SNS/WEST Merger

I have received some questions via email regarding the potential SNS/WEST merger:

The Letter of Intent contemplates that on or prior to closing Western will distribute to its stockholders all of the SNS shares beneficially owned by Western. Further, under the terms of the Letter of Intent, the consideration payable to Western’s stockholders will be based on a net transaction valuation of approximately $22,959,000.00. At closing, each share of Western’s common stock would be converted into the right to receive an amount equal to approximately $8.11 in the principal amount of debentures issued by SNS. It is anticipated that the SNS debentures will have a term of five (5) years, will bear interest at the rate of 14 percent per annum and will be pre-payable without penalty at the option of SNS after one (1) year from the date of issuance.

My thoughts are that this is good for SNS shareholders as they are getting a good amount for the $22.9 million, which includes 9% of ITEX (OTC: ITEX), 51% of an asset management company (Mustang Capital Partners ~10.6 MM AUM), a 23 acre parcel of land in Texas, and a restaurant and franchise business generating $1.5-$2 MM in operating profit per annum. Also, the transaction is essentially an LBO with no equity. The 14% interest on the $22.9 MM may seem high, but it should be thought of as a premium for Western Sizzlin shareholders and I would imagine it would paid off after one year. In addition, Steak 'n Shake is much more liquid than Western --- a plus for WEST shareholders. As a Western Sizzlin shareholder I would have preferred an all stock deal, but Biglari knows that SNS is undervalued and this potential transaction is not dilutive for SNS in any way as Western shareholders are getting the SNS shares that they already own. This also simplifies things for Biglari as now there is one capital allocation vehicle going forward (excluding The Lion Fund) and there are cost savings for Western as it would no longer be a public company.


*The author has positions in Western Sizzlin and Steak 'n Shake. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.

The Birth of a Holding Company from the Town of Buffetville --- Steak ‘n Shake (SNS)

Management Direction (from 3Q09 10Q)

New management, during the fourth quarter of fiscal year 2008, enacted a change in strategic direction under which we began to operate in a manner designed to generate cash. Our long-term objective is to maximize intrinsic business value per share of the Company. (Intrinsic value is computed by taking all future cash flows into and out of the business and then discounting the resultant number at an appropriate interest rate.) Thus, our financial goal is to maximize free cash flow and return on invested capital. We regard capital allocation as immensely important to creating shareholder value. Steak n Shake is transforming into a holding company. Its basic premise is to reinvest cash generated from its operating subsidiaries into any investments with the objective of achieving high risk-adjusted returns. Pursuant to a resolution of the Company’s Board of Directors on June 17, 2009, all investment and other capital allocation decisions are made for the Company by Sardar Biglari, Chairman and Chief Executive Officer.

Steak and Shake is a restaurant chain with system-wide sales of $700 Million and 486 units (413 company owned, 73 franchised), which is on the verge of evolving into a capital allocation vehicle.

Mr. Biglari (age 31) gained control of Steak ‘n Shake last year (after a drawn out proxy fight) and has since turned the company around by reducing expenses, curtailing capital expenditures, focusing on core products, and lowering prices --- which has resulted in positive free cash flow and increased guest traffic.

A few bullet points on SNS’s financial position as July 1st, 2009:

• Cash and cash equivalents are roughly $38MM

• Long term debt has essentially been eliminated, which should save roughly $1-2 MM/yr in interest costs (not considering the potential merger with Western Sizzlin (WEST – see Additional Information), which would add to the debt load and interest expense)

• $13.7 MM outstanding on a revolving credit facility at a rate of One Month LIBOR + 350 bps

• Operating expenses have been dramatically reduced from the prior period (Nine months ending July 1, 2008) by about $12 MM (according to Biglari there could be more reductions to come)

• Generated $41 MM in cash from operations for nine months ending 7/1/2009, $13 MM of that was related to income tax refunds that were received during the period

• Operating Cash Flows could approach $25-$30 MM annually going forward

• Maintenance Cap Ex. is expected to be roughly $5-6 MM annually (according to Biglari) as new company store openings will not be taking place

• SNS Market Cap = approximately $318 MM as of 8/28/2009

On top of the attractive financial metrics you have another layer of conservatism with management as they are value oriented, risk averse, transparent, shareholder friendly, and have the utmost integrity. In addition, “free cash flow coupons” will be redeployed to the greenest pastures rather than systematically into the business. This creates an added bonus as intrinsic value can grow at an above average rate.

In addition, SNS owns a lot of its real estate (Land and Buildings for 149 locations, 12 improved properties, and 16 parcels held for sale, carried at around $315 MM excluding improvements and depreciation, Capital lease obligations stand at $132 MM), which helps create a floor for the valuation and leaves the potential for resource conversion opportunities. Refranchising is also an option to generate cash and free up capital as SNS has many company owned restaurants.

SNS has historically generated strong cash inflows, but outflows were mismanaged and reinvested back into the company in the pursuit of sales growth with complete disregard for ROIC. A few years ago SNS was generating roughly $60 MM in operating cash flows, but it was squandered away by prior management.

Many successful capital allocaters started out in a similar way; however, not many had the type of cash flows and assets that Mr. Biglari has at his disposal. If you’re wondering if SNS is a viable business with a “moat” then I suggest you read this article written by Roger Ebert. Mr. Biglari recently said that he was even surprised by the strength of the brand after he took over.

Mr. Biglari’s record with his Investment Partnership (The Lion Fund – reminiscent of the Buffet Partnership) has been impressive and provides a paper trail for his capital allocation abilities. As of 12/31/2008, The Lion Fund (TLF) had outperformed the S&P 500 by 17% annually since inception (2000). One thing to note is that SNS and Western Sizzlin (WEST) represent over 50% of The Lion Fund. WEST has the bulk of its shareholder’s equity invested in SNS and Biglari has the majority of his net worth invested in TLF --- Interests are aligned.

So here you have a sizeable cash flow stream (relative to current market valuation), valuable assets, and an iconic brand in the hands of a capital allocator from the town of Buffetville --- who knows?...maybe good things can happen…


Additional Information:
Western Sizzlin, which was first entity where Mr. Biglari gained control, recently had their AGM. An intent to merge Steak and Shake and Western Sizzlin (Company Structure) was announced the same day. Here are the best notes I could find of the meeting.

Timeline of Biglari’s control endeavors.

Letter to SNS Shareholders (10/21/2008)

NYSE Opening Bell --- Same day as AGM and NASDAQ Stock Market Closing Bell (8/13/2009)

Western Sizzlin Corporation Rings The NASDAQ Stock Market Closing Bell --- Those are WEST shareholders who were there for the AGM in the back.

Sardar Biglari's Speech at the NASDAQ Stock Market Closing Bell

Corner of Berkshire & Fairfax Investor Message Board (They have a category dedicated to discussion about Sardar Biglari, Western Sizzlin, & Steak ‘n Shake)



*The author has positions in Western Sizzlin and Steak'n Shake. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.