Biglari Holdings (BH)

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Sizzlin' With Sardar Biglari
By Emil Lee
August 8, 2007
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After reading the latest Western Sizzlin shareholder letter, I think big things are in store for Sardar Biglari. When he's not serving as chairman of the steakhouse chain, Bigliari also manages a value-oriented hedge fund. I tapped Bigliari for an email interview to see what Fools could learn from his experience.

Emil Lee: Please tell me about your hedge fund.

Sardar Biglari: I started Biglari Capital right after I graduated from Trinity University. Biglari Capital is the general partner to The Lion Fund, L.P., a private investment partnership. I am a value investor, and I apply the same principles in running Western Sizzlin as I do in operating The Lion Fund. I focus intensely on evaluating an array of situations, searching for pockets of opportunity that are within my sphere of competence.

This maneuver leads me to be risk-averse, concentrated, and conservative with our capital. The right occasions for investment arise when there is general misunderstanding -- and therefore mispricing -- of the worth of an asset. In other words, our plan does not revolve around using common sense -- the logic of the lemmings can be flawed -- but, rather, around good sense, which can be uncommon.

Lee: As its chair, do you hope to use Western as a corporate vehicle akin to Lampert's use of Sears Holdings (Nasdaq: SHLD) or Buffett's Berkshire Hathaway (NYSE: BRK-B)?

Biglari: I have no master plan ... unless, of course, not having one is considered a plan. Opportunities, not premeditated, nearly irreversible [preconceptions], will determine what Western will look like. My job is to allocate capital in the greenest pastures, without regard to the company's history and prior policies or other institutional constraints. The consequences of those decisions will determine the eventual net worth of our shareholders. Capital allocation is a matter of discovering where we can generate the highest return, adjusted for relevant risks. It's important to remember that Western is a small corporation, and we must simply do our best with what we have.

Lee: When I read the Friendly Ice Cream (AMEX: FRN) annual report, I had no idea how you found value there. But clearly, that position has worked out well for you. Can you describe your investment thesis? How did you get comfortable with the margin of safety there?

Biglari: Though I do not wish to share the details of my thesis for a number of reasons, I can tell you that as a value investor, I am looking for situations in which the consensus is incomplete or even erroneous.

Here is a company founded 72 years ago by two friendly brothers selling ice cream quite profitably. Up until very recently, [it] was controlled by a board [with a culture] that was the antithesis of the culture developed by the brothers. When I first examined the company, I was struck by the board's unfriendliness toward shareholder interests, illustrated by a poison pill, a poison put, a classified board, onerous provisions in the bylaws, to name a few. Yet beneath the dark clouds of poor governance and a leveraged balance sheet was a company producing a well-known brand, generating great cash inflows, combined with a terrific real estate portfolio -- all adding up to substantial upside potential.

When we entered the stock, our intention was not to sell the company. But when we were presented with a rather attractive price, we took it, because doing so was in the best interests of all the stockholders. We could have vetoed the deal, and the shareholders, in all likelihood, would have elected us to the board. But a buyer was found willing to buy the entire company for $15.50 per share, which, incidentally, fully values the stock. We do not believe that every company should be put up for sale or even sold unless the price reflects its full value, as it did with Friendly.

Lee: You seem to enjoy getting your fingernails dirty in the actual operations of a company, as opposed to Buffett's typical hands-off approach. Does your background as an entrepreneur come into play here?

Biglari: We prefer a decentralized management structure, with capital centralized at the holding company level. That is how Western is set up. My partner Phil Cooley [the vice chairman of Western] and I prefer a fully autonomous management structure. On that basis, we seek to buy entire businesses for Western.

Warren Buffett enjoys a number of advantages, even though his large capital base represents an obstacle that he must overcome. As one example of Buffett's advantages, he can pay less for companies because his intention is not to integrate them; he thus cajoles the sellers into coming closer to his aspirational price. Non-integration has value, and he can capture that value. The cost, of course, is lack of synergy, which is overrated, whereas non-integration is underrated. Buffett has developed a reputation for making promises to sellers that he'll stay out of their way; thus, his reputational capital is being put to good use. Throughout his life, he has used his advantages to generate excess returns.

Buffett is currently buying large, well-established companies earning high returns on capital. Because we are dealing with less money, we can review and assess quite a few companies that are rather small.

Furthermore, we see opportunities in engaging in more underperforming companies, which are priced below their intrinsic business value. In addition, the underpricing is supplemented by higher upside potential, since most investors usually value the company they are considering as it appears to them at the status quo. By not closing our eyes to businesses that are performing beneath their potential, we augment the number of investment opportunities we can investigate.

We seek to discover value where most have overlooked it. Our continued effort to assemble a collection of companies trading below their intrinsic business value epitomizes our goal. Some firms will be growing, whereas others will not. However, the key is not growth but valuation. Many in the money management business describe their investment technique as GARP investing, or "Growth At a Reasonable Price," seeking to pay a fair price for a growing company. That's not a foolish approach if these managers don't overpay.

But to obtain truly outsized returns -- which ideally we want -- is to use what I call GULP investing, or "Growth at an Unreasonably Low Price." We are not simply passive investors, and growth is not necessarily a major component in the value calculation. We are also control investors, so named because we put ourselves in a position through which we could possibly create various positive changes. We can afford to pay more than can the passive investor who simply has no choice but to watch his holdings from the sidelines. Paying up doesn't mean overpaying; rather, value in a control position can increase exponentially.

Warren Buffett has said, "I am a better investor because I am a businessman, and a better businessman because I am an investor." Buffett's mentor, Benjamin Graham, wrote in The Intelligent Investor, "Investment is most intelligent when it is most businesslike." This statement, according to Buffett, comprises "the nine most important words ever written about investing." I view stock ownership as ownership in a business.

Furthermore, having a dual perspective -- first from the capital market's point of view, because I run an investment fund, and second from a board and management level, because I run a public company -- imparts enormous advantages to me. Because of my double-pronged viewpoint, I have become a better businessman and investor. These activities are synergistic and intellectually stimulating.

As a result, I am able to concentrate our capital in a few positions, because I am taking an approach to investing through the lens of a businessperson, not as a portfolio manager implementing tiresome academic modeling. Whether we own 100% or .01% of a company, we are acutely concerned with business values and business dynamics.

Lee: Your shareholder letter clearly states that you believe strongly in wise capital allocation. When studying a potential investment, what are some things you look for that indicate capital is being spent wisely?

Biglari: There is no ratio or algorithm that can yield a pat answer to the sagacity of management's ability to allocate capital. That kind of discernment requires rendering judgment on managerial decision-making acuity and behavior.

What is rather important, and is quantifiable, is the business's competitive advantage, which is computed by taking return on capital and subtracting cost of capital. The computation is easy to understand, but knowing the future inputs are an uncertain, complex, often fluid proposition. Naturally, when no prospects of displaying a competitive advantage exist, profits should be returned to shareholders, not reinvested in the business; otherwise, shareholder wealth would be destroyed.

Thus, growth at a competitive disadvantage destroys value, whereas growth at a competitive advantage creates value. A corollary to this notion is that the higher the return on invested capital -- and assuming all capital is reinvested -- the faster the future economics of a company will change. We find the holding company structure, such as the one at Western, ideal for businesses, because we separate capital allocation responsibility from the authority to make operating decisions. This way, a manager of a subsidiary can focus on what he or she does best, and Phil and I can focus on what we do best.

http://www.fool.com/investing/value/2007/08/08/sizzlin-with-sardar-biglari.aspx