Defending The Undefendable: Biglari Never Claimed To Be Buffett

[Parsad]

Ragnar does a nice job writing about BH.  Although I would disagree with one important point that is the foundation of the article:

 

http://seekingalpha.com/article/220193-defending-the-undefendable-biglari-never-claimed-to-be-buffett?source=yahoo

 

The current compensation package has NOTHING to do with saving Steak'n Shake!  Sardar had already implemented a $900K salary after the turnaround.  That was his reward for saving Steak'n Shake.  A salary that was more than double his predecessor's.  

 

The current compensation package has everything to do with reaping hedge fund like compensation from a corporate entity where the capital is captive.  I think the argument that most detractors from the plan are making, is that Sardar decided to shuffle the deck in the middle of the game.  The cards being dealt weren't to his liking and he decided to reshuffle.  

 

Nothing to do with Buffett, other than you would never have seen him do that.  Prem's dividend plan was equitable to all shareholders when he implemented it.  Cummings and Steinberg made sure they owned alot of stock.  In Gabelli's case, his investors were already aware of his compensation plan.  This is a cash grab pure and simple, with idealistic dialogue trying to support it!  You want shareholder support for this plan...drop the incentive fee to 15%, increase the hurdle to 10%, drop the base salary to $450K, and lock in 30% of your after-tax incentive fee for five years in BH stock each year.  I would support that!  Cheers!  

[ragnarisapirate]

drop the incentive fee to 15%, increase the hurdle to 10%, drop the base salary to $450K, and lock in 30% of your after-tax incentive fee for five years in BH stock each year.  I would support that!

 

I would REALLY like that. :)

 

In fact, if your compensation plan was adopted, and shares were at their present price, I would buy more stock in BH.

[Guest Bronco]

What am I missing - he wants a new compensation plan for ALL of BH.  Not sure of the correlation between the value of hedge fund (GP ownership interest I assume) being contributed to BH and the proposed compensation plan.

 

If Buffett had a hedge fund right now on the side that made him 2% and 20%, which equated to $100 million a year, and he contributed to Berkshire Hathaway for $1, would that entitle Buffett to 25% of all profits of Berkshire Hathaway over 6% of increase in BV???

Not sure I get the logic.

 

Regardless (irregardless in the NE US), I agree that a 10% hurdle and a 10-15% incentive fee would be ok as a bonus.  I guess I am ok simply b/c it is less obscene, but the math seems to be more logical as well.  I like Parsad's idea of reducing the base, which will never happen.

 

That being said, I bought some BH today.  Maybe Biglari is a genius and I am an idiot (idiot shareholder that is).

 

Wish me luck.

 

 

[Myth465]

This is interesting.

 

Someone proposes something utterly ridiculous (basically an ownership stack of 25% in a company that they own less than 5% of).

 

and people respond by saying lets give him something that's just ridiculous (make it 15% and we have a deal). Just goes to show - Aim for the moon, cause when you fail you will land on the clouds.

[Guest Bronco]

Myth - tough to argue your point.  But I guess with 10% and 10% - if the company grows bv by 25% per year, then shareholders would get 23.5% and Biggy small gets 1.5%.  While it may be obscene it is something I could live with - getting 23.5% would make me happy.

 

On the flip, if the company grew 11%, shareholders get 10.9% and he gets .1%. 

 

Off a $300M BV, a 11% increase in BV (using 10 and 10) gives BH a $300,000 bonus, plus $900,000 base.  Not bad for him, and not enough to make me want to sell the stock.

 

A 30% increase in BV gives him a $6M bonus, but SH BV would go up $84M. 

 

------------------

 

25% over 6% makes no sense, and I don't think anyone agrees with that plan.

[kyleholmes]

1992 Annual Report

 

HWIC is an investment counselling firm that Tony Hamblin and I founded in 1984. With

five partners, Tony Hamblin, Roger Lace, Brian Bradstreet, Frances Burke and me, who

have worked together for 18 years, and Vito Maida, a recent addition, the firm manages

approximately $1 billion in pension, corporate and individual funds. Of the $1 billion,

approximately $240 million are funds that originate from Fairfax's insurance

subsidiaries. From inception the firm was set up to manage a small number of

portfolios with a long term value-oriented philosophy. All the clients agreed to an

incentive fee, resulting in HWIC being more investment driven than marketing-oriented.

The company's long term results have ranked among those of the top investment

managers in Canada.

 

How did we value the firm? Firstly, we created an independent committee of our Board,

chaired by Robbert Hartog. Secondly, we consulted Sir John Templeton, the dean of

the investment counselling business and also a large shareholder of ours. After arriving

at a price that both Robbert and Sir John felt was fair, we obtained written approval of

this transaction from all of the more than 50% of our minority shareholders that we

contacted. Thus, the valuation of $14 million ($1.85 million in cash and 433,773 Fairfax

shares valued at $28 per share) was considered fair and approved by our Board of

Directors, the majority of our minority shareholders and all the partners at HWIC.

 

1994 Annual Report

 

As far as the business of HWIC is concerned, 1994 was another record year as incentive fees

were earned from most clients, including Fairfax's insurance subsidiaries. Incentive fees are paid

by HWIC's clients only if their results exceed the hurdle rate on both a one year and from inception

basis.

 

For example, for clients that have a Canadian common stock portfolio managed by HWIC, the

hurdle rate is the TSE 300 return plus 200 basis points, i.e., before the client pays incentive fees,

the client's results, net of all fees, must exceed the TSE 300 return plus 200 basis points for both

1994 and from inception. Incentive fees payable are 10% of any return in the past year above the

hurdle rate (90% remains with the client) up to a maximum of 1.75% of assets. All the non-Fairfax

related clients have considered this a very fair fee and have been happy to pay incentive fees in the

past two years.

 

Fairfax's insurance subsidiaries were charged incentive fees by HWIC for the first time in 1994.

Insurance subsidiaries did not qualify for incentive fees in 1993 mainly because of a block of FCA

shares purchased for them by your Chairman in 1989. Some more details about investment

management fees paid by Fairfax's insurance subsidiaries to HWIC:

 

1)Incentive fees are paid only on common stock portfolios. Results are measured against the TSE

300 return plus 200 basis points for Canadian stocks and the S&P 500 return plus 200

basis points for U.S. stocks.

 

2)The inception date for Canadian common stock portfolios is January 1, 1990, the date incentive

fees were first instituted by HWIC for its clients. The inception date for U.S. common stock

portfolios is March 31, 1994, the first quarterly date on which HWIC managed a U.S.

common stock portfolio for a U.S. subsidiary of Fairfax (Ranger). The common stocks of

any subsequently acquired insurance subsidiary will be included in the appropriate portfolio

for measurement purposes essentially from the date of acquisition.

 

3)The average base fee paid by Fairfax's insurance subsidiaries to HWIC for investment

management is 0.25% of assets significantly less than the average base fee paid by

HWIC's pension clients. Reflecting the Continental Canada purchase and a reduction in

the base fee, the average base fee in 1995 for Fairfax's insurance subsidiaries will drop to

0.17% of assets.

 

Just to refresh your memory, when Fairfax purchased HWIC in 1992, a fair revenue sharing

mechanism was instituted at HWIC. This is how it works. The revenue base for HWIC in 1992

was $3.7 million of which $2.0 million covered expenses, including salaries and overhead, and $1.7

million was pre-tax profit. In each year after the sale, HWIC retains $2.0 million of the first $3.7

million of revenue to pay expenses, while Fairfax gets the remaining $1.7 million. Any revenue

above $3.7 million in any year is split 50/50 between Fairfax and HWIC Fairfax's 50% being

additional profit (to the $1.7 million), while HWIC's 50% covers any incremental expenses beyond

$2.0 million and thereafter constitutes a profit pool to be shared among its partners and employees.

This is an excellent way to provide attractive returns for Fairfax while keeping the incentives at

HWIC.

 

In 1994 HWIC had revenue from base fees of approximately $4.6 million. Incentive fees totalled

$4.9 million of which $1.6 million was from Fairfax insurance subsidiaries. Through the revenue

sharing mechanism discussed earlier, Fairfax earned a 33% pre-tax return on its $14 million

investment in HWIC. These returns are all cash and, of course, there is no additional capital

investment needed at HWIC. As mentioned last year, while returns after goodwill amortization (of

$1.4 million annually) will be less than those mentioned above, we think the returns we have shown

are the best measure of HWIC's performance.

This is perhaps an appropriate point to mention where my compensation comes from. I get a

straight salary of $250,000 from Fairfax with no bonuses, director's fees or other payments from

Fairfax or any of its subsidiaries (other than HWIC). From HWIC, like all partners there, I get a

$200,000 salary and participate in the profit sharing pool (up to 30%) described earlier. Any bonus

that is shown for me in the proxy circular comes from this profit participation. Because my

compensation can be significant depending on investment results, I wanted to make sure you

understood exactly where it comes from.

 

Why did HWIC make sense for Fairfax? Mainly, for the following three reasons:

 

1) It was a very good investment for Fairfax. Under very reasonable assumptions

(i.e. no incentive fees or additional funds under management), Fairfax could

achieve its 20% return on investment. Also, a multiple of 3.8 times revenue and

8 times pre-tax earnings was reasonable compared to private transactions and

public valuations of investment counselling firms. Furthermore, we paid for most

of the purchase by issuing shares of Fairfax at a fair price of $28 per share.

 

2) It brought proven investment management into Fairfax.

 

3) It removed my perceived conflict of interest and placed all of my interests in one

pot.

 

 

*This is not an apples to apples comparison, but figured I would post it nonetheless out of interests sake....

[biaggio]

"Incentive fees payable are 10% of any return in the past year above the

hurdle rate (90% remains with the client) up to a maximum of 1.75% of assets"

 

I think having a maximum level (% of assets) makes sense.

[Parsad]

This is not an apples to apples comparison, but figured I would post it nonetheless out of interests sake...

 

Hi Kyle,

 

Remember that Hamblin-Watsa was made up of Tony Hamblin, Roger Lace, Brian Bradstreet, Chandran Ratnaswami, Francis Burke and Prem.  Bringing in HW was needed to make sure compensation was fair to the other partners who didn't own as much of Fairfax as Prem, while maintaining their talents to manage Fairfax's assets.  In Biglari Capital's case, there is no one other than Sardar.  

 

Someone proposes something utterly ridiculous (basically an ownership stack of 25% in a company that they own less than 5% of).

 

Hi Myth,

 

I've never been against a compensation package that would have been incentive-based for Sardar.  In fact, I would prefer that to the $900K salary.  

 

What I've always railed against was changing this whole thing mid-stream and then implementing a package that is more generous than a typical hedge fund when evaluating the associated risks.  I'm for his compensation plan structure, but would like it to be significantly tougher.  Nothing to do with appeasing Sardar, but making sure his compensation structure is equitable for shareholders and to incentivize him to grow the thing.  Cheers!

 

[Myth465]

Myth - tough to argue your point.  But I guess with 10% and 10% - if the company grows bv by 25% per year, then shareholders would get 23.5% and Biggy small gets 1.5%.  While it may be obscene it is something I could live with - getting 23.5% would make me happy.

 

On the flip, if the company grew 11%, shareholders get 10.9% and he gets .1%.  

 

Off a $300M BV, a 11% increase in BV (using 10 and 10) gives BH a $300,000 bonus, plus $900,000 base.  Not bad for him, and not enough to make me want to sell the stock.

 

A 30% increase in BV gives him a $6M bonus, but SH BV would go up $84M.  

 

------------------

 

25% over 6% makes no sense, and I don't think anyone agrees with that plan.

 

Parsad, and Bronco.

 

I dont like compensating a Manager as if he was an Owner in such a significant way but the 10% - 15% actually doesn't look so bad when you break it out with numbers. I prefer something simple like in or out of the money warrants which have all the rights of shares similar to Lancashire. The thought of someone being entitled to a percentage of profits for a business he didnt own or start bothers me. (Employees should get a small percent of profits perhaps as a bonus, but this is not so small).

 

I like incentive comps as well, but prefer the ones that Ken Peaks uses at MCF / Contango vs just a give away of the bottom line number above a 1 foot hurdle rate.

 

The thought of someone changing it mid stream annoys the hell out of me. I knew FUR and other stocks had interesting comp structures when I bought in but, that is not the case for BH and its shareholders. The guy doesnt care about share holders, he wont even let the issue come to vote if it doesnt look like he will win. If this was Joe Six Pack CEO, running any other company people would say it was ludicrous.

 

Owners are owners, and Managers are Managers. Owners get paid a percentage of profits. Managers get paid by the hour or by the year, with a bonus for good results.

 

If you want both, become an Owner Manager and buy stock / hold and add to your options. Giving someone a good start with long dated options, warrants, or grants is fine. But giving a guy a percentage of profits just for having the top job doesnt rub me the right way.

 

----

 

Also Parsad, I hope my comments didnt come off too rough. You have been on the right side of this issue from day 1, and have always been willing to vote with your feet or shares.

[kyleholmes]

Sanjeev,

 

I agree with you... just thought I would post it as I had not seen anyone mention it yet!

 

Kyle

[biaggio]

If compensation is settled with  something acceptable would you be still be willing to invest in the company knowing what Bigliari is like?

 

Can you trust him to look after your best interest?

[Guest Bronco]

Myth - just to be clear, I think the whole thing sucks.  But 10/10 doesn't eliminate this as an investment for me.  I am still interested if that were to be the case.  If a higher plan goes into place (such as the one proposed), you will never see me in this stock.

 

Right now I am playing this for a ST trade - something I rarely do but think the stock will go higher between now and the vote on compensation.

[Parsad]

Also Parsad, I hope my comments didnt come off too rough. You have been on the right side of this issue from day 1, and have always been willing to vote with your feet or shares.

 

No, not at all Myth.  I was just making it clear that I'm not against an incentivized compensation plan, but the way it was thrown on shareholders.

 

If compensation is settled with  something acceptable would you be still be willing to invest in the company knowing what Bigliari is like?

 

Can you trust him to look after your best interest?

 

I will buy anything if it gets stupid cheap.  Holding on to it as a loyal shareholder is a different matter altogether. 

 

I was once a loyal shareholder of Western Sizzlin, then Steak'n Shake and eventually Biglari Holdings.  But they had no intention of rethinking this compensation plan, so I walked.  Cheers!

[Myth465]

Also Parsad, I hope my comments didnt come off too rough. You have been on the right side of this issue from day 1, and have always been willing to vote with your feet or shares.

 

No, not at all Myth.  I was just making it clear that I'm not against an incentivized compensation plan, but the way it was thrown on shareholders.

 

If compensation is settled with  something acceptable would you be still be willing to invest in the company knowing what Bigliari is like?

 

Can you trust him to look after your best interest?

 

I will buy anything if it gets stupid cheap.  Holding on to it as a loyal shareholder is a different matter altogether. 

 

Agreed on both accounts. At the right price I will hold SNS shares but it wont be a buy and hold position. Hopefully we get a chance, either way the comp vote / issue is fun to watch.

[OracleofCarolina]

Do BH earnings come out today?

[bookie71]

Based on the past history what is to stop him from changing the 25% to 75% later in the year?  Feel free to invest (gamble) your money anyway you want, I wish you lots of luck, BUT I will invest my $ elsewhere with someone I feel comfortable with.

Chuck