Biglari Holdings: Key Issues & Tangible Solutions For Shareholders by Lonnie J. Rush & Jacob L. Taylor, Farnam Street Investments.
- We seek to focus on the facts.
- The situation is far from intractable, if a mindset of compromise is adopted by all parties.
- We provide tangible, shareholder-friendly solutions to the biggest challenges at Biglari Holdings.
Overview of the Biglari Holdings proxy battle:
While Groveland Capital makes very valid points regarding the circumvention of the incentive agreement and the egregious nature of the licensing agreement, they failed to recognize the operational and investment success of Mr. Biglari and Biglari Holdings since he’s assumed the helm. And while Mr. Biglari has done a great job operationally and with capital allocation, he and the board have neglected to address the circumvention of the incentive agreement and egregious nature of the licensing agreement.
As we will explain, shareholders (i.e owners) are being punished because of the distrust created by Mr. Biglari and the board in their end around of the $10m bonus cap, along with the growing off-sheet liability associated with the licensing agreement. If we understand the licensing agreement correctly, the potential royalty payment liability could be a staggering $700m or more if Mr. Biglari is ousted years down the road. Additionally, Mr. Biglari has contended that Groveland Capital is trying to take over the company with just .17% ownership stake, yet their position represents about 10% of one of their investment vehicles – not a small percentage . In contrast, Mr. Biglari has effectively turned his 1.5% ownership 1 2 stake (worth about $13 million) into performance fee compensation totaling $75.3 million since taking over.
As we will show, under the current incentive and licensing agreements, Mr. Biglari can continue to perform fabulously over the next several years, BUT it won’t translate into shareholders’ success because of the escalating nature of the licensing agreement liability.
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Combine that with the distrust in Mr. Biglari and the board over the circumvention of the incentive agreement, and you have a company set up to make the CEO and capital allocator rich at the expense of shareholders, even while he can claim continued operational and investment success. Unfortunately, success alone cannot dig shareholders out from the hole that the licensing agreement and distrust creates. It’s not by coincidence that the market has discounted Biglari Holdings stock since the introduction of the licensing agreement and the circumvention of the incentive agreement. It is in the interests of both parties to reach an agreement and make concessions for the benefit of the remaining 98% of the owners.
We began buying stock in Biglari Holdings (BH) in the summer of 2014 when we felt it had become too cheap, despite the well-deserved overhang and uncertainty created by some of Mr. Biglari and the board’s actions. Stocks like Biglari Holdings become cheap in an expensive market for a reason: we think it’s due to the recent treatment of shareholders – not Mr. Biglari’s operational and investment performance. In fact, as an operator and capital allocator, Mr. Biglari has been outstanding. Unfortunately, board decisions regarding the incentive agreement and the license agreement have created a persistent cloud over the stock price.
We have been keen observers of the recent proxy battle for control over the Biglari Holdings board. Like any disagreement, both sides make valid arguments while conveniently ignoring plainly obvious facts detrimental to their cases. This article attempts to provide some clarity on the issues we felt each side has either misrepresented or ignored, as well as some potential solutions to ensure everyone wins. ( In full disclosure, we own approximately twice as many shares as the challenger Groveland Capital. While we have temporarily voted our shares by mail, we will be attending the meeting in person and are prepared to revote based on what we uncover leading up to the meeting.)
Biglari Holdings – Issue #1: Operating Income/Steak and Shake Performance
Either because of poor analysis or simply ignoring the economic facts of Biglari Holdings, Groveland has taken operating income straight from the published financials and compared Mr. Biglari’s tenure with the previous management’s. That is unequivocally the wrong way to analyze Biglari Holdings’ operating income. The company’s numbers have a few major distinctions worth taking into account and backing out to analyze what’s truly happening economically.
To set the record straight, Steak n’ Shake’s (SNS) sales increases under Mr. Biglari were accomplished through the same four walls, meaning Biglari Holdings did not build extra stores to increase sales. Same store sales started to climb almost immediately after Mr. Biglari’s arrival and continue to this day, a remarkable achievement given the very little capital expenditure for maintenance or new stores. By spreading store-level fixed costs across more revenue per store, Mr. Biglari was also able to quite effectively increase free cash flow 3 for the parent company. This increased cash flow was achieved despite recent turnaround investments at Maxim and very large franchising investments since 2011.
See full PDF below.