Biglari Proves Buffett Right

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According to Warren Buffett, "In looking for someone to hire, you look for three qualities: integrity, intelligence, and energy. But the most important is integrity, because if they don't have that, the other two qualities, intelligence and energy, are going to kill you."

Now, it might seem like Buffett was talking about people like Dennis Kozlowski, who was found guilty of stealing $600 million at Tyco (NYSE: TYC  ) , or Martin Grass, convicted for overseeing a $1.6 billion accounting fraud at Rite Aid (NYSE: RAD  ) . But management doesn't need to commit a felony to cost you money.

Sardar Biglari, of Biglari Holdings (NYSE: BH  ) , formerly known as Steak n Shake, is showing just how far management can go to rip off shareholders, and it doesn't seem to be breaking a single law to do it.

Paving with good intentions
Steak n Shake had shown slow profitable growth for years, but it faltered in 2007 and 2008. Biglari began buying shares, eventually building an 8.5% stake in the company. Then, he began a heated campaign, complete with promotional billboards around the company headquarters, to win two seats on the board.

Biglari's argument was simple -- Steak 'n Shake had underperformed the peer group, and management had destroyed value. In contrast, he would run the company for the shareholders. In a February 2008 letter, Biglari wrote, "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."

About a month later, Biglari won two seats, bumped out the chairman and CEO, and began taking control of the company. Steak n Shake returned to profitability in 2009, and the stock jumped.

Finally, this year, Biglari renamed the company Biglari Holdings, seemingly telegraphing that the company would become his investment vehicle.

What's yours is mine
However, now it seems like Biglari actually meant to telegraph something else. Biglari Holdings is acquiring Biglari Capital, which acts as general partner of Biglari's Lion Fund hedge fund, for an amount equal to its assets. In the process, it's enacting one of the sweetest compensation agreements I've ever seen at a public company.

When Biglari Holdings grows, Biglari will take a quarter of the book value growth above the level of 5%, exclusively for himself. If book value declines, Biglari won't get this extraordinary compensation until the returns exceed a 5% annual growth rate over the highest book value. Roughly half of the after-tax value of the payment must be spent on shares of Biglari Holdings. Essentially, Biglari's going to use the company's assets to take the company from the shareholders, piece by piece.

Now, 25% of growth over 5% might not seem like very much, but it will make a huge difference in long-term returns. By my calculations, if Warren Buffett had made the same deal when he took over Berkshire Hathaway, it would have cost shareholders over 80% of their future returns. 

Shareholders' rights?
In a May 6 letter to outraged shareholders, Biglari defended the move as simply an innovative compensation scheme that aligns his interests with shareholders. But 5% is pretty close to the level that U.S. 30-year bonds yield right now, when interest rates are near record lows. So, if Biglari just does a tiny bit better than government bonds, he'll get a nice payday. Maybe he should consider indexing. S&P 500 companies typically post an aggregate return on equity of 10% to 12% over the long term. Biglari could buy an index fund and relax on the beach, doing nothing and draining millions from shareholders year after year.

The amazing thing is that Biglari appears to think he's the good guy defending shareholder rights. He's now attempting to take over another business, Fremont Michigan Insurance. In an incredibly brazen move, Fremont has managed to lobby Michigan's legislature to change state corporate law in a manner that has the effect of entrenching the company's management.

To show its outrage, on the very same day that Biglari's egregious compensation scheme was filed with the SEC, Biglari Holdings published a press release saying, "Fremont shareholders do not need a CEO who displays total disregard for shareholder rights and value."

Maybe Biglari Holdings doesn't need one either.

Look for alternatives
Buffett summarizes the investment lesson well: "When you hire someone to run your business, you are entrusting him or her with the piggy bank. If these people are smart and hardworking, they are going to make you a lot of money, but it they aren't honest, they will find lots of clever ways to make all your money theirs."

Buffett's absolutely right. These sorts of "jockey" situations, where a brilliant investor works on your behalf at a public company, can work out great. When the jockey has integrity and truly wants a partnership with shareholders, the long-term returns can be extraordinarily high. In fact, after the decline caused by this compensation arrangement, our own Motley Fool Special Ops team thinks at its current valuation, Biglari Holdings has a greater margin of safety that compensates for Biglari taking a huge chunk of shareholders' future value off the top.

If you'd rather steer clear, though, there are alternatives. Buffett's Berkshire Hathaway is the most obvious example, but there are a bunch of others as well. Cumming and Steinberg with Leucadia National (NYSE: LUK  ) . Bruce Flatt and his team at Brookfield Asset Management (NYSE: BAM  ) . Sears Holdings' Eddie Lampert. Terra Nova Royalty's Michael Smith. All these guys have proven to be expert investors, and done it with integrity. They offer shareholders a way to outperform the market simply by buying shares and holding for the long term.

The Foolish bottom line
Of course, often the jockey's investing prowess is already priced into the stock, but occasionally, it isn't. In such case, the returns can be even better, as the stock's return to fair value magnifies the jockey's gains. These are the jockey stocks on which you should focus.   

Our Motley Fool Inside Value team has identified several businesses led by expert investors who meet even the highest ethical standards. You can read about them with a free trial.

Fool contributor Richard Gibbons wonders if boundless greed irrespective of integrity is new, or just more noticeable today. He owns shares of Terra Nova. Berkshire Hathaway is a Motley Fool Inside Value recommendation. Berkshire Hathaway and Leucadia National are Motley Fool Stock Advisor picks. Brookfield Asset Management is a Motley Fool Global Gains choice. The Fool owns shares of Berkshire Hathaway, Terra Nova, and Biglari Holdings. The Fool's disclosure policy also plans to make money with you, not off you.

Read/Post Comments (27) | Recommend This Article (138)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 11, 2010, at 1:36 PM, GanznSchmuck wrote:


    Very well written. The recent developments in the company are certainly somthing to worry about.

    Can you please send your letter to Mr. Biglari and the Board of Directors?


  • Report this Comment On May 11, 2010, at 2:06 PM, kristm wrote:

    He's also attempting to take over Advanced Auto Parts (shades of Eddie Lampert) and there are rumors (denied by the company) that they're making a run for Denny's. Steak n Shake is a great brand, a great concept, but it's been buried first under managers who didn't understand what made the company strong in the first place (quality and core menu) and now by a leader who's going to rape the company for his own benefit.

  • Report this Comment On May 11, 2010, at 4:07 PM, rrockw wrote:

    The compensation arrangement is beyond the pale and really falls into the completely insane category. Thankfully I'm not a shareholder though its not like shareholders do anything but roll over on issues like this.

  • Report this Comment On May 11, 2010, at 4:25 PM, naandrews wrote:

    What I find striking, though, is the author's statement that "after the decline caused by this compensation arrangement, our own Motley Fool Special Ops team thinks at its current valuation, Biglari Holdings has a greater margin of safety that compensates for Biglari taking a huge chunk of shareholders' future value off the top."

    It's a striking statement because one would think the Motley Fool, which repeatedly stresses the importance of having shareholder-friendly management running publicly-traded companies, would avoid Biglari Holdings like the plague. In fact, the tenor of the article until that statement is that BH is the type of company shareholders should steer clear of.

  • Report this Comment On May 11, 2010, at 4:41 PM, yosemitebean wrote:

    Just do not pay them with commissions or based on any percentages for the first 5 years. If they do not want to put in 5 years then you probably wouldn't want to hire them anyways.

  • Report this Comment On May 11, 2010, at 5:01 PM, LakeDaisy wrote:

    The article is right on point. And I agree completely with naandrews. I sold my BH shares after Biglari changed the plan to skim 25% off the top after only earning 5% for the shareholders. Biglari believes he's the next Buffett. I believe he's a crook.

  • Report this Comment On May 11, 2010, at 5:08 PM, blesto wrote:


    I totally agree.

    That certainly threw me for a loop.

  • Report this Comment On May 11, 2010, at 5:38 PM, griffjj wrote:

    How can you trust a guy whose name is an anagram for Big Liar?

  • Report this Comment On May 11, 2010, at 5:39 PM, e320 wrote:

    Since this is still a Special Ops rec., what is one to do?

    I first bought it as Steak n Shake per a MF rec., currently have 20 shares of BH, which is 7.09%, or $517 below where I bought it. Not a real biggy, but why should I continue to hold it?

    I think we are entitled to a special alert from MF Special Ops on what to do. PBH

  • Report this Comment On May 11, 2010, at 5:42 PM, Protovist wrote:


    It is delightfully ironic that you are using Warren Buffet to illustrate your point, since he got his start using a compensation structure of precisely the same type that you vilify here.

    "Warren Buffett started his investment partnership in 1956 with $105,100 of capital made up of his own funds and investments from family and close friends. According to the BLS inflation calculator, initial capital was $840,920 measured in 2010 dollars, which would be a very small sum to start a modern day hedge fund. What is even more remarkable was the fee structure of the Buffett Partnerships. Mr. Buffett, as the general partner, took 25 percent of all profits in excess of 6 percent. There was no “2 and 20″ structure in which the general partner received any guaranteed payment."

  • Report this Comment On May 11, 2010, at 5:49 PM, Protovist wrote:


    There was in fact an alert for BH issued on May 6th, and you're much more likely to get useful information from the Special Ops forums than you will posting comments here.

  • Report this Comment On May 11, 2010, at 7:19 PM, noblepaladin wrote:

    The problem with BH's compensation structure is that there is a huge incentive to do things that are not shareholder friendly. A hedge fund can charge 2 and 20, but if they start doing bad things, investors pull their money out. With the structure of BH, you can sell your shares, but that doesn't prevent Biglari from taking money from the book! There is a bigger incentive for him to increase the size of the book rather than the return on the book. For example, suppose he can get a 15% return on a small book. If he manages a large book and gets a 10% return, he can possibly make more money. What is worst is that after skimming 25% off, a large book, it probably won't even beat the SP500. Another Buffett warning is that management often wants to manage a bigger company because managers of bigger companies get paid more, so they would do stupid value destroying acquisitions. It is the same problem that large mutual funds have. However, at mutual funds and hedge funds, people can withdraw the "book" at any time. At BH, you cannot withdraw the book.

  • Report this Comment On May 11, 2010, at 8:46 PM, CBOT217 wrote:

    At the shareholders meeting, Biglari revealed what was the key factor in his hiring method: he would look at the candidate and ask himself if he would be comfortable with investing all of his own money in this person.

    And although I'll always have respect for the Oracle of Omaha, where's the INTEGRITY with GOLDMAN SACHS?! Where is Buffet's INTEGRITY when he is defending GOLDMAN SACHS!!!!!! Oh, wait a minute. We know why he has to. But what's more disturbing to me is if he ACTUALLY believes what he's saying about them.

    Biglari rules. Who is Buffet to talk about integrity when he is in bed with Goldman Sachs. End of story.

  • Report this Comment On May 11, 2010, at 9:00 PM, mja2 wrote:

    I think that noise free investing made an interesting argument in their letter (found here

    They basically ask, using examples of Biglari's own writing, why the company wants to (1) use equity and not invested capital; (2) use a low watermark in comparison to the pay packages Biglari designed for others (they were 20% above 20% not 25% above 5% on invested capital); and (3) why he would implement a incentive system that would have paid prior SNS management more than they received in compensation. This last point is especially funny when you consider that biglari spent a lot of time ridiculing them for excessive pay in light of poor performance, yet, he would have paid them more.

  • Report this Comment On May 12, 2010, at 11:38 AM, arnieshal wrote:

    I sold my profitable 50 shares of BH after reading the recent letter to shareholders by Biglari. This egoistic individual seeks personal gain while stating that book value is more important that profits. Integrity and transperency are in short supply here; expect this stock to continue downward. I too am disappointed that Motley Fool suggests BH is worth considering as an investment. Biglari is obviously more interested in investments than in running a profitable company.

  • Report this Comment On May 12, 2010, at 12:50 PM, Rerednaweht wrote:

    I'm a bit confused...on the one hand it appears that MF is chiding BH for a their ethics regarding exec compensation...and then on the other MF is saying I should still throw money at BH?

    Well my rule of thumb is if the stock advisor isn't sure, stay away. :)

  • Report this Comment On May 12, 2010, at 1:41 PM, kehsef wrote:

    On relationshiop between BH/Biglari and DENN/Dash dissenter -

    Tuesday, March 2, 2010

    Is Biglari making a run on Denny's?

    Two investors in Denny's Corp. announced this morning that they're seeking three seats on the restaurant company's board because of dissatisfaction with the chain's direction and management. If their proxy challenge is successful, we may see the boldest takeover attempt yet by Sardar Biglari, the crafty and intriguing thirtysomething who has set out to build a restaurant empire.

    Adding Denny's to his fold, or even attempting it, would be a moonshot compared with Sardari's previous efforts to become the Warren Buffett of the restaurant business. The pillars of his holding company right now are Western Sizzlin, a fairly sleepy steak-and-buffet chain in the Southeast, and Steak N Shake, the retro burger-and-shakes concept he's aggressively trying to turn around, with noticeable success.

    Right now, he's ostensibly not involved in the effort to force a change in Denny's board--and, by implication, its management. But one of the gambit's principals is Jonathan Dash, identified as a director of Western Sizzlin and an advisor to the chairman and CEO of Steak n Shake. That'd be Mr. Biglari, folks.

    Dash is joined in the quest for board seats by David Makula, the founder of Oak Street Capital Management investment firm, and Patrick Arbor, a futures trading veteran. They and the parties they represent claim to hold a 6.5% stake in Denny's.

    Biglari wasn't mentioned by name, just inference.

    In announcing their board bids, the challengers commented, "The weaknesses of Denny's management have forced us to seek changes to the board in the interest of all shareholders. If the status quo is maintained, we are deeply concerned that the Company's future will mirror its past. " The announcement proceeds to spell out what should be done to shake the brand out of its purported inertia.

    It's deja vu all over again for those who remember the statements Biglari issued before beginning his successful takeover of Steak n Shake. The precise words may be different, but the assertions are nearly identical.

    Steak n Shake's parent company, by the way, is changing its name to Biglari Holdings Inc.

    Stay tuned for this one.

  • Report this Comment On May 12, 2010, at 9:15 PM, macsauce wrote:

    I think that it is hilarious that he has installed a poster of himself in the entrance of the Steak-n-Shake stores...He might be a little proud of himself...

  • Report this Comment On May 13, 2010, at 2:18 PM, kristm wrote:

    Steak n Shake used to be about quality. China, glass, tile, and stainless where competitors were using plastic, styrofoam, vinyl, and formica. In Sight It Must Be Right - run a super clean store and encourage customers to see how well you run it. Now BigLarry is there and the motto (from his shareholder letter) is "We have disproved the outworn quotation, 'You can’t cut your way to success.'” Cutting corners and lowering quality kills the only real thing that differentiated SnS from its competitors. Western Sizzlin is a dirty buffet with a bland menu that only does (moderately) well because it's cheap and has few competitors; SnS will be eaten alive by competition with an unremarkable menu and a loss of the quality and atmosphere it used to be known for.

  • Report this Comment On May 13, 2010, at 5:32 PM, kyddfool wrote:

    Everybody ought to sell their shares of his company and let him drop dead.

  • Report this Comment On May 14, 2010, at 1:11 PM, efmagowan wrote:

    I made a few bucks with SNS earlier this year, it was fun while it lasted, but Biglari dropped the final straw, I'm outa there (a few weeks ago, actually). Leucadia is and has always been a favorite of mine, though; followed closely by Brookfield (BAM and BIP).

  • Report this Comment On May 15, 2010, at 11:11 AM, marginjim wrote:

    It seems to me that you are premature on two counts in your proof of Warren Buffet's standards:

    1. In order to "prove" Buffet's point, bad things need to happen as the result of what Buglari has done. So far, that hasn't happened.

    2. It's an open question, at least in my mind, that what Buglari is doing shows a lack of integrity. He's changed the compensation arrangement. Now, if he makes 5% or less, I get all of whatever he makes. If he makes more than 5%, I get 75% of everything over 5%. As long as he plays it straight, doesn't lower the starting point or get compensated twice for the same thing, this could be a good thing for everyone.

  • Report this Comment On May 15, 2010, at 11:46 PM, TheHedonist wrote:

    I'm confused! Why does the disclosure policy at the bottom of the article say that the Fool owns shares of Biglari holdings and then post this article to scare people away from the company?

  • Report this Comment On May 17, 2010, at 1:27 PM, salvadorveiga wrote:

    How is this package deal ridiculous ? You guys don't see the point...

    He's making BH his own investment vehicle much like Buffett did with his Buffett Limited Partnership...

    For your information Buffett, charged 25% on the book value over 6%, which was the risk free rate at the time...

    This deal is the same thing pretty much. If he manages this conglomerate as well as he has been doing his investments for the past 10 years, in 20 years or so you would've missed a little berkshire in the making...

  • Report this Comment On May 18, 2010, at 7:17 PM, webby591 wrote:

    Great posting Protovist on Buffett structure in his early days btw. This is interesting. We come off a couple years where executives of wall street receive massive pay packages for massive losses. Now a compensation structure is created so that profits are given out only when they should be deserved (increase in book value) and nothing is paid when the compnay does poorly! Some of these posts are absurd, Biglari doing things that are not shareholder friendly? Only cares about an increase in book value, not a profitable company? Maybe its my ignorance of being a highly educated 22 year old, but in order to increase book value over the LONG TERM, you need to have a profitable company!!!!!

    When i found and wrote about this company as was as excited as I was during the crash. I even tried to get ahold of Dave and Tom (though never got through :( ). I continue to pray that you "fools" beat this stock up, naked short sell it please, but i know what I will be doing, buying, and buying and buying. I believe you are truly missing out of the fundamentals of the company, let alone the tangibles that are on todays balance sheet. Discount to future FCF, So please beat this up more, all the way to 50 dollars if would please, Turn the Ben Grahmite CEO's company into a Ben Graham stock, please give me my MARGIN OF SAFETY!

  • Report this Comment On May 18, 2010, at 7:18 PM, webby591 wrote:

    Sorry about the spelling mistakes, wrote it quickly, but you get the point!

  • Report this Comment On August 17, 2010, at 11:45 PM, mhannum72 wrote:

    How does this deal cost shareholders 80% of the returns? Can I convince someone to post the math showing this? In my mind the most this can possibly gives him is the cash value of 25% of the book value. Half of this has to be spent on buying the company's stock, by the way. So rather than giving himself an option that he can exercise and sell (which dilutes shareholder value), he's committing to using half of his salary to purchase shares of the company on the open market. I consider insider ownership to be good for shareholders.

    This article absurd. If you want to make money, buy this stock. Biglari's compensation package will not dilute your shares and does not reduce the value of this company.

    Read the earnings statement and thank populist sentiment for driving the price down this low.

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