25% of book value gains above 5% for Biglari?

[Crip1]

I did not pull the trigger months ago when this company was widely discussed by members of this board, an inactivity which in hindsight cost me substantial money. Several months ago I had placed this on my watchlist for a good entry point. As of today, it is off my watchlist.

 

Buying “management” when buying companies, or shares thereof, has been discussed several times on this board. I feel that the buying of management in a company is quite similar to the hiring of employees. As a shareholder of Fairfax, I have hired Prem Watsa to be a steward of my investment, of my savings, of my financial wealth, and am still quite comfortable with that hire (underwriting results notwithstanding). The same goes for Berkshire and Markel. Similar to when dealing with an employee, if the performance declines, or you have reason to question their judgment or integrity, the good manager seeks to help the employee improve on those things. If your efforts do not result in improvement, you have little choice to fire the employee. As an investor/business owner, you are less able to execute a performance plan, so you are left only with the decision as to whether or not you fire the management by selling the stock. There are differences as one considers valuation and so on but you get my point. One of the things that Buffett has indicated as criteria for buying a business is whether or not management (who he cannot provide for a company he buys) loves the business or loves the money. He opines, and I agree, that it is OK to love the money, but one has to love the business.

 

My impression is that Biglari loves the money, not the business. I am not necessarily faulting him for that as I would bet that he’ll be successful in his endeavor to attain more money. But I equally feel that I will not be looking to hire him any time soon.

 

-Crip

 

[Guest Bronco]

This is an interesting version of a share buyback - instead of shares being eliminated, they go to the CEO.  If someone is smart enough (not it!), it would be neat to see the current book value and projected 10, 12, or 14% BV growth year by year.  Along with the increase in BV, another column in excel could indicate the increase in Biglari ownership.  I guess you would have to assume what the stock price would be - some assumption would be necessary.

 

I would be curious to see SB's ownership % after 10, 15 years....

 

 

[collegeinvestor]

Crip you could have made a lot of money through speculation. I don't think an increase in book value is a good way to measure success. His investments really havent been that sucessful and he just talks a lot like Warren Buffett. If you put a monkey on stage and have him say he is a value investor people will invest in his company regardless of price.

[valuecfa]

Crip you could have made a lot of money through speculation. I don't think an increase in book value is a good way to measure success. His investments really havent been that sucessful and he just talks a lot like Warren Buffett. If you put a monkey on stage and have him say he is a value investor people will invest in his company regardless of price.

 

I've never quite believed his "story" either, and have never purchased a single share. It is easy to get a huge following in the value investing world by writing a shareholder letter that emulates Buffett, focuses on metrics of intrinsic value, and focuses on fair treatment of shareholders. It is quite another thing to actually follow through on those letters.

[Zorrofan]

IMHO this represents everything that is wrong with corporate America today! Greed, pure and simple. To justify such an arrangement Biglari will need to generate some very large returns. Can he do it? Only time will tell......

 

 

cheers

Zorro 

 

 

[valuecfa]

IMHO this represents everything that is wrong with corporate America today! Greed, pure and simple. To justify such an arrangement Biglari will need to generate some very large returns. Can he do it? Only time will tell......

 

 

cheers

Zorro  

 

 

 

I couldn't agree more. Corporate executives are insanely overpaid, and it is hurting shareholder value. Look at a chart that plots inflation, corporate earnings, and corporate executive compensation and the results are shocking. Absolutely shocking. What makes matters even worse are the incentive structures. --ie Bonus structures tied to short term performance of a year of less. The insane amount of bonuses regardless of mediocre or poor performance. Golden parachutes if their is a change of control and the CEO gets fired. You get paid to get fired! Brilliant. What do i have to do to get myself canned? Perhaps i will run the company poorly have someone buy the company out for a cheap price, and hope to get fired, so i can retire wealthy. Great incentive!

 

 

As for Biglari. He can't justify this egregious compensation, no matter what his future performance might be. Were i a shareholder (and still wanted to stick with the company), I would honestly attempt to get Biglari replaced as CEO. He doesn't deserve to be Chairman and CEO any longer given his newly shared vision of running the company to build his personal wealth to the detriment of shareholders. This is one of the worst examples of corporate greed i have seen. His actions speak much louder than his words.

[Santayana]

If book value shrinks in a given year, will he be taking a pay cut?

[Ballinvarosig Investors]

In fact, he could go buy Burger King with stock...increase book by $1B, and he would take home almost $250M!

What happens if there isn't enough cash on the balance sheet to pay Biglari's compensation, finance it with debt? Not only that, but this compensation package encourages leverage and risk taking.

 

I don't think Biglari would screw shareholders in such a way, but this compensation agreement is just wide open to manipulation.

[txlaw]

This development is both disappointing and fascinating at the same time. 

 

It's disappointing because the intrinsic value of BH is now less than when Biglari was only taking a 900K salary for running it.  However, it's fascinating because he has essentially gone from running an open-ended hedge fund (the Lion Fund) to a closed end fund (BH) and has increased his AUM ten-fold at the same time.  Furthermore, this publicly traded hedge fund is named after himself and has a compensation structure seemingly modeled after the Buffet Partnership. 

 

There are, however, some big differences between BH and a typical hedge fund.  First, Biglari has permanently locked up investor capital and no longer has to worry about the downside risk of having investors pull out money from his fund.  Second, Biglari now has the ability to increase AUM by a substantial amount over time through M&A, which will substantially increase his compensation if he can meet the hurdle rate specified (safe to say that he will be able to do this).  Third, Biglari is required to shovel 30% of his "bonus" back into the fund -- not sure if that's the case at other hedge funds.

 

To criticize the compensation structure as proposed is to criticize pretty much all hedge fund compensation structures, including the Buffett Partnership and any funds modeled after that partnership.  Not an unreasonable criticism if we're talking about matching up compensation with societal value.  But is this really any different than the way that the Pabrai Funds or other hedge funds are structured?

 

This turn of events shouldn't be terribly surprising to people.  Did folks really think that Sardar Biglari was the next Buffett?  For that matter, is Buffett even really the Buffett everyone claims him to be? 

 

Frankly, WEB is made out to be more of a saint than he actually is and was.  I mean, read the Snowball.  The early WEB was very focused on using OPM to grow ridiculously rich.  He would take his substantial incentive fees and shovel them back into the partnership, increasing his stake in the assets he controlled over time.  When he closed the partnership, he had AUM of over $500 M in today's dollars, so he was probably getting paid a substantial amount of money in the preceding years given his performance.  That's exactly what Biglari is going for, except that he has increased his AUM by taking a shortcut.

 

I see a lot of similarities between Eddie Lampert, Sardar Biglari, and the early Warren Buffett.  Generating high annualized returns seems to be ingrained in these guys.  They are also very focused on making money and to some extent keep their internal scorecard using this metric.   

 

I don't own any BH at this time but will keep an eye on it and trade in it if it gets substantially undervalued.  I have no illusions that Sardar Biglari is going to be the next WEB.

[vinod1]

No comparision to a hedge fund. Companies earn around a 10% ROE on average since time immemorial. Some industries earn a little more and some a little less but it is this return that gets passed on to the investors. An average business should be able to earn around this rate of return. Even if restaurent business has poor economics I doubt any investor would invest without an expectation of a minimum of 8% ROE. So book value should grow by a minimum of 8% assuming no payout.

 

This is nothing short of legalized rape of shareholders. A more appropriate name change would have been Biglari Madoff Holdings (BMH).

 

Vinod

[collegeinvestor]

I have never heard of anything like this. How will this get passed? Does the board have to sign off on this or the shareholders? (excuse my ignorance on this). I find it funny that its only 30% stock, why not make it 100%? I cant imagine why someone would need that much cash when he already gets paid 900k a year  :-*

[Christopher1]

Hi all,

 

first of all I’d like to specify that I’m very disappointed by the new compensation structure, I’ve invested along with Sardar from WEST (when he was salaried only by the board member fee :)) and now BH is the biggest position in my portfolio (due to Friday event I’m going to reduce/eliminate my position), so I have to say that I made pretty well following Sardar.

 

From yesterday I’m trying to recollect my thoughts, and I want to share my considerations with this insightful board in order to try to have better inputs in my decision making process regarding BH.

 

Forgive me my English, I’m not a native English speaker, moreover sometimes I’ll compare Sardar decisions to other well respected capital allocators only to make clearer my concepts.

 

Differently from other great capital allocators I think Sardar has an “ownership gap”. Let me elaborate.

Prem Watsa started FFH with its own money representing a core component of the Markel refinancing. Cumming & Steinberg (LUK) refinanced in 1978 Talcott (the predecessor of LUK) with their own money and credit cards. Both from the start owned a big ownership of their respective company.

 

Instead Warren for BRK and Edward Lampert for SHLD accumulated a big position in their respective companies through their investment vehicles (Buffett Partnership and ESL) and subsequently through the “incentive reallocation” they established their personal controlling ownership positions when the investment vehicles were/will be liquidated (for Lampert this has not already been done but could be a  likely scenario). From an age point of view both assumed the leadership role in SHLD and BRK relatively later compared to Sardar.

So my impression is that Sardar has not been capable to build for himself a very significant control position in BH, because SNS was to big compared to the Lion Fund and differently from Warren he has not achieved near 30% CAGR for 10 consecutive years (the “incentive reallocation” was not enough).

 

Maybe it is possible to conclude that the Warren and Lampert control positions in BRK and SHLD have been achieved through their performances at the “expense” of their partners (don’t misunderstand me, I intend cost because the incentive reallocation is a cost for the partners), which have been richly rewarded.

 

The incentive of BH is similar to Warren’s Partnership (the hurdle rate is lower 5% rather than 6%) and considerably cheaper than Lampert (2+20 on that I’m not sure), so it’s not so bad. I can understand also the argument of the free ride due to SNS annual net income increasing the BV, but it’d be similar for a money manager owning FFH in his portfolio, because for example if the BV increases and stock price follows also the money manager is helped to achieve his hurdle rate.

 

I think Sardar is trying to replicate this scheme, but in his case the partners are the shareholders because he can’t lever the Lion Fund (now sold to BH substantially for free). So I feel poorer because from a BH shareholder point of view it’d be better if someone pays for ownership building of Sardar, but maybe the process is fair for all the people who are investing their money with Sardar capabilities.

I’d have preferred a Lion Fund sale replicating was Prem has done for HWIC, but that would have precluded Sardar from building a control position.

 

I think also the move has been made in order to not create asymmetry between the Lion Fund and BH, because I suppose that they have a very similar portfolio, so the reason to stay invested in the LF rather than BH (and paying the incentive reallocation) was very weak. (Probably, at this point, the LF has no reason to exist).

 

I have to say also that for Sardar is binding to use at least 30% of his incentive to buy BH stock on the open market, that is a minimum of 50% of his compensation after tax. That is the INCENTIVE REALLOCATION.

 

We can’t blame Sardar for his choice to use a public company as his investment vehicle (float) avoiding the up and downs on the asset under management with the related disadvantages. As a partner we can choice only to sell the shares.

 

I’m sorry for the long post, I hope someone can help me on the soundness of my analysis so I can have more food for thought. Maybe in my analysis I have searched only a way to rationalize Sardar decisions, fooling myself.

Respectfully,

Christopher1     

 

[Parsad]

To criticize the compensation structure as proposed is to criticize pretty much all hedge fund compensation structures, including the Buffett Partnership and any funds modeled after that partnership.  Not an unreasonable criticism if we're talking about matching up compensation with societal value.  But is this really any different than the way that the Pabrai Funds or other hedge funds are structured?

 

Yes. 

 

- He didn't raise the capital. 

- He can use the shares to raise unlimited amounts of capital going forward. 

- The corporation covers all of his expenses including office, travel, food & entertainment, etc.

- He will never have redemptions. 

- His incentive allocation is based on growth of book value and not open to the whims of market volatility, thus he gets paid year in and year out as long as SNS is running as it is. 

 

Cheers!

[farnamstreet]

With one movement of the pen, it seems Biglari has alienated even his most loyal followers and made Fremont's CEO Richard Dunning appear dramatically underpaid for the value he creates at Fremont.

 

[Nnejad]

We should all hold some* judgment until we find out more about the Lion Fund, in particular, the filings which hopefully will be coming out shortly.  The reason I say that is this:  Let's say the Lion Fund has 100 million in AUM, and it was netting him 2 million a year in fees.  Well, now he basically gave that business away for free to BH.  Under BH, that would add 2 million a year to net income; .66% Return on Equity.  Best case, if BH is above the 5% threshold for the year, he will only be getting effectively 500k of that.  It's a net 1.5 million loss for him.

 

Now translate that over to the current situation.  Steak N Shake might have net income this year of 25 million.  15 million is about the equity mark.  25% over the threshold translates to a 2.5 million bonus.  With the inclusion of the Lion Fund into BH, its a 3 million bonus; whereas before hand, he was making 2 million directly to himself from the Lion Fund.

 

It all depends on how much he was making off the Lion Fund, and how much in AUM it had.

 

That being said, immediately you can see that it has its problems.  5% is an easy mark to beat.  Like Vinod said, the average company returns 10%.  Steak N Shake's earnings are going to move up to closer to 40 million in the future just because D&A will go down and profits will go up.  On today's equity base, that would be a 6 million bonus in the future, even if he did nothing more to improve the business from here.

 

And another thing: how do you account for dividends?  It would be very easy to re-franchise stores, return the money and shrink the equity base, and then make a killing in bonuses by showing astronomical ROEs, when the underlying earnings power hasn't really changed.  Similarly, he could leverage the business by say taking on 100 million in debt, return it to shareholders, and now your ROE has gone up.  So something has to be noted to restrict something like that from occurring.

 

[maxprogram]

I don't believe this will be seen through to the end. My prediction? One of three things will happen:

 

1. The incentive arrangement is adjusted to more adequately reflect the advantages Biglari is receiving over a hedge fund (I.e. a 15% hurdle, all comp in shares, lower incentive fee)

2. Shareholders vote the measure down, Biglari buys back TLF

3. If the measure goes through, other activists force Biglari to recend it (I.e. Gabelli)

[shalab]

Fremont's CEO Richard Dunning appear dramatically underpaid for the value he creates at Fremont.

 

Agreed - the case to remove Dunning doesnt seem strong given the recent change in compensation package for BH. That said, I would say that "Haste creates waste" and wouldnt jump out to sell my shares on Monday.

 

 

 

[txlaw]

To criticize the compensation structure as proposed is to criticize pretty much all hedge fund compensation structures, including the Buffett Partnership and any funds modeled after that partnership.  Not an unreasonable criticism if we're talking about matching up compensation with societal value.  But is this really any different than the way that the Pabrai Funds or other hedge funds are structured?

 

Yes. 

 

- He didn't raise the capital. 

- He can use the shares to raise unlimited amounts of capital going forward. 

- The corporation covers all of his expenses including office, travel, food & entertainment, etc.

- He will never have redemptions. 

- His incentive allocation is based on growth of book value and not open to the whims of market volatility, thus he gets paid year in and year out as long as SNS is running as it is. 

 

Cheers!

 

- He didn't raise the capital.  

 

Yes, true.  But why should that make a difference?  Are hedge fund managers justified in earning 2 and 20 or having a Buffett Partnership-style compensation scheme because they raised capital?  

 

- He can use the shares to raise unlimited amounts of capital going forward.  

 

I completely agree that Biglari can just empire build to raise his AUM.  But unless I'm missing something here, any capital raised will be subject to the hurdle rate (which is probably far too low) before he makes any money off it, since the "book value" figure will be adjusted for the raising of new capital.

 

So what's the difference between this and trying to hustle for increased AUM?  In one case, the hedge fund manager markets their services and gets new funds from accredited investors.  In Biglari's case, he simply goes to the public markets to raise new capital.    

 

Actually, the bigger problem may be that Biglari will try to sell undervalued shares to increase his AUM.  But that is also a problem with most corporations -- take a look at KFT's issuance of stock for the acquisition of CBY.  Benefited the CEO of KFT quite nicely, I believe.

 

- The corporation covers all of his expenses including office, travel, food & entertainment, etc.

 

Yes.  And he still gets a salary.  But lots of hedge funds justify their 2% on AUM to pay for these types of expenditures.  So I don't see the difference between this and most hedge fund compensation schemes.  Different than Pabrai though, for sure.

 

- He will never have redemptions.  

 

Yes, true.  He essentially has a permanent lock up on his investor base.  But again, why should this make a difference between whether a hedge fund is allowed to have a 2 and 20 scheme or Buffett Partnership-like scheme versus Biglari Holdings or any corporation?  Are conventional hedge funds really more justified in charging their fees in this manner because their investors will withdraw funds?

 

- His incentive allocation is based on growth of book value and not open to the whims of market volatility, thus he gets paid year in and year out as long as SNS is running as it is.

 

The volatility of the market often benefits hedge fund managers and CEOs.  Hedge fund managers that get paid based on NAV or CEOs that get paid based on share price get much greater payoffs in frothy times than does the CEO whose compensation is tied to book value growth.  Furthermore, value-oriented investment managers get paid precisely because they take advantage of volatility in the market to increase NAV by amounts that are substantially larger than the intrinsic value growth of the underlying businesses.  So I don't see why payment based on book value growth rather than NAV growth is worse.

 

In fact, if book value understates intrinsic value, like with Berkshire, then the CEO who is paid based on book value growth could potentially be paid less than someone who is paid based on share price growth over time.  

 

Of course, book value can also overstate intrinsic value.  And obviously, book value growth can be gamed, as Nick points out.  You can substantially increase risk and your chances of payout by levering up your fund/business.

 

---

 

I'm not trying to defend the compensation scheme.  I'm pointing out that this compensation scheme is very much a hedge fund-style compensation scheme and that there is no good reason why hedge funds should be paid in the manner that they are.  Why should pay be based so heavily on AUM?  It's much harder to run a big corporation than it is to run a big investment fund.

 

I would not vote for a compensation scheme like the one proposed.  I have no desire to own a publicly traded hedge fund with a conventional hedge fund payment scheme.

 

And by the way, when I said that Lampert, Biglari, and early WEB were intensely focused on making money, that was not meant to be a compliment.  

[schin]

3. If the measure goes through, other activists force Biglari to recend it (I.e. Gabelli)

 

True, Gabelli built up a big position and he, for one, would be getting robbed by this new incentive plan. If he gets out, he'll depresses prices while shares are being sold. Or he'll have to be activist.

 

Each year, Gabelli's ownership will be sliced away anyway... such that activism would be meaningless.

 

This 30% incentive plan with a low watermark, is HIV... it'll just multiple until all outside shareholders die away.

[Myth465]

Tx your arguments are mad in my opinion. I know you are playing devils advocate, but this situation really shouldnt have an advocate.

 

What does buying 1.5% of a company and getting 25% of all of its future gains (above an extremely low hurdle rate) have to do with a hedge fund. If he wants the compensation of a hedge fund money manager, then he should open up a hedge fund and raise the assets.

 

As the CEO he nothing more than an employee of a company. A hedge fund Manager is a hedge fund Manager. This guy just runs the company for now. Why should he get 25% of all the companies future gains when he owns only 1.5% of the company. He is taking a highly disproportionate share of the earnings and that is simply greed. No better then the guys he replaced at SNS or the guys he is trying to replace at Fremont. If he wants 25% of all future earnings then he should buy 25% of the company.

 

Buffett is no saint, and is greedy. But he is fair and honest and looks out for the shareholders.

 

He wants the best of both worlds, At least with Greenlight Capital Insurance this was the goal all along and owners werent mislead.

 

 

[Zorrofan]

I don't believe this will be seen through to the end. My prediction? One of three things will happen:

 

1. The incentive arrangement is adjusted to more adequately reflect the advantages Biglari is receiving over a hedge fund (I.e. a 15% hurdle, all comp in shares, lower incentive fee)

2. Shareholders vote the measure down, Biglari buys back TLF

3. If the measure goes through, other activists force Biglari to recend it (I.e. Gabelli)

 

Two things....

 

1. It sounds like the board has already entered into the agreement. Since it is an "issue of compensation" does it need to go to shareholder vote or can the board simply aprove it?

 

2. The Lion Fund was Biglari's hedge fund, BH is a holding company the same as BRK or FFH. How would we feel today if WEB announced a similar change to his compensation? If it was simply a matter of wanting to keep control of BH he could have tried to pass a poison pill instead.

 

cheers

Zorro

[collegeinvestor]

I might not be the smartest person but what has he really done for steak n shake besides decrease capital expenditures? that is all I can tell based on looking at the statement of cash flows.

[valuecfa]

Feb. 11, 2008,

 

"I have made a personal commitment to you that I will spend all the time necessary to rehabilitate The Steak n Shake Company. Not only will I refuse extra remuneration for the time I intend to commit, but I also will not accept any stock options. The reason is simple: We are one of the largest shareholders; thus, we plan to make money with you, not off you. Our conviction is that now is the time to make Steak n Shake’s culture one of ownership — all the way from the board level to the store level.

 

Because we have made a commitment to own the stock of Steak n Shake for the long haul, our allegiance is to the long-term shareholders of the company. Our aim is to join the board and explore all avenues to maximize shareholder value."

 

 

::)

[bargainman]

I really must say I'm surprised at the incredibly negative reaction to this compensation scheme.  When I first read it, I thought it was pretty interesting.  A few things:

 

How do CEOs usually get compensated?  Stock Options!  or RSU!  So they are given stocks/options and the shareholder gets diluted, sometimes quite significantly.  What's worse is that options are completely tied to... stock price!  Something that the CEO basically has next to zero control over!  If the market is a bull market, they'll make a ton of money at the expense of the shareholders for.. nothing!  No work at all! 

 

Sardar's scheme makes sure that his compensation is tied to book value.. something he does have a pretty good level of control over.  There is also the clause that someone already quoted saying that the book value will be adjusted depending on share dilution/buybacks etc.. I assume that means that if he issues a bagillion shares, that his compensation will be on the older number of shares, not the newer one, but I didn't really read it to that level of detail. That should prevent him from randomly issuing shares to increase book value.. but I could be wrong.. has anything thoroughly studied that part of the sec filing?  here is it:

 

http://www.sec.gov/Archives/edgar/data/93859/000092189510000667/ex102to8k07428_04302010.htm

 

Assuming what I said is correct, the interesting thing is...the company will pay him cash, and he will be forced to use that cash to buy shares on the open market.. I think from reading it, the 30% was because really it would be 50% of his pretax amount.. so it will force him to buy shares on the open market, ie NOT dilute shareholders!  Now where will that cash to pay Sardar come from?  That's another question..

 

Anyway it definitely seemed like a better scheme than giving him stock options or RSUs.  it also seems tied to something he can control (book value), not something random (share price).  It also doesn't dilute shareholders by issuing shares or options. 

 

What's so bad?  I guess that the hurdle is too low, and the rate too high?  That's a valid complaint... but the interesting thing is that other than his salary he gets no bonus if book value doesn't go up 5%.  That's not so bad really.  His salary is about 1/2 that of the CEO of JACK (2x the market cap of BH).

 

To me it seems like Biglari is very young and he wants to be a billionaire. He only owns a puny portion of the company, so how will he increase it?  Either he gives himself a ton of options, or he comes up with this interesting scheme that will still allow him to get rich...  I don't know. I always knew that Biglari had it in for himself, and a giant ego.  He wants to get rich, and do it with shareholders, and sound like Buffet. I think this scheme is sure better than doing it through options and RSUs.  The problem is he got too far too fast.  He got control of a 300-500 million$ company without owning it..  That leaves him in a bit of a quandry because control without large ownership is kind of a hollow victory for a capitalist.  Biglari wants the money, it's in his blood.  I remember an old article pointing out how CEOs like Jack Welch made millions, even 10s/100s of millions.  But if you wanted to be a billionaire, you had to start the company, like Dell and Bill Gates.  Problem is Biglari wants to be a billionaire, but he's just a CEO.. This is his path to the B club...

 

thoughts?

 

 

 

[ERICOPOLY]

Feb. 11, 2008,

 

"I have made a personal commitment to you that I will spend all the time necessary to rehabilitate The Steak n Shake Company. Not only will I refuse extra remuneration for the time I intend to commit, but I also will not accept any stock options. The reason is simple: We are one of the largest shareholders; thus, we plan to make money with you, not off you. Our conviction is that now is the time to make Steak n Shake’s culture one of ownership — all the way from the board level to the store level.

 

Because we have made a commitment to own the stock of Steak n Shake for the long haul, our allegiance is to the long-term shareholders of the company. Our aim is to join the board and explore all avenues to maximize shareholder value."

 

 

::)

 

Too funny!