Biglari Holdings (BH) is followed by many in the hopes that it can be the next Berkshire Hathaway (BRK.A). Steak ‘n Shake is currently the core of the company, and Biglari is starting to diversify itself with its recent purchases of Maxim Magazine and First Guard Insurance. Sardar Biglari, the chairman and CEO of Biglari Holdings, helped turn around Steak ‘n Shake from a company with large losses to a company that can generate cash flow to help invest in other businesses for further growth.
I had previously written about Biglari as a guru to watch for the next 30 years. He is an avid follower of Warren Buffett (Trades, Portfolio)’s investing style and Ben Graham’s book, “The Intelligent Investor.” He is also only 36 years old and has plenty of upside. The controversial part about Biglari is his pay package. The Incentive Bonus Agreement listed on the company’s website states that his bonus is calculated as:
(0.25)(New Book Value - ((High Water Mark)(x)))
To sum it up, his bonus is equal to 25 percent of the book value increase of the company above a 6 percent hurdle rate. 1.06 is the value of “x” in the equation. The “high water mark” equals the highest book value after a reduction for the Incentive Compensation amount paid. There is line in the agreement that says the cap on the incentive bonus is $10 million. There is also a base pay of $900,000 to go with the bonus. Biglari justifies the large pay by comparing it with the typical hedge fund compensation of 2 percent of assets and 20 percent of the gains. He is correct that his pay would be less than if the company was run as a hedge fund. Based on the book value of $553.5 million at the end of the most recent quarter in June, his compensation would be about $11 million up front and then 20 percent of any profits. The bottom line is as long as he is generating the returns, he is worth money.
What I find strange is the timing of the rights offering by Biglari Holdings. As I had mentioned, the book value of the company was at $553.5 million in its most recent quarter, lower than the book value of $564.6 at the end of its fiscal year in September of 2013. The company did great last year increasing its book value by increasing its book value by $215.5 million. The incentive was capped at $10 million. Using the incentive equation, take last year’s book value of $564.6 million, subtract the $10 million bonus, and then multiply the result by 1.06 to get the “high water mark” (including the hurdle rate) of $587.88 million.
The details of the rights offering is that shareholders received one right for every share of stock they had. Five rights can be used to buy a share of Biglari Holdings at $250 per share. That sounds like a great deal to the shareholder since it was a 42 percent discount to the closing price of the stock at $432.32 on the day of the rights filing with the SEC on August 8. Oversubscription is allowed and overall the company expects to sell 344,261 shares, which would raise about $86 million for the company. The new stock is going to dilute the current shares by 17.7 percent since there will be more shares in the market. Reducing the closing price of the stock on August 8 by 17 percent leads to a price $355.80 per diluted share. Exercising the rights then actually results in buying at a 30 percent discount. That still sounds pretty good, but factoring in that the rights led to a $76.52 loss per share on five shares in order to buy 1 share at a $105.80 discount to the diluted actually leads to an overall loss of $276.80 to the shareholder for every right that was exercised. Rights offerings are very common, though, and as long as the company puts the cash to good use to generate more returns, it can be an overall benefit to the shareholder.
The part that seems very odd to me is that without the rights offering, Sardar Biglari would not get a bonus with the decrease in the company’s book value if the year’s trend continued. His total salary would be the base $900,000. The incentive guidelines do not indicate book value per share in its calculations, just total book value of the company. While the shares are diluted, the overall book value goes up because there is cash coming into the balance sheet without creating any liabilities. Adding the cash from the rights offering to last quarter’s ending book value leads to a new book value of $639.5 million. That would be the new book value in the calculation. Subtracting last year’s “high water mark” of $587.88 million from the new book value of $639.5 million equals $51.62 million. Take that number and multiply it by 25 percent and you get $12.9 million. According to the incentive plan, Sardar Biglari just earned $10 million in bonus from the rights offering.
According to the SEC filing, Biglari Holdings intends to use the funds for general corporate purposes as well as for making acquisitions or investments. Hopefully the calculations showing that Biglari is selling just enough rights to put enough cash on the balance sheet to get his max bonus right at the end of the fiscal year is just a coincidence. We will see if the cash received from the rights offering is put to good use in investments to will further grow the company. Another factor is that the company could have a blowout quarter to end the year, and the book value could possibly increase on its own without the rights offering.
