Street Capitalist: Event Driven Value Investments

Today Steak N Shake (NYSE SNS) annouced that Sardar Biglari will serve as Chief Executive Officer:

Mr. Biglari commented, “I would like to thank Wayne for his guidance over the last several months. In reviewing Steak n Shake and beginning to implement its restructuring, the Board and I concluded that to achieve the best results, we need an executive who will be focused on restaurant operations. As a consequence, we will seek a president with significant restaurant experience to concentrate on improving restaurant operations, whereas I will assume the CEO position, leading the organization principally from a strategic, financial, and governance perspective. Concurrently, we are presently undergoing a comprehensive examination of the company and are in the process of implementing a restructuring program — closing underperforming locations, reducing G&A, shortening hours of operation in many locations, and other initiatives — all on the premise that Steak n Shake will be managed based on cash flows in order to create long-term value for shareholders. Steak n Shake is an iconic brand with greatly talented people working throughout the organization. Because of all these advantages, I am confident we will regain the chain’s prior status as a great company. Details of our plan will be disclosed within the next 60 days in a shareholder letter.”

The Steak n Shake Company Announces Change in Leadership (Yahoo)

My reaction to this change is positive but mixed. Biglari became chairman with the intention of helping influence the board into finding someone to run operations for Steak N Shake (SNS). The fact that this has not happened is a little disappointing, but I know that Biglari is working 17 hour days and he has already had a positive effect at the company (steering SNS to tax savings). I’d rather that we patiently wait for the right president to be found. We’re going to need someone good in order to excel in this kind of economic climate.

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.

In my previous post I put up a transcript of an interview with Joel Greenblatt on his magic formula book. Here’s another interview (May 15, 1997) I found on CNBC about his older book You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits. This is by far my favorite investing book and is worth taking a look at for its material on special situations/ balance sheet event driven investments.

DAVID: Your book says you can be a stock market genius, even if you’re not too smart. What are some of the tricks here that–that–that allow you these kind of astronomical returns?

Mr. GREENBLATT: Well, I think to do it the way everyone else does it every year, 80 percent of the mutual fund managers who do a lot of work, can’t seem to beat the market, you have to take maybe a little different angle. And the way I look at things is if you’re looking in places that other people aren’t, you have a much better chance of beating the market.

DAVID: And these are what you call pockets of opportunity’?

Mr. GREENBLATT: Right. There are some areas of the market where, on average, those areas beat the market just randomly selecting those areas.

DAVID: Let’s talk about spin-off securities, which is one of these pockets. T–tell us about spin-offs–I–the one I talked to you about before we went on the air, that I thought of, was Lucent Technologies–is that an example, wh–when it was spun off by AT&T?

Mr. GREENBLATT: Sure. AT&T actually had two spin-offs last year: One was Lucent Technologies and one was NCR. The one that I purchased was NCR. What happens is, is that–NCR’s a computer company, was a division of AT&T, a telephone company. And to separate itself–this small division from the company–they would distribute shares–AT&T distributed shares to its shareholders in NCR. They weren’t purchased. Just if you owned AT&T shares, you would get a distribution of NCR shares. What happens to these shares is that people who get them sell them off.

DAVID: Mm-hmm.

Mr. GREENBLATT: They bought AT&T–they bought a telephone company. They’re not interested in a computer company that AT&T lost $ 7 billion in in the last six years.

DAVID: Well, they sell them off, though, doesn’t the price go down?

Mr. GREENBLATT: The price–that’s exactly why there’s an opportunity. The people who get the stock don’t want it…

DAVID: Mm-hmm.

Mr. GREENBLATT: …they sell it. You get an initial low price, and w–on average–there was a 30-year study that showed that spin-offs beat the market by 10 percent a year just on average.

DAVID: Got a minute, so we’ll have to split it up. But the other pockets of opportunity–merger securities is another one. Give me an example.

Mr. GREENBLATT: Well, when Viacom purchased Paramount, they purchased it with cash, they purchased it with stock and they purchased it with four other securities–warrants, convertible debentures, things of that nature. If you own stock in Paramount and–and Viacom bought it, you would get stock, you’d get cash and maybe you’d keep those things. But if you get all these securities that you’ve never even heard of, you just sell them off. And there’s an–another opportunity to have extraordinary gains in that area.

DAVID: How do I turn somebody else’s misfortune into my fortune with bankruptcies?

Mr. GREENBLATT: Well, what’s interesting is, in bankruptcies, you don’t really invest in stocks after they go bankrupt, but what you can do is–the way stocks come out of bankruptcy is that they give their creditors, like a bank or a–a–a supplier, stock in the company…

DAVID: Mm-hmm.

Mr. GREENBLATT: …so that they can come out–because they can’t pay off the debt…

DAVID: Right.

Mr. GREENBLATT: …because they don’t have the cash. So these suppliers and banks get stock in a company that they had no interest in getting.

DAVID: Right.

Mr. GREENBLATT: They sell it right off. It’s the same exact opportunity as in spin-offs and merger securities.

DAVID: It’s all in here, “You Can Be a Stock Market Genius, Even If You’re Not So Smart.” Our thanks to Joel Greenblatt, author of “You Can Be a Stock Market Genius.”

While doing some digging I found another interview with Greenblatt about special situations. This interview aired April 24, 1997 on CNNfn:

THIERRY: Some would say you wrote the book on-well, “You Can be a Stock Market Genius Even if You’re Not Too Smart.” It happens to be the title of your book. Is that really true that you can be a stock market genius even if you’re not to smart? Why is that?

GREENBLATT: Well, I mean, if you look at the professionals, 80 percent of them don’t beat the market every year. So, that’s really not the place that you should look, going into work every day, picking stocks. It doesn’t seem to work. So, I think the trick that I put in my book is looking in the right places. There are certain areas of the stock market where, just if you randomly select within those areas, you can beat the market. One of the easiest things for most people to check out for themselves is the area called spin-offs. And studies have shown that spin-offs-companies that were once subsidiaries or divisions of a larger company that get spun off to the shareholders of the larger company-do quite well. In fact, they do twice as well as the market on average.

THIERRY: But you want to know about them while they’re takeover targets.

GREENBLATT: No, these aren’t takeover targets.

THIERRY: Really?

GREENBLATT: What happens is these are small divisions of a company.

THIERRY: Of a company.

GREENBLATT: So, let’s say an insurance company owns a steel company. They could possibly say, listen, people don’t want to own both an insurance company and a steel company in one stock, so what they’ll do is spin off the steel company to their own shareholders. So now, everyone will own shares in a steel company and own shares in an insurance company. And what turns-seems to happen is that the shares that are just distributed-in other words, they’re not sold by brokers or anything else, you just get these shares- seem to perform very well, mainly because they’re priced very low in the beginning. No one wanted these shares. They’re sold off. They trade at low prices, and over the subsequent three years, they beat the market by 10 percent a year. So, in other words, if the market over a long term averages 10 percent a year, these will do 20 percent a year.

METAXAS: So, what opportunities are there right now in the market, and do you think it’s a good time to be looking at some of these situations?

GREENBLATT: Well, you know, I don’t predict the market, really, or where it might go. And I really pick stocks in special situations. And what’s interesting about spin-offs in particular as one area would be they’re always happening. And the reason why they’re cheap has nothing to do with where the market is as the current time. What it has to do with is the fact that people are getting shares that they don’t want, and they sell them.

So, there’s a few coming up right now. In the next few months, Westinghouse (Company: Westinghouse Electric Corporation ; Ticker: WX ; URL: http://www.westinghouse.com) is spinning off their industrial businesses. They’re going to keep TBS and they’re going to change their name to CBS, and there’s going to be a company called Westinghouse Electric which has their industrial business which includes Thermo-King which makes refrigerated trucks. It includes power plant manufacturing and energy manufacturing.

THIERRY: So, you would like the Westinghouse portion of it more than you would like the CBS portion?

GREENBLATT: You know, the funny thing is they both work out. The parent companies do quite well. They beat the market by about 7 percent a year, whereas the spin-offs themselves beat the market by about 10 percent a year.

THIERRY: All right, then take something a little bit more complicated: Pepsi (Company: PepsiCo Incorporated ; Ticker: PEP ; URL: http://www.pepsico.com/). All right, they’re going to spin off, I guess, in three ways or something.

GREENBLATT: Well, actually, Pepsi right now is going to spin off in two ways, except one of their divisions-Pepsi’s going to separate their restaurant business which is Kentucky Fried Chicken, which is Pizza Hut, which is Taco Bell-into a separate company. And Pepsi is going to keep Pepsi and Frito-Lay as one company, and the other company will be those three fast food restaurants. And together they’ll have about 29,000 restaurants. But it will be distributed to Pepsi shareholders who generally were buying because Pepsi’s a good business, just like Coke (Company: The Coca-Cola Company ; Ticker: KO ; URL: http://www.cocacola.com/). It’s-they sell concentrate, and it’s a nice growth business, where the restaurant business has stagnated to some degree. It’s kind of mature business that’s not growing. And that will be appropriate for certain people, and the faster growing soda business will be better for others.

METAXAS: What other themes do you like?

GREENBLATT: Well, another theme that I discuss in the book is buying companies that are coming out of bankruptcy-not going into bankruptcy, and not stocks of companies that just filed for bankruptcy. But what happens in a bankruptcy is that creditors of a bankrupt company-usually a bankrupt company doesn’t have a lot of money. So, they can’t pay off in cash their debts. So, what they give out is stock in the company and the new shares in the new company, the newly recapitalized company, after it comes out of bankruptcy. And a lot of times those share-a bank who gets shares in stock don’t want it. They sell that off, too. So, there’s another opportunity there.

METAXAS: What about insider buying? That’s another one of your themes.

GREENBLATT: Well, in anything that I do, I care that management’s on my side. So, while I said that, for instance, in the spin-off area, that you can double the market just by randomly selecting, I say you can do even better than that.

Let’s-let’s find things that are actually-will do better than the average spin-off which is already doing twice as well. And how do you find those? There are certain things you look at. One of them is insiders want it. That’s the easiest way. If the-I look at how much the insiders are getting paid in common stock and options, and how much they’re getting paid in salary to see how much they’re on my team.

If they’re getting big salaries and they don’t own much stock, I figure their interests aren’t aligned with mine. So, I try to stick to situations where management has a very big incentive to get the stock up. And, even just selecting that one area which is the most important to me, and selecting spin-offs, then you could do incredibly well.

CALLER: Oh good morning everyone. I’m thinking of selling my AT&T (Company: AT&T; Ticker: T; URL http://www.att.com/)and buying Westinghouse?

METAXAS: What do you think?

GREENBLATT: Well, that’s pretty interesting. Westinghouse (Company: Westinghouse Electric Corporation ; Ticker: WX ; URL: http://www.westinghouse.com) is actually going to be spinning off some of their divisions and separating CBS the faster growing and more attractive business from some of their slower growing and industrial businesses. Their core business from the pass. So, it’s a very interesting situation.

I think if you have a long term view of the market, which I think you have to have at this point, stocks are - especially the larger capitalization stocks are pretty high priced at this point, I think some of these will work out and you pick two somewhat depressed stocks; the AT&T and Westinghouse.

METAXAS: AT&T has already gone through that process of spinning off its division.

GREENBLATT: They have. They just spun off NCR which was also an interesting spin off possibility and that’s a stock that I own right now too. AT&T has a difficult challenge. Their business is changing. I don’t know any who really has a handle on how things are going to workout there. I think they should. AT&T should have the biggest advantage. It’s really fixed -costs business where you have everything in place, and if you are the biggest you should have the best costs advantage. So if they get their management act together, AT&T could turnout very well.

METAXAS: But you’d make that trade?

GREENBLATT: Westinghouse - I like playing special situations, when something interesting is happening. I read one report on Westinghouse which suggested that if they could get the ratings up at CBS you could see a $30 stock price near the next two or three years. And I think the industrial businesses could be interesting. It depends really how much debt is put on them, and how the distribution is made. But their both interesting situations. I probably wouldn’t favor one over the other in that stance, and it depends on what your tax situation is. If you can take a short-term tax lost by selling AT&T and swap for a Westinghouse. That might make sense. If you’re going to take a big gain, you know their both fairly attractive.

THIERRY: We’ve got Westinghouse down an 1/8 at 18 and AT&T down at 31. Our next caller is Mike in New Jersey.

CALLER: Hi, how are you doing. Could you tell me your long term on Compaq (Company: Compaq; Ticker: CPQ; URL: http://www.compaq.com/).

GREENBLATT: Well, the way I pick stocks is a know a lot about a few things. And I have a position in a small company that I don’t want to name that sells a lot of Compaq computers, and services . They’ve had a slowdown lately because the changeover in the new chips, and people - company sort of waiting for either the prices of the old stuff to fall, this is the usual game in the computer business or the their new stuff to come out, and sort of in paralysis and then a short term so what they’re going to pick. So, I really don’t have a long term call on Compaq. It’s a technology stock, also out of my

METAXAS: So, you’d just avoid. You think there is plenty else out there for you to be investing in.

GREENBLATT: Well, I think there doesn’t have to be plenty to be investing. I think this is certainly a stock that was market is what they say, in other words I probably wouldn’t buy the S&P 500 here, I think it has had a very nice run. The larger stocks have done very well, and I don’t know how that continues for a long time, and if you look at Warren Buffet’s latest letter, he said most stocks are overvalued at this point, including the ones he own. And what I think he’s talking about because he runs billions of dollars, he talking about the larger stocks. There are bargains in some of the smaller stocks that have gotten beaten up. This has been a large cap rally, and there is still a lot of small stocks that have gotten beaten up already. So that you don’t have to worry about a market fall quite a much. They all fall in a bear market, but if you pick thinks that have been beaten up already, they should rebound maybe sooner.

THIERRY: Well speaking of that, really the rally has been in such narrow for the blue chips you must be concerned about the fact that it has not broaden out,.

GREENBLATT: Number 1 I have no respect for anyone who has an opinion on where the stock markets going.

Having said that, it does scare me a little the big stocks - it’s been a very narrow band of big stocks that have done particularly well and left a small stocks in the dust. The other side of that coin, there may be opportunities in some of the smaller stocks that already been beaten up, and maybe that’s where I’d look if I were going to invest in the market, because I don’t feel like taunting it and I’m just trying to pick my spots a few things that I know well, that I want to buy is the way to play.

CALLER: Yes, I’d like to know how do you find out the information on the executives that have big holdings in companies which you’ve mentioned?

GREENBLATT: That’s a very good question, and it’s-there’s an interesting answer to that. It used to be much harder. You’d have to either write to a company or go down to the SEC and actually get filings or pay a service for–$20, $30-for each filing. Now, you can really get all this stuff for free over the Internet for the price of a phone call.

SEC requires all companies to file under the EDGAR system, and these are all posted on the Internet in a number of different sources, many of which are free. And you can just look it up, usually in the proxy statement it tells you exactly. When you’re talking about a spin-off, they have to file special filing called a form 10 approximately two months before they actually spin off the company.

So, it’s not even trading yet, and you’ll have two months to study up on a company. You don’t really have to have a quote machine or something like that tracking these things. You’ll have a couple of months to do your research. And, since there were about 100 spin-offs last year, and you probably only need five or six different securities in your stock portfolio, there’s plenty to choose from just in that area. So, those are available in the form 10, also available over the Internet for free.

METAXAS: Do you think five or six stocks will do it?

GREENBLATT: Yes. I think that one of the problems and one of the reasons why mutual funds don’t really out-perform the market is they can’t just stick to their five or six or seven best ideas. Generally, they’re running hundreds of millions or billions of dollars and they have to for legal
liquidity and compliance reasons invest in 30, 40, 50, 60, 100, 200 stocks. It’s tough to have 200 good ideas at one time, but it’s not so hard to have five or six good ideas. And that’s why, if you include all the expenses and having to pay their management fees, that’s why most of them under-perform most of the time. And even the ones who do better than average for a year or two, usually there’s no correlation between how they’ll do the next year. So, that’s not even going to help you. So, I think the bottom line is to do it yourself. But you have to put in a little bit of time. But it’s not that hard.

THIERRY: So, you really shouldn’t be running with the herds. In fact, it was said this morning that a lot of mutual fund managers are worried about the Jeffrey Vinik syndrome, and therefore, they want to just invest in the same stocks that every other mutual fund manager is going to invest, so that nobody could get fired, really, for being wrong. I mean, if they’re wrong, they’re wrong with everybody else.

GREENBLATT: I think that’s true, and I think the name of the game really in the mutual fund business is not to make money; it’s to do a little better than the market, or at least not worse than the other mutual fund managers. So, when I invest for myself, I’m trying to make money. When a mutual fund manager who is down 10 percent when the market’s down 20 percent is dancing.

THIERRY: He’s trying to keep his job.

METAXAS: Let’s go to David in New York. Hello, David. You’re on the air, David. All right, David was going to ask about Informix (Company: Informix Corporation ; Ticker: IFMX ; URL: http://www.informix.com/).

GREENBLATT: Well, it’s lucky, because I don’t know anything about it.

THIERRY: All right, well, there you go.

METAXAS: All right.

THIERRY: Let me just ask you then, if you are narrowing it down to the five or six, one of the five or six that you like is American Express (Company: American Express ; Ticker: AXP ; URL: http://www.americanexpress.com/), right?

GREENBLATT: Yes, actually I’m at the tail end of that position. That was a spin-off. They spun off Lehman Brothers(Company: Lehman Brothers Holdings Incorporated ; Ticker: LEH ; URL: http://www.lehman.com/) several years back, and the reason why-and in that case American Express was the parent company. I didn’t-I looked at Lehman Brothers, and the insiders didn’t own much stock. So, that’s one of the things I look at. I usually look at three things, but that’s one of the main things I look at. They didn’t own much stock, so I didn’t want to deal with that. But then I started taking a look at American Express which was the parent company of Lehman Brothers.

One of the reasons that most investors didn’t like the stock is because Lehman’s earnings were so volatile it screwed up the growth picture that was really happening in American Express which has two very good businesses; as a charge card business and an investment management business. So, once that was freed it-and if you subtracted the value of what you got for your Lehman stock and just sold it off, then you were able to create American Express at nine times earnings. And this is a real franchise. This is a Warren Buffet franchise. It turned out about nine months after the spin-off took place, Warren Buffet did take a 10 percent position in American Express, and this was really uncovered through the spin-off process, and so American Express at that time was around $30. And it’s had a great run here, when-where people though that, gee, these are great businesses and they’ve had a huge earnings explosion, should earn over $4 this year. And it’s a very high-quality stock. It has had a nice run.

The only reason I’d hang in there now is because they were in talks with Citicorp (Company: Citicorp ; Ticker: CCI ; URL: http://www.citicorp.com/) at the end of last year. And I think once you’ve decided to sell your company, I think that’s the end of the game. It’s very hard to keep your employees motivated and everything else, and I think they’re in a little bit of Limbo now. And I think when they find the right deal-and Citicorp would have been a very good deal. It probably wouldn’t have been, from what I’ve read, a big premium to the stock price. But, what would happen if Citicorp and American Express merged together, there would be a lot of cost-cutting they’d be able to do, because Citicorp has a huge credit card portfolio, and there would be a lot of overlap and Citicorp would love to have American Express’s investment management business. And, I think both stocks would go up significantly, even if it was a merger of equals.

METAXAS: All right. We have a quick question on banking now from Diana. Good morning, you’re on the air.

CALLER: Yes, good morning, I’m interested in Chase Manhattan Bank (Company: Chase Manhattan ; Ticker: CMB ; URL: http://www.chase.com/), what you think of it. It’s gotten beaten up kind of the last week or so.

GREENBLATT: Well, actually I used to own Chase Manhattan. I actually sold it before it made its big run-up, right around $90. I guess it ran up way past there. I’m not sure where it is today, but in that area. You know, I was a seller of that, basically because you’re sort of-banks have had a very nice run. I try to look at normalized earnings, in order words, how much Chase should earn in a good environment or in an average environment, actually. And I think now we’re a little better than average.

They have a big credit card portfolio, consumers, and every few years the banks blow up in some area. At one point it was foreign loans. Now, I think the next coming crisis and that’s the issue, whether it will come or won’t it come is they have a big exposure in credit card lending. And consumers are really strapped. And I think with the economy still strong, you’re still having huge amounts of bad debt expense for all these credit card companies, and I think that-I think that we’ve hit the peak in that area, and although I don’t think it’s an expensive stock, there are probably cheaper things out there.

So, I think it ran even further than if it was going to normalize. So, I think it’s a good stock, not a great stock.

THIERRY: And, as opposed to spin-offs, we’re seeing so much consolidation in the banking industry right now.

GREENBLATT: Yes, which is a big move. And, obviously, that was- Chase has more than doubled over the last couple of years, and that was really the merger with Chemical. It was a huge cost- cutting benefit, eliminating a lot of duplicate. And that’s- operations-and that’s been the big story in that stock. And that story’s out. They’ve achieved the benefits, or at least it been
assumed that they will achieve the benefits that they planned in the stock price now, and I don’t think it’s overpriced. I just don’t-and relative to the market, it’s probably a good buy. It’s just I think it’s had its run.

THIERRY: All right, let’s go to Alice in New York.

CALLER: Hi, Joel, I just wanted to say I thought your book was terrific. Could you tell me what your favorite spin-off idea is today?

GREENBLATT: Well, there’s one that we own-I really don’t like to tout stocks in general. I mean, the idea behind my book was to really teach people to fish for themselves and they could eat for a lifetime. And one of the-but, one of the things that we do own that
was-is a big cap stock that I don’t think will move the stock one way or the other was a spin-off from, actually, AT&T (Company: AT&T; Ticker: T; URL http://www.att.com/), and that company is NCR (Company: NCR Corporation ; Ticker: NCR ; URL: http://www.ncr.com/).

Back about six or seven years ago, NCR was purchased by AT&T in a hostile deal, and they paid about $7 billion. Since that time, they’ve sunk in about $3 billion into NCR, so that’s about $10 billion. They spun it off in January. Now, the stock with no debt is priced at $3 billion. And, if you really want to look at it, the stock’s at $30. It’s got $11 a share in cash with no debt. So, really, we’re down to a valuation for the actual business of NCR of $1.9 billion. And NCR has a couple of good businesses. I’m not an expert in technology, but this is the way I look at things. If I feel like if I’m not going to lose money, then the other alternatives are pretty good. So, I’m looking down. I have $11 in cash in NCR; the stock’s at $30.

They have a data warehousing business which should do about $800 million in sales this year, and that’s the business where they provide computers for, let’s say, Wal-Mart (Company: Wal-Mart ; Ticker: WMT ; URL: http://www.wal-mart.com/) and they, at the check-out counter, there’s a huge amount of information that flows through there, there are only very few computers that can do it, and NCR is the leader in that field, data warehousing, even though it’s small relative to their $7 billion in sales, it’s a fast growing business. And, other competitors might trade at two or three times sales. Just give that one times sales. That with the cash covers most of the value of the stock. And there’s still over $6 billion of sales left.

THIERRY: All right, there you go.

METAXAS: All right.

THIERRY: Joel Greenblatt, Managing Partner at Gotham Capital. Thank you so much for joining us this morning.

GREENBLATT: Well, thank you for having me.

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.

Given the poor performance of Steak n Shake (SNS) it should be no wonder that some shareholders are disgruntled. Below is a letter to the company, by H. Kevin Byun of Denali Investors. He suggests a number of appropriate methods for the company to pursue in order to create shareholder value.

The Steak ‘n Shake Company
500 Century Building
36 South Pennsylvania Street
Indianapolis, Indiana 46204
March 19, 2008

To the Board of Directors:

The purpose of this letter is three-fold:

1. Request timing for when the company By-Laws will be reverted.

2. Understand the Board’s stance on share repurchases as a capital allocation opportunity.

3. Request an articulated and detailed turnaround plan.

Ultimately, my sincere hope is that actions taken by the directors will compel shareholders to vote for the reelection of returning directors at next year’s annual meeting. A prompt response and addressing the three issues above will surely be integral to that decision.

In my previous letter to last year’s board on February 7, 2008, I stated that to date, board actions were perhaps having the unintended consequences of increasing shareholder discontent and decreasing support for board-led initiatives. The recent proxy vote provided confirmation. By a count of 15.65m to 5.45m, a super majority of 74% of voting shareholders selected the GOLD opposition proxy. Importantly, the top four proxy advisory service firms in the country also all advised shareholders to vote for the GOLD proxy.

In moving forward, a regression back to previous patterns of insular behavior would only further the case against the seven returning directors.

What prompted the writing of this letter is that, to my dismay, we are already seeing signs that previous patterns of hazardous thinking still permeate the seven returning directors. In a press release dated March 12, 2008, the Company announced that Wayne Kelley is assuming the role of Interim CEO and Chairman, and Jeff Blade the role of Interim President. Not only are both receiving substantial pay raises, but Mr. Blade will also receive an additional lump sum payment of $150,000, in addition to his pre-existing lump sum grants, in the event of any of three listed occurrences. I was utterly shocked to see that the first occurrence listed in press release reads “On the date the Board appoints him [Blade] to be permanent President and CEO.”

It appears that the culmination of seven months of work by the special committee and spending fulsome amounts on Merrill Lynch as an advisor has only produced one specific name associated with the role of permanent CEO - the current CFO. The fact that Mr. Blade is being considered by the returning directors as a viable candidate for permanent CEO, a role that requires an executive that can affect an operational turnaround, is truly alarming. This is no way a commentary on Mr. Blade’s ability as CFO.

In order to begin repairing the reputation of returning directors, do directors disagree with the following?

1. Reversion of the Company By-Laws. Namely, the reversion of Article IV (Meetings of Shareholders), Section 3 (Special Meetings), which allows shareholders to call special meetings, from the recently amended 80%, back to the original 25%.

Indeed, Steak ‘n Shake shareholders, along with every proxy advisory firm, were dismayed that the previous board decided to amend the By-Laws in an attempt to avoid accountability. A reversion to the original 25%, in addition to future By-Law changes requiring a shareholder vote, would make the clear and positive statement that the Board is operating within a shareholder friendly framework. Conversely, failing to revert the By-Laws sends an equally clear signal that the Board still does not take seriously its fiduciary duty. It behooves directors to revert the By-Laws promptly.

Exhibit I: The Excerpt of Original Steak ‘n Shake By-Laws dated March 2006:

Article IV Meetings of Shareholders
Section 3. Special Meetings. Special meetings of the shareholders for any purpose or purposes, unless otherwise prescribed by statute or by the Articles of Incorporation, may be called by the Board of Directors or the Chairman and shall be called by the Chairman or the Secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of shareholders holding of record not less than one-fourth of all the shares outstanding and entitled by the Articles of Incorporation to vote on the business for which the meeting is being called.

In the Board’s proxy statement dated February 8, 2008, the special committee comprised of Messrs. Risk, Wilhelm and Williamson had “analyzed the outcome of various alternative future scenarios, including executing the company’s current strategic plan, modifying the strategic plan, increasing growth through more aggressive franchising, pursuing a leveraged recapitalization through a sale/leaseback of company-owned real estate and selling the company to a third party - either a strategic or private buyer.”

All these considerations mentioned remain compelling. However, there is no mention of opportunistic share repurchases as an option when shares are available at such a massive discount today.

A manager who consistently turns his back on repurchases, when these clearly are in the interests of owners, reveals more than he knows of his motivations. No matter how often or how eloquently he mouths some public relations-inspired phrase such as “maximizing shareholder wealth” (this season’s favorite), the market correctly discounts assets lodged with him. His heart is not listening to his mouth – and, after a while, neither will the market.

- Warren Buffett, 1984 Berkshire Hathaway Annual Report

What is the Board’s view of share repurchases?

To be perfectly clear, this is not to advocate share repurchases at any price. Indeed, were the share price currently $100 per share for example, share repurchases would be an inarguably improper use of capital.

Unfortunately, it is not without irony that at a time in which share repurchases would be the most effective, the Company does not have a repurchase authorization in place.

A knowledgeable Board recognizes excess capital can be directed in several ways, including: 1) dividends, 2) debt reduction, 3) share repurchases. Since the relative characteristics of dividends (tax consequences and transaction costs) and debt reduction (Company is not over levered) are fairly straightforward, the discussion will focus on share repurchases as the most attractive, given the severely discounted share price.

If I may be so bold, I would like to present the following case:

2. Implementation of an Opportunistic Share Repurchase Program. At the current share price, rather than use incremental capital to open one new company-owned store dollar for dollar, the same amount of capital through a share repurchase effectively buys the equivalent of 2.5 to 4 existing stores.

The recent share price, as low as $7.46 per share, offers a tremendous discount to the intrinsic value of the Company. At $7.46 per share, the Company is trading at only 0.7x of book value. Many shareholders believe this price represents a discount to intrinsic value of 60% to 75%, which implies a return profile of 150% to 300%. Clearly, the market is offering the Board an incredible opportunity to repurchase shares at a truly massive discount.

The previous Share Repurchase Authorization in effect from November 16, 2005 to November 16, 2007, was authorized to repurchase up to 3,000,000 shares. During those two years, only 20,400 shares were repurchased, or a total of $312,000, at an average cost of $15.29 per share (see Addendum I for more details). For reasons that cannot be explained, the previous Board allowed the program to expire.

The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value. As shareholders, we find this encouraging and rewarding… By making repurchases when a company’s market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management’s domain but that do nothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business

- Warren Buffett, 1984 Berkshire Hathaway Annual Report

Tremendous Cash Flow Masked by Growth Capital Expenditures

As the Board knows fully well, the Company generates significant cash flow. However, for the past decade, the Company has directed capital almost wholly into expansion. Growth, in the pursuit of top line numbers and without regard to the returns on incremental capital, is an inefficient use of capital. In reality, growth, depending on the returns on incremental capital, can be 1) value creating, 2) value neutral, or 3) value destroying.

(click the image for a larger version)

The Capex figures above include both maintenance capex (MCX) and growth capex (GCX). A fair proxy for MCX is Depreciation and Amortization (D&A). D&A for the past decade was as follows:

(click the image for a larger version)

As one can see, the Company, in reality, generates significant free cash flow were it not for burning capital to fund growth for growth’s sake.

During 1998, adjusted FCF was $24.1m. From 1999 to 2007, the Company pumped in $300m in growth capex, an average of $33.3m annually. During the same period, adjusted FCF totaled $236m, an average of $26.2m annually. This means that the $300m in growth capex resulted in only $17m in total incremental FCF from 1999 to 2007, implying a yield of only 5.7%.

However, each share repurchased at today’s price is the economic equivalent of buying a fractional ownership in each and every SNS restaurant at a 60% to 75% discount. To state again, the incremental dollar spent cutting the ribbon at one new company-owned store, spent instead for a share repurchase, buys the economic equivalent of cutting the ribbons at 2.5 to 4 existing stores. Compared to the returns from an incremental dollar of growth capex, share repurchases instead are an excellent and much higher return use of free cash flow at this time.

In order to better explain the magnitude of the benefit of share repurchases, the amount allocated to growth capex from 2005 to 2007 was approximately $125m. Assuming an average repurchase price of $15 per share, the Company could have repurchased up to 8.3m shares, reduced the share count by up to 30%, and increased EPS by over 40%. At the recent price of $7.46, the effectiveness and benefits of repurchases should be fully apparent and too meaningful to ignore. Notwithstanding the circular nature that a growth capex shift to repurchases affects future cash flow, one should concede that a repurchase at the current share price would yield more than the 5.7% return from growth capex.

I would greatly appreciate if the Board would communicate additional views of the case presented above, be they corrective or opposing, that I may have overlooked as well as the Board’s current position on share repurchases.

3. An Articulated and Detailed Turnaround Plan.
This is fairly straightforward. A plan should be provided to shareholders promptly.

In conclusion, it is my opinion that shareholders deserve a Board of Directors that understands and will act to address the following:

1. By-Law reversion is a necessary event and a forthright Board would act as soon as possible.

2. A Share Repurchase Authorization, available when shares are severely undervalued, is one opportunistic use of cash flow that creates significant value.

3. An articulated and detailed turnaround plan is critical to the entire process.

These are vital steps in reversing the loss of confidence and building trust among shareholders.

Again, not taking these steps sends the signal that the returning directors still continue to ignore: 1) fundamental principles of corporate governance; and 2) advantageous capital allocation opportunities.

As a concerned shareholder, I sincerely hope the Board takes these steps and rebuilds shareholder confidence, or steps down to make room for those that will. Shareholders should rightfully hold the seven returning directors responsible for continued deterioration of value, but would much rather wish to have a strong case to vote for the reelection of directors.

I appreciate the time you have afforded me and I look forward to your response on these important matters.

Regards,

H. Kevin Byun

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.