Why Sadar Biglari's proposed compensation package from BH is a fair deal for investors

After being invested in Steak and Shake (SNS) last year from $5.80 to $9, I've continued paying attention to them. Today the company has changed its name to Biglari Holdings (BH ) and trades at $320 (They reverse split 20-1, so its $16 when compared to my shares).

I noticed that their stock price has dropped from as high as $418 in early April, and wanted to see why. Apparently one big reason is because of the new proposed compensation package for the CEO, Sadar Biglari. Here is the gist of it:

1. Biglari is selling his other company, Biglari Capital, to BH for $1. Biglari Capital is the general partner of The Lion Fund, L.P., a Delaware limited partnership that operates as a private investment fund. The Lion Fund manages about $50mil, and Biglari Capital was paid 25% of any returns over a 5% annual hurdle with "high water mark" stipulations.

2. In return, Biglari would now be paid an incentive bonus based on the increase in Book Value of BH. Again there will be a 5% annual hurdle before any bonus is paid out, at which point his bonus would be 25% of the gain in excess of 5%. There is also a "high water mark," stipulation in place. Finally, Biglari would be required to use 30% of bonus money (at least 50% after taxes) to purchase BH shares within the next 120 days after issuance.

Thus far, investors have been screaming bloody murder on the message boards and even well respected (by me at the very least) NFI has sent a letter to BH against this package. However I feel that this package is quite fair and that investors will actually end up quite satisfied with their returns if Biglari makes a lot of bonus money. Let me go over my logic:

There are three main ways BH book value will go up:

1. Profits from Operations

2. Increase in the value of company investments

3. Purchase of other companies through issuance of stock

The first two ways are clearly beneficial for investors as in the long run the stock price will follow if the company's value increases in those ways. The third way is where investors could be hurt, because new stock being issued to purchase another company would potentially dilute current investors, yet possibly create a situation where Biglari could receive a bonus. However, I believe that Biglari will only use stock to purchase other companies when they represent a good long term value because he holds a lot of BH stock and the value of his shares would fall by more then his potential bonus.

Here's what BH's book value has been the last 5 years:

Now lets look at how investors might benefit long term vs how much Biglari will benefit. In the chart below I've assumed that Biglari delivers earnings of 10% of Book Value each year, giving him a bonus of 12.5% of the increase in Book Value.

As you can see, investors do quite well for themselves, pocketing 8.75% yearly gains, while Biglari receives a yearly bonus in the $3-4mil range. I feel like many CEOs at publicly traded companies make quite a bit more whether or not they deliver long term performance figures that would be as solid as these.

I think it is clear that Sadar's long term plan is to emulate Buffet and Berkshire Hathaway. He will take cash from Steak and Shake and other future acquisitions and plow it into investment opportunities which he feels will yield higher then 10% returns. I bet that in a few years the bulk of the yearly Book Value increase will be due to the increase in the value of investments owned by the company. At that point, one could consider BH to be a hedge fund, and Biglari's bonus to be his management fee. Personally, his fee structure is much more appealing that the typically 2%+20% of profits.

Disclosure: Don't own any BH at the moment, but seriously considering buying some right now.


Anonymous said...

I think a lot of people fail to understand the difference between invested capital and equity. Even with the adjustments to book value, it would make a lot more sense, as the NFI guys seem to point out, to use invested capital and not shareholder equity.

Biglari's hasty letter put out last night -- I'm guessing in response to the NFI letter -- didn't address their concerns but danced around them. Why?

The NFI letter pointed out three things:
1. The nuance between Invested capital and equity.
2. management could reap huge rewards even if BH underpreforms the market.
3. The fact he wanted a high hurdle rate for his executives when he was the majority owner of Western (the hurdle rate there - 20% versus the 5% he wants).

Those all seem like very valid points to me.

Aurelien said...

I don't remember reading that his hurdle rate at WEST was so high, but if so then that I a valid concern.