Special Situation: Steak N Shake, Landslide Victory!
One of my smaller investments is in a special situation at Steak N Shake. Steak N Shake (SNS) is a struggling casual dining chain which specializes in steakburgers. Through corporate change, I felt that the company could engage in a number of value creating opportunities, such as a sale leaseback transaction, or the refranchising of company owned restaurants. Both of these seemed to indicate a 55% upside to my initial investment ($11 per share).
With the company now trading at about $8 per share there seems to be quite a bit of fear. One of the walls that stood in the way of the company’s value was their stubborn and entrenched management. Part of my investment was my faith in Sardar Biglari of Western Sizzlin and The Lion Fund to enact change. Biglari has a keen insight on what to do with struggling casual dining chains, and so far has been quite effective with the takeover of Western Sizzlin and an investment in Friendly’s (a company taken private by Sun Capital).
During the proxy fight with Steak N Shake, Biglari mentioned Friendly’s often as an indicator of his prior success. Interestingly enough, a few days ago I ran across some new developments at Friendly’s in the Wall Street Journal:
To drive earnings growth, Sun obsesses over costs. One trick is pooling Sun-owned companies’ purchasing power for everything from health-care benefits to food. Friendly’s management has slashed about $1.6 million in expenses, including $50,000 for office supplies and $40,000 for UPS freight costs. Now, it’s looking to offset record commodity prices by gaining buying leverage on dairy and poultry. “One of the bigger opportunities could be in cheese,” says a delighted George Condos, Friendly’s CEO.
Some of these ideas seem really obvious and could probably also be implemented at Steak N Shake, especially considering the company’s steady rise in expenditures. In the last ten years, Steak N Shake has spent $566 million in capital with nothing to show for it except a decline in operating profits and negative shareholder returns. In 1998 the company’s stock price traded as high a $18.75 but now is at a mere $8.00, an almost 60% decline.
It is not as if the current entrenched management seemed open to pursuing opportunities for value, they instead focused on the wasteful implementation of grilled chicken sandwiches which costed an average of $30,000 per restaurant with nothing to show for it. In one of their recent conference calls they spent much of their time discussing the speed of their milkshake machines instead of addressing some of the problems like rising costs and same store sale declines.
But with the recent election results, that all might change:
Nominee Votes For Votes Withheld
Sardar Biglari 15,645,868 42,360
Philip L. Cooley 15,645,574 42,654
James Williamson 5,452,242 1,541,030
Alan B. Gilman 5,447,374 1,545,898
Clearly, Biglari and his former college professor Philip L. Cooley won by a landslide. However, Ted Evanoff of the Indianapolis Star makes a slight error
Although the two dissidents joined the board, they received fewer votes than any re-elected incumbent and trailed Risk by a wide margin. Risk, 79, has been a company director since 1971. Shareholders representing 17.9 million shares of stock voted for Risk, while 15.6 million shares each were voted in favor of Biglari and Cooley.
This insinuates that Bilgari and Cooley were competing against Risk, when that was not the case. Looking at the text on my gold proxy card, it is explicitly written that:
The Committtee intends to use this proxy to vote (i) “FOR” Mesrs. Biglari and Cooley and (ii) “FOR” the candidates who have been nominated by the Company to serve as directors other than Alan b. Gilman and James Williamson, Jr.
It seems clear that while Risk may have received a large number of votes, it is irrelevant. The sole intention of Biglari and Cooley was to replace Gilman and Williamson, Jr., not J. Fred Risk.
With any luck, Biglari will be able to execute some opportunities for shareholder value. I think one of the best ways would be a major franchising initiative, so that management can extricate themselves from having to operate restaurants, and focus more on strategy. In 2005 Alan Gilman asserted that he would accelerate the company’s franchising initiative, but it is painfully clear that today SNS has the same amount of franchises as it did in 2001. In addition, Steak N Shake seems to have a distorted approach to franchising, franchises make up only about 10% of the company’s restaurants, this is almost the opposite of a number of other franchise chains which adopt an approach of 80% franchises, 20% company owned.
In the Wall Street Journal article, one thing that stood out to me was Sun Capital’s views on maximizing the value of real estate:
“Now don’t get me wrong, casual dining is in the dumps and we’ve got our hands full,” Mr. Leder says of Smokey Bones. “But I’ll take a $220 million-revenue chain of restaurants for free all day long.”
Now, at current levels, SNS is not trading at levels which are equal to the potential cash that would be reaped from a sale-leaseback transaction (roughly $5.43 per share) but if you add the cash from a potential refranchising, you would come out to an extra $11.47 per share. Some critics say that SNS has had a decline in same store sales, which would make the franchises unattractive, but Applebees also reported declines in same store sales and successfully refranchised a number of locations. As a whole, this exceeds what the market perceives Steak N Shake’s value to be, making it an attractive bargain.
Other activities could be share repurchases – Biglari details how the $20 million spent to create 9 new restaurants could be better used at repurchasing shares. He also seems intent on making management act more like owners of the company by altering the compensation arrangement to adequately pay based on performance.
With most of Western Sizzlin’s investment capital tied up in Steak N Shake, Biglari seems extremely committed to making changes which will enhance value for shareholders and I believe the market’s current sentiments are of no indication of the true value of this business. The ultimate factor in a special situation is the time required for it to take place, with the bylaws change it will require 80% of the company’s stockholders to call a special meeting and replace the rest of the board. This means that we will either have to wait another year for some major changes to occur, or, Biglari will diplomatically persuade management to change their course with his new board seats. With large institutional investors such as MSD Capital and HBK Investments, I think they will have to start listening and change their course.
