Valuing Western Sizzlin

Western SizzlinOn 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.

18 thoughts on “Valuing Western Sizzlin

  • December 13, 2007 at 4:50 pm

    What about the asset management business?

  • December 13, 2007 at 10:48 pm

    I take it you mean the newly formed Western Investments, limited partnership that operates as a private investment fund. I believe all its assets are consolidated under marketable securities and included in the $19,929,305 in investments I used above.

    The one thing I don’t like is that outside partners to this fund are shielded from the first 30% of losses. I guess that is the advantage that investors in The Lion Fund (and other outside investors) might be potentially getting from this arrangement. I’m dissapointed that Biglari is putting shareholders more at risk in order to “attract” these investors. At least I don’t have to pay management fees as a WSZL shareholder.

  • December 14, 2007 at 9:19 am

    Western investments seems a good deal for WSZL. First there is the annuity stream that WSZL earns from the deal. Also if you read the offer document detail you only get the 30% of loss protection if you agree to a 5 year lock up. The 2 year lock up gives no protection. So 30%/5 years = 6% per year. Subtract from that the annual fees and it is a fairly cheap source of capital even if things go wrong.

  • December 14, 2007 at 3:35 pm

    Hey George,

    Good analysis, I think that the “2-part” analysis is correct for this business, as it is for any company that is investing in its core assets(in this case restaurants) and differently in marketable securities or businesses. It is difficult to come up with a precise estimate for an investment vehicle like WSZL. Your math seems sound, just a quick question: any reason for the 10% discount rate in particular? Curious as to how you chose it.

  • December 14, 2007 at 4:44 pm


    Great analysis. What’s your suggested order execution method for this stock (i.e., did you put in a “good til canceled” at the most recent price, bid, ask — somewhere in between — etc)? I am not asking for advice, of course, but I tried to purchase some shares late today with a limit order and didn’t get filled.

  • December 14, 2007 at 11:28 pm

    Well done. I commend you for taking a crack at an estimate of intrinsic value. Did you consider the additional value created from the reinvestment of cash earned in each period? I calculate this to be a value of $3 per share under your assumptions (which I respectfully feel are too aggressive).
    Keep up the great work you’ve done with this site!!


  • December 15, 2007 at 9:27 am

    Jeff – I used a 10% discount rate since it is my default discount rate. I was thinking of bumping it up to 12% in this case since WSZL trades on the OTC BB and has low liquidity, but given the news they are applying for the Nasdaq I decided to stick to 10%.

    Jon – I suggest you use a limit order for sure and “good til canceled” will probably save you from having to enter an order every day.

    Jason – I did not consider the reinvestment of cash from the operating businesses. Thanks for sharing your estimate of this value with me. Did you also think the 5% growth in FCF from the restaurant franchise business to be too aggressive?

    Thanks for the feedback everyone.

  • December 15, 2007 at 10:12 am

    George, thanks for the reply. If I may follow up: did you place your good-til-canceled limit order at the bid, ask, most recent price or somewhere in between?

    Also, regarding valuation, I due respectfully agree with the poster who said you were a tad aggressive. I don’t know what his reasoning was, but I think you apply to high a multiple to the operating segment’s free cash flow. By starting with a 10% discount rate and subtracting the assumed 5% growth rate, you end up using a 20 multiple. Historically, the S&P’s multiple to trailing earnings is more like 15 (the range is like 14-17) and the historic growth rate, if memory serves me correctly, is ~6%.

    Plus, even though WSZL grew free cash flow recently, some of that was by cutting CAPEX (I don’t think they can really cut much more) and they have been losing franchisees.

    In any event, if we assumed 6% growth, then I think a 15 multiple is fair (and, yes, I realize that I’m ignoring interest rate adjustments); if we assume zero growth, then I think something like an 8 multiple is warranted; assuming growth somewhere in between gives us a range of 8-15. If we could pay 8X or less, it’s a steal; if we pay 15X or more, it starts to get pricey.

    And, as a matter of fact, if we back out the excess cash, than we’re paying a multiple of 11-12 trailing free cash flow. If we assume that’s a fair price, then Biglari’s capital allocation acumen is our “free option.”

    In other words, at the current stock price, our downside protection is the operating business; our upside is capital allocation business.

  • December 15, 2007 at 5:20 pm

    Just wanted to agree with you and say that I think you’ve made an excellent argument. I’ve figured out, by perception really, that your multiple approach there is how Mohnish Pabrai really does DCF analysis, rather than the whole complex spreadsheet approach. I choose simplicity in my analyses, and the “multiple” approach to DCF is very appropriate IMO.

    Good job, and I agree that George’s valuation is a bit aggressive. You might want to calculate a downside scenario just to see what it looks like George. In any case, WSZL isn’t expensive, just maybe not quite as cheap as you thought originally.

  • December 17, 2007 at 12:10 am

    Jon wrote: “did you place your good-til-canceled limit order at the bid, ask, most recent price or somewhere in between?”

    I put my order in for what I thought got me close to a 50% discount on intrinsic value. The order was in for several days before it was executed. I anticipated that WSZL would dip in price shortly after the end of the rights offering, since that what I observed happen last time Western Sizzlin conducted a rights offering.

    Thanks everyone for all the feedback on my valuation. I learned a lot from your points. Be sure to remind me in a year to see how close my growth forecasts came to reality. I know I was rather aggressive in my estimates, but I’m comfortable sticking with them for a bit longer.

  • February 24, 2008 at 7:34 pm

    I think you should check your numbers. The cash flow from the restaurants in 2007 was small. Most of the income was from gain on sale of Friendly’s stock. You cannot expect this to repeat on a regular basis. Biglari himself, in various filings, says to expect lumpy returns. Using a DCF analysis for this business is not really appropriate. He’s structuring a financial company and valuations should be based on book value .

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