The "Next Warren Buffett": Confidence or Arrogance?

Who is the real Sardar Biglari -- young Warren Buffett acolyte and champion of the way things ought to be, or self-dealing corporate raider? 

Biglari burst onto the scene five years ago. He first gained control of restaurant chain Western Sizzlin, then forced second target Friendly Ice Cream into the embrace of private equity. His quest for board representation at money-losing Midwestern icon Steak 'n Shake culminated in his eventual appointment as chairman and CEO in mid-2008. Value investors cheered.

The cheering has since quieted. Certainly, Biglari oversaw a commendable turnaround at Steak 'n Shake, converting the restaurant into a cash-producing machine.

However, more recent moves -- including retooling the firm as a diversified holding company renamed eponymously (egotistically?) Biglari Holdings (NYSE: BH), consolidating Biglari’s other business interests under this new corporate structure, and implementing a new, generous, compensation scheme arguably somewhat misaligned with outside shareholders -- have induced howls of betrayal from many who previously praised this "next Buffett." 

Truth lies in the middle
At last Thursday’s annual meeting in New York, Biglari provided evidence for both camps. Well-attended simply because Biglari Holdings holds no quarterly conference calls or traveling road shows, Biglari and Vice Chairman Philip Cooley -- in mimicry of Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) -- held court in a Q&A session lasting several hours.

A popular theme was long-term value creation. Biglari doesn’t care about hitting quarterly earnings targets, thinks same-store-sales are an incomplete measure for assessing performance, and that the only thing that matters is creating long-term value as defined by returns on incremental capital exceeding the cost of that capital. Such a long-term approach demands, in Biglari’s thinking, a shareholder base with a similar long-term perspective. 

To that end ...
Like Buffett’s Berkshire, Biglari Holdings is implementing a dual share class structure. Buffett controls Berkshire via his ownership of the higher-voting-power A shares, though his proportionate interest there is much higher than Biglari’s is at Biglari Holdings. 

In the new dual class structure, existing shares would be redesignated A shares. A new class of B shares would be issued, worth one-fifth of the A shares and carrying 1/20th of the vote. All shareholders would receive 10 B shares for every share currently held. There would be no conversion rights between classes. Economic interests of any shareholder would be unchanged pre- and post-reclassification as per this example: 

Source: Analyst calculations.

This should somewhat assuage the fears of those distrustful of Biglari. He controls approximately 15% of the company. Biglari may sell his B shares and reload with higher-voting power A shares. But then, any outside shareholder could choose to do the same. 

What could be interesting is how the trading action of the two classes might evolve. Consider Heico (NYSE: HEI-A) (NYSE: HEI), a company with a similar dual class share structure, where classes are identical except that the A shares have one-tenth the voting rights of the common stock, yet the A shares trade at a 27% discount! Biglari indicated at the meeting that, if such a disparity were to open at Biglari Holdings, they’d look to exploit the arbitrage opportunity.

Torn between appreciation and wariness
Repetition of themes like value creation, structuring the company to maximize flexibility, and opportunistic acquisitions speaks naturally to my value investing soul. The revamped share structure doesn’t bother me -- I’d like a crack at that arbitrage myself.

The company’s measured growth plans seem promising -- five new franchised units were opened during the past year, and all are markedly outperforming expectations. And a companion signature concept for Steak 'n Shake is going to start rolling out to franchises, costing far less to set up and offering significantly less complexity of menu and of operation.  

Where I have pause is that the company has quite literally (check the nameplate) become "All Sardar, all the time." All capital allocation residing in Biglari’s hands is what shareholders have signed up for. However -- perhaps again emulating the famous childlike tastes of the Cherry Coke-slurping, cheeseburger-munching Oracle of Omaha -- Sardar, saying his taste buds haven’t advanced past age 5, is also approving all menu additions at Steak 'n Shake. Do shareholders really want their capital-allocator menu-crafting? 

Moreover, a certain arrogance was displayed that I found uncomfortable. Celebrate doing things different from other companies, by all means -- that’s one reason I’ve invested with you. But exhibiting some humility never hurts either. Instead, we heard how Biglari and Cooley are “playing chess in a world of blind checkers players," and how Biglari “likes to win,” followed by a quotation from sci-fi writer Orson Scott Card: "Most victories came from instantly exploiting your enemy's stupid mistakes, and not from any particular brilliance in your own plan."

There’s little “instant exploitation” to tout. Biglari Holdings might claim status as a diversified holding company, but the company has made exactly two acquisitions of significance -- both companies controlled by Biglari (Western Sizzlin and Biglari Capital) and both dwarfed by Steak 'n Shake in their contribution to the whole. The public investment story over the past year seems somewhat checkered.    

They’ve engaged in an unsuccessful but public takeover spat with insurance target Fremont Michigan -- which so desperately wanted to avoid Biglari that they apparently had the state government run cover for them. They bought and then almost immediately disgorged their interests in fellow burger turnaround stories Red Robin Gourmet Burgers (Nasdaq: RRGB) and Sonic (Nasdaq: SONC). They’re currently rattling the cage of CCA Industries (AMEX: CAW), where Biglari has bought a 12.8% stake and is now ironically criticizing the "generous" compensation agreements for that company’s founders who, also somewhat ironically, control CCA via a dual class share structure. Such a structure makes it unlikely to me that Biglari will be folding the company under the Biglari Holdings banner.

The Foolish bottom line
I greatly admire the turnaround accomplished at Steak 'n Shake, and I’d probably have been happy seeing that concept grown out via franchising. I like the move to revamp the dual class conversion to be friendlier to the little guy. But I think, after the past year, I’d like a few more definitive milestones, more demonstrable value creation (beyond Steak 'n Shake), and fewer aggressive ongoing fights.

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