SNS and WEST to merge

[nhall110]

Just curious, but wondering if many WEST holders would want to sell the bond they receive, post closing? 

[Hawk4value]

I am in agreement, I would rather have an all stock transaction.

 

As far as selling the bond, 14% seems like a pretty good rate.

[JAllen]

In the press release it says :

 

"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 years, will bear interest at the rate of 14% per annum and will be pre-payable without penalty at the option of SNS after one year from the date of issuance. "

 

Does pre-payable mean callable?  If it does mean callable, why didn't they just write callable?

[wabuffo]

I can understand this deal being good for WEST shareholders -- but can someone explain to me why this is a good deal for SNS shareholders?  

 

If one ignores the SNS shares that will be distributed to WEST shareholders, this deal boils down to SNS paying almost $23m (and $3.2m annual interest, though there will be a tax deduction for that to SNS for the interest expense so that $3.2m is pre-tax) for WEST's restaurant ops, and some dogs and cats (Mustang Capital, some San Antonio land).

 

If I adjust book value at 6/30 for goodwill and elimination of the fair value of the 85.1% ownership of SNS shares held within WEST, ($22.7m-$6.0m-$11.6M = $6.0m) it looks like 3.8x adjusted book value.  That doesn't seem cheap.

 

Another way to look at is to look at the restaurant ops (including franchising).  6 month, EBITDA is a little less than $1.2m.  Double that for a full year and that's only $2.4m pre-tax, pre-depreciation, pre-interest expense and therefore a 10x EBITDA multiple.  This seems very high to me given that even during the bubble days of private equity, folks were loath to pay 8-9 x EBITDA and here SNS is paying 10 x EBITDA.  

 

Any help to understand this better would be greatly appreciated.  But of all the things SNS cash could be invested in, why is this the best first deal?  

 

Once again, I fear Biglari leaves himself exposed to cynicism that this deal obviously helps Biglari consolidate his personal holdings and rewards him directly for his 33% ownership of WEST since he will get $1m+ per year of interest income on the new debentures (and thus I predict there's no way these debentures get called before the five years are up) to go with his new $900k salary.  Its obviously a good deal for him as the largest shareholder of WEST but at the expense once again of his SNS "partners".  WEST is so small in comparison to SNS, that there was no pressing need to consolidate it, IMO -- unless it was to present an "event of liquidity" for Biglari.

 

If I missed something big on the valuation of WEST, I'd appreciate it if someone could steer me to it so I can understand the valuation of WEST better.

 

wabuffo

[WideMoat]

By my notes, WEST paid about $1.2m for their share of Mustang.  The equity in the Texas real estate, marked at cost, is near $1m.  The market value of their ITEX stake was $1.2m at 6/30.  That gets you close to paying 8x EBITDA.  $23m-$3.5=$19.5m/$2.4m EBITDA= ~8.

[Munger_Disciple]

As I have previously expressed in a couple of posts, Sardar's $900K salary at SNS leaves a bitter taste in SNS shareholders' mouth. Regarding the WEST & SNS merger, the correct way to do it is to make sure SNS receives as much intrinsic value as it gives up. I believe that the proposed merger fails this basic test from SNS shareholder point of view. I may very well be missing something here, so feedback is greatly appreciated.

[Munger_Disciple]

If the merger goes thru', I am sure SNS will achieve savings in combined company corporate overhead and cost savings resulting from having only one public company in stead of two. Can someone provide an estimate of cost savings SNS can achieve in addition to current cash from WEST ops? What concerns me most is that SNS brand appears to be far superior to WEST brand, so it is not clear to me that the net $23M cannot be put to better capital allocation use by SNS management than buying WEST.

[ragnarisapirate]

From the SNS shareholder perspective, I am pretty happy with the deal. We get a company that we know a ton about and get to roll 2 great entities together. Granted, there is cheaper stuff out there, but we now have Biglari's full attention and are slowly diversifying.

 

I'd be willing to buy all of the SNS debt that I can from you you WEST guys; for pennies on the dollar :-)

 

On a serious note, is the SNS debt gonna be traded OTC like the WEST rights were? I think it would be interesting to see what it would bring in the open market. Furthermore, I would be interested to see what price that SNS would let it get to before buying it all up.

[wabuffo]

I'd be willing to buy all of the SNS debt that I can from you you WEST guys; for pennies on the dollar :-)

 

As I said, I can see why WEST shareholders would be happy -- so why would anyone sell the debentures.  Its the SNS side of the deal that I think is overpaying in exchange for its debenture issuance.

 

Can you explain in valuation terms why you think this is a good deal for minority SNS shareholders?

 

Let's try it a different way.  Assuming I accept the historical costs for the land and asset manager as well as the current mkt value of the ITEX investment (though in reality prices for asset mgrs and real estate have fallen in the last 12 months),  the restaurant ops are being purchased for $20m.  Yet pre-tax income seems to be around $2m annualized (assuming depreciation = capex), so after-tax income is around $1.2m.  That's a 17x PE ratio for a restaurant operation.

 

Even McDonald's -- with its global brand and excellent results -- only merits a 14x PE ratio.

 

wabuffo

[link01]

Yet pre-tax income seems to be around $2m annualized (assuming depreciation = capex), so after-tax income is around $1.2m.

 

wabuffo, the problem is, depreciation does not = capex at west. far from it:

 

see page, last paragraph under Western sizzlin Franchise Corp, just above Compensation heading (i tried to copy & paste the relevant section but couldnt)

 

http://www.western-sizzlin.com/pdfs/Chairmans%20Letter%202006.pdf

 

also see

 

                                                                                                Years Ended December 31,

                                                                                                              2007 2006

Income from restaurant and franchise operations ...................................... $ 507,773: $ 572,210

Plus: Depreciation and amortization expense ........................................... 1,063,017: 1,057,492

Plus: Claims settlement and legal fees associated with lawsuit ................ 741,287: 289,109

Income from restaurant and franchise operations (excluding depreciation

and amortization expense and expenses associated with the lawsuit) ........ $ 2,312,077: $ 1,918,811

 

http://www.western-sizzlin.com/pdfs/Chairmans%20Letter%202007.pdf

 

hope that somewhat helps

 

[WideMoat]

 

As I said, I can see why WEST shareholders would be happy -- so why would anyone sell the debentures.  Its the SNS side of the deal that I think is overpaying in exchange for its debenture issuance.

 

wabuffo, by saying you'd rather give stock/cash than debentures, you're implying that the debentures are more valuable.  

 

They may be (depends what you think owners' earnings are for SNS), but SNS looks to have the option of calling the debentures after one year (i want to see the definitive agreement first).  Thus, the debentures get a capped return, while SNS retains the optionality.  

 

All told, I wouldn't argue that SNS shareholders got a great deal.  But paying 8x "owner's earnings" for the restuarants, market value for ITEX, cost value for land and Mustang strikes me as a fair deal.

 

NB: I would estimate that the merger could save 500K-800K annually just in compliance costs, fees, etc.  So SNS gets that upside as well.

[wabuffo]

hope that somewhat helps

 

Yes it does help a lot -- thank you.  The numbers you provided are for 2007 and 2006.  Let me build the 2008 and 2009 ttm numbers:

 

                                                                                                                                               2009TTM           2008

Income from restaurant and franchise operations ...............................................$   630,732    $   176,583

Plus: Depreciation and amortization expense .....................................................$   706,351    $ 1,041,818

Plus: Claims settlement and legal fees associated with lawsuit .............................$     51,468    $   180,044

Income from restaurant and franchise operations (excluding depreciation

and amortization expense and expenses associated with the lawsuit)...........$ 1,388,551   $ 1,398,445

 

So these numbers have come down quite a bit.  This seems to make my estimates of PE too low.  SNS may be paying an even higher PE ratio than I thought.  Is there a reason why the "owner earnings" as the other poster stated them have fallen that much.  Is it a one-time thing or more of a steady-state earning power of the restaurant ops?

 

This makes it look like SNS is paying more like 23x earnings for a restaurant business that isn't growing.  Have I made a mistake here somewhere?

 

wabuffo

[link01]

hope that somewhat helps

 

Yes it does help a lot -- thank you.  The numbers you provided are for 2007 and 2006.  Let me build the 2008 and 2009 ttm numbers:

 

                                                                                                                                               2009TTM           2008

Income from restaurant and franchise operations ...............................................$   630,732    $   176,583

Plus: Depreciation and amortization expense .....................................................$   706,351    $ 1,041,818

Plus: Claims settlement and legal fees associated with lawsuit .............................$     51,468    $   180,044

Income from restaurant and franchise operations (excluding depreciation

and amortization expense and expenses associated with the lawsuit)...........$ 1,388,551   $ 1,398,445

 

So these numbers have come down quite a bit.  This seems to make my estimates of PE too low.  SNS may be paying an even higher PE ratio than I thought.  Is there a reason why the "owner earnings" as the other poster stated them have fallen that much.  Is it a one-time thing or more of a steady-state earning power of the restaurant ops?

 

This makes it look like SNS is paying more like 23x earnings for a restaurant business that isn't growing.  Have I made a mistake here somewhere?

 

wabuffo

 

have you made a mistake somewhere? since adding back 1x non recurring charges to arrive at an est of normalized owner earnings is a subject of some debate, you be the judge.

 

here are some 1x non recurring expenses that you might consider adding back to get a cleaner picture of normalized owner earnings:

 

A note on the 2008 numbers. These are skewed by a couple of items:

 

a. The departure of Jim Verney from Western Sizzlin Franchise Corp. resulted in severance expense of $250,000.

 

b. Sub-leased property expenses increased by $444,000 in 2008 as compared to 2007.

These sub-lease arrangements will cease at the end of 2008.

[total 08 sub-lease exp was $545,226…all these will exp at end of 08]

 

***08 operating costs associated with the closed west express op was $218,000 & occupancy costs were $78,000= total of $298,000. pretax loss for 4 months of operation was $152,000.

 

should probably also subtract out west 2008 capex of (33,669)

 

as far as 2009 6 months, btw, i cant seem to find my notes. i'll have to buckle down this weekend or next & re-read the 10Q's.

[wabuffo]

here are some 1x non recurring expenses that you might consider adding back to get a cleaner picture of normalized owner earnings:

 

A note on the 2008 numbers. These are skewed by a couple of items:

 

a. The departure of Jim Verney from Western Sizzlin Franchise Corp. resulted in severance expense of $250,000.

 

b. Sub-leased property expenses increased by $444,000 in 2008 as compared to 2007.

These sub-lease arrangements will cease at the end of 2008.

[total 08 sub-lease exp was $545,226…all these will exp at end of 08]

 

***08 operating costs associated with the closed west express op was $218,000 & occupancy costs were $78,000= total of $298,000. pretax loss for 4 months of operation was $152,000.

 

Thanks - this is good detail and I will look at it.  Any one-time positives that would be offsets?

 

wabuffo

[link01]

Any one-time positives that would be offsets?

 

just capex which i added in bold above.

 

btw, tho the blog is closed now, here is an excellent resource by ragupati on both west & sns. unfortunately, ragu along with jeff of the also now defunct circle of competence blog have jumped their ships for bluer waters at cgi growth & value focus, where they are still terrific, but are spread much thinner.

http://riskvsrewardinvesting.blogspot.com/search/label/Western%20Sizzlin

[wabuffo]

thanks all.  I'm not trying to be negative. 

 

In full disclosure - I've been a buying of WEST below $13 this week as I've been looking at SNS over the last couple of years and now feel the best way to establish a position is via this deal for WEST. 

 

While I think I understand SNS, as it shows I don't know WEST very well.  One of my concerns in establishing my WEST position is that SNS shareholders view it as such a bad deal that the SNS takeover deal of WEST unravels.

 

This discussion has been very helpful and I will continue my analysis of WEST's fundamentals to either get comfortable or not with SNS's POV of price/value.

 

wabuffo