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.