On Monday, Western Sizzlin (WSZL) announced the final results of its rights offering. As was discussed in my post announcing that I was buying Western Sizzlin for the Fat Pitch Financials Portfolio, Sardar Biglari issued 898,875 new shares of WSZL through a rights offering that started on October 17 and ended November 16, 2007. The rights allowed holders to purchase Western Sizzlin stock for $8.50 per share. This financing event makes valuing Western Sizzlin a bit more complicated, but I’ll step you through how I adjusted for it.
The first thing I did was to look up the latest 10-Q filing for Western Sizzlin. Right at the bottom of the cover page of this third quarter filing I found the number of shares, 1,797,750, as of November 14, 2007. I then added 898,875 shares to the original 1,797,750 shares to get the current number of shares, 2,696,625.
Next, I headed to the statement of cash flows to find the net cash from operating activities. For the last nine months in the 2007 fiscal year, the restaurants and franchises generated $1,954,783 in cash. However, to value Western Sizzlin, I really want the latest 12 months of operating cash flows. What I needed is to get the fourth quarter operating cash flow from 2006. This is pretty easy to do by going to the third quarter 2006 statement of cash flows, which reports on 9 months of cash flows from operations ($1,390,612), and then subtract that from the full year’s operating cash flow ($1,780,673), which is reported on the 2006 10-K. I added the fourth quarter operating cash flow back to the 9 month 2007 operating cash flow. That gave me $2,344,844 in operating cash flows for the past trailing 12 months.
Now that we have the trailing 12 months of operating cash flows, we need to subtract out capital expenditures to get free cash flows. Capital expenditures were only $33,420 for the past 9 months in 2007. However, in 2006 capital expenditures were a whopping $492,107. That got me a little nervous, because value investors have a reputation for skimping on capital expenditures. You don’t want to have poorly maintained restaurants because they will often rapidly go down hill. Reading the 2006 10-K, I discovered that $425,000 was for the remodeling of two company-operated restaurants in 2006. Western Sizzlin actually only has five total company-operated restaurants. Calculating the trailing 12 month capital expenditures, I got $45,635. I’m going to assume $45,635 is sufficient for annual maintenance capital expenditures even if this number is a little low, because Mr. Biglari has stated he is interested in reducing the number of company-owned restaurants in the future.
Taking the $2,344,844 in operating cash flow and subtracting $45,635 in capital expenditure from the trailing 12 months, I got $2,299,209 in free cash flow from Western Sizzlin Corporations restaurant business. I’m conservatively estimating that Mr. Biglari will be able to compound free cash flows at around 5% per year for the restaurant and franchise businesses. In fact, operating cash flows actually increased 43% from 2006 to 2007. However, I don’t believe the restaurant franchise has a sustainable competitive advantage so I am not comfortable using a high growth rate for the restaurant and franchise portion of the Western Sizzlin Corporation. Using the Gordon Growth model and a discount rate of 10%, I estimated that future value of the free cash flows from these businesses are worth $45,984,180 ($2,299,209/(0.10-0.05)). If you take that value and divide it by the current number of shares, you get an intrinsic value per share of $17.05 for the restaurant and franchise businesses of Western Sizzlin.
However, Western Sizzlin Corporations is becoming much more than just a restaurant franchise. Value investor Sardar Biglari is transforming the company into an efficient capital allocation machine with the ability to actively effect changes in companies that Mr. Biglari chooses to invest in.
From the third quarter balance sheet, you can see that Western Sizzlin had a net $14,296 in cash after adjusting for long term debt on September 30, 2007. It then received another $7,640,438 in cash from the recent rights offering. More interestingly, the company had $9,149,740 in investments in marketable securities. There was also $3,124,831 in money market investments that will likely become stock investments when good opportunities are discovered by Mr. Biglari. My guess is that almost all of the investments and cash ($19,929,305) will be devoted to investments very soon.
In my valuation model, I estimate that the $19,929,305 in potential investments will earn a 15% rate of return over the next ten years as a result of Mr. Biglari investments. My estimate is that these investments will grow to over $80.6 million at the end of ten years. The present value of this amount is $31 million using a 10% discount rate. This adds another $11.52 to the intrinsic value of Western Sizzlin shares, giving me a total of $28.58 per share for both the restaurant franchise and capital allocation business. Rounding this imprecise estimate to $28 per share, I currently think Western Sizzlin provides a 45% margin of safety assuming some of my growth estimates are sufficiently conservative. I don’t believe this margin of safety will last for long especially if the company is successful in getting its stock listed on the Nasdaq.
I’ll probably have to revisit my intrinsic value estimate for Western Sizzlin soon. The company released a press release today announcing that it will commence an exchange offer for all outstanding shares of ITEX Corporation (ITEX). A quick look at ITEX shows it is a marketplace for cashless business transactions with a P/E of 3.6, P/B of 1.2, and an ROE of 35%. Those numbers look great and I’m kind of wishing I found this little company myself. I thought that Steak n Shake (SNS) was the only investment in the works, but it looks like Sardar Biglari is willing to take on more than one opportunity at a time. I look forward to seeing how both of these investments work out.
Disclosure: I own shares of Western Sizzlin. I do not own shares of ITEX or Steak n Shake. Note that WSZL trades on the OTC Bulletin Board and due to its low liquidity may pose additional risks.