Biglari Build a Store - Newsflash!
Board: Value Hounds
Biglari Holdings (NYSE: BH), modestly and eponymously named after Sardar Biglari, has been called the next Berkshire Hathaway (NYSE:BRK) and Mr. Biglari the next Warren Buffet. Biglari clearly is a Buffett disciple.
Berkshire of course is the company Warren Buffet built in large part using insurance company floats for cash. The lesson was not lost on Biglari and he has pursued two insurance companies in the past two and half years ostensibly hoping to acquire them, for the cash they would provide, but failing to reel them into his holding company both times.
Fremont insurance was so anxious not to be acquired by BH they lobbied the State of Michigan successfully to require 66.7% of shares to approve a merger. Biglari had to settle for a $2.7 million profit when Fremont was acquired by Auto Club Insurance.
Undaunted, Biglari made advances towards Penn Miller, beginning to accumulate shares both in BH and the Lion Fund in March 2011. Again, he was elbowed aside and Penn Miller was sold to Ace Limited. BH shareholders did not do as well this time. BH earned a little over $1 million and Lion took the rest—around $1 million.
List of things to do this year? Find more insurance companies to chase but in the meantime shareholders are stuck with a restaurant business.
Steak ‘n Shake ‘N Western Sizzlin’
Biglari Holdings made its bones in the restaurant business.
In 2007, from his position on the board of Western Sizzlin’ (WEST) and as CEO, he lobbied for seats on the board of ice cream/sandwich shop Friendly’s and used WEST cash and his own to buy 15% of Friendly’s shares. The day after Biglari sent a letter to shareholders outlining plans for change and before he and his mentor Phil Cooley could be elected to the board, Friendly’s began searching for buyers and was sold to Sun Capital. Biglari is credited for a turnaround. In fact he simply chased them into the arms of private equity and made money on his shares. Friendly’s recently declared bankruptcy.
Biglari was put on board of directors at Western Sizzlin’ in 2005 and became the CEO in 2007. During his four years he oversaw a disappearing chain of franchises and poorly performing company stores tied to a holding company that failed to see positive GAAP earnings from 2005-2008. They did manage some positive cash flow from operations to fund the Friendly’s share purchase.
--Restaurant revenue declined 12.3%
--Franchise revenue down 14%
--Operating income for company stores was negative
--Total number of restaurants went from 140 to 102
--Company restaurants stayed flat at 5
--Franchises dropped to 96 from 135
For a chain that stressed the importance of a healthy franchise business, WEST was something of a failure. As a holding company, it did allow enough cash flow to invest in Friendly’s and make a run at Steak ‘n Shake.
In turn, WEST was acquired by Steak ‘n Shake in 2010 for $23 million paid as debentures to shareholders. Biglari was a 30% shareholder and did well. Steak ‘n Shake shareholders-- not so much. Western Sizzlin' revenue was only $8 million for the nine months in 2010 it was under Steak ‘n Shake ownership after doing $16 million in 2008. It recovered to pre-acquisition levels in 2011 but revenue is now in decline Q1 2012.
Steak ‘n Shake has fared better under Biglari than previous management. It is the only hands-on successful turnaround he can be given full credit for.
The company was in desperate straits and in 2007 was spending $1.03 for every $1.00 of sales growth. They were growing through careless expansion and operating expenses were off the charts.
Biglari took over as CEO in 2007 and immediately began to slash operating costs and capital investments in new stores. Unprofitable locations were closed and he managed to sidestep almost certain bankruptcy that loomed from breaching debt covenants by drawing on tax returns overlooked by previous management. Same store sales went from high single-digit negative numbers to double-digit positives and traffic counts grew by double digits.
[See Post for Tables]
2010 was a high water mark for comps in both traffic and same store sales and since Q1 2010 the rate of growth in comps has been in decline.
Revenue growth for restaurants also appears to have peaked at 7.2% in 2010. In the first quarter of 2012 it was 3.8%. Gross margins for the restaurant side of the business have improved 3% to 26% over the past three years in spite of rising commodity prices and heavy promotional pricing. Biglari has vowed to not raise prices in 2012 in spite of rising costs. We will see how that works out as 2012 goes along. Operating margins went from negative numbers in 2008 to 8% in Q1 2012.
It may be that Biglari has gone as far as he can go with the core concept. The easy fixes are done and the difficulty attracting more traffic outside of heavy promotional activity and success selling franchises seem to be eluding him. SNS franchise growth is nonexistent since he took the helm with 75 units in 2008 and 76 locations in Q1 2012. Company stores are down from 415 to 413 and WEST franchises continue to disappear and stand at 89.
Enter the new concept -- Steak ‘n Shake Signature. I usually find the introduction of an ancillary concept a sign of fatigue in the core concept both in retail and restaurants. The new SNS restaurant is a diner called Steak ‘n Shake Signature with counter service only. The all night schedule has been abolished—revenue drops sharply after 10PM. In addition to signature burgers and fries, they will supplement milkshakes with beer and wine. Base price for a unit is $460,000 and meant to attract and bring back the franchise market.
Biglari Holding does not want to be a restaurant company. However, for the time being, that’s what it is. Fremont and Penn Miller were taken out by other investors and Biglari’s hopes of parlaying an insurance float into a big conglomerate along the lines of Berkshire are on hold. He’s still young and it may happen.
At present, Biglari is chasing Cracker Barrel – another restaurant. Over the past two years, Biglari failed to gain seats on Denny’s (NASDAQ: DENN) board; has so far not been awarded seats at Cracker Barrel; been in and out of Sonic and Red Robin with minimal gains; seen two insurance companies acquired by someone else; and invested in a down at the heels cosmeceutical company-- CCA Industries (AMEX: CAW).
Both Lion Fund and Biglari Holdings still own CCA shares. Their basis is around $5.50 and the stock currently trades at $4.70. It does pay a $0.28 dividend. The company sells wrinkle remover, bikini shave gel and weight loss pills and has been on a downward trajectory for most of 2011. It’s unclear what Biglari and Phil Cooley will be able to do for them as board members. So far, it has not been much.
If we had invested in other pure restaurant companies over the past two years, the returns would have been far better than betting on Steak ‘n Shake and its holding company model.
While Biglari is trying to be Warren Buffett and run a holding company, he has a long way to go. In Q1 2012, affiliated investment revenue was just $2 million out of a total of $166.4 million in revenue. He earned no management fee from partners for BH. BH investment gains were only $3 million. Non-controlling redeemable carrying value in the Lion Fund is slightly down in Q1 at $50 million. Like it or not, Biglari Holdings is very much a restaurant chain and not a diversified holding company yet
Assuming for the near-term, Biglari Holdings remains a restaurant business (that looks likely), it is incumbent on Biglari that he continue to generate high returns for investors. Slowing growth in comps, mid-single digit restaurant revenue increases and only a small percentage of earnings from the investment arm, are making growth hard to create. The new Signature concept may be an attempt to reignite the slowing of the core.
In addition to generating high growth through capital investments, he will be forced to start spending on the Steak ‘n Shake business at some point. Free cash flow may shrink with the new restaurant builds and the inevitable required capex investment in older stores. He has managed to cut capex costs on units from a high of $130K in 2007 per unit to an average of $21K over the past three years. The last real spending on stores was 2007. Considering that a company like Denny’s turns over the décor of a restaurant every 7 years due to dated décor and high traffic wear, Steak ‘n Shake stores will be needing some work in the next few years. With the blessings of bigger traffic counts comes the corrosion from higher use of the facilities —- everything from the bathrooms to the parking lots will show wear and tear.
McDonald’s (NYSE: MCD) regularly revamps its units as do Jack in the Box and Wendy’s. A redo at McDonald’s historically ran around $500K, but the new coffee shop/café remodels are closer to $700K. If a teardown is involved the amount is double and that’s for a quick service restaurant—not a fast casual. Biglari has been living off former management’s spendthrift ways, getting substantial tax breaks from the depreciation and seeing higher cash flow as taxes go down when depreciation is up. The free cash flow has been supercharged by the capex cuts. His current cash flow has benefited from the painful overspending by previous management.
That may be set to change over the next few years as he is forced to invest capital into his store base. While he has been seeing excellent free cash flow since 2009, that may not hold as a rationale for future investment in this jockey. Cash to make deals may be harder to come by. If he fails to invest in remodels, business will almost certainly suffer. McDonald’s expects sales to increase 30% to 50% following a remodel. The expected sales increase is high because the consumer experience is improved. A newer, cleaner store has a better image and customers are more satisfied. Biglari should take note.
In order to avoid the heavy consequences of having to finally spend on the restaurant business, Biglari will have to step up his game as a master capital allocater and require that the investment side begin to add substantial cash to the operations. With increased spending, the restaurants will be unable to fund as much of the growth as they did in the past.