Buy ‘Em Back at Western Sizzlin’
A great, but not surprising, piece of information was released today regarding Western Sizzlin’: share buyback authorization.
The 8-k filed today by the company tells us that Western Sizzlin’ has authorized Biglari to buy back up to 500,000 shares. Doesn’t sound like much, until you consider that the company only has a total of 2,700,000 shares outstanding.
What does this mean? With Western Sizzlin’ trading at an appreciable discount to its intrinsic value, Biglari can purchase up to 18.5% of the company, and I expect he will do just that as the opportunity arises.
He won’t be able to move quickly, however. WEST is still an extremely thinly traded stock right now. Even with its recent addition to NASDAQ, a mere 520 shares traded today. Average volume is only around 1,000 shares/day.
The hope is that Biglari will be able to find block purchases at advantageous prices now and into the foreseeable the future, but with the illiquidity of the stock as it currently stands, I wouldn’t expect him to be able to swiftly purchase 500,000 shares. At current prices, the program will cost Biglari around $6.5mm, a number that will only rise over time as WEST appreciates.
Overall, though, this is a big positive for Western Sizzlin’ shareholders.
Why Do Buybacks Make Sense?
If I own a company, then by definition, I believe it to be trading at a discount to its intrinsic business value. Otherwise, I wouldn’t own it. Now, except for extraordinary circumstances, I’m also buying into companies with strong, healthy balance sheets and strong, healthy cash flows.
The only reason a company should be repurchasing its own shares is if they believe them to be a highly attractive use of capital. Essentially, they are increasing the ownership stake that all of the remaining shareholders retain. These buybacks shouldn’t be done to offset dilution from stock options, increase earnings per share, or any other reason you often hear. The only reason should be a steep undervaluation of the shares.
Let’s run a hypothetical to illustrate why this works, one I’m sure you’ve all seen before if you are experienced investors:
Let’s say I believe Company X is worth $1000 in enterprise value with 100 shares outstanding, or $10/share. Company X currently trades for $5 a share, for a market cap of $500.
Now, with a redirection of free cash flow, the company buys back 30% of its shares at $5 a share, leaving them with a total of 70 shares outstanding. I still believe they are worth $1000 total, that much hasn’t changed. However, that $1000 in value is now only spread over 70 shares, so the company is now worth $14.28/ share, without any operational improvement!
Had Company X not bought their shares, and merely let that cash pile up, the company would have been worth slightly more than $10. The $5 x 30 shares, or $150, would have added to the enterprise value of the company, bringing the total to $1,150 on 100 shares outstanding, or $11.50 a share. Our value after the buyback, $14.28, is still much higher.
Given the two highly likely and/or necessary conditions for me to purchase a piece of a company that I mentioned above, wouldn’t I naturally want that company to be buying its own shares back? If I’m allocating capital to the business, I generally believe they should be doing so as well. It’s a logical corollary. Unless I believe that company has a very high internal reinvestment rate in its operating business, share repurchases usually make sense for companies I own.
There’s a reason why intelligent value investors are often pressing companies to buy back their own shares, and it is due to the above rationale. Take, for example, Eddie Lampert’s work at Autozone in the late 90’s and early 00’s. As soon as he was elected as a director, he pushed hard for AZO to buy its own shares back with free cash flow. To see how this worked out, again, check the numbers:
From 1998 - 2007, net income at Autozone went from about $225mm to now just over $600 million, an increase of about 2.7x, or 170%. Certainly a respectable improvement in operating performance. What else happened?
In 1998, Autozone had 154 million shares outstanding. Today, that number stands at 69 million. Look at the stock price: shares that were once around $30 in 1998 are now bouncing around near $120, a 4 four fold increase, or 300%. Likewise, earnings per share went from $1.48 in 1998 to a whopping $8.82 in the trailing 12 month period! That’s a five-fold increase. Investors profited 300% even though earnings only grew 170% and their trailing PE ratio compressed over time.
The share buyback provides the difference. By pressing Autozone to allocate capital to an undervalued asset, its own shares, Lampert created an immense amount of shareholder value at Autozone above and beyond the improvements in its operating businesses. Indeed, Mr. Lampert is doing just that at Sears today.
Biglari now has an opportunity to do the same at Western Sizzlin’ and, I might add, at Steak N Shake as well. While I expect the businesses to improve over time at WEST and SNS under the leadership of Biglari, share repurchases at these levels will create value for shareholders above and beyond operational improvements.
Nice job!
good post.
I’d imagine that the buyback will occur slowly, each quarter for a great deal of time. I can’t imagine that they would want to buy back too many of their own shares since SNS is quite drastically more undervalued of a company.
Really, from the message that were getting, I am curious as to how the franchising of WEST restaurants is going……
You’re right on with Steak N Shake. With Biglari in control, I’d expect that they would purchase SNS over WEST right now. They have more cash coming in the door from franchising than they could put to work buying WEST shares anyways, due to illiquidity, so SNS is a smart purchase.
I’m sure WEST franchising is going fine, but it’s not easy to grow that business. Likewise, they don’t need to commit much capital to expanding franchise operations. It’s not a capital intensive business model. That’s why Sardar likes it so much. They could be adding franchisees while simultaneously purchasing shares of SNS and WEST.
well, the expansion of the franchises doesn’t cost much, though, if they go by splitting ownership as they did with W. Proffitt, it will take more money. Though, since they got, what, a 86% ROIE from the cash flow of that venture? Id did rack up a good deal of debt.
While at the annual meeting, I am gonna ask about the debt loads that the company feels comfortable with/sees from this type of investing activity… It doesn’t seem like the sort of deal that many entrepreneurs would want to get involved with-plus, I can’t see guaranteeing 3 million dollar loans forever either…
The W.E. Profitt deal wasn’t a recurring event, ragnar. It doesn’t seem to me that Biglari is going to be doing such things very often, as it much less capital intensive to expand the franchising effort through franchise and royalty fees, rather than joint ownership.
The company, indeed, had a very high ROE last year. You are correct that the debt load improved that, as well.
However, the return on total invested capital in the venture was over 18%. That is an excellent number considering the economic environment it experienced in the second half as well as the generally poor economics of restaurant operations. The JV is going very, very well.
But yes, to your question for the meeting (which I’m planning on attending), I’m guessing he will tell you that it was an opportunistic investment, rather than a strategy they will continually pursue in the future.
Great comment.
I meant to say free cash flow on ROEC… my bad.
yeah, it is pretty understood that these deals don’t come around very often, though, using leverage to increase earnings forever can be dangerous. Which is the essence of the question.
you are probably right on what he will say.
Remember, also, that the debt is secured by the physical restaurant. So, yes, WEST has a 1.5mm contingent liability if the JV were to fail, but right now, even in the poor environment for restaurants, the Wood Grill cranked out a 57% return on equity in the first quarter and $92,000 in profits.
If the JV did nosedove, and WEST was obligated to pay the $1.5mm, the building could be sold for proceeds that would probably pay down the loan entirely, or at a very small loss to WEST (relative to total assets/equity).
Indeed, they borrowed, but it is debt secured by real estate, which is a different beast then general unsecured debt that depends on the ongoing cash flows of the enterprise. It is uncommon for a restaurant operator to buy all of their real estate outright without secured debt.
$3,000,000 in secured debt on top of $650,000 in equity isn’t a debt level that worries me. Given the success of the venture so far, the debt is reasonable and managable. In Q1 they generated about $200k in EBITDA to cover $54k in interest charges.
This is a good transaction for WEST.
[...] He is also signalling that he feels Western Sizzlin is undervalued by initiating a significant share buyback last week. There other developments that probably deserve some discussion if I had more [...]
I have loosely followed this company. Didnt he recently do a rights offering? Isnt he planning to do more? Why would you do a rights offering and then turn around and buy back stock? Sounds like he is simply trying to juice the market cap so he can make an acquisition with stock.
Vic,
He did a rights offering over a year ago. He’s stated that he’d like to do another at some point, if need be. There is no rights offering even being considered right now, to my knowledge.
The buyback is in place, again, as need be. I stated above that he might not purchase shares for awhile, and even if he does, it is very illiquid so he can’t purchase much at once.
Both are options, now, depending on the situation.