Compounding Machines

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Western Sizzlin’

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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…

http://www.noisefreeinvesting.com/blog/?p=53

http://www.fatpitchfinancials.com/719/valuing-western-sizzlin/

http://www.circleofcompetenceblog.com/2008/06/dissecting-western-sizzlin-corporation/

http://www.circleofcompetenceblog.com/2008/06/looking-through-western-sizzlin/

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.

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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.

Written by sdinvest

December 23, 2008 at 11:32 pm