Why would anyone invest in SNS? There may be a catalyst. There is a proxy fight to gain two board seats by tenacious value investor Sardar Biglari. A sale of Friendly Ice Cream was announced about 9 months after he disclosed his initial 13D filing in 2006 for about twice his average cost.
SNS has deminimus debt ~$20 million. It does have about $145 million in capital lease obligations. Only management knows the exact terms, but I think the franchisees would be on the hook for those (assuming refranchising). For example, Friendly Ice Cream had cross-default provisions on their leases so the franchisee would be responsible for default. Also, even if the franchisee couldn't pay the lease, they are still worth something since they could be subleased. I'm not subtracting for the capital leases and the debt is only about .60 cents a share.
SNS owns about 155 of its properties. In 2001, it averaged about $1.1 million for 14 sale/leaseback transactions. Assuming $1.1 million x 155 properties equals $170 million or about $5.97 a share. Or, if the company doesn't believe it can obtain a fair price and/or is sensitive to taxes, it can rent the properties to franchisees. In addition to selling the real estate at its company-owned stores, SNS could sell the stores themselves to franchisees to generate even more cash – this move is an important objective of Biglari. One goal (of many) of Biglari’s is for the company to refranchise its company-operated restaurants. Applebee’s and Denny’s received about $900k-$1 million per refranchised unit. Also, SNS paid $1-1.1 million to repurchase restaurants from franchisees in 2006. SNS operates 435 restaurants, so if each restaurant is worth $950k, that is another $413 million ($14.50 a share) .
For 2006, SNS had 48 franchised restaurants and earned $3.88 million, or $80,854 per franchised-unit. SNS plans to open 9 company restaurants and 6 franchised restaurants in 2008. It will probably take 2-3 years to refranchise all 435 restaurants. Assuming franchise units grow 15 per year, that is a total of 536 franchised-units at the end of 2010. 536 units @ $81,000 is about $43 million in revenues. A pure franchise model should yield at least 15% operating margins. Operating income should approximate $6.5 million. A pre-tax multiple of 12 (reasonable for a business with relatively high operating margins and very little in capex) gives us $78 million or $2.73 a share.
Putting it all together, SNS’s earnings are worth $78 million in three years, discounted at 10% equals $59 million or $2.06 present value per share for the pure-franchise model. In addition, a sale/leaseback plan for the real estate would generate $5.97 a share for the 155 properties it owns. Finally, refranchising 435 units might generate $413 million, or $14.50 per share. Since this operation would take time, I use a 10% discount rate and a three year time frame. I derive a present value of refranchising of $327 million, or $10.90 per share.
Thus, intrinsic value is $2.06 future earnings + $5.97 sale/leaseback proceeds + $10.90 refranchising cash for a total intrinsic value of about $19 per share. SNS is currently trading around $11.
Biglari currently owns about 9.6%. This will drop after Friday when his options expire but will still be high 7% or low 8% since he has been adding daily since Nov 15, 2007. This is an abnormal proxy fight. Biglari met with Gilman back in August and Biglari said the talks were "fruitless." Usually management sends out a letter to shareholders proclaiming their vision for the company and criticizes the investor (Biglari in this case) that is trying to get board seats against their wishes.
However, management hasn't even acknowledged a proxy fight through a press release nor the 10k filed in December. They formed a special committee on August 23rd to explore cost savings and potential opportunities among other things. Normally there is a disclosure in the 10k since a proxy fight can be quite costly and the shareholders should be aware of this.
I think one of two scenarios will happen (1) a sale of the company is announced before the annual meeting or (2) Biglari wins his 2 board seats at the annual meeting in February and a large refranchising (among other things) initiative is implemented. Once Biglari's initiatives are put into place, margins will improve and there will be a significant cash infusion (from refranchising)to the company. The stock price will eventually follow.
Phillip Ristau is an investor in Texas, he has a position in Steak N Shake. He can be reached at firstname.lastname@example.org