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The Fyre Festival Of Capitalism

|About: Biglari Holdings Inc. (BH), BH.A

A good friend encouraged me to learn a little about Biglari Holdings and go to their annual meeting (which was last week). I owe him a beer because this was one of my favorite experiences I’ve ever had in corporate America. This company is quite interesting and its annual meeting was Netflix-worthy entertainment. As an example, the first questioner (or it may have been the second questioner) began their question by stating: “While the Berkshire Hathaway annual shareholders meeting is referred to as the ‘Woodstock of Capitalism’, shareholders have been referring to this meeting as the ‘Fyre Festival of Capitalism.’” And it only got more entertaining from there.

One shareholder asked if Steak n Shake would introduce “vegan hamburgers.” Another questioner asked for applause for the company’s management, a request which was greeted with awkward silence. One shareholder was displaying a copy of John Carreyrou’s Theranos book “Bad Blood” and was asking if people thought Biglari Holdings’ board was like Theranos’ board and if Sardar Biglari was like Elizabeth Holmes (and another shareholder then referenced this in a question).

My perception of Sardar Biglari’s attitude towards Biglari Holdings shareholders reminded me of John Updike’s great line about Ted Williams refusing to respond with a hat-tip to the pleading ovation of Red Sox fans after Williams’ home run in the last at-bat of his career: “Gods don’t answer letters.” This meeting made this point crystal clear: Sardar does not answer to shareholders, nor does he work for them. You [shareholder] want me [Sardar] to buy stock back to close what you perceive as a price-value gap, too bad, I’m not going to do it. If you are upset because the share price went down 58% last year and then the board increased my compensation, sell your shares in the company. If you have any questions about me [Sardar] earning something like $80 million over the previous few years while the market cap of the company is like $250 million, or the employment of Sardar’s family members for “consulting services”, or the company’s Netjets membership, or the opening of Biglari Café so Sardar can spend time in the Port of Saint-Tropez, or anything else for that matter – then sell your shares. If you wonder if he should be spending more time on Steak n Shake after a year in which it lost 7% of its customer-traffic and a three-year period in which it lost 12% of its business – and you have some doubt that his plan to install new milkshake machines (yes this is his turnaround plan) will succeed in stopping the bleeding – then you just don’t believe in his vision and you should sell your shares. If you bought your shares seven years ago and have a significantly negative return on them and suggest to Sardar that it would be great to get a positive return on them at some point, then you just don’t share the same time horizon as Sardar. If you wonder why he calls Biglari Holdings an acquirer but they have only ever done a couple of tiny deals and haven’t made an acquisition of any size in over five years, then you just don’t understand his “program of conglomeration.”

I’m not proud of myself for enjoying this so much, because I genuinely feel bad for many of the fellow shareholders I met (you have to be a shareholder to attend the meeting) – because they had no idea when they bought shares in this company that they would be treated to, perhaps, the worst corporate governance in America. Many managements probably revile their shareholders, but most of them do not publicly delight in doing so. Sardar Biglari and Phil Cooley, Chairman and Vice Chairman of Biglari Holdings, seem to delight in the annoyance of its shareholders. At one point laughing at them for being upset that the share price went down 58% last year and then subsequently watching the board increase Sardar’s compensation package. It is not my best-self that enjoyed this spectacle, it was more like the part of me that likes watching dragons fight dragons on Game of Thrones that was riveted by Sardar Biglari and Phil Cooley or the part of me that once saw two clowns get into a fist fight at a kid’s party in St. Petersburg and rather enjoyed it.

Anyway, I will post many of the questions and answers below – but with the caveat that shareholders are not allowed to record the meeting and it moves kind of fast at times – so some of these answers may not be verbatim accurate or even fully accurate at all. I believe they capture the gist of what was said by the questioners and by Sardar and Phil – by using the notes and memories of a number of shareholders – we believe we got a lot of the answers essentially verbatim – but we can’t be sure.

Here are the main highlights:

-Steak n Shake has closed more than 60 out of the company’s 415 stores so far this year and more closures are likely

-They are shrinking Steak n Shake

-Steak n Shake’s debt is due in 2021 and they have to get the operations of Steak n Shake figured out before then; the parent company [Biglari Holdings] will not guarantee the debt

-Steak n Shake lost -7% or so of its customer-traffic last year

-Sardar’s plan to turn it around involves inventing a new process to make milkshakes

-The new milkshake equipment and other Steak n Shake Capex will cost $100k or $40 million per store (and that is partly what the Cracker Barrel proceeds are going towards)

-The other main part of the turnaround plan is a franchise partner initiative, where they are turning over company-owned stores to franchise partners to run

-They currently have four franchise partners in place out of the company’s 415 stores at the beginning of the year (or 350 current stores it seems)

-Sardar said that Biglari Holdings or the Lion Fund are very unlikely to buyback Biglari Holdings shares any time in the near future (not for two or three years)

-Buying back shares would reduce the company’s size and optionality and he does not want to do that; he said he thinks there is a good chance that he can earn more with future investments than he can by buying the company’s shares back at or near current prices

-Sardar said that Steak n Shake’s turnaround is going to take a very long time

The bottom line to me is it seems that Steak n Shake’s problems have not abated – but probably have gotten worse in 2019. He refused to say how they were doing so far in 2019. He just said, “The turnaround is going to take a while.” That seems, to me, like Steak n Shake is struggling at the same level or worse in the first quarter – though one shareholder pointed out to me that it may be hard to get a feel from their next 10-Q because they have closed so many Steak n Shakes in 2019.

The other main takeaway is that shareholders basically kept pleading with Sardar to admit the stock was undervalued and he would buy it back because it is so cheap. Except that Sardar kept saying the opposite - saying that he would not be buying the shares back – at least for years. One shareholder questioner said the purpose of splitting the shares into two share classes was to have non-voting B shares to be able to use for acquisitions – but in this shareholder’s view the shares were so undervalued that he surely wouldn’t use them for an acquisition at these prices right? I felt bad because he really seemed to want Sardar to back him up on this but Sardar wouldn’t really do it. He said, no, we’re not going to buy shares to close what you feel is an intrinsic value gap on what is your timeframe to close that gap. This left me with the impression that he may use shares for acquisitions at these prices. The bottom line of this was that while many shareholders believe it is undervalued – it may not be. It may be overvalued. And if that is the case, then acquisitions with these shares at these prices are a definite possibility.

Phil Cooley is now, perhaps, my favorite nihilistic figure in corporate America. He is one of the great trolls I have ever seen. He seems to get a charge out of trolling shareholders at this meeting. When questioners challenged Sardar Biglari’s compensation, after all he has received something like $80 million from shareholders, meanwhile the entire market cap of the company is like $250 million (excluding shares the company owns of itself), and after a year in which the share price was down 58% - the board increased Sardar’s potential compensation further by removing a cap on his incentive payments – and Phil responded to all of this by telling shareholders that he believes Sardar and Biglari Holdings’ executive compensation is very generous to shareholders. That the board negotiated a great deal for shareholders.

Biglari Holdings Annual Meeting

April 2019

-Sardar Biglari was asked about Steak n Shake’s outstanding debt and noted that Steak n Shake’s debt is due in 2021 and they had to get Steak n Shake figured out and turned around by then. He noted that Steak n Shake’s lenders were in the crowd attending the meeting. He said that if he had wanted the parent company, Biglari Holdings itself, to guarantee Steak n Shake’s debt he would have done that, but he chose not to have Biglari Holdings guarantee Steak n Shake’s debt.

-Steak n Shake turnaround is going to take a very long time. There are not quick fixes for the problems they have.

-Sardar Biglari was asked a number of times about why he did not have the company buy shares back, or I guess it would technically be the Lion Fund (or just one of the Lion Funds, I’m not sure which) buy shares back after the company’s 58% share price decline during 2018. Mr. Biglari said, basically, we are not going to buy shares back in the near future. He doesn’t want to reduce their war chest. He said if you buy shares back you lose that money you spent on share repurchases – and you can’t generate future investment returns with that capital – it’s just gone. Mr. Biglari did say at some point they would take action if there is a significant price-to-value gap “but he is not in a hurry to do so.” He asked this numerous times, “Why no buybacks last year/this year so far?” And he just basically said, we’re not going to do that any time soon. I believe he then later said something like, “If there was a price-to-value gap in two or three years – we would maybe buy shares.” So he very much made it seem like buybacks, or Lion Fund Biglari Holdings share purchases, are not in the cards – at least for two or three years.

-When asked how Steak n Shake was doing in 2019, he said he was not going to disclose the first quarter numbers at the meeting. Sardar then immediately said something like, “I will say that Steak n Shake’s turnaround is going to take a long time.” This, to me, makes it seem like Steak n Shake’s 2018 trajectory – which featured major negative trends in both same store sales and customer traffic, -5.1% same store sales and -7% customer traffic.

-There were 20 Steak n Shake franchise closures in 2018 – which was roughly 10% of the franchised units at the start of the year (these are separate from the 60-plus company-owned Steak n Shake closures so far this year), when asked how many closures of franchised Steak n Shake units have there been so far in 2019 (again apart from the 60-plus company unit closures) – Sardar said he was not going to answer that. He said, the important number is the net opening/closing number

at the end of the year.

-When asked why they didn’t try to make these improvements they are now trying to make to turn Steak n Shake around in previous years, Sardar and Phil said because Steak n Shake was making money. Why change things when it is making money?

-Sardar said their plan is to shrink Steak n Shake and then to try to fix it.

-In just the first few months this year they have closed 60 company-owned Steak n Shakes, or 15% of the company-owned units so far in 2019, and then Sardar added “There have been 60 closures, so far”, implying that additional closures are or could be coming. He said they didn’t close company-owned stores for years – so even with all these closures now – their per annum closure rate since he has taken over is actually in line with competitors. The bottom line is it sounds like there are going to be more closures – potentially many more – though it is unclear from the meeting as to how many more closures there will be. Could it be over 100 closures when all is said and done? 150 closures total? It was not exactly clear.

-So after losing over 7% of their customers last year, 13% of its customers since 2015, and over three straight years of negative customer-traffic and same-store-sales numbers during which time Steak n Shake went from profitable to unprofitable, what is Sardar’s plan to turn around Steak n Shake? What he said at the meeting is that he has a plan to turnaround Steak n Shake and one of the main elements of it is fixing the milkshake making process – so they are creating a new milkshake making process. This is not a joke, this is what his plan is. They are also trying to make homemade ice cream at Steak n Shakes. They think this and other similar improvements is the crux of the turnaround plan (along with the franchise partner plan).

-The other part of his turnaround plan is a franchise partner plan based on Chick Fil A’s program in which potential restaurant operators without a lot of capital can become franchise partners at Steak n Shake. These franchise partners will turn around the company. For a $10,000 investment they can run a Steak n Shake. I’m not sure I have this right but the terms are interesting – the operator after paying their $10,000 will only become a franchise partner if they can get metrics like employee turnover and customer complaints to extremely low levels – that some shareholders were saying are unrealistic for most operators to reach – but if they hit those low levels they then become a franchise partner. Once they become a franchise partner, the terms of the deal are something like: The company (Steak n Shake/Biglari Holdings) will get a royalty of 15% of the revenue and then 50% of the profits after that. Many shareholders before, after and during the meeting were commenting on this not being such a hot deal for the operator – and the royalty seems intense – but I am not sure about that exactly. Anyway, this franchise partner program is the other main crux of the turnaround – along with the new milkshake process. There are currently four franchise partners in place – out of the company’s 415 stores at the start of the year, or I guess the 350 stores that are now operating after the most recent round of closures.

-One shareholder commented on how last year, his turnaround plan to fix Steak n Shake was thicker cheese and better bacon – but then they lost 7% of their customers in that year. And the year before his turnaround plan was a new menu launch, but that seemed to accelerate the customer-traffic and same-store-sales losses, or at least did not halt them. Why was this year’s turnaround plan – new milkshake processes and homemade ice cream – going to work when the last few did not? He said, because they have to get Steak n Shake turned around. He said he has been through uncertainty with businesses in the past and it has always worked out. He is comfortable with uncertainty. He said something like he doesn’t worry.

-They are going to spend about $100k per store on these milkshake making improvements – so about $40 million total of Capex to update the company-owned Steak n Shakes with the new milkshake making equipment and other improvements like that.

-So many shareholders were wondering what Sardar Biglari is spending the Cracker Barrel $200 million or so of sale proceeds that he has generated in the last few months by selling shares of Cracker Barrel on the open market. Some of those proceeds are going to fund Steak n Shake’s Capex – the $40 million milkshake machine improvements. I don’t know if he directly said that – but he talked about the $40 million required and at other points talked about the Cracker Barrel sales proceeds. Some of the proceeds went to paying down the $200 million debt associated with the Cracker Barrel position in the Lion Fund II, so they paid down the $200 million to $160 million and received a better interest rate. I believe he said some of the sales proceeds are going to taxes – and some went to loaning money to Fat Brands (Mr. Biglari recently loaned $20 million or so to Fatburger after he met Fatburger CEO Andy Wiederhorn and offered him a loan.) They also want some of the money just to increase their optionality in the future. So the Cracker Barrel proceeds are going towards taxes, paying down the loan, Steak n Shake Capex, some of the $20 million loan to Fatburger/Andy Wiederhorn and other minor investments, and to increase their optionality.

-Speaking of the loan to Fatburger, Mr. Biglari was asked about how that came about? Mr. Biglari said he met with Andy Wiederhorn recently (he actually said the fellow the runs Fatburger, so I’m assuming it is Mr. Wiederhorn) – and Mr. Biglari told him about the Lion Funds – and offered him a loan (or his companies a loan rather) and shortly thereafter Mr. Wiederhorn (or whoever the Fat CEO is) took him up on the offer. Mr. Cooley said, “[Mr. Wiederhorn] was very happy to lend from us, and we were happy to lend to him.” (Or something to that effect.)

-There were numerous questions about Sardar Biglari’s compensation. Shareholders pointed out that the share price was down 58% last year and yet he increased his compensation package and has this compensation package which many shareholders clearly think is unfair and outrageous. Sardar Biglari and Phil Cooley repeatedly said it is more than fair, it is a good deal for shareholders, the board has negotiated well for the shareholders of Biglari Holdings, that his compensation is market. I may be missing some of the finer details of these questions and answers – but the basic questions were, “You’ve made like $70 million in incentive compensation over the last few years, you have the company pay for Netjets membership for you, you hire your dad and brother for consulting services, you have the company have an office in Monaco, you had the company open a one-off café for you in the Port of Saint-Tropez called Biglari Café – and yet the whole market cap of the company was like $200 million at year-end. Shareholders have lost a lot of value on this over the last one year, five years, and even someone said like seven years and eight years. Basically, other than people who bought at Steak n Shakes low – just about everyone has lost on this – except Mr. Biglari has somehow received like $70 million in incentive compensation.” So he would be asked about his in various ways, and Mr. Biglari and Mr. Cooley simply said repeatedly that it is fair compensation, the board negotiated well, it is market rate. Mr. Cooley, I believe, at one point said, this generous to shareholders. It is literally like he is trolling their own shareholders.

Sardar at one point said, before my incentive kicks in – “the first 6% is on the house.” And the shareholder said something like, “Nothing is on the house at Biglari Holdings.”

-Sardar Biglari at one point said that Steak n Shake spends $1 million per year on cherries for milkshakes and that he would love to get rid of that $1 million. Three different shareholders pointed out, in conversations, how ridiculous that sentiment is. Decrying having to spend $1 million for cherries on milkshakes while spending $8.4 million on administrative expenses to manage the Lion Fund, spending lavishly on hiring his brother and father at Steak n Shake consultants, maintaining an office in Monaco, the company’s opening of Biglari Café on the Port of Saint-Tropez and the Netjets memberships that the company apparently pays for – anyway, given all of that, shareholders were pointing out that maybe there is a better way to save $1 million rather than eliminating cherries from Steak n Shake’s milkshakes.

-Mr. Biglari, I believe while discussing Cracker Barrel said something like, “We do not believe in external excuses or blaming external factors for lack of execution.” He said we do not blame external factors multiple times. In unrelated news, he said the 58% drop in Biglari Holdings share price was due to “technical trading issues.” He said that the drop, or the stock price of Biglari Holdings in general, says nothing about the company or him. After making the point that management should not make excuses or blame external factors, he also said they inherited an expensive labor cost structure at Steak n Shake, the tightest labor market in 50 years is hurting Steak n Shake, and increases in food costs is what has cost Steak n Shake profitability over the last few years. He then again made the point that it is management’s job not to make excuses or blame external factors. Then he said something like the quick service restaurant industry difficult industry and we were dealt a difficult hand – but we’ve played it well and the recent downturn was not due to our decisions over our time running Steak n Shake – what were we supposed to do when it was making money? Change it?

Mr. Biglari once more said that they do not blame external factors. Later, when asked why there was a price-to-value gap in Biglari Holdings stock price, he said, “IF there is a price-to-value gap, it is” due to a conglomerate discount. Conglomerates nearly always get discounted in the market.

-If I haven’t mentioned this, Phil Cooley is a world-class troll. I am so glad I know he exists. I feel like he may have a tattoo covering his entire back and snaking down his leg a little that just reads “zero [bleeps] given.” Again, I’m not sure if I have these quotes verbatim – but when asked about Sardar’s compensation – he would say “This is very generous for shareholders.” Or, “I think shareholders are very happy.” One asked about their reputation, given that their own shareholders vote against them apparently in extremely high numbers. A few shareholder questions listed out the exact voting numbers from last year’s board votes – and apparently 85% of shares that were not voted by Sardar and Phil were voted against Sardar and Phil for their own board. Obviously, it doesn’t matter since Sardar controls the company. And this shareholder said something like, I’m actually very glad you control the company – but the point is even your own shareholders have deep concerns about Sardar Biglari as evidenced by the fact that 85% of them voted against Sardar Biglari for the board of Biglari Holdings last year. The questioner asked, does this reflect well on Sardar Biglari or Biglari Holdings? And the world-class Phil Cooley said, “Our side won.” Someone actually yelled out, “That is exactly the attitude we are talking about.” And Phil said again something like, “We won control of this company, get over it.”

-Sardar Biglari was repeatedly was asked about the $8.4 million that Biglari Holdings pays to him (through Biglari Capital) to manage the Lion Fund – I’m not sure what he calls it an administration fee or something like that. He said repeatedly that it was not a management fee. He was asked about this a lot – and talked a lot sort of around this – saying it is not a management fee – So what is the fee for? He was asked repeatedly. Mr. Biglari would then say that it simply makes things easier for the company and for him to have this as a flat fee of $8.4 million per year rather than an alternative arrangement. He said this actually saves the company money this way. So then he was asked how it saves money, what is this fee actually for? And Sardar Biglari said, it is better this way – and said it was for “allocation issues.” When asked what this meant – what was the fee for? Mr. Biglari said, “It is for allocation issues” and “the board has perfect visibility into this.” He said this arrangement is better for the shareholders. A shareholder pointed out that the audit of the Lion Fund II costs like $50,000 or so, there was no full-time investment analysts in Biglari Capital and essentially just one administrative employee of Biglari Capital, and there were no proxy fights – so given all that what were the shareholders paying $8.4 million to Biglari Capital for? And Sardar Biglari said, “It is better for shareholders this way and the board has perfect visibility into it.” The questioner said something like, “the Board of Theranos had visibility into much of Elizabeth Holmes’ activities at Theranos but that didn’t save its investors.” And Mr. Biglari quipped something like, “That was a bloody comment.”

-The point is that I believe Mr. Biglari was asked this question more than any other question during the meeting – what is that $8.4 million that shareholders pay to him through Biglari Capital go for? And to me it seemed like none of the shareholders thought he answered it. I asked one of the shareholders who seemed like he understood a lot about this about why everyone was asking Mr. Biglari about this – and this shareholder said that Mr. Biglari simply does not want to tell shareholders what this $8.4 million is spent on – so that is why continued to be these questions with this weird circular question-answer pattern. Eventually Sardar said, “The board has visibility into this. If you want more than that, you want to see every record and receipt related to this, we are not going to provide that.”

-At other points in the meeting, Mr. Biglari was challenged on his compensation – apparently he raised his potential incentive compensation by removing a cap on it this year. A few shareholders were upset that he would raise his compensation after a year in which the stock was down 58% and in which company’s main operating unit, Steak n Shake, that Sardar Biglari runs, is bleeding out in the street – and despite these facts – the cap on Mr. Biglari’s incentive compensation was raised.

-Evidently, the proxy disclosed that Sardar Biglari employs his brother and his father at Steak n Shake for hundreds of thousands of dollars for “consulting services.” One shareholder asked Mr. Biglari about this – but I don’t really know Mr. Biglari’s answer was.

-A few questions were about how Mr. Biglari is considering changing the way Biglari Holdings is valued for purposes of calculating the value of the Lion Fund? I’m not sure how the shareholder knew this – but it surprised some people – that Mr. Biglari is considering using a metric other than market value for Biglari Holdings for purposes of the value of the Lion Fund’s portfolio. I did not fully get the answer to this – the shareholder was asking if this meant that he could get an incentive payment from the Lion Fund II even if Biglari Holdings share price goes down because the alternative valuation metric that Biglari would be using for the value of Biglari Holdings in that portfolio. I do not fully know about this but I believe that Mr. Biglari said this would not affect shareholders. That this alternative metric would not be used for incentive payments for the Lion Fund II. I’m not completely sure about the answers to this – but I believe there were at least a couple of questions about using something other than the market value of Biglari Holdings to calculate the value of the portfolio in the Lion Fund. (My apologies to you all if I’m mangling the finer points of this question and answer.)

-He is not going to retire the shares of Biglari Holdings owned by the Lion Funds.

-Sardar was asked about Maxim and he said it was not a mistake. They have spent over $40 million on Maxim (including the purchase price and the operating losses incurred to turn it around). Last year, in year five of Biglari Holdings’ ownership of it, compared against the over $40 million investment, Maxim made $1 million last year. And this was not a mistake and he does not regret doing the deal.

-At one point, a questioner was reading numbers from the SEC’s website (I believe) on her phone, she said basically – when you subtract out the shares voted by Sardar and other directors, there were about 650,000 shares voted against you for the board last year and 100,000 votes for you. (The shareholder read the exact numbers; I haven’t look them up, but I think these were the approximate numbers the questioner she was reading.) So that means 85% of shareholders voted against you last year. And then they were asking some kind of question about reputation when Phil interjected something like, “Those numbers are not right.” The shareholder said: “They were in the 8-K filed with last year’s vote totals.” And Phil said, “I don’t know where you got those numbers.” Shareholder: “From the SEC filing. Are these not accurate? They were filed with the SEC?” Phil: “I don’t know about those numbers.” Then Sardar interjected something like, “He has additional visibility. He can see this year’s numbers.” Shareholder: “These were the filed numbers last year.” Anyway, you get the idea. People around me looked up these numbers on their phone and the numbers the shareholder was reading were indeed what was in the SEC filing. Anyway, Phil seems to love trolling shareholders.

-Another fun/telling moment was when a shareholder was upset because they felt the shares were significantly undervalued and Sardar said something like, “Our shares have been overvalued in the past. At a past annual meeting I said, quit bidding our share price up. And everyone laughed.” Then he leaned into the microphone, looked out at shareholders, who lost 58% of the value of their stock in 2018, and said, with delight: “Who’s laughing now?”

Disclosure: I am/we are long BH, BH-A. I wrote this article myself with the notes and questions of others at the shareholders meeting, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.