Saturday, June 14, 2008

Sardar Biglari letter

A great letter in the Warren Buffett mould:

To the Shareholders of Western Sizzlin Corporation:
In 2007 Western continued its evolution as a holding company in order to
maximize intrinsic business value on a per share basis.1 To achieve our objective, we
have made the conscious decision to be in the business of acquiring other businesses. To
describe our performance accurately, we must begin this year’s report with a few
comments about accounting because, depending on the percentage of voting stock
owned by Western in other businesses, under generally accepted accounting principles
(GAAP) three major categories are used for reporting our results.
GAAP dictates that we consolidate the financial statements (including income
statement and balance sheet) of businesses in which we own more than 50%. Western
Sizzlin Franchise Corp. (“WSFC”), 100% owned by Western, is an example.
Consequently, we fully record all the sales, expenses, assets, and liabilities of WSFC.
Businesses in which we own between 20% and 50% impact our income statement
in a different manner, termed the equity method of accounting. Their earnings are posted
as a single item on our consolidated income statement. For example, we have a 50% joint
venture in a Wood Grill Buffet restaurant; yet on the income statement, you will notice
just a one-line entry of our portion of profits or losses. Unlike businesses in which we
own the majority of shares, the revenues and expenses are not itemized on Western’s
consolidated income statement since we do not own the stipulated 50% plus of Wood
Grill Buffet.
Then we possess holdings in which our ownership is under 20%. GAAP
prescribes that Western cannot enter the earnings of such investees on its income
statement, and that only dividends received should be listed on it. In past years, such
investments did not affect Western’s income statement (unless shares were sold).
However, last year we decided to transfer most of our marketable securities to an
investment partnership, Western Acquisitions, L.P., in which we have limited partners
investing alongside us. Because of the limited partners, the partnership is deemed an
investment company, and accounting rules further stipulate that fluctuations of the
market price of our holdings are applied to earnings every quarter. Thus, the actual
earnings of our investees are not incorporated in our income statement; rather, the
market value changes, either up or down, are identified as part of our “earnings.” And,
to complicate matters even more, stocks that we hold outside the partnership are treated
differently; here, changes in market value affect our net worth but do not appear on the
income statement unless the shares are sold.
We have provided the abridged outline of accounting rules because Western
owns portions of businesses ranging from less than 1% of the voting stock to 100%. This
view is particularly important to positions in which ownership is less than 20% because
1 Intrinsic value is computed by taking all future cash flows into and out of a business
and then discounting the resultant number at an appropriate interest rate.
investees’ earnings are not recorded in our operating earnings, even though the unstated
amount may exceed listed figures. Consequently, our approach to GAAP earnings is
simple: We ignore them. Phil Cooley, Vice Chairman and my partner, and I make our
own assessment of the value of Western by accounting for all cash flows, whether we
own 1% or 100% of another concern, to arrive at Western’s “economic earnings.” It is
our ownership of our holdings and therefore our claim on cash flows that are relevant.
Accordingly, we account for the cash flows of businesses we own in whole and in part to
compute Western’s total cash flows. Our claim on the unaccounted cash flows from noncontrolled
businesses and their subsequent use is of great import to us. The growth of the
aggregate cash flows of the businesses we own — both controlled and non-controlled —
will signify the growth in Western’s intrinsic value. Our view, we warn you, is
unconventional. Then, again, our mindset is geared to pay attention to what counts and
not to how the numbers are counted under GAAP.
While we do not disclose our estimated values of the businesses we own in whole
or in part, we do provide the information you require so that you can construct your
own appraisals. We arrive at our personal valuations independent of the accounting
values for wholly-owned businesses or for the values the market places on our partiallyowned
ones. Stock market values at times are capricious, and we caution anyone about
equating them with intrinsic values.
We operate under a highly decentralized management structure with financial
decisions centralized only at the holding company. The returns on invested capital from
the operating businesses combined with my capital allocation work produces Western’s
overall return which, according to our criterion, must exceed the S&P 500 Index. Over
time, we are focused on seeking a rate of growth in Western’s business value that
surpasses the total return measured by the S&P. I am confident that the operating
businesses we own will deliver good-to-great returns on capital; my responsibility is to
reinvest the surplus cash in a manner that improves overall corporate results.
Western Sizzlin Franchise Corp.
Our largest wholly-owned subsidiary, WSFC, which franchises and operates 117
restaurants, is our main source of operating earnings.
Years Ended December 31,
2007 2006
Income from restaurant and franchise operations ...................................... $ 507,773 $ 572,210
Plus: Depreciation and amortization expense ........................................... 1,063,017 1,057,492
Plus: Claims settlement and legal fees associated with lawsuit ................ 741,287 289,109
Income from restaurant and franchise operations (excluding depreciation
and amortization expense and expenses associated with the lawsuit) ........ $ 2,312,077
$ 1,918,811
In 2007, our restaurant and franchise operations did well as profits increased by
20%. The major contribution to this heightened performance stemmed from our 50%
joint venture in Wood Grill Buffet. However, same-store sales decreased by
approximately 1% for both franchise and company-operated restaurants. While we seek
improvement in comparable sales, our approach is not simply to escalate sales at any cost
but to do so profitably. We want to attain increases in same-store sales through boosts in
guest traffic rather than by inflating menu prices. Thus, our focus is on understanding
customer value — by providing enticing offerings that will engender a lasting and
profitable relationship.
In 2006 and 2007 we cut unnecessary expenditures without curtailing the
services we provide our franchisees. For example, we moved offices from a venue in
which a number of offices were vacant to one that is more appropriate to our needs and,
best of all, will save us annually around $74,000 in rent. Moreover, we have trimmed a
number of like expenses to become more productive. Yet while we continue to fight
costs to save wisely, we have concurrently pursued investments in our core business to
expand franchised openings. Although these expenditures increase our operating costs,
in our mind, they are a form of investment that should supplement our long-term cash
flows. As a corollary, we must ensure the health of the existing franchise system.
Total capital expenditures for company-operated stores were $35,493 in 2007,
and in 2008 we expect them to approximate $50,000. We view these outlays as expenses
to maintain operations even though they do not appear on the income statement.
As I wrote in previous letters, lawsuits have plagued our company. In the 2005
letter I had deemed certain legal costs a one-time expense, but in last year’s letter I wrote,
“I was wrong. Shortly after the [2005] letter we were slapped with another lawsuit.” This
litigation has cost us nearly a painful $1 million. As an investor, when I see the term
“one-time” expense repeat every few years, I no longer designate it as “one-time,” but as
“habitual.” In our case, the recent significant legal liabilities stemmed from past years
when WSFC’s former management made the unsound decision to lease properties under
unfavorable terms. Because of the failures to recognize and remedy past problems, I
have made the decision to become more involved and to that end have assembled the
appropriate legal counsel. As for future exposure to litigation, we now have only one
more sublet arrangement (expiring later in the year), and we are assiduously working
through any issues to avoid future liabilities. Consequently, by the end of the year we no
longer will need to report the expense line “subleased restaurant property expenses.”
In my view, we are displaying signs of progress. We are pleased that in December
2007 a new franchisee started an updated yet still traditional Western Sizzlin concept with
a smaller footprint. This Parkersburg, West Virginia store is expected to generate sales of
approximately $3 million in its first year of operation. The unit economics are very
attractive with a sales-to-investment ratio of 1.5:1. In addition, a newly recruited
franchisee in California later in the year will introduce the first Wood Grill Buffet there.
Whether the store is a Wood Grill Buffet or a Western Sizzlin, we are happy with the unit
economics for a franchisee. Because we have proven concepts, our key task is to
encourage potential operators to learn that these outlets are accessible and lucrative. (Call
Jerry Plunkett at 540-345-3195 if you’re interested in becoming a restaurateur
representing our brands.)
We entered into a joint venture in 2005 to build a single Wood Grill Buffet
restaurant of 12,600 square feet, seating 400, located in Harrisonburg, Virginia. This
venture has been exceptional mainly because of our partner in the project, W.E. Proffitt,
who because he knows how to run a buffet concept to perfection, lives up to his name by
producing exceptional profits. W.E. has day-to-day operating responsibility for the
business. The decision to team up with W.E. was easy, given his success at his other
restaurant located in Charlottesville, Virginia, which is also generating around $5 million
in revenue.
Below is the result for the Wood Grill joint venture for 2007:
Year Ended
December 31, 2007
Statement of Operations Data:
Total revenues ............................................................................. $ 4,960,695
Food............................................................................................ 2,110,602
Labor........................................................................................... 1,502,077
Marketing.................................................................................... 204,374
General and administrative .......................................................... 404,106
Depreciation and amortization ..................................................... 200,869
Interest ........................................................................................ 223,574
Earnings (loss)............................................................................. $ 315,031
In partnering with W.E., we formed a jointly-owned entity that borrowed $3.3
million with each partner contributing $300,000 in capital for a total investment of $3.9
million, which includes land and building. Western also guaranteed 50% of the bank
loan. Last year, earnings before interest, depreciation, and amortization but after capital
expenditures were $726,479. The return on invested capital was 18.6% with a free cash
flow2 return on equity capital of 83.8%.
Needless to say, we like the unit economics of Wood Grill, and as evidenced by
our experience, we think it can make an effective operator a healthy stream of income.
It’s a concept based on the sound premise of delivering great values to consumers, whose
patronage in turn delivers great returns to the owners.
Mustang Capital
We are in the process of purchasing 51% of Mustang Capital for $1,173,000.
John Linnartz is the founder and managing partner of Mustang, an investment
management firm with approximately $55 million in client assets. (For sharp-eyed
readers, we are technically purchasing a 50.5% limited partnership interest in Mustang
Capital Advisors and a 51% membership interest in Mustang Capital Management, which
owns a 1% interest in Mustang Capital Advisors as its general partner.) Western plans to
pay a total purchase price of $300,000 in cash and $873,000 of Western’s common
stock, priced at $16 per share.
I met John a few years ago at a Christmas party held by an accounting firm
servicing our respective investment companies. As two value investors, John and I
naturally gravitated to a corner to discuss pink sheet stocks. His knowledge is impressive;
as a sample, I gave him a few facts about a certain stock, and he identified the company
simply through my sketchy data.
2 Free cash flow represents earnings plus depreciation and amortization minus capital
The next time I saw John was last year in New York at Western’s annual meeting,
as he then was one of our largest shareholders. Several months later he asked for a
meeting and broached the idea of Western’s purchasing his business, a proposition I
immediately embraced. To John, price was not the primary factor; rather, he wanted a
good home for his business and also wished to continue running it. His investment
record, founded on a very stable client base, is phenomenal. He will continue to operate
his business as before.
We believe that other money managers like John would find Western an ideal
solution to monetize a portion of their business, establish a succession plan, and be part
of a public company without being saddled with all the drawbacks: e.g., meeting with
analysts, regulatory filings, press interviews, and so on. Furthermore, they could
continue to run their business as they had before we purchased them. Phil and I are
excited about the prospects of working with John, and we expect that Western
stockholders will be equally excited about the value added from this acquisition. If you
plan to attend the annual meeting, be sure to say hello to him.
(Mustang, through its funds and its managed accounts, held approximately 7.2%
of Western's common stock. However, at the closing of the transaction, Mustang’s funds
will distribute Western’s stock to their limited partners.)
Friendly Ice Cream Corp.
In my letter to you last year, I wrote concerning our plans for one of our then
largest equity positions, Friendly Ice Cream Corp. Shortly after writing you on June 8,
2007, a week later, the company agreed to be purchased by Sun Capital Partners, a
private equity firm, amounting to $15.50 per share or $337 million (which included the
assumption of debt). Because of Massachusetts law, which requires the affirmative vote
of the holders of not less than two-thirds of the outstanding stock to approve such a
transaction, Sun indicated privately to us that unless we contractually agreed to the offer,
it would not buy Friendly. Because the price reflected full value and it was the right
decision for all shareholders, we concurred with the transaction.
Friendly was a fascinating situation for Phil and me. It epitomized our love for
great businessmen like Friendly’s co-founder, S. Prestley Blake. Moreover, we were not
the only ones who thought Friendly’s situation was thought-provoking. Harvard
Business School made our proxy fight and Prestley’s lawsuit with Friendly’s top
leadership the subject of a case study. Professors V.G. Narayanan and Fabrizio Ferri
along with Senior Researcher James Weber wrote an extraordinary study, adhering to the
facts with admirable accuracy. You may order a copy of the case by visiting I will refrain from recounting much of
what you can read in the case.
We started purchasing the stock for Western in July 2007, accumulating 531,318
shares by the end of 2007 at an average price of $8.54. This purchase price in relation to
the buyout amount was approximately 82%.
The Steak n Shake Company
Around the time Friendly announced its intentions to sell, we began investing in
another restaurant chain that like Friendly boasted an iconic brand but had also fallen on
hard times: Steak n Shake.
The company was started in 1934 by A. H. “Gus” Belt. In the years since its
founder passed away in 1954, the ownership has changed hands three times. Luckily for
the business, in 1981 E.W. “Ed” Kelley sealed the contract to purchase the company and
began to grow it. Over the next two decades under Kelley, the chain snowballed into a
great restaurant company. Unfortunately, Kelley’s decline in health in 1998 reduced his
role in the firm, and the health of the company began to deteriorate. For the next ten
years, the company increased its top line but failed to create shareholder value for the
capital that it retained in the business.
Observing that the firm’s predicament had culminated in lowering its stock price,
I allotted capital from Western to purchase shares amounting to 5.4% of Steak n Shake.
The ownership reported in our public filings, however, is 13.2% because of The Lion
Fund, L.P. and other shareholders who are acting in concert with Western. Consequently,
our group represents the largest stock ownership in the company. Members of the group
consist of a couple of Ed Kelley’s former business partners, one of whom includes the
former Vice Chair of the company, S. Sue Aramian, Mr. Kelley’s right hand person.
On August 13, 2007, Phil and I traveled to the company’s headquarters in
Indianapolis, scheduled to visit with Peter Dunn, then CEO, and Jeff Blade, CFO. Thirty
minutes before our meeting, we read on the wire that Mr. Dunn had resigned. Alan
Gilman, at the time chairman of the board, was appointed interim CEO. Consequently,
we met only with Messrs. Gilman and Blade, and by the end of the meeting we asked for
two board seats to help restore and unlock the value inherent within the company. After
several months during which the desired results were not forthcoming, we initiated a
proxy contest. In addition to mailing letters to shareholders, we set up the website to communicate with all stakeholders.
Of course, a proxy fight is only a prelude to improving the performance of a
company. The proxy contest accomplishes a change in the boardroom, which alters the
dynamics of the leadership in a company. To us it was the last resort, but one that we felt
forced to take; Steak n Shake’s former leadership had lost sight of its purpose.
In proxy contests, several proxy advisory firms are in business to advise
institutional investors on how to vote. Phil and I received the backing of all major
advisory firms: Institutional Shareholder Services, Glass Lewis & Co., Proxy
Governance, Inc., and Egan-Jones Proxy Services. The net effect at the annual meeting
on March 7, 2008 was that these recommendations along with the support of
shareholders eventuated in our winning two board seats in a landside with 74% of the
votes cast in our favor.
Steak n Shake’s intrinsic value per share has been declining. While the economy
provides a difficult environment for restaurants, the company’s performance is
unacceptable. What attracted us to Steak n Shake was the power of the brand, its real
estate, and the chain’s ability to generate substantial cash inflows. Even though Steak n
Shake has experienced larger operating shortfalls than I anticipated when I began
purchasing the stock, its problems Phil and I believe are fixable. Thus, we believe in the
company’s long-term prospects.
The former management’s revenue strategy in the new millennium — to grow
top line without achieving the proper return on invested capital — was fallacious. Theirs
was a case of opening stores without the proper management systems and operational
capabilities in place to execute effectively, a mistake culminating in low returns on
invested capital. Nevertheless, we think that the situation can be remedied if the
principles, objectives, and alterations we have in mind are implemented.
The primary objective of Steak n Shake’s board and management must center on
intelligent ways to maximize the intrinsic business value of the company on a per share
basis. This long-term view will keep leadership disciplined to create value on an
enduring basis. Otherwise, it is easy to become myopic — with detrimental results. It is a
requisite to begin to implement certain strategic initiatives to create substantial and
sustainable shareholder value. The reasons underlying these imperatives are that the
record clearly shows, in quantifiable terms, that during the last ten years approximately
$566 million in capital has been spent, yet operating profit declined and negative
shareholder returns were produced!
Steak n Shake has exemplified the antithesis of a value-based strategy, proving
that sales growth is not tantamount to value growth. Growth at a competitive
disadvantage — when cost of capital exceeds return on capital — destroys shareholder
wealth. The decision to plow money back into low-return investments has resulted in the
detrimental effect of lowering the price of the stock. A larger company has been created
with more company-operated restaurants, but shareholders have been denied the
opportunity to reinvest their capital elsewhere in more remunerative opportunities. In our
proxy contest, we advocated that a moratorium be placed on new store openings.
We continue to espouse the notion that the company focus on the generation of
free cash flow and the judicious reinvestment of capital, a policy intended to maximize
the value per share of the company. It can no longer allocate capital without considering
opportunity cost. If intrinsic value per share increases, the stock price will eventually
follow suit.
In pursuit of optimizing free cash flow, the uppermost levels of leadership must
constantly review projects and eliminate the unnecessary ones to curtail nonessential
spending. Equally important is to take the savings from excess spending and reinvest
Steak n Shake’s Capital Allocation Record
($ in thousands)
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 10 Yr.
Revenues $295,944 $350,879 $408,686 $445,191 $459,014 $499,104 $553,692 $606,912 $638,822 $654,142 $358,198
Growth per Yr. – 18.6% 16.5% 8.9% 3.1% 8.7% 10.9% 9.6% 5.3% 2.4% –
Pre-tax Profit $ 32,850 $ 30,602 $ 33,204 $ 32,366 $ 36,044 $ 32,424 $ 42,438 $ 44,444 $ 42,292 $ 14,871 ($17,979)
Growth per Yr. – (6.8%) 8.5% (2.5%) 11.4% (10.0%) 30.9% 4.7% (4.8%) (64.8%) –
% of Revenues 11.1% 8.7% 8.1% 7.3% 7.9% 6.5% 7.7% 7.3% 6.6% 2.3% (8.8%)
$ 51,430
$ 66,974
$ 75,765
$ 39,910
$ 41,351
$ 30,707
$ 46,278
$ 63,622
$ 80,840
$ 68,643
Cumulative Capital Expenditures (10 Year Period): $565,520
Source: As Reported in SEC filings
those funds prudently. Complying with the maxim to save wisely and invest sensibly is
imperative to turn Steak n Shake around. But turnarounds cannot turn without
management’s reducing unnecessary overhead. General and administrative (“G&A”)
spending must be limited to appropriate levels. The reduction in G&A should become
part of the corporate culture at Steak n Shake to conserve resources and to distribute
them productively.
Towards that end, just returning to past G&A levels — on a per unit basis —
would save the company around $15 million annually. Bottom line: Steak n Shake like
WSFC is in the penny-profit business. We continue to believe that a great deal of money
has yet to be saved at Steak n Shake’s headquarters and at the store level.
In altering the corporate culture, we must select an entrepreneurial CEO who will
be relentless in fighting costs, who will concentrate on the customer by leading
employees and franchisees to champion a common standard of quality, service, and
cleanliness. The culture of the organization should revolve around capitalizing on the
mental prowess of entrepreneurs. With the right leadership team, the company can
become more nimble and inventive as it adheres to principles and practices placing a
premium on individual performance.
The CEO must be a vigorous leader willing to instigate grassroots searches to
improve operations. Steak n Shake must adapt to the very sharpest ideas and practices
pervasive in the marketplace. Borrowing or emulating the most effective industry
methods is essential to molding a profitable restaurant chain. As Wal-Mart founder Sam
Walton once said, “Most everything I’ve done I’ve copied from someone else.” At Steak
n Shake, we can learn a great deal from other highly resourceful retail and restaurant
We want Steak n Shake to be best-in-class in product, in menu, in customer
metrics, and in financial returns. Every day, roughly a quarter of a million people go
through Steak n Shake restaurants; the quality of their overall experience will ultimately
determine whether they will increase or decrease their number of visits. The pleased
guests will certainly spread the good word that their listeners ought to visit frequently,
whereas the displeased guests can hugely damage future traffic. An organization that is a
standout for its employees, franchisees, and customers will ultimately be a standout for
Current plans must focus on turning around operations with unit economics that
are attractive for the company and its franchisees. Over the longer term the company
should strategically zero in on growth through franchising. Franchising represents a
strategy of disciplined unit growth by leveraging the brand with market penetration in a
manner that begets low-risk revenue and high-return cash flows. Such a long-range plan
would yield numerous benefits: It would allow management to concentrate on propelling
the value of the brand by allotting more resources to development of better products,
improved quality control, shrewder marketing practices — all resulting in better overall
productivity, resource allocation, high returns on capital, and significant free cash flow.
Thus, the company should be in the franchising and real estate businesses for the cogent
reason of maximizing return on capital while concurrently minimizing cost of capital —
a powerful combination that would lead to creating value for all shareholders.
Improvement of store-level profitability, growth through franchising, reduction
of corporate G&A, focus on generation of free cash flow, share repurchases, pay-forperformance
compensation, a more effective governance board — these are strategies we
have in mind to enhance the value of the company. Western’s 5.4% equity interest in
Steak n Shake represents about $33 million of revenue, larger than WSFC’s entire
restaurant and franchise operations. Consequently, we are working with the board so we
can become more involved with the company, effect necessary changes, and invite in the
right CEO.
Thus far, the investment result has been dismal. But we think that it will improve.
ITEX Corp.
ITEX is in the business of barter, functioning as the clearinghouse for
approximately 24,000 member clients through a franchise network. Barter is the oldest
form of commerce, so we are going back a few thousand years with this concept. Instead
of businesses bartering directly with each other, ITEX provides a marketplace for its
member clients to purchase goods and services from one another utilizing trade credits,
which are administered through ITEX’s bookkeeping system. Thus, ITEX manages the
marketplace and acts as a third-party record-keeper, charging its members a percentagebased
transaction fee as well as an association fee.
By now you may wonder why one would use ITEX when ages ago a convenient
medium of exchange had been invented, money. ITEX has in essence an alternative
monetary system using its own unique currency. ITEX’s exchange, or bartering, can be
another source of revenue for most businesses, particularly those with excess inventory
or capacity. Instead of unused products lying fallow and services remaining
unproductive, bartering opens the door for firms in like situations to work with one
another. Thus, it’s an effective way to enter new markets or reach clients who otherwise
may not have paid cash. I myself have been using barter services since I was 13 years
old. ITEX helped me launch my early ventures. In fact, years ago I paid for office rent
and obtained office furniture all through the barter exchange. At our operations in
WSFC, we have been utilizing the bartering program since early 2007.
ITEX’s business is attractive to us because, as a franchise system like WSFC, it
generates stable cash flows and pleasing returns on capital. Initially, we sought to
purchase the entire business, making an unsolicited tender offer at an exchange ratio of
.06623 shares of Western common stock for each outstanding share of ITEX’s common
stock. While we believe the value of ITEX would be enhanced as a wholly-owned
subsidiary of Western, for reasons such as elimination of redundant public company
costs and potential revenue sources, ITEX management vehemently opposed the
transaction. Nonetheless, we proceeded, and we thought we probably would have
succeeded if we upped our offer, a move which we vehemently opposed (for reasons we
explain in the next section). But the shareholders who did wish to tender their stock were
given the opportunity to do so as we revised the offer and in the process increased our
ownership by 5% of the company. We had previously purchased 4% in the open market
with cash. Therefore, we currently own approximately 9% of the company and are its
largest outside shareholder, a position that leaves us quite comfortable.
Stock Issuance
Because our goal is to maximize the value per share of Western, we are
concerned both with the numerator, intrinsic business value, as well as the denominator,
the number of shares. When considering a share issuance in purchasing a business, we
follow a basic policy: We will issue shares only when we receive as much or more
intrinsic value on a per share basis. What concerns us is not whether an acquisition is
accretive to earnings per share but whether it adds to intrinsic value per share.
In negotiated acquisitions, the price paid often is so high that any potential
benefit to the buyer is negated. In our analysis we have found that acquisitions
predicated on cost savings usually have a more successful outcome than do ones based
on revenue generation. Unfortunately, synergy often has been used as a pleasant word in
mergers and acquisitions to justify a premium when in fact synergy did not exist. A
significant premium, incidentally, is not necessarily a concern if it can be defended. We
do not look for acquisitions on the basis of synergy; rather, we seek to capture the value
of non-integration. Non-integration has value, and as a holding company we plan to
capture that value in allowing acquirees to retain their autonomy. The cost is lack of
synergy, which we believe is overrated, whereas non-integration is underrated.
Acquisition Goals
We will continue to seek ownership in businesses in their entirety as well as in
part. When purchasing a controlling interest, we will do so only at a sensible price. While
we remain flexible in structure, our basic criteria for a business acquisition are that the
acquiree comes with intelligent management who has historically produced healthy cash
flows and earned high returns on invested capital. Therefore, we are not interested in
somewhat chancy new ventures, as promising as they may appear to be.
If the principals in a business are interested in becoming a part of Western
companies, we would welcome hearing from them.
Western Real Estate
Western purchased 23.5 acres of land in San Antonio through Western Real
Estate, L.P. on December 13, 2007 for $3.75 million. The property is near an 800-acre
mixed-use development, The Rim, in one of the most robust and fastest growing areas of
the city. We knew that all 23.5 acres were not usable, but after the due diligence we
received reliable data and was in a position to offer a price and close on the transaction
expeditiously. The price was favorable in relation to the property’s potential usability.
We received attractive financing from our friends at Wachovia Bank. They have
provided a $2.6 million note at prime minus 50 basis points, which at the date of this
letter stood at 4.5%. We are delighted with the after-tax carrying cost of around 2.8%.
Thus far, we have not accepted outside money for Western Real Estate, L.P. although
certain parties remain interested.
The entitlement process began as soon as we purchased the property; of course,
this process will increase our costs but eventually should lead to sufficient cash flows
when compared to our total investment. There is value in converting non-income
producing real estate to one that is producing. With many of our investments, but
particularly with real estate development, it pays to follow Benjamin Franklin’s advice:
“He that can have patience can have what he will.”
NASDAQ Listing
Earlier this year, on February 25, 2008, Western’s shares were listed on the
NASDAQ Capital Markets and now trade under the symbol WEST. Our decision to list
on NASDAQ was driven by our desire to reduce the transaction costs for our
Over the long haul, the most investors can earn from a stock is equal to the
profits achieved by the business less transaction costs, namely the commissions charged
by brokerage firms and the net spreads realized by market-makers. We attempt to attract
long-term shareholders who seek to profit in concert with the business and not from the
faulty reasoning of their co-shareholders on the value of the company. Irrespective of
the exchange on which the stock is listed, we have connected with the right shareholder
base. Phil and I have been pleased by the quality of our shareholders — savvy long-term
business owners. Because we view Western as a medium through which shareholders, not
the company, own the assets and claim the profits, we are ultimately concerned about the
pre-tax return of our shareholders.
The legal and listing fees in connection with our presence on NASDAQ were
approximately $90,000 and expensed in the first quarter, 2008. We expect that this
amount is far less than the long term savings on our shareholders’ transactions. Clearly,
we are not income statement driven, but rather we are concerned with the long-term
economic consequences of our decisions for our shareholders.
Board of Directors
In 2007 we added two new board members: Kenneth R. Cooper and Martin S.
Fridson. Ken, a real estate attorney who has been a trusted friend, is also able to proffer
valuable assistance with Western’s real estate transactions. Marty is the master when it
comes to the junk bond market. Marty and Phil knew each other over the years, at one
point serving simultaneously on a non-profit board. I first learned of Marty when I was
an undergraduate student in Phil’s investment class because Phil required his entire class
to read Fridson’s book Financial Statement Analysis. Last fall, Phil and I visited with
Marty about his joining Western’s board, and shortly thereafter he enthusiastically
agreed. While I enjoy all of Marty’s writings, I recommend your reading his latest,
Unwarranted Intrusions: The Case Against Government Intervention in the Marketplace,
one of my favorite volumes from 2007.
Rights Offering Redux
Last year I offered an explanation of the use of a rights offering, which you can
read by accessing the letter on our website.
In 2007, as in 2006, we initiated a rights offering. We raised $7.6 million in 2007
and $4.2 million in 2006. In both years Western did not hire an investment banker to
assist with the rights offering. As I mentioned in last year’s letter, flotation costs (namely
issuing expenses, e.g., legal, printing, accounting, and numerous smaller associated
outlays) would be quite low in 2007. Actually, expenses were remarkably low at 1.3% of
issuance, resulting in net proceeds of $7.5 million.
Phil and I are puzzled why more companies do not initiate rights offerings
because it is an excellent method to raise equity capital and minimize costs. (No
investment banker fees perhaps!) When boards and management review their alternatives
in equity financing, they invariably opt to sell discounted shares to outside parties along
with paying high underwriting fees — the effects of both are to the detriment of their
shareholders’ net worth. Not only are flotation costs much lower in rights offerings than
they are in most other forms of equity offerings, but they are a quite equitable method
and provide all shareholders equal terms.
* * *
As the former CEO of Coca-Cola, Roberto Goizueta once articulated, “We, in
business, do have a calling. We have a calling to reward the confidence of those who
have hired us — and to build something lasting and good in the process.” This is our
guide as we attempt to grow Western’s value in many dimensions. We seek to utilize all
available options to create value. We have a strong balance sheet and plan to conduct our
affairs in a manner to maintain extreme flexibility. We are willing to trade near term
performance to maximize long-term value and in the process strengthen Western.
However, we should warn you that our methods will produce erratic results but ones we
believe will be above par in the long haul. If volatility in operating performance
unnerves you, then Western’s stock is not for you.
Annual Meeting
Our annual meeting will be on Wednesday, July 9, 2008, in New York City at the
St. Regis Hotel. Annual meetings represent ideal times to communicate with a number of
shareholders simultaneously. The bulk of the meeting will center on answering your
questions. We will begin at 1:30 pm and continue until all your questions are answered.
To be fair to all shareholders as well as to be efficient with our time, the annual
forum is a surrogate for one-on-one communication. While we cannot respond to
individual inquiries throughout the year, we will gladly spend as many hours as
necessary to answer shareholder questions at the annual meeting.
We have attempted to set forth our principles in this as well as in past letters and
hold annual meetings that are informative. I find our annual letters and annual meetings
to be practicable media to attract like-minded shareholders who embrace the
multidirectional nature of Western’s future. Because the management of most companies
is consumed by quarterly computations and pursue targeted, preconceived results, they
attract shareholders with similar time horizons and expectations. We, on the other hand,
think in terms of decades. Of course, quarterly and annual performances are important to
us but not at the expense of generating higher long-term value. Our approach may be
unconventional, but we find it to be more productive and sensible than conventional
We look forward to welcoming you on July 9th.
Sardar Biglari
June 10, 2008 Chairman of the Board

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