Archive for December 2008
I look forward to two things on the first Saturday in May. First, the Berkshire Hathaway annual meeting in Omaha and second, buying the newest version of Andy Kilpatrick’s Warren Buffett biography, Of Permanent Value. I recommend buying this book as there is no more detailed biography available on Buffett. You can buy it on Amazon, or as I plan to, you can have Andy sign a copy at the next Berkshire annual meeting.
One of the most interesting parts of the book for me is an image of the 1962 year end statement for Buffett Partnership, Ltd. The portfolio had a total value of $9,856,297 and about 50 long and 4 short positions. The top 5 positions accounted for 52.7% of the total portfolio value, while the top 10 positions represented 72% of the portfolio.
The reason the year-end statement was published in Kilpatrick’s book is that 1962 was the year Buffett first purchased shares in a New England textile company named Berkshire Hathaway. At the end of 1962 the Partnership owned 30,752 share of Berkshire at $7.56/share. Note: If you’re keeping track at home…those 30,752 shares are worth about $3 billion today, or about a 22.8% compounded return over 46 years.
During the partnership years, Buffett would get his ideas from the Moody’s Manuals which contained a brief summary of basically every business in America. In those days, he was not too concerned with the quality of a business as much as he was looking for statistical bargains. Heavily influenced by the teachings of Benjamin Graham, he was looking for stocks selling below estimated liquation value, or below net working capital. Buffett now refers to this process as looking for “used cigar butts.” They are soggy and repulsive, but they are free and you can usually get one good puff out of it before you move on to the next used cigar butt (the antithesis of looking for compounding machines). Berkshire was a cigar butt in 1962.
I was able to obtain a copy of the 1962 Moody’s Industrial Manual from the library. Out of curiosity I wanted to see just how cheap some of the stocks were that Buffett was buying in the 1950s and 1960s. Below is the Berkshire Hathaway page which shows that at $7.56 per share, it was selling well below its net working capital of $12.35 per share.
What is Western Sizzlin’ (WEST)? At first it looks to be a boring, perhaps dying, buffet restaurant chain. To me, I think it might be a Compounding Machine. I will defer to the following write-ups that do a top-notch job describing the history of the company and its Chairman, Sardar Biglari. A couple of the links also take a stab at putting a value on WEST…
Determining what WEST is worth is rather difficult as there are several moving parts. You have the 6 company-owned, 106 franchised and 1 joint venture restaurant operations which produced about $2.3 million in free cash flow in 2007 after accounting for maintenance capital expenditures (what I will refer to as free cash flow). I think this figure is lower on a normalized basis partly because a $636,000 franchise royalty amortization expense goes away soon. For valuation purposes, I assume restaurant and franchise FCF will be roughly $1.875 million per year (average of 2006 and 2007 FCF minus $636,000 * 37% tax rate).
Next you have WEST’s common stock holdings which include Steak n Shake, ITEX and “Other.” WEST owns about 1.6 million shares of ITEX worth $704,340 at $0.45/share, about 1.3 million shares of Steak n Shake (after deducting minority interest) worth $8,027,774, and Other worth $146,191 (after deducting minority interest) as of the last 10-Q. Adding these up you have a total marketable securities portfolio worth $8.88 million as of December 22, 2008, or about 30% of WEST’s market cap.
Third you have a 23 acre piece of real estate in Bexar County, Texas that was purchased in December 2007. The purchase price was $3,745,152 financed partly by a note now in the books at $2,641,220. For valuation purposes, I assume the real estate is worth what WEST paid for it less what it owes on it, or about $1.1 million. No specific plans have been outlined for this investment. WEST has a director named Kenneth Cooper that specializes in real estate law that could be instrumental in what eventually becomes of this investment. As Jeff Annello of the Circle of Competence blog puts it, this is a “trust Sardar moment for shareholders.”
Finally, you have Mustang Capital Advisors, a hedge fund with about $50 million of assets. WEST owns a 51% interest in the General Partner and thus receives about $255,000 per year in management fees. For valuation purposes, I give no credit for any potential income should Mustang generate a return in excess of 4% per year. WEST is entitled to its pro rata share of 20% of the profits above a 4% return.
Because I want to value WEST with a margin of safety, I do not want to make any assumptions regarding any share price appreciation potential of SNS or ITEX, any appreciation of the Bexar County land value, nor any aggressive assumptions in terms of the free cash flow potential of the restaurant operations. Basically, I want to mark all real estate investments and marketable securities to market and see what free cash flow multiple the market is applying to the operating businesses (restaurant and money management). At $10.35 per share, I believe I am paying conservatively about 9x free cash flow of the operating businesses. Not a screaming bargain, but a fair price to pay in my view given the sagacity Sardar Biglari brings to the company, as well as the admittedly conservative cash flow assumptions.
WEST’s average cost of SNS shares is about $12.32 per share, or about 51% below where the stock trades today. If WEST could somehow get back to breakeven (timing highly uncertain, but probable in my view), WEST’s current stock price implies a 5x multiple on the free cash flow of the operating businesses.
Disclosure: I am long WEST
Disclaimer: This article by no means should be considered investment advice. I am not an expert (you probably figured that out already) and make plenty of mistakes. Please do your own research before buying any stock.
A Compounding Machine is a term I am borrowing from money manager Chuck Akre (FBR Focus Fund). He uses the term to describe the type of businesses he likes It is a business that earns an above average rate on owner’s capital (equity), with an owner/manager that has a history of acting in the best interest of all stockholders, and one that has the ability to reinvest excess cash at above average rates of return. These factors combined result in a business that can compound its economic value (and stock price) at an above average rate for a long period of time. It should come as no surprise given this strict criteria, that Akre has held shares of Berkshire Hathaway since the 1970s.
At this stage in my investing career (4 years in) my understanding of businesses/industries is limited. I have a basic understanding, and feel comfortable with, any business that uses a cash register. I am working on expanding my circle of competence. However, I do feel that I have the capacity to read what owner/managers write, listen to what they say, look at their track record, and understand what is important to him or her.
In general I am looking for a company with a Chairman or CEO that owns a significant portion of common stock so that his interests and future success is closely tied with my own, that buys into the investment philosophy pioneered by Benjamin Graham and perfected by Warren Buffett, and that is able to effectively communicate the long-term goals and objectives of the business either through annual letters, conference calls, annual meetings, television interviews, etc. In my view, combining a manager that meets these criteria with a business that produces significant free cash flow can result in a Compounding Machine.