Street Capitalist: Event Driven Value Investments

Anyone who has followed this blog for a while knows that we are fans of Sardar Biglari and his work at Steak N Shake (now Biglari Holdings). One of Biglari’s goals is to add an insurance operation to the holding company. This would add a number of benefits to BH, namely the fact that its float could be redeployed into accretive investments.

Lawmakers in Michigan seem intent on curbing his efforts:

A bill wending its way through the Legislature aimed at protecting a small insurance company from a hostile takeover will have a chilling effect on investment and job creation in the state, an opponent said today.

Sardar Biglari, CEO of San Antonio-based Biglari Holdings, which owns 19 Steak ‘n Shake restaurants in Michigan, said the measure — which passed the Senate last month to block his company from acquiring Fremont InsuraCorp. of West Michigan — sends the wrong message to potential investors.

“This bill will send a signal that Michigan poses greater risks, greater uncertainty than other states,” said Biglari, who was in Lansing to meet with members of the House Insurance Committee, which is scheduled to take up the bill Thursday.

He said his holding company has no intention of moving the small insurer out of Michigan or of laying off its 75 employees. The only change in the works is to replace the company’s CEO, he said…

The legislation would require approval of two-thirds of outstanding shares of a company to elect director candidates who are not backed by a majority of that company’s board of directors. Biglari, who owns nearly 10 percent of Fremont InsuraCorp., said the bill would make it “nearly impossible to consummate the transaction.” He said the measure dilutes shareholder rights.

Biglari added he’s looking to acquire other businesses in Michigan and said the outcome of this legislation “will determine our level of interest.”

Cobb said the bill is narrowly tailored to block the takeover of Fremont and would affect only a couple other companies in the state.

“We don’t think it will have an effect on outside investment,” he said. “Shareholders will still have their say.”

Bill seen as roadblock to takeover of Fremont insurer

The really unfortunate thing here is that if a company in Michigan underperforms, with legislation like this in place, it will be extremely difficult to turn them around. Shareholders will have a say, but it will be weakened. Michigan should by now be well acquainted with how insulated management teams can run amok, after all, US taxpayers had to bailout their state when GM and Chrysler went bankrupt. It seems as if they haven’t quite learned the lesson yet.

After Steak N Shake (NYSE:SNS) reorganized as a holding company I knew that it was only a matter of time before he started to use the company’s free cash flow to target investments outside of restaurant operations. This is precisely what he did with Western Sizzlin. Today, we found out what he was up to– Steak N Shake filed a 13D saying that they had purchased 9.9% of Fremont Michigan InsuraCorp (OTC:FMMH).

Fremont is actually a company I’ve heard of before. Texas-based activist investor Harry Long has been lobbying for change there. Check out his whitepaper: Build Fremont (PDF).

I can’t be sure of whether Biglari agrees with Long, I know that the folks at Chanticleer have a different opinion of the company’s management. It will be an interesting company to watch though.

The Indy Star has a new article by Ted Evanoff about the merger between Steak N Shake (NYSE:SNS) and Western Sizzlin (NASDAQ:WEST):

If past takeover attempts by Steak n Shake’s new chairman and chief executive are any indication, the 75-year-old burger chain soon may be recast as a corporate raider.

Sardar Biglari, the young Texan who took control of the Indianapolis-based company last year, has quietly remade the cheeseburger purveyor into a holding company — a business whose business is owning other businesses.

It gives the 32-year-old chairman of Steak n Shake an open hand to invest what the company calls “surplus cash” in whatever strikes his interest. In the past, those interests have included failed efforts to take over the bartering exchange service ITEX Corp. and California-based Jack in the Box.

Biglari’s new plan for Steak n Shake was noted in an amendment to a loan agreement with Fifth Third Bank reported by the restaurant chain to the U.S. Securities and Exchange Commission.

Biglari himself can tap Steak n Shake for “up to $10 million of surplus cash to make investments of any lawful nature,” says the July 8 report filed with the SEC.

It’s also nice to see Kevin Byun get quoted, he’s one of the brightest fund managers that I’ve had the opportunity to meet:

Kevin Byun, managing director of Denali Investors, a New York investor that owns shares of Steak n Shake, said he expects the holding company strategy could pay off as investments begin to lift Steak n Shake’s stock value.

“I’m actually quite optimistic with the whole holding company framework,” Byun said. “He has the authority to make investments over a wide area that will be to the advantage of Steak n Shake shareholders.”

Armed and ready to raid? (IndyStar.com)

Read the full article, there are a number of different takes on the situation.

Be sure

David J. Reynolds of the WSJ reports that Sardar Biglari purchased $1.1M in Steak N Shake (NYSE:SNS) shares last week:

Steak n Shake recently disclosed plans to purchase Western Sizzlin, a steak restaurant chain that Mr. Biglari also heads.

The young activist — he is listed as 31 in a recent regulatory filing — became chief executive of Western Sizzlin in 2007 after buying shares and agitating for change at the company.

Ben Silverman, director of research at InsiderScore.com, said Mr. Biglari’s purchase showed his confidence in the outlook for the combined company. “The buying here is bullish,” Mr. Silverman said.

Mr. Biglari is “a value guy,” who has had plenty of opportunity to assess the worth of the business combination, Mr. Silverman added. “The proposed transaction seems to be the culmination of a two-plus year plan” to take control of both companies and combine their operations…

Mr. West said the proposed buyout was a “liquidity grab” by Mr. Biglari, a 33% holder of Western Sizzlin — more attractive for Western Sizzlin holders because those shares trade relatively infrequently.

Activist CEO Builds His Stake in Steak n Shake (WSJ)

Be sure to read the full article, it’s short.

A year ago, I remember thinking about this exact possibility, that Steak N Shake (NYSE:SNS) and Western Sizzlin (NASDAQ:WEST) could merge.

Here’s what I said:

One thing I’m wondering is whether we’ll see a merger between Steak N Shake (SNS) and Western Sizzlin (WEST). It would be a little similar to what Eddie Lampert did with Kmart and Sears. The same could happen with Steak N Shake with Western Sizzlin since both are in the restaurant industry, we could see some cost savings and synergies achieved by merging. Although getting the financials to work out, especially currently, would be a major stretch.

Sardar Biglari is CEO of Steak N Shake! (Street Capitalist)

At the time it seemed highly unlikely because Steak N Shake had a number of issues relating to debt and management that needed to be worked out. The common thread here is value investor Sardar Biglari, who manages the Lion Fund. As chairman of both companies, Biglari has implemented a holding company structure in both of them.

The real benefit here is simplification in the organization structure. Merging both companies will preserve the benefits and reduce the redundancies of running two different holding companies.

So let’s look at the transaction and figure this out. For shareholders, the changes are on the WEST side rather than the SNS side.

The Letter of Intent contemplates that on or prior to closing Western will distribute to its stockholders all of the SNS shares beneficially owned by Western. Further, under the terms of the Letter of Intent, the consideration payable to Western’s stockholders will be based on a net transaction valuation of approximately $22,959,000.00. At closing, each share of Western’s common stock would be converted into the right to receive an amount equal to approximately $8.11 in the principal amount of debentures issued by SNS. It is anticipated that the SNS debentures will have a term of five (5) years, will bear interest at the rate of 14 percent per annum and will be pre-payable without penalty at the option of SNS after one (1) year from the date of issuance.

The Steak n Shake Company and Western Sizzlin Corporation Announce Intent to Merge

From Western Sizzlin’s 10Q we know that Western Acquisitions owns 1,5553,545 shares of SNS. Shareholders of WEST own 85.1% of Western Acquisitions. So this means that WEST shareholders control 1,322,066.79 shares of SNS. There are 2.38M shares of Western Sizzlin outstanding.

1 share of WEST = 0.466 shares of SNS + $8.11 in SNS debenture.

The debentures pay a rate of 14% per annum, creating an added incentive for WEST shareholders. For SNS shareholders, I think the real question is going to be whether or not the integration of WEST adds any real benefit to justify the debentures. I would guess that there is a long term benefit from owned Western Sizzlin. Western Sizzlin’s restaurant operations alone will likely add about $2.2M per year in FCF which could be used for accretive investments which would benefit shareholders of Steak N Shake.

Today is the Western Sizzlin annual meeting in New York. I expect that we’ll see some interesting conversations come out there. I’ll be sure to link to any blogs that post up notes from the meeting. I’m sure more details surrounding the proposed merger will be out by then so we can do a more comprehensive analysis.

Jason Zweig’s latest column at the WSJ (Psyching Yourself Up to Let Losers Go ) tackles a tough issue for most investors – when to sell. Selling can be difficult for a variety of reasons, but a big factor is psychology. We don’t like to let go and give up things we’ve bought. Zweig provides us with a telling statistic:

Individual and professional investors alike struggle with selling. Berkeley finance professor Terrance Odean has found that investors are at least 50% more likely to sell their winners than their losers. Among the money managers surveyed by Cabot Research, a Boston consulting firm, fewer than 30% base their sell decisions on “extensive research.” The rest concede they basically sell by the seat of their pants.

To defend our portfolios from our emotions, Zweig offers us six techniques.

1. Use stop-loss orders

I’ve never been a fan of using a stop-loss order on a company’s stock. I know that Investors Business Daily advocates the use of selling whenever a company falls 10% and I think it’s too trivial of a rule. Zweig says that he doesn’t advocate the use of stop losses but prefers “stop look” orders:

Whenever a stock drops, say, 25% below what you paid, automatically review your original top three reasons for buying to see whether they are still valid. That will prevent you from selling without thinking first.

This is a pretty good idea. I practice the same kind of exercise myself. I don’t have any alerts set to tell me when about a drop of 25%, but I do check my company’s prices regularly. An easy way to get notified of drops in your companies can be done with Yahoo Alerts, you can get an e-mail or text message based up requirements you set (price drop/rise or percent drop/rise). Two of my holdings, Air Transport Services Group (NASDAQ: ATSG) and Steak N Shake (NYSE: SNS) have fallen a bit from my initial buying points ($1.70 and $10.00).

In each of these cases, I re-analyzed my investment thesis, to see if anything changed. With ATSG, the fall from $1.70 to below $1.00 was triggered by almost no news. DHL severing business ties with ATSG was already part of my investment idea- so I didn’t see a reason to sell. With SNS, my thesis hinged on Sardar Biglari getting onto the board and gaining control so that he could make the right decisions for the company. I decided that I would not sell till that thesis was properly tested.

2. Don’t Go Far Afield

Here, Zweig recommends buying an industry index if the company you purchased ends up having poor results. I don’t quite agree with this advice. It all seems a little bit like decisions made by an investor who doesn’t know what they’re doing who is trying to catch a trend (and may be too late).

The only time I think that this is valid is when you’re investing in an industry with good economics but where the individual players might be too hard to pick. I’m thinking of Buffett’s investments in pharma with companies like Sanofi Aventis (NYSE: SNY), GlaxoSmithKline (NYSE: GSK), and Johnson & Johnson (NYSE: JNJ). The difference with Buffett’s investments in pharmaceutical companies is that he still was not buying an ETF, he bought just a few of the players in that industry. An ETF will usually have many more holdings and carry the risk of over diversification.

3. Shop Before You Drop

Zweig’s next technique is a bit better-

Ask yourself: Which stock or fund would I most like to own? Then view your losers as a source of funding to reduce the amount of cash you would otherwise need to raise

Sometimes I think that selling losers can be good, especially if you’re purchasing a better buy. Maybe a new opportunity has presented itself with a higher return or the margin of safety in your losing investment has narrowed.

4. Re-price it.

Here, the idea is to take your original purchase price and divide it by 10 and compare that price with its current price. A simpler method might be to look at the price you’re seeing right now and compare it to your conservative estimate for the company’s margin of safety(the spread between the current price and the company’s intrinsic value you in your eyes). If you’re buying companies at what you think are 50% discounts, you’ll see a wider margin of safety. It will then be up to you to decide if anything has changed.

If the margin of safety has narrowed to a point where maybe the capital could be better used elsewhere, then you should.

5. Follow your sales.

This is some of the best advice in the column.

Using an online portfolio tracker, monitor the returns of all the stocks you sell after you sell them. Studying the aftermath of your mistakes will enable you to learn which you sold too soon and which too late. You cannot improve what you do not measure.

I try to do the same. On my Google Finance page I keep all of my stocks, even after selling them. I like to see what they’re currently doing and learn from my mistakes and the company’s mistakes. By doing this, you expand your circle of competence. It makes me think of a quote from Edward Lampert in Fortune Magazine.

[The] idea of anticipation is key to investing and to business generally. You can’t wait for an opportunity to become obvious. You have to think, “Here’s what other people and companies have done under certain circumstances. Now, under these new circumstances, how is this management likely to behave?” The plays my father designed for me helped me learn to think ahead. Lots of days I asked him, “Why can’t we just invite kids over and play a game?” In order to do something well, he explained, you have to keep practicing and preparing.

And I think that’s one of the more important concepts to keep in mind when investing. You can often draw upon past experiences when making future decisions. The situation might not be entirely the same, but it’s incredibly useful to have that kind of knowledge filed away for future reference.

It looks like one analyst seem to think so:

Analyst Steve West said in a note to investors that the company’s “long-awaited” strategic plan is due to be released in the next few months – a move that likely will improve sentiment in the stock and make for the beginnings of a turnaround.

West said he does not see traffic at the chain improving until at least 2009 “as the strategic plan will take time to implement and the consumer remains strained.”

But he said the company’s management is “taking the right steps for a fiscal year 2009 rebound.”

Although he said he does not know details of the plan, he expects it to include closing underperforming stores, cost-cutting, selling real estate, refranchising company-owned stores and repurchasing shares.

Steak n Shake shares rise on analyst report (IBJ)

I believe that one of the right steps was the sale-leaseback transaction Biglari executed recently. The move elicited a pretty negative response from some investors, but when faced with the possibility of bankruptcy since the company was/came close to violating debt covenants, it seemed like the right move.

Biglari’s withdrawal of the tax abatement plan appears to be the right move as well. Receiving that kind of support from the local government could have added to the costs of Steak N Shake (NYSE: SNS). These tax abatement plans are there typically for a business that is supporting and employing members of the community. They would discourage or possibly prohibit the closing of underperforming restaurants and firing of employees, which is just the sort of cost-cutting we might need right now.

Right now, controlling costs is at the forefront for most fast food and casual dining chains. It’s evident from the reports coming out that describe McDonald’s (NYSE:MCD) retooling of the double cheeseburger to make it less of a loss-leader and Burger King’s (NYSE:BK) hope of reducing the size of the Whopper Jr. to control costs. With most commodities going up, all of these companies are in a tough position. It’s an intensely competitive business, with your enemies usually operating next door. If you raise your prices to push your increasing costs to the consumer, you risk losing sales.

I’m still holding my shares, and believe that my previous estimate for the company’s valuation of $20 per share is still in tact, but I’m not entirely sure of how long it will take to play out. We’ve already seen the bankruptcies of Bennigans, Steak & Ale, and creditor pressure on Uno’s.

It’s likely that we’ll see more distress in this sector, just as some of the highly leveraged chains find themselves strangled by a perfect storm of debt, higher costs, and lower customer traffic. Shrewd capital allocation skills are going to be needed as the industry passes through this rough period, luckily our new CEO seems to have them.

In an ideal world, managers at corporations would listen to the ideas that shareholders bring to them. After all, the shareholders are the true owners of a company. Usually though, egos start to fly and things don’t work out that way. When that happens, shareholders often utilize proxy contests in order to replace members of the board of directors and make their voices heard. The problem is that these proxy fights are messy and expensive. You have to obtain extensive legal council and take on the costs of actually mounting a campaign to distribute ballots and get votes yourself. For smaller investment funds the fight just might not be worth it.

The reason I bring this up is that there seems to be a little controversy regarding Sardar Biglari’s reimbursement of $500,000 from Steak N Shake (NYSE: SNS) while also serving as CEO of Steak N Shake (and taking a salary).

In connection with his appointment as Chief Executive Officer of the Company, Mr. Biglari’s annual salary was increased to $280,000. There is no other plan, contract or arrangement to which Mr. Biglari is a party or in which he participates that was or will be entered into, or any material amendment to such a plan, contract or arrangement, in connection with Mr. Biglari’s appointment as Chief Executive Officer. Mr. Biglari does not receive board fees or any other compensation.

On August 6, 2008, the Company’s Board of Directors agreed to reimburse Western Sizzlin and the Lion Fund for expenses related to this year’s proxy contest in the amount of $500,000. Mr. Biglari serves as the Chairman and Chief Executive Officer of both Western Sizzlin and the Lion Fund. This expense reimbursement is being disclosed pursuant to Item 404(a) of Regulation S-K.

Form 8-K for STEAK & SHAKE CO (Yahoo!)

While this looks sketchy, it’s not. Back in January, Biglari publicly disclosed that he would be seeking reimbursement for expenses incurred by having to wage a proxy contest with Steak N Shake. He says here:

The expense of soliciting proxies is being shared pro rata by the Lion Fund, Western Sizzlin and Western Acquisitions based on their pro rata share of the aggregate number of Shares held by all members of the Committee. Costs of this solicitation of proxies are currently estimated to be approximately $[________]. The Committee estimates that through the date hereof, its expenses in connection with this solicitation are approximately $[________]. We intend to seek reimbursement from the Company of all expenses we incur in connection with the solicitation of proxies for the election of the Nominees to the Board at the Annual Meeting. We do not intend to submit the question of such reimbursement to a vote of security holders of the Company.

Preliminary proxy statements, contested solicitations (Steak N Shake)

Had Biglari pulled the reimbursement out of a hat, as a shareholder I’d be angered. But he didn’t. When he began his proxy contest with the company he publicly disclosed that he would seek reimbursement. If shareholders had disagreed with this, they could have voted in favor of company management.

In general, I like to see these reimbursement policies in play. They are enablers for shareholder activism which means that even in the micro-cap/small-cap area, we can see corporate management held accountable to their shareholders.