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.
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.
(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.
- 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.
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.
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.