Biglari Holdings (BH) – Forced Selling & Expected Repurchases – 20% upside

Current Price – $203

Expected Price – $250

Upside – 20%

Expiration Date – Aug 31, 2018

This idea was shared by Russell.

 

This idea is about a company that I have detested for years but I believe it is an idea worthy of consideration due to potential short-term catalysts. Due to the company’s atrocious corporate governance, the only reason the investment is of interest now is due to the short term special situation aspect of the company’s current circumstances. Many investors would generally not touch this company with a 100-foot pole, and outside of current special situation I’m pretty much in that camp as well.

 

Summary

The company’s share price plummeted 30% in one week due to forced selling by institutions after the company’s dual share class conversion and removal from S&P Small cap 600 index.

The company has been an aggressive purchaser of its own stock, but refrained from purchasing in the period directly before and after the dual share class conversion. The company, though, is poised to potentially restart its open market purchases. The probability of near-term company purchases seems greater due to the fact that the company recently specifically amended its insider purchase plan to allow it to purchase a greater number of shares.  The 10b5 insider purchase plan terminates on August 31, 2018, so any purchases under the amended purchase plan would have to occur relatively soon.  Over the last two years or so, the company has purchased shares through one of these 10b5 insider plans three separate times. Each time they initiated purchases under one of these plans, the share price rose more than 20% within two months. I expect similar outcome to occur again.

 

Outline

(1) Biglari Holdings shares plummeted by 30% in one week due to force selling by institutional investors in the wake of a dual share class conversion. The company converted from a single share class to a dual share class structure, and one of the new share classes lacks voting rights. Certain institutional owners of this stock have policies disallowing them from ownership of any company with a non-voting share class. Due to these policies, many institutions sold their shares the day after the dual share conversion was officially approved. To give an idea of the magnitude of the selling, the recent average trading volume prior to the approval of the conversion was about 4,000 shares per day. The day after the approval of the conversion saw approximately 260,000 shares trade.

(2) The company (through a controlled fund) has been aggressive purchaser of its own stock, purchasing more than 40% of its outstanding shares in three years, but refrained from buying directly before and after the dual share class conversion.

(3) After Biglari Holdings’ share price plummeted similarly last year, in September 2017, the company filed an insider 10b5 plan to allow it to resume its aggressive repurchasing. This drove the share price up about 25% within about a month or so once the repurchases began in earnest in December 2017.

(4) In late 2017 and early 2018, the company (or, more accurately, its associated fund) purchased 71,981 shares pursuant to the insider purchase plan.  The company amended the 10b5 plan on 11/24/2017 to raise the amount of shares they are allowed to purchase under the plan from 80,000 shares to 110,000 shares.  Thus, the plan allows the company/fund to purchase an additional 38,019 Biglari Holdings shares. The termination date of the plan is August 31, 2018.

(5) The magnitude of these insider plan company purchases is significant: 110,000 shares represents nearly 10% of the outstanding shares of the company (excluding the unretired shares the company owns of itself).

(6) Pursuant to the insider plan, the company repurchased shares as recently as March for a price more than 25% greater than the current market price.

(7) Putting all of this together, given the fact that they specifically filed an amendment allow for a greater number of additional share purchases and given the fact that the company purchased shares at a price 25% higher than the current market price, it seems likely that the company had the plan pause repurchases around the dual share class conversion, but that they will resume open market purchases – especially since the share price is dramatically cheaper than the price of its recent purchases.  Also, since the plan terminates on August 31, 2018, any purchases under this plan have to occur in the relatively near future.

(8) The last three times the company initiated purchases under a 10b5 insider plan, the company’s price has risen more than 20% each time. The share price has usually risen that much within a month or so of the initial purchases under each respective plan.  Thus, if the company does resume their purchases prior to the end date of the plan on August 31, 2018, it seems likely that these purchases would lift the price of the shares in the near-term.

(9) The company’s valuation is that market value of the company’s 19.5% Cracker Barrel stake (net of taxes and everything) is now almost 10% more per share than the value of Biglari Holdings stock. Thus, the company would potentially warrant an investment on just valuation terms due to its Cracker Barrel holdings, except that its corporate governance and its CEO Sardar Biglari severely complicate any investment simply on valuation terms alone.

(10) For those that want to hedge this trade, or are uncomfortable with the pass-through exposure to Cracker Barrel’s stock due to Biglari’s ownership of about 20% of Cracker Barrel’s shares, it is possible to hedge with an investment on the short side of Cracker Barrel – either through the purchases of puts or an outright short position.

(11) One note of caution about shorting Cracker Barrel: Cracker Barrel will pay a dividend and special dividend in early August amounting to a total of $5 per share. Thus, short sellers as of the respective record dates in July will have to pay these dividends – though this is the fourth straight year that Cracker Barrel has done this on the exact same timeframe and each of the first three times – subsequent to the ex-date of the special dividend, the company dropped by a larger amount than the special dividend itself was – so that could mitigate it but is far from a sure thing. The Cracker Barrel special dividend could arguably be a mini-catalyst for Biglari Holdings because due to its ownership stake of CBRL it will receive total dividend payments of  about $25 million in early August, and most of that amount is tax free (because when a C-corp owns between 10-20% of another C-corp, 70% of dividends received are not taxed, so the effective tax rate of these dividends is about 10%).  This $20-plus million cash flow that it will receive is a weirdly high percentage of the company’s market cap, so that perhaps could catalyze some interest in this, but I doubt it. I do not assign any value to that possibility.

 

Risks

  • To implement this idea, one has to purchase shares in company with the worst corporate governance in America.
  • If the company (through its associated fund) does not begin repurchasing shares, then this removes the short-term catalyst. Again, it seems likely that they will begin repurchasing shares, otherwise why would they have amended the agreement, and they have been aggressively repurchasing shares for three years through 10b5 plans, but it is not a guarantee that they will do so.
  • Continued deterioration of the company’s main operating asset, Steak n Shake, is another risk. One of the reasons the price fell in 2017 is due to the underperformance of Steak n Shake over the last few years. Like much of the restaurant industry, Steak n Shake’s results have deteriorated significantly. Just a few years ago, the company was cash flowing $50 million but now it is barely profitable (though it is still cash flow positive, even with a net income at about $0). There are a few mitigating points to this risk: The next results for Steak n Shake will not be released until the company’s 10Q is filed on August 3, so if the company’s repurchases begin in earnest before this time, then the exposure to Steak n Shake’s results will likely be limited. An additional mitigating point is that Steak n Shake has a negative implied market value and even with its poor performance of late, it is not losing money and franchises are still opening, so extremely negative future performance is already priced in.

 

Corporate Governance

For those that are unfamiliar with Biglari Holdings, Sardar Biglari and the endless controversies around both, they would take a book-length treatise to fully describe. Since it directly relates to this thesis, though, I will try to briefly describe the rough contours of these matters. Sardar Biglari ran a hedge fund called the Lion Fund which had previously taken control of a fledgling restaurant chain, Western Sizzlin. Sardar acquired operational control of Western and, according to him at least, turned the chain around. After Western was performing well and generating cash flows, he acquired a significant ownership steak in Stake n Shake through both Western and his hedge fund. Eventually, he won a proxy contest and became the CEO of Steak n Shake in August 2008. The only problem was that Steak n Shake was nearly bankrupt and was hemorrhaging both money and customers.  Over the course of just about one year, Sardar turned around Steak n Shake, such that it became significantly cash flow positive – generating more than $50 million in free cash flow just a few years later. He then took Steak n Shake’s cash flow, and some debt, and made a series of successful activist investments. He also merged Western into Steak n Shake.  Sardar was, at this point, being lauded by Steak n Shake’s shareholders and the investing world in general.

So far so good. Yet, as soon as he started receiving accolades and glowing headlines, he began doing one thing after another to undermine his own reputation. He renamed the company after himself – so Steak n Shake became Biglari Holdings. He passed an incentive arrangement that would reward him on hedge fund like terms for running Steak n Shake. As if this wasn’t enough, he then subverted limitations in the original (shareholder approved) incentive arrangement to get a potentially much greater incentive arrangement by creating a new hedge fund and putting most of the company’s cash and investments in it. The first incentive arrangement, the one with limits, was shareholder approved, but the second was not. This is the source of much of the controversy, coming off of Sardar’s dramatic early success turning around Steak n Shake and investing the company’s money very well, he received shareholder approval for the name change and the original incentive agreement. Yet, he eventually alienated nearly all of those shareholders, by going much further than shareholders would have approved by using clever tactics to (arguably) legally circumvent shareholder control and institute policies and arrangements that shareholders would likely never have approved.

There have also been a serious of more sort of personal actions which have infuriated shareholders. He purchased Maxim magazine (yes the famous lads mag) and eventually made himself Editor-in-Chief and he even appeared posing with a super model in Europe in the pages of Maxim. This whole Maxim saga has cost the company nearly $50 million (including the original purchase price and the ongoing losses), though he has gotten the magazine to a break even rate currently. Other questionable moves include putting his brother and father on Steak n Shake’s payroll for lucrative consulting fees, even though no one has ever adequately explained what they actually do. He also had Biglari Holdings recently pay for what seems to be a personal vanity project; a luxury café in the port of Saint-Tropez (where he often takes his yacht) where he can sample some of the world’s finest caviar (this is not a joke).

Things have gotten to the point where about 90% of the shareholders voted against Sardar and the rest of the board at this year’s annual meeting. It doesn’t matter though, because of the Lion Fund II’s share ownership (which is actually just Biglari Holdings itself), Sardar has voting control of the company – so the rest of the shareholders votes do not matter – even when they are near-unanimous.  This is the level of corporate malfeasance you are buying into if you buy shares in this company.

 

Cracker Barrel Investment

The corporate governance situation has become so farcical, that the company is arguably trading for a dramatic discount to the value of its assets. That is, if those assets were owned in any other context other than Biglari Holdings. One of Sardar’s investments was purchasing about 20% of the shares of Cracker Barrel on the open market in 2011-2012. Biglari initiated a proxy fight during each of the following three years against Cracker Barrel and lost each time. But no matter because the market price of Cracker Barrel’s shares soared. The 20% stake cost a total of $241 million and is now worth more than $750 million.  Additionally, by early next year Biglari’s Cracker Barrel investment stake will have paid nearly $200 million in dividends, which is not far from their total purchase price in 2011-2012. By almost any measure, this investment was a grand slam for Sardar Biglari. But not for Biglari Holdings shareholders, not yet at least. Despite the value of its Cracker Barrel stake soaring, amazingly, Biglari Holdings is worth less today than it was when they made the Cracker Barrel investment (if you exclude the market value of the shares that Biglari Holdings owns in itself).

Here are the financial details of the Cracker Barrel stake. The Lion Fund II owns 4,737,794 shares of Cracker Barrel. These have a current market value of $753 million. Of this, 92.3% of this value belongs to Biglari Holdings (through the Lion Fund II) for a BH/CBRL Value of $695 million. The fund has a loan associated with a prepaid variable forward contract (which facilitated the 2015 tender offer) – so I take the value of that loan, $200 million, off of the value of the stake, for an adjusted total of $495 million. If they sold the Cracker Barrel stake today, Biglari Holdings would incur taxes of about $85 million, so I take that off as well. So the net of everything value of the Cracker Barrel stake is $410 million. If you apply this across every share of Biglari Holdings that is not owned by Biglari Holdings itself, that equals a per share value of about $220 per Biglari Holdings B share and $1,100 per Biglari Holdings A share, compared to their respective market prices of $205 per B share and $1,000 per A share. Additionally, the company has a significant amount of cash, other investments and short-term bonds. So, this gives some perspective on how much investors do not want to invest with Sardar Biglari or in his company – you can by a dollar for well less than a dollar but you have to go to the corporate carnival that is Biglari Holdings to get that discounted dollar.

 

Dual Share Class Conversion and Forced Selling

Here is a little background on the recent corporate action, the dual share class conversion, which caused the share price drop that gave rise to this thesis.  On April 30, the company officially converted to a dual share class structure.  On that date each of what were previously common shares became 1 B Share and 1/10th of an A Share.  The A Shares have all of the voting rights and have five times the economic rights as the B Shares. Due to the difference in voting shares between the classes, multiple institutional shareholders were forced to sell their shares due to their own internal rules. Some funds and institutions have adopted internal rules such that they are not permitted to hold shares in companies that have multiple share classes when one or more of those share classes does not have voting rights (or has only minimal voting rights).  Thus, upon the enactment of the dual share class plan, there was a massive amount of selling. The plan was filed many five months before it was enacted and the approval of it was certain, since Sardar Biglari has voting control of the company and it was his plan, but for some reason the institutions who were forced to sell due to their “no-voting” rules did not sell shares prior to the plan’s official approval.  This created frenetic trading activity in the days around the enactment of the dual share classes.

To show the effect of this frenetic period, there were around 4,000 “old BH” shares trading per day in the few months before the dual share class plan was approved. Yet, on April 27, the day after the official approval of the plan and a few days before the conversion actually occurred, about 260,000 shares traded.  So from a near-term average of about 4,000 shares per day to about 260,000 in one day.  Since nearly all of the increased volume related one way or another to the forced selling, the price plummeted precipitously.  The price just before the dual share class issuance was about $420 per “old BH” share.  Three days later the price was as low as $290 per “old BH” share. (The $290 figure is adjusting the blended market cap of the post-conversion A Shares and B Shares into the “old BH” share price, just to facilitate comparison.) The bottom line is the company’s shares dropped by about 30% in less than one week and that week had no news or numbers in relation to the actual value of the company.

 

The Company’s Repurchase History 

One of the factors that led me to consider this investment is that the company has been “repurchasing” its shares very aggressively for three years.  Repurchase is in quotes because the company is actually purchasing shares through a hedge fund, The Lion Fund II, that the company owns 92.3% of but is controlled solely by Sardar Biglari. This allows him to vote the shares of BH that BH has purchased and thereby preserve his absolute control over the company. The current era of “repurchases” in fact started after Biglari narrowly won a proxy contest in April 2015. Following that, in June 2015, he had The Lion Fund II purchase more than 600,000 of the company’s outstanding shares, more than 30% of the company, through a tender offer.

The tender offer secured his control over the company, but he has had the company, through The Lion Fund II, continue to purchase shares aggressively since then through three separate 10b5 insider purchase plans. These purchases were not necessary to preserve his control, so they are likely driven by the fact that he thinks they are undervalued and/or because the purchases will facilitate his incentive compensation in the future.

The company, over the last three years, has spent a total of more than $350 million on purchases of Biglari Holdings shares. This is amazing because it roughly equals the company’s entire current market cap (excluding the unretired shares that the company owns in itself).

All of these purchases occurred at prices higher than the current market price of Biglari Holdings shares. Some of them at prices 30% higher than current prices. This fact also, in my view, makes additional purchases more probable.

There is a weird benefit, to our special situation investment thesis, to the convoluted “repurchases” through a controlled hedge fund: The company (actually the fund) has to file a Form 4 within two days of any purchase; this provides greater visibility into whether the company has restarted open market purchases. An investor could actually wait until the first Form 4 has been filed and then buy shares of Biglari Holdings and minimize risk/time exposure that way.  During the past three 10b5 insider purchase plan purchases, if one just bought shares of Biglari Holdings after the first Form 4 for each 10b5 plan was filed, then they still could have made about 15% over the course of the following month or so. The downside to this is that the share price each time rose, not insignificantly, prior to the first Form 4 filing.

There is a side benefit to Sardar Biglari’s insatiable greed and control of the company, as it relates to this thesis. Much of the controversy around Mr. Biglari and his control of the company and much of the outrage associated with all of this relates to his incentive compensation. He has set up a lucrative incentive arrangement, where he gets paid like a hedge fund manager for managing the company’s investments. As wrong as this may be, the current circumstances are such that he is nearly entirely dependent on the market price of Biglari Holdings shares rising a lot in order for him to get a sizable incentive payout in the next year or two. (The one caveat to this is if the share price of Cracker Barrel went up a lot, he could also get a payout from that, though it would be difficult unless the share price of BH had also risen.) Thus, if the 10b5 plan kicks in and the company’s share purchases restart in the near future and this causes the share price of Biglari Holdings to rise, this would facilitate a potential payment for Sardar Biglari. Indeed, this may be the whole point of the company/fund’s aggressive open market purchasing of Biglari Holdings shares.

 

Conclusion 

So that’s it. The basic idea is that I believe it is likely that the company resumes its open market purchases soon and in the past two years the three times they have resumed open market purchases the stock has quickly gone up 20% or so.

I would love to hear other opinions.

 

15 COMMENTS

  1. dt

    Russell,

    Thanks for sharing detailed write-up on BH. Let me check if I understand your core thesis correctly:

    1) Shares dropped after dual share class structure was instated due to forced selling by institutional investors who were not able to hold stocks with non-voting shares in the structure. Increased volume right after restructuring is a proof of that.

    2) BH shares are expected to revert back to pre-restructuring levels after company starts repurchases. Changed language in the 10b5 (could you point out how this has changed?) and expiration of 10b5 in Aug indicates the repurchases are imminent. Historic price reaction around previous repurchases (through owned fund) suggests favorable expected share price reaction.

    If this is correct, I have couple of issues/questions regarding this thesis:

    - My understanding is that restructuring (creation of dual class shares) was carried out in order to allow Biglari to raise capital by issuing non-voting shares and still maintain the control (this is even stated in the annual letter). So instead of repurchases there might be dilution coming. Couple shareholders even brought company to court regarding this (https://www.ibj.com/articles/68610-biglari-holdings-shares-tumble-after-restructuring-boosts-ceos-grip-on-company) and I think court proceedings are still ongoing.

    - Company has limited amount of cash ($45m) and burned $13m in the last quarter. Also likely big part of remaining cash tied up in operating businesses rather than the lion fund. So it is not clear how the repurchases will be funded. It can obviously sell down Cracker Barrell to fund further acquisitions, but then there was no point in creating the dual class structure.

    - At the same time it is not clear why the company is not carrying out the repurchases already since one month has passed after restructuring and Q1 result announcement. So any repurchase activity should definitely be allowed by now. What is the management waiting for?

    - Due to the above (i.e. tighter control by CEO and expected dilution) I would say that company deserves higher discount to NAV than before. Why this was reflected in the stock price only after shareholder vote, I am not sure – maybe some expected that due to court proceedings the vote would be cancelled. Potentially market overacted and share price will climb up to something like mid-range between current and previous share price, but I we will see repurchases as a catalyst.

  2. RJChicago

    Thanks for your reply. I’ll try to address some of the points you raised below:

    - This is the fourth 10b5 plan in less than three years. Each time they have begun purchases under one of these plans, the price has gone up more than 20% in the following month or so.

    - Under the current plan which was instituted in September 2017, though purchases occurred later, the shares went up about 30%.

    - So it seems, to me, that there is a high-probability that if the 10b5 purchases resume, the share price is likely to go up significantly – as it has the previous four times. This is especially likely because the starting point (in terms of share price/market cap) is lower.

    - And they have the 10b5 purchase plan in place. Here is a link to the original plan, filed on September 28, 2017 in an Amended 13D:

    https://www.sec.gov/Archives/edgar/data/93859/000134100417000607/ex99_1.htm

    - As set forth in that filing, the purchase plan runs from October 2, 2017 to August 31, 2018. The original plan allowed for the purchase of up to 80,000 shares.

    - Then in buried in an amended 13D filing on December 28, 2017, linked to below, the company referenced the fact that it had revised the purchase plan to allow for the purchase of up to 110,000 shares rather than the original 80,000 shares.

    https://www.sec.gov/Archives/edgar/data/93859/000134100417000793/sc13d-a33.htm

    Here is the relevant quote: “Item 6 is hereby amended and restated as follows: On November 24, 2017, Lion Fund II and J.P. Morgan Securities LLC agreed to amend the 2017 Purchase Plan. The amendment increased the total amount of Shares that can be acquired under the 2017 Purchase Plan from 80,000 Shares to 110,000 Shares.”

    - One quirk of this is that the company/Sardar has almost no ability to change this plan. The point of the 10b5 plan is that you lock yourself into a plan – and you can’t change it even if company results deteriorate or some other material fact changes. One of the only amendments they can make is the one they did: parties are permitted to raise the amount of shares they are purchasing in certain circumstances. In each of the past agreements, and this one, there is strong evidence indicating that the 10b5 plans had very specific purchase instructions for JP Morgan as it related to dates, prices and volumes of purchases. The interesting thing in this situation is whatever those specifics were that Sardar set forth in September 2017, they will compel the purchases (or lack thereof) from now to the termination of the plan on August 31. He has no legal ability to change it based on current information.

    - As to your excellent question about how they will fund the purchases. Let’s say they need a maximum of $10 million to fund the remaining 38,010 shares or whatever it is on their purchase plan. If you use a share value 20% greater than the current one, that would still be less than $10 million for those shares. (It could be more than this if they purchase A Shares in full or in part of those 38,010 remaining shares but they do not have to do that – so for the purposes of figuring out if they have the cash to fund repurchases I don’t think we have to worry about that wrinkle.) So the maximum we need to worry about them needing for these purchases before August 31 is $10 million. I understand the points about some of their cash limitations but they have had more severe cash limitations during past plans and what they did was used margin debt in The Lion Fund II (which is easy for them to obtain and they have had quite a large margin balance at times in the past, but I believe they do not have one now) – anyway they fund the purchases on margin and then basically pay the margin back with Cracker Barrel dividends. They will receive nearly $25 million from Cracker Barrel on August 3 – so if they follow the pattern that they have in the past now – that is how they would fund these.

    If they do not want to use the Cracker Barrel payments this time for some reason, they have a few other options for the $10 million. Biglari Holdings has a little more cash than you suggested they have the $43 million – but they have $23 million or so in short-term investments – which is under First Guard – but which they got regulatory approval two years ago to take $20 million of that out of First Guard and out of short-term bonds whenever they want – though they haven’t done that yet. They also have like $12 million I believe in what is not listed as cash, it is listed in Current Assets I believe, but is actually “Restricted Cash” that they can also take out anytime – they posted it last year (according to my researcher who is excellent) pursuant to a potential insurance transaction that they are not pursuing. They can evidently pull that back if they wanted to.

    - So since the catalyst entirely comes down to whether they resume repurchases, in my view, one of the key questions is why the plan stopped the purchases in early March and what that indicates about future purchases.

    - Purchases under this plan stopped on March 9, even though they could have purchased shares at a slightly lower price at different points between March 9 and April 27. This is the big question about this thesis is why did they stop buying on that date. There are a few reasons that they likely stopped around the restructuring. In the past, during these 10b5 purchase plan runs, they have refrained from repurchasing around certain corporate events – like he had one of these plans pause purchases before the annual meeting and a few other times. There are some other possibilities too that the securities lawyer has discussed with me but I am honestly not sure about this. The 10b5 plans have often had a sort of erratic pauses in the purchases – and I have not been able to figure out the reason for those either during past plans. With this plan, for instance, there were a few purchases in October and some in November – then they paused for a little while – and then they started purchasing the legal daily max they were allowed to in mid-December and with a much higher price limit than they previously had been paying (from $335 to $420 limit). There were was probably some kind of reason for the timing but it is not readily discernible.

    - Though I am uncertain as to why this plan had JP Morgan stop purchasing shares on March 9, I still find it likely that they will resume repurchases because Sardar knew the timing of the dual share class conversion at the time when they initiated the 10b5 plan and then when he amended the agreement. He also knew the contours of the 10b5 purchase plan, so he knew that they wouldn’t be purchasing shares around the time of the conversion. Yet, he still amended it allowing them to purchase additional shares. And the other thing is that he has had the Lion Fund II purchase shares over and over again in the last few years since the tender – like 20% of the non-BH owned outstanding shares of the company through these 10b5 plans.

    I will address a few of the other specific questions you raised:

    - You wrote: “My understanding is that restructuring (creation of dual class shares) was carried out in order to allow Biglari to raise capital by issuing non-voting shares and still maintain the control (this is even stated in the annual letter). So instead of repurchases there might be dilution coming.”

    This is absolutely true over the long-run and probably the medium-run, but I do not think they will issue shares at any price close to the current one. He actually planned the dual share class conversion for a decade; the first reference I found to it in all the annual meeting notes that my researcher assembled when we first started looking at this was in 2009. He has talked about it each year since then. So this was a very long-range plan. He said at this year’s annual meeting, they wouldn’t issue shares if the BH shares are trading below their intrinsic value, and he has said the intrinsic value was much greater than the share price – and this was when the shares were at $420. Another point is that his incentive payments are now largely tied up with the BH share price, and if he issued shares at the current price, he would be sort of locking in that lower price – so the acquisition would have to be an absolute grand slam for that to make sense. Everyone talks about Sardar trying to be a Warren Buffett wannabe, and he clearly is with the name of the company/aesthetic of the website/format of the annual meeting/etc., but the person he has quoted the most over the years is Henry Singleton. In one of the transcripts I have he went on for like 6 pages just talking about Singleton’s issuance of shares/repurchases of shares and some other aspects of Teledyne. He seems to be to be trying to following the Teledyne blueprint of buying an enormous amount of shares back when they are cheap and then issuing shares when they are expensive. He is just doing it in the opposite order as Singleton.

    Anyway, given all of that, there is a lot of evidence to suggest that he will issue shares and cause dilution until the price of shares is much higher.

    -You wrote: “At the same time it is not clear why the company is not carrying out the repurchases already since one month has passed since restructuring and Q1 result announcement. So any repurchase activity should definitely be allowed by now. What is the management waiting for?”

    I partially addressed this above, but he actually doesn’t have the authority to specifically authorize purchases now – he is bound by what the plan says. And why the plan hasn’t initiated buybacks yet, I tried to address above.

    -You wrote: “Due to the above (i.e. tighter control by CEO and expected dilution) I would say that company deserves higher discount to NAV than before. Why this was reflected in the stock price only after shareholder vote, I am not sure – maybe some expected that due to court proceedings the vote would be cancelled.”

    As I wrote above, I do not think that dilution is an issue for this short-term thesis because for numerous reasons it is unlikely to occur until the share price is much higher. As far as tighter control by the CEO, I do not think that is the case and the other large shareholders I’ve spoken with also don’t think he has tigher control now; basically he had complete control before and he still has it now, but he is not any further entrenched now – he is the same level of entrenched but with the additional ability to issue shares now without threatening his control.

    As far as the court proceedings, I do not think that the failure of the court proceedings to stop the reorganization vote contributed to catalyzing the stock downward. The litigants had agreed, in earlier April, to drop the request for an injunction. So it was clear before the vote that the vote would proceed, and yet the share price was hitting recent highs ($429 per share) in the days after the parties reached that agreement.

    Also my researcher talked to numerous of the institutions about Biglari and the reorganization, and some of them actually talked to him about this, and they told him they were not selling until the vote even though the vote was fait accompli. I am baffled by this and really questioned whether they would all of the sudden sell after the vote – but that indeed seems to be what happened. I don’t want to say who, but large well-known institutional investor was actually at the annual meeting and my researcher talked to him there – and this guy basically said that they would have to sell because of the conversion. This astounded me on two levels – why go to the meeting if your firm was no longer allowed to own any, but more importantly, why did they hold shares after it was clear the litigation would not delay the vote and the vote would be on April 26 and it was certain to pass at that point.

    In general, I don’t think the litigation was a significant factor. Biglari has had at least one ongoing shareholder lawsuit for seven consecutive years I believe. These particular ones were mostly filed by plaintiff firms that are likely to settle. Based on the constant litigation around the company and from my discussions with others, I do not think that the current litigation played a role in the recent drop/short-term idea.

  3. dt

    Thanks for detailed response.

    If Biglari has only 38k remaining under the 10b5 purchase plan – do you think this will still have material impact on the market price? In total that is c. 5 days volume worth. If this is spread out across three months then we are left with c. 600 shares per day which is c. 10% of the daily volume. If this is done over a few days.

    My understanding on how 10b5 works is quite limited. Can the plan be terminated permanently before the full allocation is filled? Maybe that is what happened here?

    I agree with you that before issuing any new shares for potential M&A it would make sense for Biglari to lift up the share price through open market purchases, but not sure whether such purchases with limited allocation would have any lasting effect.

    1. RJChicago

      Good points. I will try to address them in turn.

      –Question: “My understanding on how 10b5 works is quite limited. Can the plan be terminated permanently before the full allocation is filled? Maybe that is what happened here?”

      Response: It could likely only be terminated for a few specific reasons having to do with certain technical situations. They could not rescind the agreement for reasons having to do with the performance of the company or that sort of thing – because that would be tantamount to simply making controlled broker purchases. The point of the 10b5 plan is you get protection from insider trading issues because you are willing to handcuff yourself to a specific plan. In permitted windows, you can raise the amount of shares you will purchase, as they did, but most other amendments by the ‘insider’ are prohibited. If he did that, he would be risking securities law issues. And from my research of this, Sardar has been careful to cut very square corners in terms of the specific legal mechanics of these situations (which is ironic because he uses these legal mechanisms to subvert shareholders rights); he has been especially careful with this stuff after he incurred an $850,000 fine from the FTC I believe associated with his building up his Cracker Barrel stake without filing his 13D in time. Anyway, he knows he will be looked at closely by the SEC, and the courts, so he is unlikely to do something impermissible with this.

      Also, if it was terminated, it would have to be filed. This is not always true with 10b5s, but in this case it is certainly true since they filed the original agreement each of the four times they have done this, and since they filed the updating amendment increasing the purchase authorization. At that point, they have a clear duty to file a termination. I’m sure Sardar’s lawyer Steve Wolosky sees this the same way.

      The link below has some information about not voluntarily terminating 10b5 plans and some other details pertinent to these plans.

      https://media2.mofo.com/documents/faq10b51.pdf

      –Question: “If Biglari has only 38k remaining under the 10b5 purchase plan – do you think this will still have material impact on the market price? In total that is c. 5 days volume worth. If this is spread out across three months then we are left with c. 600 shares per day which is c. 10% of the daily volume. If this is done over a few days.”

      Response: As you said, they have 38,019 shares remaining on the current plan – under 10b5 plan protections they are allowed to buy 20% of the rolling 30 day daily average I believe. (It may be the 90 day rolling average but it is something like that.) Anyway, if they only purchased B Shares – this would mean they would have about 30 trading days of purchasing the legal daily limit. But say it is only 20 days because they also mix in purchases of A Shares (though they really can’t purchase many A Shares because the daily average trading volume is so low).

      In each of the four previous times over the last few years that they started purchases under a 10b5 plan, the shares had gone up very significantly (like more than 15%) after 10 straight days of insider purchases. What happens is the Form 4 is filed covering three days, and then the next Form 4 is filed covering the following three days, and in each of these situations I think technical traders/Form 4 hunters have piled in at that point – because with just two consecutive Form 4 filings – the stock price went up very quickly. In other words, it has not taken 20 days of open market purchases at the daily legal max, it has only taken five or so to start significant upward movement and ten days of purchases to have risen quite significantly.

      I believe this is especially true because there was so much forced selling and such a quick drop – that the herd has been thinned to some extent – and the volume is now quite low. This creates the possibility of a faster rise if there is a new buying force.

      In other words, if they buy the 38,019 shares over a month or two months, if this follows the pattern of the last four 10b5 purchase periods, it will rise significantly. That is, of course, no guarantee though that it will do the same again this time though, but the conditions suggest that the stock would react if purchases restart.

  4. Steven Emer

    Thanks to both of you for the detailed analysis and probing questions.

  5. Baruch

    Great analysis. I learned a lot from it, and you do a nice job at highlighting many of the risks involved. My only question is,
    Is there any other way to explain the sudden price drop besides forced selling of index funds? Stock leave indices all the time, and they have a responsible and organized way of selling… Why not explain it as the markets valuation of loss of voting rights?

    1. RJChicago

      This is a great question and one I have thought about it. Of course, no one can say with 100% certainty that there were no other factors at play. And as I wrote, Steak n Shake is struggling, compared with their pretty solid long run before that, and Steak n Shake’s bad quarters have caused the stock to fall a few times over the last few years. But there was no news regarding Steak n Shake or anything else associated with the value of the company. And the volume explosion (from 4,000 shares a day to 250,000 shares) and the price drop started immediately upon opening the day following the vote, which was three days before the actual dual class conversion.

      As you pointed out, Baruch, stocks get removed from indices and ETFs all the time without this sort of selling, so why would that be the case here? In this case, it seems that they did not do it in an orderly fashion, it seems at least a few large sellers just sold over like a two-day period. This rapid selling is evidenced by the fact that the volume exploded right after the vote, then within two days, the volume went back down and the price has stayed pretty much static since then. Further evidence of this, and this is anecdotal, is that at least one institution that was at the annual meeting said they had to sell after the vote. Of course, they could have sold gradually, but from the immediate volume explosion and price drop over two or so trading days and then the low volumes and price stability in the month following that – it doesn’t seem that most of the sellers were gradually offloading. If a number of parties did in fact sell all of their shares rapidly, my best guess as to the reason why is that they were removed from indices and from ETFs not via the normal review/categorization process, but rather because of this company specific dual share class conversion that immediately disqualified them from these funds/institutions. It makes no sense to me why they would not have slowly sold off shares beginning earlier in April, because Sardar himself controlled the vote, but the volume and price readings strongly suggest that there was no gradual selling.

      As to the last question you asked: “Why not explain it as the markets valuation of loss of voting rights?”

      This is a good point as voting rights would generally be a valuation factor. In this case, I do not think they were for a few reasons. Sardar has had voting control of the company since June 2015 – so there wasn’t actually a de facto change in voting rights. No one has had any in this company since June 2015. Another strong piece of evidence suggesting that the market has not and does not value the voting rights for this company is that post-dual share class conversion – the A Shares have voting rights and the B Shares do not – yet the shares have traded near economic parity (the A Shares have five times the economic rights as the B Shares, and only the A Shares have voting rights) and if anything the A Shares have traded at a discount to the B Shares, despite their voting rights. There is probably some sort of liquidity discount baked into the A Shares, but the fact that they have been trading for less than 5 times the B Shares suggest that the voting rights have little or no market value.

      Thanks for the thought provoking questions – I would love to keep the discussion going if you have any other thoughts.

      1. Vvm15

        Great writeup, and excellent follow up questions. I myself am in this name from unfortunately a significantly higher level post index delete. In response to the index effect comment ” stocks get removed from indices and ETFs all the time without this sort of selling,”, I trade a great deal of these events. The influx of passive investing has made some of these moves very dramatic. Due to the success of small caps over the past several years, there is even a greater amount of index tracking in this particular market segment. If you follow some of the last SP 600 deletes you will some very dramatic moves and then rallies after. RRTS, FRED, HNGR, AMRX, DHX are 4 I can recall off the top of my head. The moves were similar, if not greater than that of BH. They have all recovered the move fairly quickly. I myself am i bit stumped by this one, and am confused where all this selling pressure is coming from. The free float minus BH self held shares has almost rotated entirely. The selling pressure post move felt very technical, but now I am just not positive of the catalyst that would give it an upward trade or bring buyers in. Another thing to consider is who would take control of the shares that were given up by passive holders. It was a decent percent of the free float and the name is so under covered that it may take even more time for these shares to find a permanent home. Either way this is one of the weirder situations I’ve seen playout. So in our case for all of us that played it , I hope weird is good haha.

  6. Baruch

    This is a very mysterious situation. You suggested that the long term goal as to why Biglari issued 2 share classes in the first place is to enable the company to raise capital by selling the B Shares and still retain control with the A shares. Fair enough.
    But what still puzzles me is , why did they transfer the majority of the companies wealth to the B shares owners? Remember, for every 10 shares you owned, you got 1 A share, and 10 B shares. The A shares have 5 times the Economic value of the B’s.
    That means that for every 10 shares you owned, you now have 2 parts of economic value in the B’s, and one part in the A’s.
    Essentially, Biglari has transferred the beef of the company over to the the B shares.

    Why? Why not keep it equal?
    Would sort of seem to me that he wants to extract as much value from his position as possible by selling the B’s, and still retaining control with the A’s for cheap.
    I don’t know what he is thinking, I am just trying to put myself in his crooked shoes.
    How would you explain his master plan?

  7. RJChicago

    All good questions – I’ve thought about each. I don’t have too much time to reply to all of the points, but I’ll respond to a few of the specific points.

    –Someone else suggested that he was going to “sell” B shares to raise capital. From everything I have learned about this company over the last year (and I have read everything available I believe), I do not believe there is any chance he will actually sell B shares directly. What he wants to do is exactly what Henry Singleton did – which uses shares as a currency transaction. If this is what people mean by selling, then I think that is right – but I don’t think he will sell them in the open market. I don’t have time to list all of the reasons why – but I think it is nearly certain that the B shares will be used as a currency acquisition to acquire an insurance company in the near future (within 1-2 years at most). In any event, he will not sell them into the open market.

    I think two other forms of dilution, though, are probable. First, if the shares of BH perform well, he will get an incentive payment that will be paid in limited partnership units of the Lion Fund II – which is partly comprised of Biglari Holdings shares. So some of the shares that the company currently owns will become shares owned by him, but only if the share price of BH performs well. Which is one of the reasons I think that buybacks are highly likely – that is about the only way shares will go up in the near-term.

    The other form of dilution that is possible is a rights offering. If he actually wants to raise cash, then he will not do it by selling B shares – he will do it by issuing transferable rights to current shareholders. I think a rights offering is likely, but only at a much higher price. He actually addressed this question head on last year and he said something to the effect of he would only do a rights offering if the share price were higher. But he declined to say a similar thing this year, so a Rights Offering could be a possibility – even at a lower valuation as at present.

    –As to the question as to why he transferred 2/3rds of the value to the B shares, this is obviously a complicated situation and I don’t pretend to know everything about his master plan and it is probably not worth anyone’s time to read my long speculations on the subject. I’ll just offer a few thoughts. As you say, one way to think of it is that 2/3rds of the value of the company was transferred to B shares. But Sardar seems to look at it a bit different as most shareholders do. The B Shares represent more continuity with the “old BH shares.” The equivalent of the B shares had 100% of the value and 1/3rd was broken off to the A shares – into a special class of shares essentially that will trade lightly and will always be controlled by Sardar. As time goes on and B Shares are issued for acquisition, the balance of the company (economically) will shift even more to the B Shares. The B Shares will probably end up with 90-plus-% of the company within a few years due to acquisitions. The master plan is to have a currency for acquisitions, while protecting Sardar’s control. Sardar and the TLF II will probably tilt their purchases to A shares, for a number of reasons, but it is nearly certain that B shares will be issued. The corporate charter for the “New BH” post dual share class conversion, allows up to 10 million B Shares I believe (or something like that) and currently there are only 2 million outstanding, or 1.2 million outstanding if you subtract out the company-owned shares in the hedge funds. But they built in the ability to issue 8 million more B shares without shareholder approval.

    Another point is that, I don’t think the balance of ownership, which percent is beneficially owned by which class of shares, is all that important. For the reason mentioned above it will tilt hard toward B shares, but what if it didn’t. I’m not sure the effect would be all that large if currently 80% of the economic ownership rested in the A Shares, but in the future he still issued B Shares for an acquisition. Maybe there would be an effect on what a seller of a business would accept – but any seller of a business to this company is unique and has a different view of Sardar then the general public and would clearly be accepting Sardar’s control of both BH and the company they are selling – so I don’t even think in that scenario there would be much of an issue with B shares or anything.

    The bottom line is that Sardar is going to be an acquirer with B shares, but in order to do that he needs the BH share price to go up. Sardar also wants to get his lucrative incentive bonuses, but in order to do that he needs BH share price to go up. He could also do some other things like rights offerings, but in order to do that he likely needs BH’s share price to go up. These are the reasons, I began thinking about investing – because the things he wants to do would be facilitated by getting the BH share price up. And they have the 10b5 plan in place. But with a personality like this, and an idiosyncratic company and situation like this, it is impossible to say with near-certainty what he is thinking.

  8. Baruch

    Meaning, selling his own personal b’s, not just the company’s.

  9. RJChicago

    I’m sorry I may have misunderstood. Is what you meant that he may personally sell his B shares?

  10. dt

    Negative view on BH developments from Eschler Recovery Fund. Key takjeaway:

    “Part of my original thesis was that the dual-share class structure could serve as a catalyst: Mr Biglari would retain his beloved control while redeeming from the hedge fund Biglari Holding’s non-voting shares it owns in itself and then cancelling them, greatly increasing Biglari Holdings’ per share value via lower share count. Unfortunately, at the annual meeting Mr Biglari suggested this was unlikely

    https://seekingalpha.com/article/4192721-eschler-recovery-fund-q2-2018-letter-eschler-recovery-fund

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