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Click here for Part IV

Sardar Biglari - A Wolf in Sheep's Clothing?

Sardar Biglari burst onto the investment scene in 2008 with his successful proxy fight for The Steak n Shake Company. While only 35 years old, he has assembled an outstanding investment record over the past sixteen years that is largely unknown and unappreciated. Biglari Holdings, Inc (NYSE:BH): Sardar Biglari - Bet The Jockey is a series of eight articles to investigate Biglari's investment results since inception, the strategies he has used to achieve these results, analyze his concentrated investment decisions and the likelihood that he can achieve outlier status and outperform the market over the long term.

Sardar Biglari has been viewed by some in the investment community as a controversial figure and Part V in this series investigates these issues in some detail.

The Coronation

Sardar Biglari was quickly becoming a rising investment star with his successful Friendly Ice Cream proxy fight, the rapid turnaround at Steak n Shake and his bid for Fremont InsuraCorp. His coming out party was at Steak n Shake's annual shareholder's meeting on April 8, 2010 at the tony St. Regis hotel in New York City. Over 100 shareholders attended the event including a number of high profile investors intrigued by Biglari's plan to harvest cash from the restaurant chain and redeploy it to other unrelated businesses or investments. Several recent stories in the media had compared Biglari to a young Warren Buffett and he drew a warm reception from the annual meeting crowd. Biglari quickly dispensed with the formal business portion of the meeting and spent the next five hours answering shareholder's questions. Investors wanted to know his strategy, his formula, his secret sauce and Biglari seemed to relish the attention.

Biglari was a disciple of Warren Buffett's value investment style and he copied many of Buffett's trademarks including a disdain for employee stock options and restricted stock, folksy annual letters to shareholders, interest in the insurance business and communications with the media and shareholders limited to the annual meeting. Early investors in Warren Buffett's Berkshire Hathaway Inc. turned a $2,000 investment in 1967 into $12 million by 2010 and many in the audience that day felt they had discovered the next Warren Buffett. Steak n Shake closed up $6.75 at $402.05 the day of the annual meeting representing a 218% increase from when Biglari took over as Chairman in June 2008.

The warm glow of the comparison to Warren Buffett would be short lived.

A Wolf in Sheep's Clothing?

While the investment community was premature with the hype and comparison to Warren Buffett, Biglari indirectly cultivated the image through his public comments and actions. In a 1996 letter to Berkshire Hathaway shareholders, Warren Buffett famously wrote, "We are here to make money with you, not off you." In a 2008 letter to Steak n Shake shareholders during the contentious proxy fight, Sardar Biglari parroted Buffett, "Not only will I refuse extra remuneration for the time I intend to commit, but I also will not accept any stock options. The reason is simple: We are one of the largest shareholders; thus, we plan to make money with you, not off you." Biglari's salary when he was hired as Chief Executive at Steak n Shake in 2008 was set at $280,000. He did not have a bonus plan, stock options or grants. Many shareholders believed Biglari's goal, much like Buffett, was to build personal wealth through the increase in the company's stock price versus personal compensation from the company.

On June 19, 2009, Steak n Shake's Board of Directors voted unanimously to increase Biglari's salary to $900,000 per year in recognition of the company's improved financial performance and his strong leadership in the turnaround. The Board noted that Biglari continued to hold a significant investment in the company through his related entities ensuring that his interests were closely aligned with shareholders. The new salary was less than the restaurant peer group average and comparable to previous executive officers at the company.

With Biglari now fully in charge, the Board realized that three rather complicated corporate governance issues had to be quickly resolved. First, significant potential conflicts of interest existed through Biglari's position and ownership in Western Sizzlin. How would he allocate his time? How would he ensure one chain was not favored over the other? The Board had seen firsthand how this issue was not properly managed at Friendly Ice Cream and wanted to eliminate any potential conflict of interest at all costs.

The second issue pertained to Biglari's ownership and management of Biglari Capital Corporation and The Lion Fund. Because of Biglari's dual role in managing investments for a public company as well as a private fund, the Board was concerned that he would favor The Lion Fund when he purchased interests in other public companies. While the Board felt it was critical for Biglari to focus exclusively on the long-term interests of Steak n Shake, the objective was complicated by the significant personal compensation Biglari realized from managing the fund. The lucrative pay package provided for a management fee on total assets under management, as well as the opportunity to earn 25% of any return in excess of 5% in a given year.

The final challenge facing the Board was Biglari's relatively small ownership position in the company. While he had been the driving force behind the turnaround at Steak n Shake and was responsible for all major operating, investment and capital allocation decisions, the fact of the matter was that Biglari was still a very young man and had not built up a meaningful ownership position in the company. He directly only owned one share of Steak n Shake stock in addition to his personal holdings in The Lion Fund, which were largely invested in the company (per Biglari Holdings, Inc. 2010 10 K report, Sardar Biglari and related interests held $2.1 million in The Lion Fund as of September 29, 2010. Biglari held over 90% of this amount).

Believing that the services of Sardar Biglari were critical to Steak n Shake's long-term success, the Board set out on a plan to consolidate Biglari's various related entities and to develop a compensation plan that would allow him to earn a material ownership position in the company over time.

Western Sizzlin Acquisition

In August 2009, Steak n Shake announced a formal agreement to acquire Western Sizzlin Corporation. Under terms of the deal, Steak n Shake would pay Western Sizzlin shareholders $22.9 million in the form of a subordinated debenture, bearing interest at 14 per cent per annum, as well as a special dividend in the form of 1,322,806 shares of Steak n Shake stock owned by Western, totaling $15.9 million. The deal was negotiated between special committees consisting entirely of independent directors of the Boards of Directors of both companies.

Duff & Phelps, LLC acted as the financial advisor to the special committee of the Steak n Shake Board of Directors in connection with the merger and provided an opinion of fairness on the transaction. The company concluded a range of value for Western Sizzlin was $11.30 to $13.10 per share. The announced buyout agreement was for a total of $38.8 million, or $13.67.

The purchase price was estimated to be approximately 10-12 times Western Sizzlin's adjusted free cash flow estimate. While shareholders were being asked to pay a higher multiple than Biglari's typical investment hurdle rate, the buyout price represented just a 7.2% premium from the previous day's closing price. Some analysts suggested self-dealing and that the transaction was overly generous to Biglari, but shareholder's reaction to the buyout was muted with Steak n Shake shares dropping just 1.7 percent on the day of the announcement.

Biglari Capital Corporation Acquisition

On April 30, 2010, Steak n Shake announced the acquisition of Biglari's investment company, Biglari Capital Corporation, which was the general partner in The Lion Fund LP. The purchase price was $1 plus an amount equal to Biglari's capital base, estimated to be $4.175 million. The buyout was contingent upon shareholder approval of a new compensation package for Sardar Biglari consisting of a $900,000 annual salary as well as the opportunity to receive annual incentive compensation payments based on the company's book value growth each fiscal year. If the company exceeded a 5% annual book value growth hurdle, Biglari would receive an incentive bonus payment of 25% of the company's book value in excess of the hurdle. The agreement also provided a "high water mark," where by in a fiscal year in which book value declines, the marker for subsequent fiscal years would require the complete recovery of the deficit from the last high water mark plus attaining the stated 5% hurdle rate before Biglari would be eligible for a bonus. In essence the compensation plan was a hedge fund incentive type arrangement within a public company.

The compensation agreement also provided that Biglari must use an amount equal to at least 30% of his annual pre-tax incentive compensation to purchase shares of the company's stock in the open market within 120 days of receipt of the payment. This represented approximately 50% of his after-tax incentive compensation. Biglari would be required to hold the shares for a minimum of three years.

Investor reaction to the compensation plan was immediate and overwhelmingly negative. An editorial in the Indianapolis Business Journal claimed the plan was a pure bait and switch, "It wasn't long ago that Mr. Biglari sang a different tune on compensation to win the hearts of Steak n Shake shareholders and gain a seat on the company's Board. The proposed compensation arrangement, applied retroactively to prior Steak n Shake management would increase the very rewards Mr. Biglari claimed, at the time, were excessive in light of management's poor performance and value destruction." Negative reaction to the pay arrangement contributed to a swoon in Steak n Shake's shares, with the stock dropping 26%.

Biglari responded to the decline by buying large blocks of the company's stock through The Lion Fund. When those funds were depleted, Biglari arranged for Steak n Shake to invest a total of $35.7 million cash in The Lion Fund, which was then used to purchase additional shares in Steak n Shake. Jonathan Moreland, founder of InsiderInsights.com was quoted at the time, "On its face, the buys would suggest Biglari believes the company's shares are oversold because of the controversial compensation plan, but I would not read too much significance into this buying given the incestuous relationship between the individuals and entities." One large shareholder speculated that Biglari was snapping up more shares to ensure he could have enough votes to approve his pay package. Other shareholders voiced frustration that Biglari had created the compensation controversy driving down the price of the stock, and now he was benefiting by purchasing shares in the company at a reduced price.

Biglari attempted to defend the pay package in a letter to Biglari Holdings shareholders by detailing what he was personally sacrificing to the company and what he would gain from the compensation system. To illustrate what he was giving up, Biglari provided an example assuming The Lion Fund had $50 million in assets and generated a 25% return. Biglari Holdings, through its ownership of Biglari Capital, would earn a $2.5 million incentive fee that previously would have gone to Biglari personally. What he was receiving was a variable compensation arrangement that would only pay out if he succeeded in growing book value. A significant portion of the incentive fee would be reinvested back into the company to align his interests with shareholders.

The compensation debate raged on throughout the summer and the company postponed the initial meeting in which shareholders were set to vote on the controversial pay package. Finally, to address shareholder concerns, the company scaled back the amount payable under the compensation agreement by a) increasing the hurdle rate from 5% to 6% b) capping the maximum amount of the incentive payment in any fiscal year at $10 million and c) requiring that any material amendment to the incentive agreement must be approved by shareholders. Shareholders approved the pay plan on November 5, 2010

Unfortunately for Biglari, the damage was done. Warren Buffett had famously worked for a salary of $100,000 per year. Biglari now stood to earn millions. Bullet point #1 in Buffett's Owner Manual reads in part, "Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner/partners, and of ourselves as managing partners." Biglari Holdings' shareholders were no longer feeling like owner/partners.

The comparisons to Buffett continued, but unfortunately Biglari was being cast in a different light. His efforts to mimic his investment idol now seemed to many as self-serving and nothing more than an attempt to enhance his image. Specific actions that gained notice included:

  • In December 2009, Biglari implemented a 20 for 1 reverse stock split that sent the company's shares from $13 to $260. He later announced plans for a 15 to 1 reverse split that would have increased the company's share price to $7,000. Investors cried foul over the proposed second reverse split and plans were put on hold. Biglari indicated that the reverse splits were to weed out short-term investors, "We will continue to strive to avidly excite the attention of blue chip shareholders who are unfazed by near-term fluctuations in our stock by the vagaries of the stock market. Such investors are placing confidence in us and, like us, judge performance on the basis of long-term value creation." Critics felt the reverse splits unfairly cut out small investors and were a short cut to mimic Berkshire Hathaway's high share price.
  • In January 2010 Steak n Shake announced plans to change its corporate name to Biglari Holdings and reserved the trading symbol BH. Biglari claimed the change would reflect its new direction as a diversified holding company and would eliminate confusion among the activities of the holding company and those of its subsidiary, Steak n Shake, "The critical point is that we could in one particular moment derive most of our earnings from one industry, such as restaurants, and then with a single large acquisition begin to derive most of our earnings from a different industry." Critics felt the name change was an arrogant act given Biglari's relatively small ownership position in the company and that the BH trading symbol was conveniently too similar to Berkshire Hathaway, Inc. Biglari defended the name change by comparing himself to, "a painter doing his masterwork. An artist, after all, always signs his work."

Other Biglari actions that raised shareholder ire included:

  • Biglari arranged to have his picture installed in the lobby of every Steak n Shake restaurant. Some shareholders viewed this as an act of self-promotion.
  • In April 2011, Biglari Holdings proposed to recapitalize the company through the creation of a dual class stock structure. The company planned to designate all existing common stock as Class A shares and issue ten Class B shares through a pro-rata dividend for each Class A share outstanding. Class B shares would be entitled to one-one hundredth (1/100) of one vote per share and economic rights equivalent to one-fifth (1/5) of Class A shares. Biglari claimed that the new B shares would provide better liquidity for shareholders and allow the company to gain increased flexibility in structuring and financing acquisitions. The proposal proved confusing to shareholders who were concerned the plan would enable Biglari to buy voting control of the company on the cheap. The company later pulled the plan realizing they did not have shareholder support.
  • Biglari reintroduced the A Share/B Share stock plan to be voted on at a special shareholders meeting in November 2012. The company once again postponed the meeting realizing they did not have shareholder support.

Rather than the second coming of Warren Buffett, investors were now debating if Biglari was nothing more than a Buffett copycat attempting to cash in on his new found fame at their expense.

Undeterred by the controversy, Biglari moved on to his next investment target, Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL).

Source: Biglari Holdings, Inc: Sardar Biglari - Bet The Jockey Part V