Stumb offers an analysis of Biglari’s restructuring
Amelia Morrison Hipps
Given the recent movement in activist investor Sardar Biglari’s businesses, The Wilson Post asked Dr. Paul Stumb, dean of the Labry School of Business and Technology at Cumberland University, to comment on the presentation Cracker Barrel Old Country Store executives will present to shareholders next Wednesday.
“I think the presentation is well done and that the Cracker Barrel folks have raised some really good points about questionable practices by Sardar Biglari,” Stumb told The Post.
“He clearly has engaged in some questionable governance practices.”
Stumb explained that what Biglari has done with his various business interests – Biglari Holdings, a publicly traded company; Biglari Capital Corp., The Lion Fund I L.P., The Lion Fund II L.P. and Steak ‘n Shake Operations – “is trading assets back and forth between those companies to increase his personal control over those assets.”
Stumb said The Lion Fund II is a new fund Biglari established and that he did for one of three reasons.
“One was to separate the Cracker Barrel stock ownership from Steak ‘n Shake so that he can avoid that conflict of interest issue,” Stumb said.
“Last year, the Cracker Barrel board made a strong point about the conflict of interest between Steak ‘n Shake and Cracker Barrel and the fact that he couldn’t serve on their board because it would be a direct conflict of interest with a direct competitor.”
Biglari has said several times in letters that there is no conflict of interest because the two restaurants are not in the same category, and that approximately 50 percent of publicly-traded restaurant boards of directors have someone from another restaurant company serving on their boards.
Possible reasons for restructuring
Stumb said the fact that he has moved approximately 17 percent of his CBRL stock to The Lion Fund II, while approximately three percent remains under Biglari Holdings and Steak ‘n Shake Operations indicates to him “like a move to separate or distance the Cracker Barrel ownership from Steak ‘n Shake.”
Prior to the restructuring, approximately 19 percent of his CBRL stock was under Biglari Holdings, the parent company of Steak ‘n Shake Operations, with approximately one percent in his original The Lion Fund.
“Two, the moves provided himself greater singular control over those shares, because if they’re under Biglari Holdings, that’s a publicly traded company and he doesn’t have as much personal control,” said Stumb.
By moving the majority of his CBRL shares into The Lion Fund II, where he is the general partner, ‘he has total control and voting control over those shares of stock.”
The third reason Stumb offered was that by making the changes he can increase his own personal wealth by avoiding the compensation cap at Biglari Holdings.
Why compensation caps matter
“In any company, for example a public trading company like Biglari Holdings, the board of that company will establish compensation caps for the officers and directors,” Stumb said. “Those are maximum amounts payable to any one individuals.
“What he's apparently done by moving funds around, he’s allowing himself to be compensated in unique ways that bypass those compensation caps, just to increase his personal wealth by essentially cheating the system.”
Stumb explained that the compensation for directors and partners of The Lion Funds is set up differently than the compensation for executives of Biglari Holdings, which have compensation caps.
“These caps basically say that no matter how well your investments perform, you’re not going to get compensated over this amount. That’s reasonable.”
According to Cracker Barrel’s presentation, prior to the restructuring, Biglari’s compensation was subject to a shareholder-approved cap, and that in fiscal year 2012 Biglari received the maximum bonus possible, primarily driven by gains made through Cracker Barrel stock.
However, at the 2013 Biglari Holdings’ 2013 Annual meeting, that ended.
Stumb explained that ordinarily in publicly traded companies, stockholders are not engaged in the details like executive compensation, more have started doing it.
“Usually, executive compensation is done by the board or even a subcommittee, like a compensation committee of a board,” he explained.
However, recently many companies have decided to let shareholders have a say on pay. “They’ll put out a proposal for executive compensation, and the shareholders get to weigh in on that and ultimately get to vote on it.”
At Biglari Holdings 2013 Annual Meeting, a non-binding advisory “say on pay” vote failed with 46 percent voting no, 33 percent voting yes and 21 percent not voting.
“I’m certain that he exercised his voting rights on however much percentage of stock he owns against it and then he got others who are majority shareholders to vote against it, too,” Stumb said.
‘Lining his own pockets’
Additionally, the restructuring allows Biglari to receive a personal increase in compensation of 25 percent of the net profits that he wouldn’t otherwise have received had the assets remained part of Biglari Holdings as opposed to being in The Lion Fund, Stumb said.
Biglari Holdings, which is also a limited partner of The Lion Fund II, will also receive the additional compensation, according to Cracker Barrel’s presentation. However, this additional compensation is contingent on the investments exceeding “their applicable hurdle rate,” or threshold.
There is also no compensation cap with Biglari Capital Corp. and the investment gains on the Cracker Barrel shares transferred to The Lion Fund are included.
“If he can find a way to drive up the share price of Cracker Barrel stock, then he not only stands to make money from that increase, but also he would get an incentive reallocation of 25 percent of the net profits, because of the way he has the ownership of those shares structured within The Lion Fund,” Stumb said.
While the structure will make money for other investors in Biglari Holdings and partners in The Lion Fund, probably keeping them happy, Stumb said, “he’s paying himself really handsomely for making these decisions.
“He’s lining his own pockets. He’s being very shrewd. He’s not doing anything illegal here, but what the Cracker Barrel board is saying is that’s not good corporate governance. He’s being really greedy, and that’s not the kind of person we want on our board.”
Built in Golden Parachute
Another interesting aspect of the presentation is that Biglari appears to have built himself a Golden Parachute to guarantee he continues to make money should he ever be fired ore someone were to buy Biglari Holdings.
In January of this year, Biglari Holdings entered into an exclusive trademark license agreement with the man himself for the use of the name “Biglari” for 20 years. For example, Steak ‘n Shake signs and promotional items now include “Biglari” on them.
In addition, if a “triggering event,” such as change of control or certain conditions under which he would leave Biglari Holdings, Biglari would receive a royalty of 2.5 percent of revenues for at least five years.
In fiscal year 2012, Biglari Holdings’ net income margin was approximately 2.9 percent.
“He’s just simply negotiated one other way to line his own pockets,” Stumb said. “If it were to happen, it would take the vast majority of the company’s profits and allocate them to him instead of any of the other shareholders in the company.
“It essentially assures him a spot there. They’re not going to get rid of him if they have to pay him that amount of money.”
Risky, but profitable, for Biglari Holdings investors
Stumb said if you look at the performance of Cracker Barrel stock, “you’re not only getting appreciation on the stock, but also the dividend rate has tripled in the past few years.”
As a result, Stumb said if a person is an investor in Biglari Holdings, “even though Sadar Biglari himself is getting a disproportionate benefit from that growth, you don’t have to do anything but sit back and count your money, and you’re getting a better return than you are anywhere else.”
Still, Stumb it’s “a little bit scary” for so much of Biglari Holdings’ investments to be tied to one company like Cracker Barrel.
“I don't know what other investments Biglari Holdings has, but clearly a disproportionate percentage of their assets lie in one company and that is risky. That's always risky.”
In addition, Stumb said there’s no easy exit plan for Biglari in regards to his investments in Cracker Barrel.
“Even if he wanted to, which he apparently doesn't, he couldn't get out of CB stock any time in the foreseeable future quickly. It would take probably several years for him to exit if he wanted to.”
The bottom line
Stumb said Biglari’s intentions do not appear to be about improving Cracker Barrel’s operations, but is more about “improving the value of the stock so he can simply make more money.”
The eight-year dean acknowledged that Biglari would offer a different explanation.
“He would say he has this prowess and expertise in running restaurants, and than he can come in and improve operationally the performance of the company,” Stumb said. “But his track record would suggest that he has lined his own pockets very handsomely.”
Stumb said he doesn’t think Biglari’s going to get his board seats, but that he will continue to fight for them.
“Unless something else attracts his attention and he starts easing out Cracker Barrel, then he’ll probably continue to fight for those board seats, and we’ll see this same battle continuing for the next several years.”
Even if Biglari does get discouraged, Stumb is concerned about what will happen when he starts exiting, particularly if he does it in a big way. “That could cause a precipitous drop in Crack Barrel stock prices. A portion of it could be bought back by the company itself and they may chose to do that.
“But the scariest thing, I think is, if he actually does get them. What happens then? That would be interesting to see.”