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Recently, after heated attacks by both Cracker Barrel (NASDAQ:CBRL) and Biglari Holdings (NYSE:BH), Cracker Barrel shareholders voted to side with their Board, rejecting Sardar Biglari's recommendations. Ultimately this was a fight for two board seats - Biglari wanted a board seat for himself and his comrade, Phil Cooley. It turned out to be quite a battle - we all know who won, at least superficially, (Cracker Barrel's board). This article reexamines this war in hindsight. Also, in light of the results of this proxy contest, are CBRL shares a buy, sell, or hold?

The Background: Cracker Barrel vs. Biglari Holdings

Cracker Barrel's board, through open letters to all shareholders, engaged in a heated conversation with Biglari Holdings, also its largest shareholder with a 17% stake. The (very condensed) timeline appears as follows:

October 11 - Biglari Holdings sends letter to CBRL, questioning Chairman James Bradford's qualifications. CBRL had written in its regulatory filings that Bradford had previously been CEO of a New York Stock Exchange company, when this was not the case.

CBRL largely ignored and minimized this fact, offering a terse apology. No other action resulted from this.

October 18 - Sandra Cochran, CBRL CEO, sends letter to shareholders questioning Biglari's qualifications.

Cochran raised the following issues:

  • "Creeping takeover". Cochran cited two Biglari comments from previous filings: "We, however, are control investors.," from an annual report; and "Biglari Holdings is a jockey stock. You are choosing the jockey; I am choosing the horses. It would be asinine to bet on the jockey and then deny him the saddle or whip."

Cochran also took issue with what she thought were contradictory actions by Biglari, specifically that he had said that he did not want control of CBRL, yet had launched multiple proxy fights and continued accumulating stock (presumably to facilitate acquiring control of the company).

  • History of Poor Corporate Governance by Biglari. Cochran cited Biglari Holdings two-class voting common stock structure, reverse stock split, and CEO compensation policy as exemplars of poor corporate governance, and another reason why Biglari should not be allowed to obtain control of CBRL.
  • Successful operations. Cochran also argued that, because CBRL has recently performed exceptionally, no changes of any sort were necessary.

October 25 - Biglari responded by public letter. In my opinion, this letter raises some interesting issues in this debate, because it questions the best way to operate the CBRL business.

The crux of BH's argument was that in the 2005-2012 period, CBRL's sales increased by $338 million, operating income increased $12 million, while the company spent a cumulative $696 million in capital expenditures during the period.


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Source: 10/25/2012 SC 13D/A of CBRL.

Cochran responded by claiming that, between 2004 and 2009, CBRL spent $382 million building 116 new stores which generated $62 million of EBITDA in 2011, amounting to a 16% EBITDA margin.

Biglari's response was that the EBITDA figure didn't include expenses such as SGA (selling, general, and administrative expenses).

After this, the mudslinging accelerated on both sides, with arguments about whether Biglari is an egomaniac, etc.: the end result was a lack of meaningful discussion about operational performance, and more about character attacks.

So Who Was Right?

Actually, I largely agree with Biglari on the operational points. Let's ignore the EBITDA calculation discussion, as it is largely irrelevant.

If one considers sales and capital expenditures. CBRL spends about $70-80 million per year on capital expenditures, except in 2005 when the chain spent $120 million. So the company spent about $600-700 million to increase sales by about $300 million.

This is a relatively poor use of capital, since CBRL currently has $2.5 billion of sales and a $1.5 billion market valuation. In other words, the company was investing $700 million of capital for $338 million (for a resulting price to sales ratio of more than 2) when the company currently trades a price to sales ratio of 0.6 ($1.5 billion market cap divided by $2.5 billion sales).

Even if one uses Cochran's number for capex during this period ($382 million for new stores, because Cochran's number presumably separates maintenance capital expenditures and newbuild capital expenditures), that's still a price to sales ratio of about 1.0 (382 million of capital expenditures for an additional incremental sales of $336 million). Cochran's number also is only from the 2004-2009 period, not the 2005-2012 period, which is more years and therefore would have a higher capex number).

So, even using management's numbers, by using capital to invest in stores rather than repurchasing stock, the company was paying, according to this metric, roughly double what they could have otherwise merely by repurchasing shares, assuming a constant price to sales ratio during this period.

However, although I may agree with BH's assertions about excessive capital spending at CBRL (not withstanding its recent run-up in stock price etc.), I largely agree with the CBRL board and its concern about creeping control by Biglari.

This is driven mostly by Biglari's history with Steak n Shake (now called Biglari holdings). Biglari took control of Steak n Shake, named the company after himself, although he personally owned much less of Steak n Shake than the 15% owned by the Lion Fund.

Source: 10/5/2012 BH 14A.


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The 14A shows that Biglari directly owns only 10,000 shares of BH (worth about $3.5 million), about 1% of the company, yet renamed the company after himself.

Biglari also, since taking over Steak n Shake, has substantially increased compensation to himself.

Source: Biglari Holdings' 3/16/2012 14A.
(Click to enlarge)

As you can see, soon after the 2009 takeover it may be that Biglari wanted to appease shareholders and convince them that he was "one of them", taking a low salary. Since then, his salary/benefits, including stock has risen ten fold. Even since 2010, his remuneration has more than doubled. Not bad, not bad at all.

Interestingly, Biglari's stake in Biglari Holdings appears especially small considering his largely increased remuneration.

Conclusion:

I suppose this sort of tooth and nails fight is what one would expect from two entrenched managements eking it out for more power. The sad conclusion is that the real losers from this contest are the Cracker Barrel shareholders (as small shareholders usually are), stuck with an inefficient and largely ineffective management team and lack of any palatable change on the horizon. The clear-cut winners are the CBRL management, retaining their positions and the benefits associated with them. As a result, CBRL shares seem to be a sell.

Source: War Is A Racket: The Battle Between Cracker Barrel And Biglari Holdings