Buying 'Em Back at Western Sizzlin'

A great, but not surprising, piece of information was released on Thursday regarding Western Sizzlin’ (WEST): share buyback authorization.

The 8-k filed on Thursday by the company tells us that Western Sizzlin’ has authorized Biglari to buy back up to 500,000 shares.  Doesn’t sound like much, until you consider that the company only has a total of 2,700,000 shares outstanding.

What does this mean?  With Western Sizzlin’ trading at an appreciable discount to its intrinsic value, Biglari can purchase up to 18.5% of the company, and I expect he will do just that as the opportunity arises.

He won’t be able to move quickly, however.  WEST is still an extremely thinly traded stock right now.  Even with its recent addition to NASDAQ, a mere 520 shares traded on Thursday.  Average volume is only around 1,000 shares/day.

The hope is that Biglari will be able to find block purchases at advantageous prices now and into the foreseeable the future, but with the illiquidity of the stock as it currently stands, I wouldn’t expect him to be able to swiftly purchase 500,000 shares. At current prices, the program will cost Biglari around $6.5mm, a number that will only rise over time as WEST appreciates.

Overall, though, this is a big positive for Western Sizzlin’ shareholders.

Why Do Buybacks Make Sense?

If I own a company, then by definition, I believe it to be trading at a discount to its intrinsic business value.  Otherwise, I wouldn’t own it.  Now, except for extraordinary circumstances, I’m also buying into companies with strong, healthy balance sheets and strong, healthy cash flows.

The only reason a company should be repurchasing its own shares is if they believe them to be a highly attractive use of capital.  Essentially, they are increasing the ownership stake that all of the remaining shareholders retain.    These buybacks shouldn’t be done to offset dilution from stock options, increase earnings per share, or any other reason you often hear.  The only reason should be a steep undervaluation of the shares.

Let’s run a hypothetical to illustrate why this works, one I’m sure you’ve all seen before if you are experienced investors:

Let’s say I believe Company X is worth $1000 in enterprise value with 100 shares outstanding, or $10/share.   Company X currently trades for $5 a share, for a market cap of $500.

Now, with a redirection of free cash flow, the company buys back 30% of its shares at $5 a share,  leaving them with a total of 70 shares outstanding.  I still believe they are worth $1000 total, that much hasn’t changed.  However, that $1000 in value is now only spread over 70 shares, so the company is now worth $14.28/ share, without any operational improvement! 

Had Company X not bought their shares, and merely let that cash pile up, the company would have been worth slightly more than $10. The $5 x 30 shares, or $150, would have added to the enterprise value of the company, bringing the total to $1,150 on 100 shares outstanding, or $11.50 a share.  Our value after the buyback, $14.28, is still much higher.

Given the two highly likely and/or necessary conditions for me to purchase a piece of a company that I mentioned above, wouldn’t I naturally want that company to be buying its own shares back?  If I’m allocating capital to the business, I generally believe the company should be doing so as well.  It’s a logical corollary.  Unless I believe that company has a very high internal reinvestment rate in its operating business, share repurchases usually make sense for companies I own.

There’s a reason why intelligent value investors are often pressing companies to buy back their own shares, and it is due to the above rationale.  Take, for example, Eddie Lampert’s work at Autozone (AZO) in the late 90’s and early 00’s.  As soon as he was elected as a director, he pushed hard for AZO to buy its own shares back with free cash flow.  To see how this worked out, again, check the numbers:

From 1998 - 2007, net income at Autozone went from about $225million to now just over $600 million, an increase of about 2.7x, or 170%. Certainly a respectable improvement in operating performance. What else happened?

In 1998, Autozone had 154 million shares outstanding.  Today, that number stands at 69 million. Look at the stock price: shares that were once around $30 in 1998 are now bouncing around near $120, a 4 four fold increase, or 300%.  Likewise, earnings per share went from $1.48 in 1998 to a whopping $8.82 in the trailing 12 month period! That’s a five-fold increase. Investors profited 300% even though earnings only grew 170% and their trailing PE ratio compressed over time.

The share buyback provides the difference. By pressing Autozone to allocate capital to an undervalued asset, its own shares, Lampert created an immense amount of shareholder value at Autozone above and beyond the improvements in its operating businesses. Indeed, Mr. Lampert is doing just that at Sears (SHLD) today.

Biglari now has an opportunity to do the same at Western Sizzlin’ and, I might add, at Steak N Shake (SNS) as well.  While I expect the businesses to improve over time at WEST and SNS under the leadership of Biglari, share repurchases at these levels will create value for shareholders above and beyond operational improvements.

Comments

[UncleLongHair]

What is WEST's intrinsic value, and why do you believe it is trading at a discount? The current share price is $12.85. Over the past two years, Biglari sold shares of WEST in rights offerings at split-adjusted prices of $14 and $17. Meanwhile, WEST's largest investment, SNS, which accounts for about 60% of WEST's book value, has declined by 50%. I think it's hard to make the case that WEST's intrinsic value has increased since the rights offering, in fact it has probably declined. Why would Biglari buy back shares that is issued only a year or two ago?

[Jeff - CoC]

Hi,

I'll point you to a previous post I made on WEST, where I outline my thoughts on the entire company and why it's underpriced.

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