By Greg Ruel, Senior Research Associate
As Cracker Barrel Old Country Store (NASDAQ:CBRL) prepares for its November 15 annual meeting, its largest shareholder is waging war over two board seats. This marks consecutive years that Biglari Holdings, owner of family dining chain Steak 'n Shake and led by chairman and CEO Sardar Biglari, is mounting a proxy contest. GMI Ratings scores Cracker Barrel a "C" on long-term sustainability risk, with more than half its flagged metrics pertaining to issues with ownership and control as well as board and compensation concerns. In fact, Mr. Biglari's concerns about the company are step in step with why GMI Ratings considers Cracker Barrel to be averagely run.
On Oct 4, Cracker Barrel's President and CEO Sandra Cochran said in a letter to shareholders that "despite being rejected by a significant margin last year, Mr. Biglari has not only chosen to re-fight the same battle to elect himself, but has also nominated his company's vice chairman, Phil Cooley, for election, without providing any specific plans or proposals for the Cracker Barrel business". She added, "We believe Mr. Biglari and Mr. Cooley are wrong for Cracker Barrel's Board and their election could jeopardize the powerful momentum we have built in the past year."
Most recently on October 18, Ms. Cochran stepped up her opposition to the proxy contest, describing the campaign in a letter to shareholders as "inexplicable" given the appointment of seven new directors in the past 18 months. However, none of those new directors is named Sardar Biglari, and that's and that's the main issue of contention for the company's largest shareholder, whose ego has been widely reported.
Cracker Barrel's recent performance has been exceptional. In its October 4 letter, Ms. Cochran notes the announcement of the company's "six strategic priorities" on September 13, 2011 as a recent turning point in its success. The company notes a 68.4 percent appreciation in stock price through September 28, 2012, in addition to a 100 percent increase in its quarterly dividend and successful continuation of its share buyback program. The same day, Mr. Biglari issued his own letter to shareholders, appealing to shareholders by criticizing the board for a lack of stock ownership in addition to accusing the company of failing to perform to potential. Mr. Biglari cited "chronic underperformance and excessive spending as reasons to bring in a new face", according to the Wall Street Journal.
During last year's proxy contest, in a September 2011 letter to shareholders, Mr. Biglari stated that "top leadership has shaped a culture that lacks, inter alia, accountability, transparency, and stock ownership", further stating that the board has "failed to perform up to the company's potential." He further criticizes a lack of stock ownership by directors, stating "I have invested about $100 million in the stock of Cracker Barrel whereas the entire Board since 2003 has spent a total of $251,600 in purchasing stock in the open market". In addition, Mr. Biglari criticizes the company's reporting, which he describes as the minimum according to Generally Accepted Accounting Principles (GAAP). Specifically, he cited a "failure to disclose operating segments for both the restaurant and the retail operations of the business" in 2011.
Mr. Biglari owned 9.3 percent of outstanding shares when mounting his unsuccessful proxy battle in 2011. Since the start of 2012, he has made 20 additional purchases of Cracker Barrel stock on the open market- acquiring more than 1.8 million additional shares and nearly doubling his company holdings to a current 17.3 percent. Biglari Holdings issued a press release on September 25 targeting shareholders which stated, "we believe that some positive changes implemented by the company would not have occurred without our involvement." Mr. Biglari mentions separating the roles of CEO and chair, appointing a new independent director, pursuing retail royalties through licensing, increasing transparency, and returning cash to shareholders as positive changes first initiated by his holding company.
Cracker Barrel's management has sincere doubts about Mr. Biglari's board involvement, characterizing his previous takeover of Steak 'n Shake as a "history of creeping control" and accusing him of sidestepping a premium he should have had to pay to Steak 'n Shake shareholders. Ms. Cochran believes Mr. Biglari is attempting to gain creeping control of Cracker Barrel as well. Furthermore, she has questioned his ability to stand as a contributing board member, citing "poor governance tactics" at his own company that includes "an uncapped compensation scheme for himself, a deal similar to the profit-sharing compensation plans often used at hedge funds and private equity investment firms, even though he runs a publicly traded restaurant holding company." It's also worth noting that while Mr. Biglari wants credit for separating the chairman and CEO of Cracker Barrel, he does serve in these joint roles at his own company; in essence telling the company to do as he says and not as he does.
Remarkably, it was Cracker Barrel's biography for its most recently elected chairman that has served as the running platform for Mr. Biglari in 2012. Up against a soaring stock price, the Biglari Holdings owner unearthed a proxy error in the biography for James Bradford, who is to become Cracker Barrel's chair on November 7 when current chairman Michael Woodhouse retires. The error concerns the representation of Mr. Bradford's prior executive experience. Cracker Barrel's proxy statement originally referred to Mr. Bradford as a former CEO of an NYSE company while at AFG Industries Inc. In fact, the company was listed on the exchange during a portion of the time he served as General Counsel but not when he was CEO. Mr. Biglari demanded an immediate response from the company, who answered with a next day mea culpa and expressed regret over any misunderstanding; but not without also questioning the motives of Mr. Biglari, adding that "the accusations and innuendo in Mr. Biglari's letter represent a continuation of his contentious rhetoric. We urge shareholders not to be distracted by Mr. Biglari's proxy fight and instead focus on the company's business and strong operating results."
Aside from Mr. Biglari's "gotcha" moment, he does have some valid concerns regarding Cracker Barrel's strong results. In an October letter to shareholders, Mr. Biglari turns a September 2011 statement from Ms. Cochran on its head. He cites her quote, "our major priorities for 2012 are focused on increasing customer traffic, growing retail sales as a percent of total sales, and controlling costs", before explaining that the company ultimately failed in these objectives. He explains rising profits as temporary in the face of expansion, stating "new stores have been opened, shrouding the decrease in unit profit because overall profits are maintained through new openings." Mr. Biglari also compares the company's Operating Income in fiscal 1998, $164.9 million with 357 stores ($462,000 of operating income per store) to 2012, operating income of $181.3 million with 616 stores (or $294,000 of operating income per store).
Cracker Barrel has also failed in its attempts to further insulate the company from shareholders acquiring large amounts of stock. On September 22, 2011 the board adopted a poison pill, "in response to Biglari Holdings' clearance under the HSR Act to acquire up to 49.99% of our outstanding common stock". The poison pill served to impose a significant penalty upon any person or group acquiring 10 percent or more of the company's stock without getting board approval. However, the pill expired at the 2011 annual meeting when shareholders voted just 28 percent in favor of the takeover defense mechanism. In April 2012, the board adopted a poison pill with a 20 percent triggering threshold that will expire if not approved by shareholders in November. GMI Ratings currently flags Cracker Barrel for multiple ownership and control flags including plurality voting for directors, lack of shareholder rights to act by written consent, as well as its shareholder rights plan.
Mr. Biglari's assertion that directors are not invested in the company as exhibited by the stock ownership isn't entirely fair. After all, there have been seven new directors added in just the last 18 months, leaving little time to accrue stock ownership. It does seem fair to criticize the stock ownership of directors like Robert Dale, Martha Mitchell, Charles Jones, Jr. and B.F. Lowery. These four directors have an average tenure of more than 29 years on the board but own an average of only 14,206 shares a piece. However, Mr. Dale, Mr. Jones and Mr. Lowery are among the four directors who are not standing for re-election to the board.
In addition, while director Glenn Davenport and incoming chairman Mr. Bradford have purchased 2,000 and 1,000 shares, respectively, on the open market, there have been far more recent sales by directors than purchases. For instance over the last two fiscal years, director Robert Hilton has sold 92,046 shares for a profit of nearly $4.8 million, Mr. Jones has sold 50,624 shares for $2.9 million and Mr. Lowery has sold 17,597 shares for a profit of more than $1 million. It's certainly fair of Mr. Biglari to question the stock ownership levels and lack of open-market purchases for these long-time directors.
Ultimately, there are issues working against Mr. Biglari's quest to join Cracker Barrel's board beyond its climbing stock price. On September 25, he was assessed a fine of $850,000 by the Department of Justice for failure to report a significant acquisition stake in Cracker Barrel to the U.S. antitrust authorities. According to Federal Trade Commission, Mr. Biglari claimed the share purchases were a "passive" investment when his true intention was to become involved in Cracker Barrel's management. Also working against him is the fact that the company has listened to his concerns and made prudent attempts to address them, aside from appointing him to the board of course. The four directors that Mr. Biglari wanted off the board are not standing for re-election. The company also offered him two board seats as he desires, with the caveat that the directors are not Mr. Biglari or Philip Cooley, who serves as vice chairman of Biglari Holdings.
Mr. Biglari wants more credit than he is receiving and on multiple fronts. In his letter to shareholders, he points out how he has brought positive change to executive pay at the company. Mr. Biglari believes it was his call for "clear, unambiguous, and detailed rationale for compensation programs" that resulted in "additional clarity and a performance matrix" for 2012 executive compensation programs after a Say on Pay vote in 2011 that saw 32.2 percent of shareholders voting against the plan.
Furthermore, he takes credit for the company's branching out into merchandising through grocery stores and feels Cracker Barrel took the idea from him only after first dismissing it as "exotic" and unable to "produce the immediate 'return on effort'". Mr. Biglari cites his long belief that licensing would be accretive to the value of the company, adding "It appears that the Board now agrees" and "The company rejected our ideas outright, yet through its own actions displayed how we have added value by ultimately adopting our ideas."
Given Mr. Biglari's increased ownership stake over the past year, we would not be at all surprised to see an increase in withhold votes for directors over last year, when nearly all directors received withhold votes around 13 percent. There could be a spike in Say on Pay as well, perhaps to the point of failing, as the activist investor continues to accrue stock and increase his voting rights. He describes additional improvement in compensation policy as "absolutely essential."
Despite some very legitimate concerns, it's unlikely that Mr. Biglari's attempt to gain a board seat will be any more fruitful this year than last. In addition to increasing his demands over last year by asking for a seat for his vice chairman, he is asking shareholders to rock the boat at a time of strong company growth. It's clear the CEO does not want him there and it's likely he has voted against most of the directors he hopes to join as peers.
While Mr. Biglari may indeed have some good ideas for Cracker Barrel's long-term future, his motives are not above reproach and present an understandable concern for shareholders. Ms. Cochran has stated the company believes his "true intentions may be to take control of Cracker Barrel without paying shareholders a premium", and points to Steak 'n Shake as a specific example of his carrying out such a scheme in the past. She describes him as someone "without tangible ideas or suggestions", though Mr. Biglari claims in his letter to shareholders to have already played a significant role in improving the company. Ultimately, it will be up to shareholders to decide if Mr. Biglari adds something to the board that it presently lacks, though they must also be willing to accept what his considerable influence could mean for company ownership in the future. This isn't a struggling company in need of a turnaround like Steak 'n Shake, but there is no doubt that it can be improved.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.