Today I’m adding Western Sizzilin Corp (WEST) to the Small Cap Values Portfolio. This one is a little different than other companies as they’ve recently agreed to be acquired by Steak n Shake (SNS). So let’s start the story in San Antonio, Texas, with one Sardar Biglari, Chairman and CEO of Steak n Shake AND Western Sizzilin.
Who is Sardar Biglari? Well Mr. Biglari is a hedge fund manager who is 32 years old this month. He’s run The Lion Fund since 2000 when he sold an Internet business and invested the proceeds in a fashion similar to Warren Buffett. He runs what appears to be a concentrated portfolio, which as of 12/31/08, consisted of 44% WEST, 22% SNS, 12% DHIL (another SCV Portfolio holding), 9% Berkshire Hathaway, and 8% Idexx Labs, among others. WEST is an 85% owner in Western Acquisitions, which owns a bunch of SNS shares.
Wait a minute, this guy’s the CEO of both companies and runs a hedge fund which owns a huge position in both SNS and WEST, and now SNS is acquiring WEST? Can’t that be construed as self-dealing? well yes. And that’s why I’m buying WEST.
Mr. Biglari first took over WEST in a proxy fight. He then took WEST’s capital to acquire shares in Friendly’s Ice Cream (FRN). Before he could take the company over, another fund came in with an all cash offer for FRN, and he agreed to sell his shares and drop the take over attempt. He took the cash from that and bought shares in SNS. Each share of WEST actually owns ~.47 shares of SNS, along with some other things, like some land in San Antonio, some shares in ITEX, an interest in Mustang Capital, and oh yeah, a restaurant chain called Western Sizzilin.
So why the merger and why WEST? Well, the merger is just a way to consolidate Biglari’s empire, with the added benefit of reducing some duplicate public company costs. Unfortunately we have very little in the way of details yet, other than a press release. But as part of the merger, the SNS shares that WEST owns will be distributed to WEST shareholders (about $4.75 worth fo SNS for each WEST share at SNS’s $10.10 close). In addition, WEST shareholders will receive $8.11 worth of SNS debt paying 14% interest. This debt is callable after 1 year and due in 5 years. So buying WEST is really buying 2/3 SNS debt paying 14% per year and 1/3 shares of SNS.
I think the 14% SNS debt is a great deal, and here’s where the self-dealing comes into play. Not only is Mr. Biglari going to be the largest holder of this debt through his fund (he’s going to own about 1/3 of of it), he’s also going to be the CEO of the company that issues it. So you can bet that there is almost zero chance that this debt would ever default. And since he owns the debt, there is little chance that he’s going to call it after 1 year, because 14% is pretty nice when you’re a hedge fund manager taking 25% of profits as he is.
So what about SNS, should you hedge the SNS by shorting .47 shares of SNS for each share of WEST you’re long? While I can definitely see the appeal in this, I don’t think it’s necessary. I don’t mind owning SNS, I actually think Mr. Biglari could be the next Buffett, and I’ll gladly own shares in his $300m company on its way to Buffett’s $150billion empire. Who knows if this will be the case, but there is definitely a chance, he says the right things and so far has done the right things…
So a little background on Steak n Shake. Due to compensation practices that rewarded growth more than profits, SNS was mis-managed by opening more stores for the sake of getting bigger. Biglari saw this and decided he would put a stop to it. He managed to get the original founders of SNS to be a part of his director slate and won a proxy fight replacing the prior management.
So what’s happened since he took over? Well, he’s stopped the unprofitable growth, closed underperforming stores, and managed to get both traffic and sales to increase during the Great Recession. He’s done some Sale-Leasebacks of company owned locations, paid off all long term debt (the company only has $13m in revolving debt above their lease commitments). And the board gave him a nice raise to $900k from $265k (ok, so maybe he’s not just like Buffett, but he did forgo any bonus or stock options).
Steak n Shake has recently converted into a holding company meaning he’s going to be using the cash flow SNS generates to make other investments. So while I’m not entirely sure what SNS is worth, I do know that 1.) they own buildings and land for over 150 stores. The sale/leasebacks he did recently averaged about $1.5m per location. So this gives me $225m in value. That means the rest of the stuff in the stores, the brand, and the ongoing operations, are only valued at about $45m after deducting the $25m in net cash they have. Alternatively, the company generated about $40m in annualized EBITDA over the first 3 quarters of the year, which means it’s trading at about 6x-7x Ev/EBITDA. So I think SNS is cheap, and I’ll gladly own it. But I’m not going to pass up the opportunity to earn 14% per year on the debt, hopefully for 5 years, but for at least 1.
Disclosure: Long WEST.Please see full disclaimer.
Tags: Steak n Shake, Western Sizzilin
