Steak n Shake - Situational Analysis

Recently I was accumulating Gander Mountain (GMTN), a retail play that caters to the outdoorsmen. This was violating the "invest in what you know" rule, since I'm an avid indoorsman. Somehow I was ahead a few dollars on GMTN, and when a weekend edition of the Economist had an article on how the number of hunters are rapidly declining in the U.S., I had sell tickets entered that next Monday morning.

Realizing that I was lucky, rather than good, I made a conscious decision to get back to familiar ground. I have a Yahoo portfolio of twenty-five restaurant stocks that I like to keep an eye on. No sooner had I scanned the news headlines when I saw the name of Sadar Biglari next to an old favorite stock of mine, Steak n Shake (SNS).

I had owned Steak n Shake soon after they brought Peter Dunn aboard as CEO in 2003. He had good credentials as a large company food executive and he immediately put together a multi-point operational plan to address SNS shortcomings. Some of the points of attack were:

* Get consistent products at each of the stores (there were stories of the curly fries being made differently at many of the sites)

* Reduce employee turnover, which was exceedingly high

* Develop bench strength at the store management level to prepare for the next round of expansion

* Keep innovating new menu selections to drive traffic (the new product when I visited Indiana in 2004 was side-by-side shakes, featuring two flavors of ice cream sitting side by side)

The company performance and stock price started improving very nicely. I think I bought around $9 and took profits around $14, missing some of the double that occurred in 2004 from the 2003 prices.

I made another round trip in equity in 2005, but I basically broke even when my motivation for selling came on the news of weak same-store-sales.

Meanwhile I had invested in the northeast low-end restaurant chain, Friendlys. First, I bought their bonds at $.60 on the dollar and when I started seeing some gains on that position, I hedged by shorting the stock. Then along came Sadar Biglari. Someone I never heard of until he filed a 13D (disclosing a position of greater than 5% ownership). He killed my short and made me a bunch of money on my bonds. Biglari was a young gun who made his name by taking a position in Western Sizzler restaurants and pitching a campaign that the board room had fallen asleep allowing the company to underperform for too long. He fought for board seats (2) and basically won the war he waged which included billboards to state his case. He is now the CEO.

Some of his investment firepower comes from a hedge fund that he runs, and he now has the cash flow of Western Sizzler to direct, much like a Buffett or Lampert. Biglari is smaller scale; but the guy is barely 30 years old. It seems he made his initial wad by starting an ISP while still in college.

He used many of the same tactics from Sizzler's experience at Friendlys, though he never won his way on the board. He did remain active as the company reviewed its options and he ultimately agreed with the company's steps to be taken out by private equity.

He now had two notches in his gun belt, and when I saw a filing of a 13D for his position in SNS, I was quick to get on board. I didn't even realize that Dunn was gone as I took my new position. True to his pattern, billboards are up around Indianapolis (SNS headquarters) and letters are being written demanding seats on the board.

My shares purchased on November 6 @ $13.69 were not treated kindly and soon were under $11. At the beginning of December it was announced that Biglari upped his ownership to just under 10%, or 2.7 million shares, of SNS. I wanted to buy more but the weakness of the stock froze me into a "wait and see" mode. I remained that way for the entire month and only over the New Year's Holiday did I look at the internet for some new information on SNS.
The new information came in the form of a Motley Fool interview: http://www.fool.com/investing/general/2007/12/27/a-special-situation-at-steak-n-shake.aspx

Here a value fund manager gives Biglari credit for being a catalyst for him to purchase SNS stock. Read the link and make your own assessment and read my summarization of the key points that I take away:

Opportunities: Company-owned assets could recapitalize SNS by selling franchises; Biglari has the board in the "review options and take action" mode. Biglari is two-for-two in extracting a value-premium from a restaurant stock. Lower-end dining may be the last segment impacted from the stretched consumer pocketbook.

Risks: Steak n Shake has always been at an awkward price point with higher prices than fast food, but the quality of the food is inconsistent with wait-staffed dining. Management can't explain their poor same-store results. This is not where a health-conscious consumer eats; this risk is mitigated by the chain's 400 stores being in the Midwest and Southeast where obesity is the highest in the country. Food inflation likely to get worse, with an unknown capacity for passing cost increases through prices.

Finally, it is interesting to note that Biglari's 2.7 million share ownership is less than the short-interest in the stock by about 1 million shares - establishing an interesting tug-of-war on the future stock price.

I'm surprised that the December 27 Motley Fool article did not generate any additional volume or price action to the stock. That may be a statement to the Fool's declining influence on investing, but never-the-less tread careful with this situation.

An Inconvenient Divergence

Above is the three month comparison of the QQQQ's and the SOXX ****click image for full screen view ****

In the last three months the Semiconductor Index (SOXX) has been hammered while the Nasdaq-100 was flat. That is an unusual correlation. Sure, the SOXX is no longer the growth engine that it once was, but is it now the perfect hedge to Nasdaq-100?

The two major drags on the SOXX were Micron (MU) and Advanced Micro Devices (AMD). Micron is usually a story of dRAM prices and inventories; I don't claim to have a good perspective on either, except buying memory is always getting cheaper. AMD was just flying high two short years ago, with the stock over 40, and Ruiz seemed to have delivered the company out of the shadows of Intel. Finally, faster AMD chips were being accepted by Dell. Then Intel did what they always do to AMD, they dropped their prices and upped their R&D to beat them to the next generation chips.

A questionable acquisition of ATI by AMD also contributed to the valuation collapse. Three months ago AMD was at $13, but recently has been hovering around $7.

Is the whole index, including giants Intel and Applied Materials, destined to be a commoditized set of products which take the sizzle out of the steak? Even maturing companies have a few good moves left in them, like an aging athlete who still shows their stuff periodically.

Early in 2008 I plan to establish a ratio spread with long options on SOXX and relatively fewer short positions on QQQQ.

Oil Services

**** Click on Image for Full Screen View ****

With the soaring price of oil, Oil Services remain an interesting place to be in 2008.

The graph above shows the price of the Oil Services Index (OSX) for the last nine-plus years. The price, in green, shows a six-bagger return for those that took the long ride. Even if one would've waited until the late summer of 2004 to catch the wave, a triple-bagger was in store.

The blue line shows the price in relation to the price's 34-day moving average. The wider the range, the more volatility is in the stock price. The volatility has been declining, with the range of the price move remaining within +/- 10% of its moving average.

Combining the fundamental and technical point of view, I would expect the former high prices in the OSX to be revisited as the price of oil breaks the $100 per barrell mark early in 2008. From there, I would expect another price correction, perhaps disconnected to increasing oil prices, and then another long bull run.

I will be building an Option Vertical Spread, selling Out-of-the-Money calls into the next leg up and then buying more At-the-Money calls as the price corrects.