Street Capitalist: Event Driven Value Investments

Looks like the management at Steak N Shake (SNS) have taken a step in the right direction:

NDIANAPOLIS, June 19 /PRNewswire-FirstCall/ — The Steak n Shake Company (NYSE: SNS - News) today announced that its current board member, Sardar Biglari, has been appointed Chairman of the Board of Directors, replacing interim Chairman Wayne L. Kelley. Mr. Kelley will remain on the Board of Directors and will retain his position as Interim Chief Executive Officer until the Company concludes its search for a permanent Chief Executive Officer.

The Steak n Shake Company Announces Appointment of New Chairman of the Board

Naming Sardar Biglari as chairman of the board of directors is a good start. He should be able to command more influence with how the company is run and this is a sign that management is being more proactive to the ideas of shareholders.

Since the announcement in February, investors have been looking forward to Carl Ichan’s blog The Icahn Report. Finally, after being bogged down by antsy lawyers, the blog is live. From the initial posts on the blog, it looks like Icahn will focus on critiquing the poor corporate governance of today’s companies.

Icahn is an investor we can learn from, many of the situations he involves him in are inherently event driven, where he focuses on pushing management towards value creating initiatives like spin-offs and breakups, see: Temple Inland (TIN).

Here is what Icahn has to say about poor corporate boards:

When you rid a company of a fruitless board, the rewards are often enormous because the underlying company and its employees can be excellent. It is the top level management that hangs like an albatross around the company’s neck. Years from now historians will marvel why we the shareholders – the legitimate owners of companies – did not do something effective about removing terrible managements. We can do something about the current situation. I will discuss in future entries how simple it can be and what has constrained us from taking action.

Corporate Democracy is a Myth (Icahn Report)

One of my own holdings, Steak N Shake (SNS) is currently held hostage by the kinds of machinations perpetrated by poor corporate boards that Icahn describes. At Steak N Shake, management enacted a change in the bylaws to require an 80% vote of the shareholders in order to call a special meeting (before it was only 25%). The result of this is a board that is difficult to change and the promotion of a corporate culture based on excess and value destruction.

While I doubt that a blog will be able to do much in terms of changing corporate governance, maybe it can stimulate some discussion of governance with the public and nudge management towards being more proactive to their shareholders.

At the Wall Street Journal Deal Journal, a recent post featured William Ackman of Pershing Square Capital and his strategies for short investors. One key idea that I took away was:

Find a theme and export it: Ackman says he invested in Sears and Sears Canada because the retailing companies financed their credit-card receivables on its own balance sheet, which wasn’t well-understood by the markets. He used the same kind of thinking to tackle Target, which he believed was strong company with a solid debt profile and also one of the only retailers to still finance its credit cards in-house.In the case of Sears, Ackman evaluated it as its component parts, including Sears Hardware, Home Services, Sears Canada, Land’s End and Sears Mexico, all of that is before you get to the company’s extensive real estate value. “The only thing wrong is the stock price,” he said, a line that drew laughs, because Ackman acknowledged later, it bore a similarity to the old joke about “other than that, how was the show, Mrs. Lincoln.”

Bill Ackman Part II: Eight Easy Steps to Becoming a Short-Seller (WSJ)

I’ve noticed a few themes playing out so far this year: railroads, real estate rich fast food chains, shorting bond insurers, shorting investment banks/mortgage companies, brazilian banks, and so on.

Today, Bloomberg announces Ackman’s new short.

Hedge fund manager Bill Ackman, who correctly predicted shares of MBIA Inc. and Ambac Financial Group Inc. would tumble, said he now is betting against Financial Security Assurance Holdings Ltd.

Financial Security may be insolvent because it sold investment contracts backed by mortgage securities that have tumbled in value, Ackman, 42, told a conference hosted by law firm Jones Day yesterday in New York. Financial Security, a New York unit of Brussels and Paris-based Dexia SA is one of two bond insurers to retain their AAA credit ratings after rivals were roiled by losses from collateralized debt obligations.

“The market has not woken up to FSA,” said Ackman, who runs the $6 billion Pershing Square Capital Management hedge fund. Ackman says he will make hundreds of millions of dollars if MBIA and Ambac go bankrupt. “FSA is AAA stable, just don’t look too close.”

We’ve already seen Ackman’s thorough due-diligence employed in his analysis of MBIA (MBI). This could be another fine short opportunity, especially if you’re betting that the credit markers will continue to deteriorate.

The Wall Street Journal has a good article on Eddie Lampert that talks about him betting on a rebound in housing.

ESL acquired small stakes in U.S. home builders Centex Corp. and KB Home, according to its latest Securities and Exchange Commission filings. At recent prices, the stakes in the two home builders are valued at $10.4 million and $10.8 million, respectively.

ESL also is tip-toeing into mortgage origination and servicing, acquiring about four million shares of CIT Group Inc., a struggling subprime home and commercial lender, as well as 1.4 million shares of PHH Corp., a mortgage originator and mortgage-service company.

Lampert Puts Money On Housing Rebound (WSJ)

One thing that this article leaves out is that Lampert appears to be targeting companies that are involved in failed buyouts. Often, these companies will enact large share buyback programs or other value creating initiatives in order to please their investors. Also, keep in mind that many companies are taken private because they are undervalued, this means that almost any of these companies can be value investments. The trick is to figure out if the companies needed a buyout in the first place to unlock their value.

A company like The Tribune needed a buyout, because its savings were going to be derived through a tax friendly structure. In other companies, it might be the case that the market simply undervalued them or management didn’t take the correct steps — like at Friendly’s.

Here’s a list of Eddie Lampert investments that are failed buyouts: Acxiom (ACXM), SLM Corp (SLM), PHH Corp. (PHH)

Another casualty of the credit crisis was announced today, Erin Callan the CFO of Lehman Brothers (LEH). I find this interesting because Callan has only held the job since December. Callan was even the feature of some favorable stories in the Wall Street Journal:

After sifting through the numbers for nearly an hour, Ms. Callan coolly answered more than 20 analyst questions. Then she strode down to Lehman’s bond-trading desk and high-fived trading executive Peter Hornick. Later that day, bond traders gave her a standing ovation, a Wall Street rite typically reserved for CEOs. Profit had plunged, yet Lehman shares surged 46%.

Six months into one of investment banking’s toughest jobs, the 42-year-old Ms. Callan is emerging as a galvanizing force at Lehman and a finance chief who topples much of the conventional wisdom about CFOs. She also is the highest-ranking woman on Wall Street. Many Lehman insiders consider her among the contenders to become the firm’s president someday.

Unlike Lehman’s two previous CFOs, Ms. Callan isn’t an accountant and had never worked in the finance department.

Lehman’s Straight Shooter (WSJ)

These changes weren’t enough when Callan famously came up against famed value investor David Einhorn of Greenlight Capital as he launched a short campaign against the company. David Einhorn is one of the best value investors today, he definitely is able to apply traditional value investing to areas that most investors skip over like pharmaceuticals, technology, and financancials. He should be studied by any aspiring investors.

The difficulty that Callan faced was having to defend Lehman Brothers against Einhorn’s insurgency in a time when the company already faced extreme pessimism. In an environment like this, a company like Lehman is weak. The large amounts of leverage they employ hold them hostage if there’s a crisis of confidence. Lehman had winded down some of their leverage, going from the low 31.7:1 to 25:1, but still - this is still excessive. Einhorn’s claims were easy to rock confidence in Lehman because he questioned their accounting, the foundations of their financial position - in doing so he (or the market) forced Lehman to pursue $6 billion in capital.

To see how Callan sought to pacify Einhorn, just look here:

In his comments, Mr. Einhorn squared off in particular against Erin Callan, Lehman’s chief financial officer and the executive who has led the public charge against the firm’s critics. Mr. Einhorn met with Ms. Callan last week to discuss his research.

In a statement, a Lehman spokeswoman said: “We will not continue to refute Mr. Einhorn’s allegations and accusations. Mr. Einhorn cherry-picks certain specific items from our quarterly filing and takes them out of context and distorts them to relay a false impression of the firm’s financial condition which suits him because of his short position in our stock. He also makes allegations that have no basis in fact with the same hope of achieving personal gain.”

In attacking Lehman, Mr. Einhorn took issue with large, unrealized gains the firm booked in the first quarter from marking up equity positions that don’t trade in public markets. Like other brokers, Lehman has large amounts of illiquid assets that it values using management-driven financial models.

A Shorter Slams Lehman (WSJ)

By choosing to ignore or “not continue to refute” Einhorn’s claims, Lehman makes it easy to appear sketchy to any of the company’s outsiders. I’m not expert on the company, but when someone like David Einhorn goes around giving presentations that easy describe and show how weak your company is to hedge funds and the general public - the precise people who can hurt your company, you should not decide to “not continue to refute”.

In refuting, a company legitimizes the short-seller but they also have a chance of countering whatever may be flawed in the analysis. Not refuting almost makes it look like Lehman has something to hide. From my experiences, I’ve noticed that most companies try to brush aside short-sellers, as if de-legitimizing them is good enough. Often it isn’t. Often, companies need to engage in an aggressive operation where they actively come up with easy-to-consume evidence that counter’s the short’s claim. I’m talking 100 slide power points a la Bill Ackman. This could be a problem if your company really is sketchy and in that case then the short will triumph. Also, Lehman could have tried to push its efforts towards discrediting Einhorn. No investor is infallible, just look at Einhorn’s investment and directorship of New Century Financial (he did note that Greenlight’s analysis was “sub-prime” for New Century). This would have been better than simply ignoring him and hoping he goes way. If a company can bring evidence that its position is sound, then it should do everything in its power to show that, at the very least it can bolster or even increase their stock price.

Lehman’s precipitous fall in stock price demonstrates that they did not do enough to assuage investor fears and with any luck, under the new CFO Ian Lowitt, Lehman will be able to handle these issues with better execution. Management of companies who are currently engaged with short sellers could do themselves a favor by reading up on counterinsurgency (COIN). COIN after all is in its essence is “winning hearts and minds of the people”. Winning the hearts and minds of the investor community would do good for any company’s stock price.