Monday, December 22, 2008

A lesson in value-destroying "growth": Presented by former Steak 'N Shake management

Number of Steak 'N Shake restaurants in 1998: 233 company owned and 51 franchised
Number of Steak 'N Shake restaurants in 2007: 435 company owned and 56 franchised

Revenues at the end of 1998: $312.552 million with franchise fees accounting for $3.355 million
Revenues at the end of 2007: $654.142 million with franchise fees accounting for $3.726 million

Sales grew at a compounded rate of 8.55% for those 9 years. What about profits?

Reported earnings for 1998: $11.225 million
Reported earnings for 2007: $11.808 million

That's right. Earnings grew(if that's the right term here) over the same period at a compounded rate of about half a percent per annum. To achieve this tremendous result, management spent more than $500 million in capital over that period. Little wonder then that shareholders were the ones left holding the bag as management embarked on a value destruction spree. Shareholders would have instead been much better off if management had simply paid out all of the owner earnings as dividends during this period.

As management continued down this path of destruction, Sardar Biglari, the Chairman and CEO of Western Sizzlin, began buying shares of Steak 'N Shake. After buying about 7% of the stock, Sardar wrote his first letter to SNS shareholders in October 2007 announcing his intention to nominate Western's vice-chairman Dr.Phil Cooley and himself for election to SNS' board at the 2008 Annual meeting:

This is how SNS' balance sheet looked at the end of 2007:

A line of credit that had been drawn upon to the tune of $27.185 million.
Long term debt of $16.522 million.

Against this debt, we had:
Assets Held for Sale valued on the books at $18.571 million.  
Property and Equipment valued on the books at $492.61 million.

Remember our discussion on capital lease accounting? You'll see that SNS' balance sheet has a liability line item called Obligation under Leases to the tune of $139.493 million. So, the book value of SNS' property and equipment was closer to $353.117 million(492.61 - 139.493). Debt looked reasonable relative to assets on the book at this point.

We also had $16.644 million in owner earnings for 2007(there were quite a few one-time charges in that calculation that weren't added back, so these earnings are likely understated if Sardar were to get control), down precipitously from about $35 million in 2005. Sardar had mentioned a possible $12 million in savings from bringing G&A expenses down to prior levels. Nevertheless, the business operations were in serious decline as is clear from the numbers above. Having demonstrated it's ineptitude on the capital allocation front, management had turned it's sights to operational ineptitude over the last couple of years. Consequently, SNS was selling for about $303.9 million a week after the 2007 10-k was filed, for less than the value of Property and Equipment on it's books. 

So, the situation at the end of 2007 was: A restaurant "brand" that had been around since 1934 being decimated by management incompetence, primarily on the capital allocation front, and more recently, on the operational front. An extremely shareholder friendly group led by Sardar that was looking for two seats on the board to fix the capital allocation and operational issues. If Sardar and Phil Cooley were elected to SNS' board, things were likely to get better, albeit over time. We'll see what actually happened in 2008 next.

Often wrong but seldom in doubt,

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