Biglari Holdings vs. Groveland Capital: Whose Alamo Is It?

I'll be the first to admit that I dislike much of what goes on in the activist world. Seemingly anyone can buy a pittance of stock, put together some shabby research, build a 160-page PowerPoint presentation, and beat the drum for short-term moves to boost the price of a stock. That's just not my style. My preference is to invest in good businesses managed by capable people who are aligned with the interests of long-term shareholders. These owner-operators take a long-term view to value creation, and that suits me just fine.

Sardar Biglari has been a controversial figure for his bold moves and willingness to play the unpopular role of activist investor to maximize shareholder value. Biglari Holdings issues no stock options to its directors or employees. The company does not have directors and officers liability insurance for board members, and executives receive no perks except for Biglari's hedge fund-like compensation plan. Biglari ousted the former CEO of Cracker Barrel for taking outsized compensation for years even as the company plowed capital into opening new stores while the unit economics of its locations deteriorated.

Biglari has done a formidable job turning around Steak 'n Shake and improving restaurant traffic without investing much capital into the operation. In fact, Biglari pulled capital out of Steak 'n Shake to acquire nearly 20% of Cracker Barrel for about $240 million. That stake now resides in Biglari Capital Corp. (BCC), a subsidiary of Biglari Holdings, and is worth in excess of $700 million.

But despite this performance, Biglari's detractors from Groveland Capital -- which owns less than 1% of Biglari Holdings -- are stirring up tension. Groveland's CEO, Nick Swenson, wants to replace the entire board of directors at Biglari Holdings, including Sardar himself. Let's dig into the reasons behind Groveland's complaints.

Costs are risingGroveland points out that Biglari Holdings'SG&A costs have increased from $70 million in fiscal 2009 to $128 million in fiscal 2014. For a man like Bilgari, who claims to run a lean operation, this is somewhat troubling.Sure, Biglari Holdings has touted increasing franchising revenuefrom $4 million in 2010 to $12 million in 2014. At last year's annual meeting, Biglari said, "We put $15.5 million in [investing platforms to enable franchise growth] and have increased annual franchise revenue from $4 million to $11 million."

We know the company invested in building out its international supply chain and logistics, in addition to opening up a Steak 'n Shake in Cannes, but where is the rest of the SG&A money going?

Who is getting paid?In order to get his hedge fund-like pay package approved, Biglari eventually agreed to a $10 million annual maximum on his incentive pay, but at a prior annual meeting he suggested he didn't expect the cap to stick. Sure enough, he found a loophole: He sold BCC back to himselfwith the board's approval. Then he transferred all the Cracker Barrel stock into the Lion Fund, which is owned by BCC. Under the terms of his pay, Biglari takes 25% of all returns above a 6% hurdle rate. Unsurprisingly, this loophole never required approval from shareholders. Presto!

Allocating capitalAll of Biglari Holdings' capital allocation decisions start and end with Sardar Biglari. At annual meetings he usually reminds shareholders that he's nimble, entrepreneurial, and all about maximizing the return per unit of risk assumed.

At last year's meeting, I asked if he would consider repurchasing stock in Biglari Holdings since the company's annual report indicated that both he and Phil Cooley, board vice chairman, believed growth in the company's intrinsic value handily outpaced growth in the share price. Biglari and Cooley said they needed more capital to deploy at this embryonic stage of the business,and they weren't interested in buying back shares. Instead, they issued $85 million worth of stock at $250 per share to raise more capital for Biglari to deploy.

But his view of buying company shares changed late in 2014 when the proxy battle began to heat up. Despite his stated preference for buying whole businesses such asMaximmagazine and First Guard Insurance, Sardar transferred $174.4 million of cash and stock to BCC, his preferred vehicle for investing in publicly traded stocks, in 2014. That was on the heels of the transfer of $377.6 million of stock and cash in 2013, after Biglari bought BCC back from the company. Biglari has said that generally the holding company will purchase whole businesses while BCC will make stock purchases.

A shareholder asked last year about the flexibility of allocating that capital. What if Biglari found a company to buy and all that capital was trapped in BCC? It certainly seemed like his arrangement limited the flexibility he so treasures. Biglari quipped that the holding company could form another vehicle and deploy the capital if an opportunity arose.

Recently, Biglari has deployed that capital by purchasing Biglari Holdings' stock. By my accounts, he has purchased 48,405 shares through BCC since Dec. 18, 2014, at an average price of $399.45. Keep in mind that this stock is not retired and that it is held in BCC, so Biglari gets to vote the shares as he sees fit. Additionally, he can claim 25% of all increases in value above the 6% hurdle rate.

Could he be using shareholders' money to control the votes for Biglari Holdings stock? Just a year ago he wasn't at all concerned with repurchasing stock. It's true that his Cracker Barrel holdings increased handsomely in value while Biglari Holdings stock stood still. However, I don't think his mentor Warren Buffett would endorse a plan in which you issue stock at $250 per share, buy it back at $400, and tout that as creating shareholder value. To add fuel to the fire, GAMCO Investors Inc. , which is the largest outside owner of Biglari Holdings shares, recently stated its intention to back Groveland's proposal if Biglari didn't abstain from voting the shares BCC controlled.

Some interesting disclosuresA recent proxy filing revealed some interesting hires in the "related party" section.

Ken Biglari was a military officer in Iran in the 1970s for then-Iranian leader Shah Reza Pahlavi. When revolutionary forces ousted the Shah in 1979, Ken was detained. He escaped in1984, and the family gained asylum in the United States. They landed in San Antonio, where they started a rug business. This is an interesting story, but only raises more questions. How does this relate to Steak 'n Shake? When did Shawn and Ken go on the payroll? Does anyone find it a bit ironic that Ken is responsible for cost management while costs are rising dramatically at Biglari Holdings?

Lastly, we've learned that Biglari Holdings has registered some private aircraft. We're not talking about Cessna 152s here. These are Gulfstream IVs, the kind that Mark Cuban and other high rollers use. It appears these are likely purchases of fractional shares of planes from NetJets.

As Groveland pointed out, Sardar Biglari has criticized executive perks excesses like this in past battles with other CEOs. He has also stressed that lean operations and zero perks are a priority at Biglari Holdings, but how can this not count as a perk? I'm curious to hear how much Biglari spent on corporate travel last year. For someone who has clearly tried to model himself and associate himself so closely with Buffett, this is concerning behavior. Why can't he pay for this expense out of his own compensation, as Buffett does?

Buffett isn't the only one who deplores exorbitant travel costs. Selim Bassoul, the chief capital allocator at Middleby recently spoke about expenses at a Motley Fool investment gathering. Middleby is now a $6 billion company, and the stock has increased over 100 fold under Bassoul's watch. He is paid very well for the immense value he created over the years. Middleby has 50 operations around the world. and last year Selim spent less than $100,000 in travel related costs. He flies coach and prefers to stay in Hampton Inns.

Foolish takeawayAs a investor that started with Western Sizzlin', Steak 'n Shake, and now Biglari Holdings, I can clearly say I'm in this for the long term, unlike most of activist investors.My message to you, Mr. Biglari, is this: Charlie Munger says, "The best way to get what you want is to deserve it." Berkshire Hathaway has built up a web of trust among its shareholders. If you treat your shareholders as true partners in this venture, you may one day author your 50thletter to the shareholders of Biglari Holdings. Perhaps it will conclude with a similar line, "I am a lucky fellow to have you as partners."

The article Biglari Holdings vs. Groveland Capital: Whose Alamo Is It? originally appeared on Fool.com.

Buck Hartzell owns shares of Berkshire Hathaway and Biglari Holdings. The Motley Fool recommends Berkshire Hathaway and Middleby. The Motley Fool owns shares of Berkshire Hathaway and Middleby. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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