Sunday, December 28, 2008

Steak 'N Shake: 2008 in review

After Sardar asked for 2 board seats at the end of fiscal 2007, SNS management explored various "strategic" alternatives, including a sale of the company. I believe bids came in although management rejected all of them as being insufficient. Meanwhile, operations continued to deteriorate through the first quarter prompting a second, and more detailed letter, from Sardar:

http://www.western-sizzlin.com/pdfs/Second%20Letter%20to%20Shareholders%20of%20the%20Steak%20n%20Shake%20Company.pdf

SNS was going to post an operating loss for the first quarter. Sardar outlined his vision for the future of SNS: Moving away from a majority company-owned stores model to a majority franchisees-owned stores model i.e. a translation from a capex-heavy and risk-abundant model to a capex-light and risk-light model. Sardar also made it clear that he was going to seek to replace the majority of the board at a special shareholder meeting following the Annual Meeting. 

Management's reaction was swift and a vivid illustration of the depths that they would sink to in order to keep their jobs: The company's by-laws were amended such that 80% of shareholder votes would be needed in order to call a special meeting, up from the original 25%. This caused significant consternation amongst Sardar's camp, as one might imagine. The proxy fight was now on in full force. Sardar and Phil won support from the major proxy advisory services, and in early March, were decisively voted on to SNS' board. 

Things didn't end here though. The atmosphere within the board was hardly congenial. The CFO at that time, Jeffrey Blade, was appointed interim Chairman, when the obvious choice would have been Sardar. It took 3 long months, and further operational deterioration, until things took a turn for the better when Sardar was appointed Chairman in June. After a fruitless search for a new CEO, Sardar himself was appointed CEO in August. So, how did things go operationally this year?

Q1 results:
---------
The company posted an operating loss of $2.415 million before taxes with same store sales declining a whopping 9.5% and guest traffic declining 13.3%. Given how dismal new store openings had proved over the last decade, management also considered it prudent to open 4 more new restaurants! 4 restaurants were refranchised and 2 new franchised restaurants were also opened. Owner earnings estimates for the quarter came in at a piddling $1.987 million. 

Q2 results:
---------
The company posted an operating loss of $5.112 million before taxes with same store sales declining 6.3% and guest traffic declining 8.8%. Unimaginably, in the face of all of this operational decline, management continued on it's merry spending spree, opening 5 more restaurants in Q2. The company also refranchised 4 of it's owned restaurants. Alarmingly, the company reported that it was in violation of covenants with respect to it's debt agreements and that some covenants had to be reworked in order to enable SNS to be in compliance with them. Although SNS had the assets to cover the debt, this wasn't good news at all.

Q3 results:
---------
Sardar had been appointed Chairman just prior to the end of this quarter. The company posted an operating loss of $16.179 million before taxes with non-cash restaurant impairment charges of about $14 million. The noose was also being tightened wrt the line of credit facility. SNS entered into a sale-leaseback transaction for 10 of it's owned stores for $14.817 million and used pretty much all of the proceeds to pay down the line of credit to $9.18 million. This was essentially a financing transaction, a swap of one type of debt to another, more expensive type of debt. The interest on the line of credit facility was 4.94%. The imputed interest on the sale-leaseback transaction was 8.27% (lease payment of $1.226 million for these leased-back properties in fiscal 2009 divided by the total proceeds of $14.817 million). Clearly, this was a transaction best avoided, if possible. I suspect that with operations deteriorating fast, the lenders pushed hard and Sardar had no choice in this matter.

The 10-Q also indicated that SNS had been granted a current quarter waiver of covenants wrt to both the Senior Notes as well as the Line of Credit facility. SNS was also prohibited from making cash dividends as well as share repurchases. SNS would also be required to secure their Senior Notes borrowings with real estate assets effective November 21,2008. SNS was basically being told what to do by their creditors as a result of operational deterioration, and one suspects, the freeze-up in the credit markets.

Prior to the announcement of Q4 results, Sardar wrote his first letter to shareholders as CEO of SNS:

http://www.sec.gov/Archives/edgar/data/93859/000009385908000070/exhibit99_1.htm

Plenty of discussion about cost cutting with G&A expected to be $20 million lower from 2007 levels. SNS was also expecting a $16 million(!) refund from taxes that were paid in 2006. SNS also expected to pay down the Senior Notes. 

There was an interesting comment about hiring an experienced restauranteur, Dennis Roberts, formerly at Friendly's (Western's first stock investment under Sardar), to help with improving operations. Roberts had been granted 50,000 stock options of SNS as part of his offer of employment at a strike price of $10 effective Sept 29, 2008. Closing price of SNS stock on Sept 29, 2008: $8.59. You heard that right. Sardar had hired Roberts to work at SNS with an options agreement where the stock price was lower than the strike price of the options. Although there exists a remote possibility that there is a precedence for this occurence, I suspect this is a first and one that Sardar deserves credit for.

Q4 results:
---------
This was Sardar's first full quarter in charge of SNS. The company reported an operating loss of $11 million before taxes with same store sales declining by 7.4%. The operating loss came back of $6.366 million in charges associated with the restructuring that Sardar alluded to in his last letter. 

Estimated owner earnings for fiscal 2008 was $14.13 million, compared to $16.644 million in fiscal 2007. Just like the 2007 estimate, the 2008 estimate also included certain one-time charges. The difference with the 2008 charges were that one could be reasonably confident that these charges would be non-recurring, given their nature and also given that Sardar was now in control. The addition of the non-recurring expenses increases the estimate of owner earnings in fiscal 2008 to $15.885 million, still significantly off from the highs of about $35 million in fiscal 2005. 

Sardar had also announced an SNS investor day for November 11th, a day after the results for the 4th quarter had been posted. Notes from that day are available here:

http://seekingalpha.com/article/106523-notes-from-steak-n-shake-s-investor-day?source=article_lb_author

A more detailed, and brilliant, set of notes came from a service I subscribe to. All I can say is that I wish all current and prospective SNS shareholders could read it. I was disappointed to not be able to make it to that investor day but I suspect there will be plenty of chances in the next few decades to see Sardar at SNS/WEST annual meetings.

Warren Buffett has often said that he looks for three qualities in evaluating a person: integrity, passion and intelligence. In my admittedly subjective opinion, Sardar ranks very highly in all 3 categories. 

He has a tough job turning SNS around but I'll say this: Underestimate Sardar Biglari at your own cost of opportunity.

Disclosure: Long Sardar(SNS & WEST).

Often wrong but seldom in doubt,
Ragu 

3 comments:

  1. "A more detailed, and brilliant, set of notes came from a service I subscribe to. All I can say is that I wish all current and prospective SNS shareholders could read it."

    Ragu,

    Which service are u alluding to ? Would it be possible for you to share this (if it is not proprietary) ?

    thanks
    Qleap

    ReplyDelete
  2. Qleap,

    The service I am referring to is the Motley's Fool's Pay Dirt service aimed at small cap deep-value investments. Unfortunately, TMF pulled the plug on this service towards the end of last year. The notes from Jim Gillies were posted on the SNS discussion board there. Those discussion boards are currently not accessible to the general public. If that changes, I will post the link to the notes here.

    --Ragu

    ReplyDelete
  3. Btw, I was re-reading his Western's chairman letter and it's eerie to see him imitate Buffett's style. :)

    ReplyDelete