareholders on the day of the annual meeting and he said that CBRL should be able to grow traffic by at least 3%/year and should be able to target 5%. Someone asked where that number came from. The answer was that after years of traffic declines, it shouldn't be too difficult to turn traffic around. He mentioned SNS. He mentioned that it was getting harder for SNS to grow traffic as they have been growing for many quarters in a row. But after declining for so long, Biglari insists that it won't take much to turn it around a modest amount.
Incentive Compensation
So someone stepped up to the microphone and asked Biglari about his compensation. He said that if Biglari cared about the shareholders, why not reduce his $900,000 salary and incentive compensation and use it to invest and enhance value for shareholders?
Biglari mentioned that the compensation was overwhelmingly approved by shareholders. He said that if he didn't like the compensation package, he shouldn't own BH stock. Biglari asked that if you invested in a hedge fund, would you ask the hedge fund manager to lower his management and incentive fees? (my comment: a lot of investors *are* actually asking hedge funds, private equity funds etc... to lower fees!).
But I understand Biglari's point.
At some point, Biglari said that this is an unintelligent question so he doesn't want to respond any more to it or some such thing (I'm pretty sure "unintelligent" was the word he actually used). Of course, Biglari is not known for, say, the folksy charm, wit and humor of Warren Buffett. I thought to myself, hmmm... I would not answer a shareholder question like that even if I did think it wasn't the best question (you know what he's gonna say).
Of course, it only took seconds for someone to notice the 'hypocrisy' of the comment "if you don't like it, don't own the stock". So someone jumped up and said, hey, that's not a stupid question and you can't tell people not to own the stock when BH also owns shares in CBRL and complains about compensation there. Why not just sell CBRL stock if you don't like it?
I knew this sort of question would come right when Biglari said "if you don't like it...".
But Biglari's response made sense too. This is different because you are looking at a compensation package at BH that is based on results. If BH doesn't succeed and make money for shareholders, it will cease to exist.
At CBRL, management is failing and trailing the industry on many measures. The complaint against CBRL is not so much the compensation but the (non) performance of the business.
So that is a fair distinction; he's not trying to get on the board of CBRL to cut compensation (even though that may be part of the plan), but to create value for shareholders by improving the operations of the business.
I agree with Biglari that this is a different thing altogether.
This is not to say that people shouldn't complain about what bothers them. They could bring it up and leave it up to other shareholders.
Other Things
Someone asked him what he's learned from other financiers taking over businesses and trying to run them. What has he learned from watching Eddie Lampert, for example? His answer was that he learned that retail is a hard business.
He went on to talk about how the restaurant business is full of horrible operators that make really bad decisions all the time. He made it sound like an easy business to do well for that reason.
He talked about Sam Walton and Walmart and about Henry Singleton/Teledyne and knew the important metrics of his management tenure (book value growth, sales, earnings or whatever it was... he just threw out a bunch of numbers off the top of his head).
Conclusion
It is clear that Biglari loves business and is deeply passionate about it. He is no fool. You can tell he is a voracious reader and knows what he is talking about. He seemed to answer questions well. I didn't have any problems with anything he said that I remember.
He doesn't have any of the charm that you see from a Buffett, of course. There aren't many of those. He does have this intensity about him, though, which give you the feeling that Biglari will be spectacularly successful or flop miserably. But my sense is that he won't flop miserably.
He does have an incredibly arrogant vibe about him. He is definitely not the warm and friendly type. But you know, that's OK. When I look at investments, I look for people who are passionate about succeeding, works hard and loves to do what they do; I'm not looking for friends. I really did get that sense from him after watching him for five hours. He is there for the money, of course. But it seems to me that he really loves it too (unlike many highly paid people I've known on Wall Street over the years).
I think this is an interesting situation. I understand many people don't like Biglari for many reasons but I think it would be a mistake to write him off. I think there is a bit more substance there than people seem to think.
But then again, I could be totally wrong! If I am, I apologize in advance.
Friday, February 10, 2012
Cracker Barrel / Biglari Holdings
To continue the story, Biglari Holdings (BH) bought 1.05 million more Cracker Barrel (CBRL) shares in January for $54 million.
So that sort of changes the composition of the balance sheet. At the end of December 2011, BH had cash and investments of:
Cash: $115 million
Investments: $119 million
So the above transactions changes that to:
Cash: $61 million
Investments: $173 million
So that's a pretty big position now in CBRL. In my last post, I thought BH is worth around $580 million as is, but may be worth $840 million as margins at the restaurant (SNS) improves. So either way you look at it, CBRL is a pretty big position for BH. (I ignore small changes in the stock price of CBRL for now).
Partly because of that, I spent some time at the SEC website reading through the filings at both companies; CBRL and BH. The back and forth during the proxy contest last year is very interesting with both sides making interesting points and both sides having good presentations.
Whatever you think of either side, it's really interesting and educational to see what each side has to say. All of this stuff is available at the SEC website for corporate filings, and the respective corporate investor relations websites. Biglari set up a website specifically for his CBRL proxy contest and it makes for very good reading.
It is accessible at the following website:
http://www.enhancecrackerbarrel.com/
You can read all of Biglari's points in his letter to CBRL shareholders. It is well written and easy to understand. Again, I don't worry too much about who is right or wrong. One learns from listening to both sides.
Unprofitable Capex
Anyway, one interesting point Biglari makes is that CBRL has spent a lot of money building new stores that increased revenues but hasn't really been profitable:
This is a very good point. This is similar to Ed Lampert's point about capex in the retail industry and really cut down on capex. In that case, so far, it doesn't look like it's working too well. But let's not let one or two situations influence our decision. I too tend to believe that corporations tend to spend money by 'inertia'. There are a lot of motives that drive companies to spend or to grow at the expense of profitability. (Some older blue chip firms obsessed with market share is a typical example).
Bad Traffic
CBRL has had some pretty horrible traffic trends in the past few years. Below is a table from Biglari's letter:
I don't think you can blame the economy for this as the economy was in a boom during 2005 - 2007. I too wonder about expanding stores when trends aren't favorable. Many retailers will keep opening stores even if it cannibalized their existing base if they think they can get more profit dollars from the market. But in CBRL's case, as is shown in the above table, this expansion in the face of declining traffic trends has not led to increased profits.
Store Profitability
We already know from the above that profits per store is down; sales are up and operating income is flat, so obviously profit per store is down.
Biglari makes the case that this downtrend began when Evins retired and the current CEO Woodhouse took over.
I think the basic story of CBRL, as Biglari states in the above cut-and-paste text from his letter, is that if CBRL can stop building new stores for the sake of building new stores and focus on store profitability, it can really increase shareholder value. Biglari says that if they can get per store profit back to the old levels, that would double the value of CBRL.
Anyway, here is a table of what happened to operating margins at McDonald's and Starbucks:
These are his big recent transactions; it seems that he has done well.
Conclusion
I am no expert on the restaurant industry, so I wouldn't be surprised if some restaurant industry veterans looked at CBRL and laughed at the notion that it can improve operations and make more money.
But *if* they can make some changes, especially cutting back on growing while they suffer declining traffic and other things (like MCD and SBUX did), they may be able to boost margins. If they do, this can certainly lead to a doubling or at least a higher stock price.
If that happened, from the above analysis, BH stock too can be worth as much as $700/share (CBRL doubles in price and SNS gets to 8.5% operating margin for the year, and then valuing that business at 16.5x p/e).
Again, this is if things go well at CBRL (and continues to go well at SNS). I think there is a reasonable chance that both go well, but many things can obviously go wrong. BH is not a Berkshire Hathaway or a Coca-Cola. It is a small, concentrated investment dependent on the actions of a single person. So many things can go wrong here.
This is something that I will watch closely with interest. Biglari continues to buy shares even as he lost the proxy contest, so it will be interesting how this plays out going forward. I do think the pressure is on, though, at CBRL and sometimes that's all that is needed to make some positive changes (it was encouraging that the shareholders voted down the poison pill, at least).
Stay tuned.
So that sort of changes the composition of the balance sheet. At the end of December 2011, BH had cash and investments of:
Cash: $115 million
Investments: $119 million
So the above transactions changes that to:
Cash: $61 million
Investments: $173 million
So that's a pretty big position now in CBRL. In my last post, I thought BH is worth around $580 million as is, but may be worth $840 million as margins at the restaurant (SNS) improves. So either way you look at it, CBRL is a pretty big position for BH. (I ignore small changes in the stock price of CBRL for now).
Partly because of that, I spent some time at the SEC website reading through the filings at both companies; CBRL and BH. The back and forth during the proxy contest last year is very interesting with both sides making interesting points and both sides having good presentations.
Whatever you think of either side, it's really interesting and educational to see what each side has to say. All of this stuff is available at the SEC website for corporate filings, and the respective corporate investor relations websites. Biglari set up a website specifically for his CBRL proxy contest and it makes for very good reading.
It is accessible at the following website:
http://www.enhancecrackerbarrel.com/
You can read all of Biglari's points in his letter to CBRL shareholders. It is well written and easy to understand. Again, I don't worry too much about who is right or wrong. One learns from listening to both sides.
Unprofitable Capex
Anyway, one interesting point Biglari makes is that CBRL has spent a lot of money building new stores that increased revenues but hasn't really been profitable:
This is a very good point. This is similar to Ed Lampert's point about capex in the retail industry and really cut down on capex. In that case, so far, it doesn't look like it's working too well. But let's not let one or two situations influence our decision. I too tend to believe that corporations tend to spend money by 'inertia'. There are a lot of motives that drive companies to spend or to grow at the expense of profitability. (Some older blue chip firms obsessed with market share is a typical example).
Bad Traffic
CBRL has had some pretty horrible traffic trends in the past few years. Below is a table from Biglari's letter:
I don't think you can blame the economy for this as the economy was in a boom during 2005 - 2007. I too wonder about expanding stores when trends aren't favorable. Many retailers will keep opening stores even if it cannibalized their existing base if they think they can get more profit dollars from the market. But in CBRL's case, as is shown in the above table, this expansion in the face of declining traffic trends has not led to increased profits.
Store Profitability
We already know from the above that profits per store is down; sales are up and operating income is flat, so obviously profit per store is down.
Biglari makes the case that this downtrend began when Evins retired and the current CEO Woodhouse took over.
I think the basic story of CBRL, as Biglari states in the above cut-and-paste text from his letter, is that if CBRL can stop building new stores for the sake of building new stores and focus on store profitability, it can really increase shareholder value. Biglari says that if they can get per store profit back to the old levels, that would double the value of CBRL.
Incentive plan
So why is CBRL so bent on building new stores and expanding? They have mentioned over the years that they target 1000 stores nationally. Maybe this is what it's about. They did have a goal of growing their store base by 5%/year but at some point they decided to slow that down. I think they are going to start picking up again (plan to spend $50 million this year on new stores).
Biglari mentions that the CEO got a bonus for achieving a hurdle of $90 million in operating profits in 2011, but points out that this hurdle is way too low as the company hasn't had operating profits below $90 million in years (see table below). There isn't any mention of margins or growth.
I also notice in the proxy that the long term incentive is based on "achieving long term revenue growth and profitability over performance period" (as well as stock price performance).
It doesn't say, "achieving long term revenue and profit growth", but revenue growth and profitability, which might explain why CBRL keeps spending money to open stores even when it doesn't contribute to earnings growth; as long as they are profitable, it doesn't matter. They need to grow revenues.
So on the issue of growing stores without growing profits, Biglari has a good point and the reason might have something to do with this long term incentive plan.
Operating Margins
OK, so let's get back to store profitability. I will actually just look at the overall operating margin of CBRL over the years. Below is the sales, operating income and operating margin of CBRL since 1994.
So you will notice that operating margins have been trending down starting with a big drop in 1999 (same store sales trend were down back then and they acquired Logan's Roadhouse in February 1999 which probably accounts for some of the margin drop too. They have since sold Logan's).
Between 1994 and 1998, CBRL seemed to earn operating margins of 10-14%. Biglari mentioned above the year 1998. Operating margin in that year was 12.52%. If CBRL can earn a 12.52% operating margin, that would be an EPS of:
$2.4 billion sales (in 2011) x 12.52% = $300 million in operating income, less $51 million interest expense (assuming same capital structure) for a pretax profit of $249 million. With a 27% tax rate that is net income of $182 million. With 22.9 million shares outstanding, that's an EPS of around $8.00/share.
From the previous analysis, we know that restaurant companies trade at around 16.5x p/e, so applying that we get a CBRL value of $132/share. That's 150% higher than the current price of around $53/share.
But wait a minute. How the heck does a company with sub 7% operating margins suddenly improve that to 12.5%? That might seem quite a stretch. The restaurant environment too is very different from what it was in the late 90s. Surely there is much more competition. Also, consumers are still pressed, unemployment high and food and energy inflation continue to put pressure on margins. So it would be unrealistic to expect such a huge increase in operating margins over a short period of time.
Let's do the same exercise at 10% operating margins. If CBRL achieves a 10% margin (which still might be aggressive), then the value of CBRL might rise to:
$2.4 billion sales x 10% = $240 million operating income, less $51 million interest expense = $189 million pretax income x (1 - 27% tax rate) = $138 million net divided by 22.9 million shares outstanding is $6/share. $6 per share x 16.5x typical restaurant p/e ratio is still $99/share. Pretty much a double. [ If the value of CBRL doubles, then the total value of BH can be up to $700/share (that includes the improvement in SNS too ]
For another sanity check, I jotted down some operating margin levels from some listed restaurant companies to see if 10-12% operating margins are reasonable or possible.
It's difficult to compare since the business models are so different. I tried to include companies that mostly owned their restaurants versus the franchise model like YUM brands or DIN (the old IHOP) which have drastically different models.
Anyway, just from looking at this, it seems that most restaurants have suffered declining margins over the years. Of course, higher costs and high unemployment has really been a negative factor in the sector. But looking at the table, it doesn't seem to me that 8-10% margins is impossible. Again, we are talking about a big change in direction so margins can change dramatically in that case (as opposed to the same management just making minor tweaks here and there).
Off the top of my head, I remember other recent situations where companies got used to growing for the sake of growing and lost sight of what was important. They stopped or slowed expansion to refocus their operations and boosted their margins.
The ones that come to mind are McDonald's and Starbucks. Both of them have grown for many, many years and came to a point where they decided growth wasn't adding value to shareholders, and that focusing on improving operations at their store base was the right thing to do. Walmart too, by the way, came to that conclusion recently although I don't see margin improvement there yet.
So McDonald's got stuck in the early 2000s, and decided to focus more on profitability instead of growth. Their margins went from the teens to over 30%. It's important to remember that MCD was facing a crowded market that was overly competitive ($1.00 menus etc...) and many thought that MCD has gone as far as it can go and that there wasn't much they can do. SBUX too was in a simliar situation. They had gone as far as they can go and saturated their stores (and markets with stores) with all kinds of products and there wasn't much more they can do to increase profits. SBUX too, has done well by refocusing, recently hitting operating margins that are far higher than in their best years between 2004 and 2007.
So rethinking strategy and reallocating capital *can* make drastic changes, even at companies where few people imagined anything can change much.
This is not to suggest that CBRL can make 30% operating margins or anything like that. MCD and SBUX are both drastically different businesses.
But what I think it's important to remember is that things *can* change and slowing or stopping expansion to improve operations *can* work to boost margins.
Of course, this doesn't mean it's easy.
I just wanted to point out that it can happen and work, even when the rest of the sector continues to suffer (MCD improves while Wendy's, Burger King etc.. continue to not do too well etc...).
Biglari's Track Record
This is a "by the way", but this was included in one of Biglari's letters to CBRL shareholders.
Conclusion
I am no expert on the restaurant industry, so I wouldn't be surprised if some restaurant industry veterans looked at CBRL and laughed at the notion that it can improve operations and make more money.
But *if* they can make some changes, especially cutting back on growing while they suffer declining traffic and other things (like MCD and SBUX did), they may be able to boost margins. If they do, this can certainly lead to a doubling or at least a higher stock price.
If that happened, from the above analysis, BH stock too can be worth as much as $700/share (CBRL doubles in price and SNS gets to 8.5% operating margin for the year, and then valuing that business at 16.5x p/e).
Again, this is if things go well at CBRL (and continues to go well at SNS). I think there is a reasonable chance that both go well, but many things can obviously go wrong. BH is not a Berkshire Hathaway or a Coca-Cola. It is a small, concentrated investment dependent on the actions of a single person. So many things can go wrong here.
This is something that I will watch closely with interest. Biglari continues to buy shares even as he lost the proxy contest, so it will be interesting how this plays out going forward. I do think the pressure is on, though, at CBRL and sometimes that's all that is needed to make some positive changes (it was encouraging that the shareholders voted down the poison pill, at least).
Stay tuned.
Wednesday, February 8, 2012
Biglari Holdings: Real Deal or Phony?
Biglari Holdings (BH) is a Berkshire Hathaway like investment vehicle run by a young manager named Sardar Biglari. Actually, BH is what was Steak 'n Shake (SNS), a hamburger restaurant chain that Biglari's hedge fund owned. After a bunch of transactions which merged the hedge funds with Steak and Shake and another restaurant chain, Western Sizzlin, SNS was renamed BH (like the intials of Berkshire Hathaway).
Anyway, the details of these transactions are well documented so I won't repeat them here.
This is certainly an interesting situation as Biglari is going in the direction of Berkshire Hathaway in that he wants to run this business taking the cash generated by the restaurant business and invest it wherever he sees fit. Of course, this rubs some people the wrong way, but I don't think it's a bad idea at all.
Controversial
So anyway, Biglari has been talked about on the internet largely due to his similarity to Berkshire Hathaway. Of course, this has caused a lot of the coverage to be negative. His renaming of Steak and Shake to Biglari Holdings was seen as egotistical. His annual reports, website and letter to shareholders have the same sort of look and feel as Berkshire Hathaway's etc...
Other actions that have been criticized are:
Sure, some of this stuff is a little irksome, but I actually don't see anything 'wrong' with it. Emulating Buffett and Berkshire is actually a good idea, I think. Some feel that he is only emulating the look and feel to deceive investors into thinking he is the next Buffett. Well, that may be so, but I tend to think the Berkshire fans are overreacting a little bit and feel offended that some young kid is copping stuff from their hero.
That's OK with me. Leucadia's website looks just like Berkshire Hathaway's too.
As for the 'egregious' compensation, I think it might have been a bit tone-deaf to shoot for a hedge fund-like compensation structure but I don't see too much a problem with it as long as he performs. There is a hurdle rate of 6%, so the book value has to increase 6% before he gets paid. Plus the bonus is capped at $10 million.
This pay is probably high for a business of this size, but again, if he does well I think it should be fine. But then again, I am OK with the compensation at banks and investment banks which are way more ridiculous so I know my view won't be shared by most and that's OK.
There are some other issues out there with respect to past transactions, but I think that's more about upsetting some people but not anything illegal.
Anyway, so there is a lot to be critical about with BH and there are plenty of negative comments on the internet.
But as I read them, for the most part, I see problems more with people just not liking Biglari and some of his methods. But I don't see anything really glaring that is a big problem. I actually think he is honestly trying to do well.
So setting aside all of these distractions, let's see how he is doing in the business.
Steak 'n Shake
So let's get down to business.
This is the trend in customer traffic in same-store sales at Steak & Shake from the 2009 BH annual report:
So when Biglari took over management of SNS, the fundamentals were horrible. Customer traffic was down consistently as were same store sales. You can't blame the economy for this horrible performance since the figures seem horrible from late 2005 (2006-2007 were boom years).
The bold figures show how SNS has done since Biglari took over. There is a huge change.
And here is the same from the 2011 BH annual report that includes the figures for 2011:
So there is a very noticable improvement. We know that Biglari has made a big positive change at SNS.
They just opened a new store concept on Broadway in NYC in January, which is called the Steak 'n Shake Signature, which is more like a fast food joint with counter service only and few tables. The yelp reviews are mixed (as they always seem to be) but I've heard recenty from people outside NYC that they do like the Steak and Shake stores.
Yes, the burger market is crowded with everyone from McDonald's to the new age Five Guys, Shake Shack, In-and-Out and many others.
BH is going to manage the restaurants for their cash flows so will continue to invest as long as they can do so with good returns. Otherwise, they will allocate capital to other areas.
I tend to like these kinds of models (LUK, L, MKL, BRK etc...).
So What is BH Worth?
So that's the real question. I'm not really that interested in a hamburger joint, but am interested in what Biglari can do with it and where BH will invest capital in the future. Right now, the next largest piece of BH is Cracker Barrel (CKBL), which BH owns 15% of and is trying to activist the stock back to health. Maybe the CKBL drama will be another post for another day.
I do certainly agree with the likes of Biglari that a lot of businesses tend to get stuck in old ways of doing business even if it is no longer the right way to go. So I am not at all opposed or bothered with Biglari's activism (so far from what I've seen).
I think this is another thing that bothers BRK fans; Buffett is a passive investor and doesn't rock the boat (or at least he doesn't do that anymore... or he doens't do it publicly).
Anyway, looking at BH was a bit confusing. First of all, I was disappointed when I searched around for a valuation of BH that most people just took the published financials and used them without any adjustments; people used the GAAP book-value per share, earnings and cash flows and just slapped on the usual multiples and made judgements based on that.
However, BH is a strange animal and the GAAP figures can be very misleading.
For example, BH owns shares in a hedge fund that Biglari runs, but GAAP requires full consolidation of the partnership units even when a large part of it is owned by hedge fund investors and not BH. That's fine. This is an issue with private equity funds too and investment banks that have to consolidate holdings held in their private equity businesses.
But what makes it confusing for BH is that the hedge fund (The Lion Fund) owns a large stake in BH. So BH owns a part of the Lion Fund, which owns a big stake in BH. This is all consolidated, but since the Lion Fund owns shares in BH, the shares of BH held in the hedge fund are deducted from shareholders' equity as treasury shares (because by consolidating the hedge fund, they own shares in themselves).
This is all well and fine, but the problem is that the BH shares that the hedge fund owns is still outstanding as outside investors own a majority of the hedge fund.
The correct way to net out this BH holding in BH is to deduct from shareholders equity only the portion that is actually owned by BH, not the entire BH position owned by the hedge fund.
Confusing?
And since the BH shares are deducted from shareholders equity and is accounted for as treasury shares, they don't appear on the asset side of the balance sheet.
OK. So don't worry about that too much. I *think* I have it figured out. I may be wrong. But let's go on.
What's the Restaurant Business Worth?
In the year-ended September 2011, the restaurant business looked like this:
Revenues: $705 million
Operating earnings: $42 million
Net earnings: $30 million
Depreciation and Amortization: $28 million
Capex: $11 million
Identifiable assets: $414 million
Goodwill: $26.5 million
SNS did a dividend recap; they issued long term debt and paid a cash dividend to the parent company.
As far as I can tell, this debt, $112 million is owed by SNS but the interest expense doesn't seem to be included in the restaurant business segment breakdown above. Segment operating income typically excludes interest on debt and the difference between operating earnings and net earnings in the above figures suggest that the interest on this debt goes below these lines.
So when valuing the restaurant business, we will just have to deduct the debt from the equity valuation.
What is a restaurant company worth these days?
Here is a quick table for restaurants and valuations:
ttm ttm Operating
P/E EV/EBITDA margin
McDonald's 19x 11.7x 30.7%
Darden Restaurants 15.2x 8.4x 9.1%
Yum Brands 25.5x 12.5x 15.9%
Brinker International 16.5x 7.7x 8.2%
Bob Evans Farms 17.6x 6.2x 6.7%
Cracker Barrel 14.9x 7.7x 6.9%
Ruby Tuesday 16.9x 6.9x 4.2%
Red Robin Gourmet 18x* 6.8x
*Red Robin has been having problems so 18x is based on what they earned in the past.
So it looks like anywhere between 15-20x is normal for a restaurant business. California Pizza Kitchen was taken private last year and their merger proxy had valuations for restaurants too, and out of their universe, the median p/e ratio was 16.5x p/e and EV/EBITDA ranged from 6-8x depending on the universe.
So let's say 16.0x p/e and 7x EV/EBITDA is fair for SNS. That does not seem unreasonable at all given that even Red Robin is trading at 18x what they used to earn in good times and 7x last twelve months' EBITDA.
SNS earned $30 million in net last year, so 16x that is $480 million (I say SNS, but actually I mean the restaurant business; this includes Western Sizzlin, most of the restaurant business is SNS). With $112 million of debt, that leaves an equity value of around $368 million. Using a 7x EV/EBITDA figure, we get $70 million in EBITDA x 7x = $490 million less $112 million in debt gives us a $378 million value; very close to our p/e valuation.
So the first part of the valuation is the restaurnant business:
Restaurant business value: $368 million (use 16x p/e value)
So what else is there? We know that BH owns shares in the hedge fund. But a lot of that is invested in BH, let's not even include the non-BH assets owned by BH.
Then there are two big pieces left. One is cash. and the other is investments:
Cash at September 2011: $99 million
Investments: $115 million
It's important to remember that the "investments" don't include anything owned in the hedge fund, as those are in "Investments held by consolidated affiliated partnerships".
So the total valuation is the sum of the above three (in simple terms): $368 mn + $99 mn + $115 mn = $582 million
The total value of BH is $582 million.
How many shares do they have outstanding? They have 1.5 million shares outstanding, but deducting as treasury shares the amount BH actually owns through the hedge fund give us 1.43 million shares outstanding.
It's important to keep in mind that on the balance sheet, the number of shares outstanding shows 1.2 million shares outstanding after deducting 284,000 shares in treasury stock which is wrong. This deducts the entire amount of BH shares owned in the consolidated hedge fund of which BH only owns a portion of.
So the total valuation is $407/share.
Keep in mind this is a simplified analysis. BH owns a part of the hedge fund and there are assets other than BH in them. BH also earns a management fee and incentive fees on the hedge fund. I left all of this out and other smaller items as the above three, I think, look at the big value determinants of BH.
So with BH trading at $411/share, it looks about fairly valued using balance sheet data as of September 2011.
However, let's take it one more step as BH did announce earnings for the 12/2011 quarter. We can update the above figures and come up with a more up-to-date value for BH.
Updated Value of BH
First of all, as of the end of December 2011, cash and investments have moved up to $234 million.
The restaurant business is interesting, though. In 2011, the operating margin for the restaurant business was around 6%, but in the December 2011 quarter, operating margins went up to 8.5%. This makes sense as they continue to improve operations there.
If we assume, perhaps conservatively, that SNS grows sales 5% in the year to September 2012 (year-over-year sales in the December quarter was around +5%) and they achieve an operating margin for the year of 8.5%, they would get a nice boost in operating income.
This might be conservative as they just launched the new model store, Steak 'n Shake Signature.
Anyway, so 5% growth from $705 million is $740 million. And an 8.5% margin would give us operating earnings of $62.9 million. Using the same tax rate as last year, net income would be around $45 million.
Going back to the above model of 16x p/e for the restaurant business which is not aggressive at all, I don't think, that's a value of $720 million. Deduct the $112 million and you get $608 million equity value for the restaurant business.
So, with the current $234 million cash and investments on the balance sheet, and $608 million equity valuation on what the restaurant business can do this year, that's a total valuation of $842 million.
With 1.43 million shares outstanding, that's a value of $590/share, or 40% above current levels.
Is 8.5% operating margin achievable? Biglari has said during 2011 that their earnings are subdued due to investments made for the future implying that the 6% operating margin for last year was not going to be normal.
Judging from how restaurants typically do, 8.5% operating margin does not at all look like a stretch. Also, their new, smaller concept (Signature) and their moving forward on expanding franchising should be good for margins.
(When Chipotle started rolling out their A-model stores, their margins seemed to explode; they were able to make smaller stores for cheaper, but generate simliar amount of traffic as their larger restaurants, which was good for operating margins and returns on capital. Something simliar may happen with Steak and Shake if they can succeed in the Signature rollout. Also, franchise businesses tend to have higher margins and returns on capital for obvious reasons if done right).
Conclusion
So that's just a quick look at BH and I do find it interesting. If they meet even modest goals I laid out above, this stock can easily move up to $500-600 range.
I have to say that this is a quick first look so I may be missing something. I think the overall look is correct but as I follow this going forward, I may have to make some corrections.
Interestingly, this doesn't even take into account anything else that might happen there, including what happens with the $100+ plus cash on the balance sheet (I assume the restaurant debt will be paid back over time out of restaurant cash flows, so this current cash is deployable).
Also, further progress in the CBRL drama can give a boost too as it is a large holding in BH. Of course, Biglari failed in his bid to get a board seat, but these things never end just like that. The pressure is on at CBRL and sometimes that's all it takes to get operational improvements and other changes. We'll see about that.
I understand that there is a lot of criticism against Biglari and there are things that bother me too. But as long as he isn't doing something outright wrong, illegal or unethical, I don't really have a problem. Aggressive tactics is all part of business.
We shall see how this turns out. Of course, like anything else, there is a lot that can go wrong here, so do your own homework!
Anyway, the details of these transactions are well documented so I won't repeat them here.
This is certainly an interesting situation as Biglari is going in the direction of Berkshire Hathaway in that he wants to run this business taking the cash generated by the restaurant business and invest it wherever he sees fit. Of course, this rubs some people the wrong way, but I don't think it's a bad idea at all.
Controversial
So anyway, Biglari has been talked about on the internet largely due to his similarity to Berkshire Hathaway. Of course, this has caused a lot of the coverage to be negative. His renaming of Steak and Shake to Biglari Holdings was seen as egotistical. His annual reports, website and letter to shareholders have the same sort of look and feel as Berkshire Hathaway's etc...
Other actions that have been criticized are:
- Did a 1/20 reverse split to get the stock price up into the hundreds (wanted a high price like BRK?)
- Attempted another 1/15 reverse split to get stock price up from $400 to $7000 to artificially create a high stock price, (wanted a higher price just like Berkshire Hathaway?)
- Proposing the issuance of Class B shares with 1/10 the economic value and 1/100th the voting power (just like Berkshire Hathaway's B-shares). (why go to the trouble of reverse splitting and then issuing low priced B-share?)
- High compensation: $900,000/year salary (versus $150,000 or so for Buffett) plus an incentive bonus plan very hedge-fund-like; 25% of the increase in book value over a 6% hurdle rate (this is capped, however, at $10 million)
- Put a photo of himself in every SNS store (egotistical!?)
- Drives fast cars
Sure, some of this stuff is a little irksome, but I actually don't see anything 'wrong' with it. Emulating Buffett and Berkshire is actually a good idea, I think. Some feel that he is only emulating the look and feel to deceive investors into thinking he is the next Buffett. Well, that may be so, but I tend to think the Berkshire fans are overreacting a little bit and feel offended that some young kid is copping stuff from their hero.
That's OK with me. Leucadia's website looks just like Berkshire Hathaway's too.
As for the 'egregious' compensation, I think it might have been a bit tone-deaf to shoot for a hedge fund-like compensation structure but I don't see too much a problem with it as long as he performs. There is a hurdle rate of 6%, so the book value has to increase 6% before he gets paid. Plus the bonus is capped at $10 million.
This pay is probably high for a business of this size, but again, if he does well I think it should be fine. But then again, I am OK with the compensation at banks and investment banks which are way more ridiculous so I know my view won't be shared by most and that's OK.
There are some other issues out there with respect to past transactions, but I think that's more about upsetting some people but not anything illegal.
Anyway, so there is a lot to be critical about with BH and there are plenty of negative comments on the internet.
But as I read them, for the most part, I see problems more with people just not liking Biglari and some of his methods. But I don't see anything really glaring that is a big problem. I actually think he is honestly trying to do well.
So setting aside all of these distractions, let's see how he is doing in the business.
Steak 'n Shake
So let's get down to business.
This is the trend in customer traffic in same-store sales at Steak & Shake from the 2009 BH annual report:
So when Biglari took over management of SNS, the fundamentals were horrible. Customer traffic was down consistently as were same store sales. You can't blame the economy for this horrible performance since the figures seem horrible from late 2005 (2006-2007 were boom years).
The bold figures show how SNS has done since Biglari took over. There is a huge change.
And here is the same from the 2011 BH annual report that includes the figures for 2011:
So there is a very noticable improvement. We know that Biglari has made a big positive change at SNS.
They just opened a new store concept on Broadway in NYC in January, which is called the Steak 'n Shake Signature, which is more like a fast food joint with counter service only and few tables. The yelp reviews are mixed (as they always seem to be) but I've heard recenty from people outside NYC that they do like the Steak and Shake stores.
Yes, the burger market is crowded with everyone from McDonald's to the new age Five Guys, Shake Shack, In-and-Out and many others.
BH is going to manage the restaurants for their cash flows so will continue to invest as long as they can do so with good returns. Otherwise, they will allocate capital to other areas.
I tend to like these kinds of models (LUK, L, MKL, BRK etc...).
So What is BH Worth?
So that's the real question. I'm not really that interested in a hamburger joint, but am interested in what Biglari can do with it and where BH will invest capital in the future. Right now, the next largest piece of BH is Cracker Barrel (CKBL), which BH owns 15% of and is trying to activist the stock back to health. Maybe the CKBL drama will be another post for another day.
I do certainly agree with the likes of Biglari that a lot of businesses tend to get stuck in old ways of doing business even if it is no longer the right way to go. So I am not at all opposed or bothered with Biglari's activism (so far from what I've seen).
I think this is another thing that bothers BRK fans; Buffett is a passive investor and doesn't rock the boat (or at least he doesn't do that anymore... or he doens't do it publicly).
Anyway, looking at BH was a bit confusing. First of all, I was disappointed when I searched around for a valuation of BH that most people just took the published financials and used them without any adjustments; people used the GAAP book-value per share, earnings and cash flows and just slapped on the usual multiples and made judgements based on that.
However, BH is a strange animal and the GAAP figures can be very misleading.
For example, BH owns shares in a hedge fund that Biglari runs, but GAAP requires full consolidation of the partnership units even when a large part of it is owned by hedge fund investors and not BH. That's fine. This is an issue with private equity funds too and investment banks that have to consolidate holdings held in their private equity businesses.
But what makes it confusing for BH is that the hedge fund (The Lion Fund) owns a large stake in BH. So BH owns a part of the Lion Fund, which owns a big stake in BH. This is all consolidated, but since the Lion Fund owns shares in BH, the shares of BH held in the hedge fund are deducted from shareholders' equity as treasury shares (because by consolidating the hedge fund, they own shares in themselves).
This is all well and fine, but the problem is that the BH shares that the hedge fund owns is still outstanding as outside investors own a majority of the hedge fund.
The correct way to net out this BH holding in BH is to deduct from shareholders equity only the portion that is actually owned by BH, not the entire BH position owned by the hedge fund.
Confusing?
And since the BH shares are deducted from shareholders equity and is accounted for as treasury shares, they don't appear on the asset side of the balance sheet.
OK. So don't worry about that too much. I *think* I have it figured out. I may be wrong. But let's go on.
What's the Restaurant Business Worth?
In the year-ended September 2011, the restaurant business looked like this:
Revenues: $705 million
Operating earnings: $42 million
Net earnings: $30 million
Depreciation and Amortization: $28 million
Capex: $11 million
Identifiable assets: $414 million
Goodwill: $26.5 million
SNS did a dividend recap; they issued long term debt and paid a cash dividend to the parent company.
As far as I can tell, this debt, $112 million is owed by SNS but the interest expense doesn't seem to be included in the restaurant business segment breakdown above. Segment operating income typically excludes interest on debt and the difference between operating earnings and net earnings in the above figures suggest that the interest on this debt goes below these lines.
So when valuing the restaurant business, we will just have to deduct the debt from the equity valuation.
What is a restaurant company worth these days?
Here is a quick table for restaurants and valuations:
ttm ttm Operating
P/E EV/EBITDA margin
McDonald's 19x 11.7x 30.7%
Darden Restaurants 15.2x 8.4x 9.1%
Yum Brands 25.5x 12.5x 15.9%
Brinker International 16.5x 7.7x 8.2%
Bob Evans Farms 17.6x 6.2x 6.7%
Cracker Barrel 14.9x 7.7x 6.9%
Ruby Tuesday 16.9x 6.9x 4.2%
Red Robin Gourmet 18x* 6.8x
*Red Robin has been having problems so 18x is based on what they earned in the past.
So it looks like anywhere between 15-20x is normal for a restaurant business. California Pizza Kitchen was taken private last year and their merger proxy had valuations for restaurants too, and out of their universe, the median p/e ratio was 16.5x p/e and EV/EBITDA ranged from 6-8x depending on the universe.
So let's say 16.0x p/e and 7x EV/EBITDA is fair for SNS. That does not seem unreasonable at all given that even Red Robin is trading at 18x what they used to earn in good times and 7x last twelve months' EBITDA.
SNS earned $30 million in net last year, so 16x that is $480 million (I say SNS, but actually I mean the restaurant business; this includes Western Sizzlin, most of the restaurant business is SNS). With $112 million of debt, that leaves an equity value of around $368 million. Using a 7x EV/EBITDA figure, we get $70 million in EBITDA x 7x = $490 million less $112 million in debt gives us a $378 million value; very close to our p/e valuation.
So the first part of the valuation is the restaurnant business:
Restaurant business value: $368 million (use 16x p/e value)
So what else is there? We know that BH owns shares in the hedge fund. But a lot of that is invested in BH, let's not even include the non-BH assets owned by BH.
Then there are two big pieces left. One is cash. and the other is investments:
Cash at September 2011: $99 million
Investments: $115 million
It's important to remember that the "investments" don't include anything owned in the hedge fund, as those are in "Investments held by consolidated affiliated partnerships".
So the total valuation is the sum of the above three (in simple terms): $368 mn + $99 mn + $115 mn = $582 million
The total value of BH is $582 million.
How many shares do they have outstanding? They have 1.5 million shares outstanding, but deducting as treasury shares the amount BH actually owns through the hedge fund give us 1.43 million shares outstanding.
It's important to keep in mind that on the balance sheet, the number of shares outstanding shows 1.2 million shares outstanding after deducting 284,000 shares in treasury stock which is wrong. This deducts the entire amount of BH shares owned in the consolidated hedge fund of which BH only owns a portion of.
So the total valuation is $407/share.
Keep in mind this is a simplified analysis. BH owns a part of the hedge fund and there are assets other than BH in them. BH also earns a management fee and incentive fees on the hedge fund. I left all of this out and other smaller items as the above three, I think, look at the big value determinants of BH.
So with BH trading at $411/share, it looks about fairly valued using balance sheet data as of September 2011.
However, let's take it one more step as BH did announce earnings for the 12/2011 quarter. We can update the above figures and come up with a more up-to-date value for BH.
Updated Value of BH
First of all, as of the end of December 2011, cash and investments have moved up to $234 million.
The restaurant business is interesting, though. In 2011, the operating margin for the restaurant business was around 6%, but in the December 2011 quarter, operating margins went up to 8.5%. This makes sense as they continue to improve operations there.
If we assume, perhaps conservatively, that SNS grows sales 5% in the year to September 2012 (year-over-year sales in the December quarter was around +5%) and they achieve an operating margin for the year of 8.5%, they would get a nice boost in operating income.
This might be conservative as they just launched the new model store, Steak 'n Shake Signature.
Anyway, so 5% growth from $705 million is $740 million. And an 8.5% margin would give us operating earnings of $62.9 million. Using the same tax rate as last year, net income would be around $45 million.
Going back to the above model of 16x p/e for the restaurant business which is not aggressive at all, I don't think, that's a value of $720 million. Deduct the $112 million and you get $608 million equity value for the restaurant business.
So, with the current $234 million cash and investments on the balance sheet, and $608 million equity valuation on what the restaurant business can do this year, that's a total valuation of $842 million.
With 1.43 million shares outstanding, that's a value of $590/share, or 40% above current levels.
Is 8.5% operating margin achievable? Biglari has said during 2011 that their earnings are subdued due to investments made for the future implying that the 6% operating margin for last year was not going to be normal.
Judging from how restaurants typically do, 8.5% operating margin does not at all look like a stretch. Also, their new, smaller concept (Signature) and their moving forward on expanding franchising should be good for margins.
(When Chipotle started rolling out their A-model stores, their margins seemed to explode; they were able to make smaller stores for cheaper, but generate simliar amount of traffic as their larger restaurants, which was good for operating margins and returns on capital. Something simliar may happen with Steak and Shake if they can succeed in the Signature rollout. Also, franchise businesses tend to have higher margins and returns on capital for obvious reasons if done right).
Conclusion
So that's just a quick look at BH and I do find it interesting. If they meet even modest goals I laid out above, this stock can easily move up to $500-600 range.
I have to say that this is a quick first look so I may be missing something. I think the overall look is correct but as I follow this going forward, I may have to make some corrections.
Interestingly, this doesn't even take into account anything else that might happen there, including what happens with the $100+ plus cash on the balance sheet (I assume the restaurant debt will be paid back over time out of restaurant cash flows, so this current cash is deployable).
Also, further progress in the CBRL drama can give a boost too as it is a large holding in BH. Of course, Biglari failed in his bid to get a board seat, but these things never end just like that. The pressure is on at CBRL and sometimes that's all it takes to get operational improvements and other changes. We'll see about that.
I understand that there is a lot of criticism against Biglari and there are things that bother me too. But as long as he isn't doing something outright wrong, illegal or unethical, I don't really have a problem. Aggressive tactics is all part of business.
We shall see how this turns out. Of course, like anything else, there is a lot that can go wrong here, so do your own homework!
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