How an Activist Shareholder Has Increased Cracker Barrel's Value

In the following final segment of a show devoted to Southern restaurant and travel store powerhouse Cracker Barrel (CBRL -1.96%), we look at the influence of activist shareholder Biglari Holdings (BH 1.61%) on the company's financial returns over the past several years. Despite a tense relationship with Cracker Barrel management, the investment company has initiated much positive change that has benefited shareholders. The segment ends with some final thoughts on Cracker Barrel as an investment; click below for our podcast team's analysis of the opportunity going forward.

A full transcript follows the video.

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This video was recorded on Feb. 19, 2019.

Nick Sciple: One other red flag that stands out for investors, or yellow flag, maybe, is the presence of an activist stake in this business. Biglari Holdings is run by Sardar Biglari. He has held a very large stake in Cracker Barrel over a period of time, up to nearly 20% for a long period, although he has been selling it down over the past. He's been very open about criticizing management's capital allocation strategy. He's been behind some of the shareholder-rewarding aspects of Cracker Barrel's dividend policy over the past few years. What should investors know about this activist stake in Cracker Barrel and what it means for the investment?

Asit Sharma: Biglari Holdings now, I believe based on an article you sent me, their holdings are down to about 15% from a close-to-20% stake. This 20% stake has been a sore point for management for many years because they've always felt that Sardar Biglari and Biglari Holdings are going to take a greater stake. So they adopted this poison pill to combat that. But investors should know that actually, by remaining under a complete control, Biglari Holdings has had a positive impact on the stock. They've helped improve operating margin, they've helped improve cash flow, which has rewarded shareholders. They really agitated against this expansion without looking at profitability first. Some other things they've done, they forced management to break out the retail sales, which management had never done. There are several actions that the company has taken that Biglari Holdings has agitated for.

An interesting thing that you pointed out to me, Nick, is that they've never given credit to the activist shareholder. The activist shareholder will point out that X, Y, or Z needs to be done in a very loud voice, and the pattern is that management will, next quarter, start implementing those changes as if they came up with it themselves. I guess, if the share price is rising, Biglari Holdings doesn't need the credit, but I find that very interesting.

The one thing that I really quickly wanted to talk about in terms of this poison pill, this dispute between management and Biglari Holdings. Biglari Holdings has always maintained that it doesn't really want to have more than a 20% stake. For its side, it's said, "If we take more than a 20% stake, that's going to trigger a debt covenant, which will then make us have to immediately pay $164 million to our lenders. We're not going to go above 20%." One other thing that Biglari has always maintained is, there's an act on the books in Tennessee called the Tennessee Control Share Acquisition Act, which prohibits a shareholder who owns a 20% or greater stake in a company from voting more than 20% of their share. So even if they were to acquire 30%, 40%, 50%, they wouldn't have the voting control past 20%.

They've often argued, "This whole poison pill issue is moot. We can't because of our debt covenants, and anyway, the law prohibits it." Management's never really responded to that. I will say, going forward for shareholders, you want Biglari to keep that 15% stake. They've been good for Cracker Barrel. They've kept management honest. They've been responsible for a lot of good change. Your druthers would be for Biglari to stay invested and stay active with this company.

Sciple: Yeah. I would say, he would be much more identified, at least from a shareholder's perspective, as a white knight than a corporate raider in this situation, and really has been very rewarding for shareholders over time. If he's beginning to sell down his stake, I don't know if there's any read-through to that for investors as to what the potential upside might be for the investment over the long term. Definitely something to continue watching, both for his advocacy and maybe as a signal of what opportunities there are for the business.

Last thing I wanted to address, we've touched on this a few times, is how the rise of off-premise sale, this food delivery concept, how that might affect Cracker Barrel. Obviously, we mentioned that Cracker Barrel's retail strategy depends on getting folks into the restaurant, to eat at the restaurant, and then converting them into retail customers. Of course, if folks use delivery, they never end up in your restaurant, and they can never be converted. Cracker Barrel is investing some in off-premise sales. You mentioned some food truck concepts they might be doing as well as expanding their catering and takeout offerings. What are your thoughts on the rise of off-premise sales and what that means for Cracker Barrel as an investment going forward?

Sharma: It's obviously an important trend for the company to explore. We see so many companies -- Chipotle is a great example of trying to expand off-premise sales either through catering, or have people come in and take food away. For Cracker Barrel, it's more catering. The only question that I've got -- I know you've got a great question, Nick -- the only question that I have is, given that so many of the locations are interstate locations, so they're not smack in the middle of big urban areas, they tend to be around smaller metropolitan areas, how big is the opportunity to do business catering? I think it's limited. Sure, it may be a good revenue stream to explore, but I have my doubts that it's this major source of income that management is trying to communicate that it could be. I'm a little skeptical on that front.

Sciple: Yeah. Wrapping it all together, I think Cracker Barrel exists in a niche that makes it very difficult for someone to come in and disrupt where they operate. However, both due to the nature of the business and that you need folks to come into the restaurant to sell things, which is moving counter to trends toward delivery, as well as the retail items that it sells, its old country store theme, the Southern food, is going to cap its ability to really grow and move nationwide. I may be wrong there, but that's my belief.

I think Cracker Barrel, given the assets that it has and its positioning, is going to continue to make money over time. It's going to be probably a really attractive investment from a dividend perspective, spitting out cash over time. However, from a capital appreciation point of view, I don't know how excited I would be in buying this business looking for it to double over the coming years. What are your thoughts on that thesis, Asit?

Sharma: I think that growth will rest more on menu innovation than almost anything else because it is this niche product. I agree with you. We'll see how this westward expansion works. There may be some opportunity within the next five or 10 years for some unexpected returns, let's say if units accelerate faster than expected or the concept really takes out West. But if you are a dividend-oriented investor and you want capital appreciation with some downside protection, this isn't a bad stock to look at. That's where the beauty of this particular concept lies.

Like you said, Nick, the interstates are going to be here long after you and I are gone. I believe Southern food will be popular within the South long after you and I are gone. There is something to be said for buying this model for what it gives to you, that, so far, 5% to 7% effective yield on the rising dividend and special dividend.

Sciple: Yeah, definitely an interesting investment opportunity. Asit, I'm heading down South tomorrow for Mobile, Alabama, Mardi Gras. Maybe I'll get hold of some Southern food while I'm down there.