In case you’ve been wondering what Ragu’s been up to:

Dear Ms Cochran,

I am writing in response to your letter dated November 21st 2011 to Cracker Barrel (CBRL) shareholders with respect to the ongoing proxy fight with Mr. Sardar Biglari, Chairman and CEO of Biglari Holdings (BH).

CBRL and new store openings

On pg. 2 of your letter, you write: “Mr. Biglari says we shouldn’t be building new stores and we’re not getting a good return on our investment.”

The first part of your statement is indeed true. Sardar Biglari, in his second letter to CBRL shareholders, asks for a moratorium on new store openings. The second part of your statement, unfortunately, reflects a lack of understanding as to why Biglari wants that moratorium.

The question is not simply whether CBRL is getting a “good return” on investment in new store openings. Rather, it is whether opening new stores represents the best use of CBRL’s capital, given the demonstrated and fairly prolonged deterioration in existing unit-level performance?

Given the severity of the deterioration, it is a virtual certainty that fixing the existing units will lead to the greatest increase in value. It is also an extremely reasonable proposition that efforts that are focused only on reviving the existing units are far more likely to succeed than those that are accompanied by the distraction of the effort to concurrently grow in size.

Secondly, as Biglari demonstrates, the market, then and now, is valuing the existing units at a price that is significantly less than the cost of building a new unit. Tack on the risk of execution, and it is clear as daylight that a significant share buyback is, on a risk-adjusted basis, by far the better use of CBRL’s capital when compared to a new store opening.

Indeed, if you are convinced that you can restore CBRL to it’s historical level of unit-level performance, a share buyback is the equivalent of a purchase of a dollar bills for 50 cents. CBRL can’t come close to matching those economics when opening a new store.

Biglari simply makes the rational assessment, based on the current situation at CBRL, that a share buyback is far preferable to a new store opening. Not only that, it is also likely the most optimal use of shareholders’ capital.

Clearly, the idea that Biglari says that CBRL is not getting a “good return” on investment in new stores is a straw man argument. Nevertheless, your response to this straw man argument is also flawed.

Appropriate evaluation of return on investment

While the idea of using return on invested capital (as opposed to simply equity) to determine the economic attractiveness of the investment is sound, using EBITDA in that calculation is not. Warren Buffett, in his 2000 letter to Berkshire shareholders, under the section titled ‘Full and Fair Reporting’ (pg. 17) says: “References to EBITDA make us shudder does management think the tooth fairy pays for capital expenditures?” (emphasis supplied)

CBRL’s pre-tax “owner’s earnings” on these new stores is EBITDA less an amount that fairly represents the amount of maintenance capital expenditures that need to be spent on those stores in order to maintain today’s level of sales. Those numbers, which will necessarily lead to a return on capital numbers lower than those you cited, will be a far more accurate representation of the returns that CBRL is achieving on those new stores. This Yogi Berra quote seems appropriate in the context of your calculation: “If you don’t know where you are going, you might not get there.”

Share repurchases

On pg. 2, somewhat incongruously under “Here is what we’re currently seeing”, you mention a “balanced approach to capital allocation” that includes increased return of capital to shareholders via, amongst other things, share repurchases.

In your most recent 10-K filed September 27th 2011, the section talking about share repurchases (pg. 58) states: “In 2011 and 2010, the Company was authorized to repurchase shares to offset share dilution that results from the issuance of shares under its equity compensation plans.” (emphasis supplied)

This is not a repurchase that is a return of capital to shareholders. It is, quite simply, a mechanism to hide what was earlier taken away from them.

Intriguingly, on pg. 34 of the 10-K, the language for share repurchases for 2012 has changed. It reads: “Additionally, subject to a maximum amount of $65,000, we have been authorized by our Board of Directors to repurchase shares during 2012 at the discretion of management.” (emphasis supplied)

What are the odds that the change in language was precipitated by Biglari’s raising the issue of your options dilution hiding program, that was masquerading as a share repurchase program, as a serious concern in your initial discussions with him? Quite high, in my opinion.

Unfortunately, whilst that language changed, the criterion for repurchases, that they “be accretive to expected net income per share” is extraordinarily poor. It shows a serious lack of understanding as to how share repurchases add value to the shareholders that choose to hold on to their shares. If the value of the shares in relation to the price paid is not important when making the decision to repurchase shares, then what is?

Earnings guidance

In fact, the emphasis you lay on the impact of repurchases on “expected net income per share” is enough grounds for CBRL to put an end to the misguided practice of earnings guidance. The practice may please some analysts, but it does nothing for long-term shareholders. Indeed, it detracts, perhaps significantly, from long-term value creation.

Biglari on CBRL’s board

Commenting on Biglari’s second letter to CBRL shareholders, you write:” Indeed, in my view, his recent 11-page manifesto of all-things wrong with Cracker Barrel dating back to 2000 is both misdirected and misinformed.”

Au contraire, Biglari’s missive is based on facts and sound logic, qualities that would be a welcome addition to CBRL’s board. You may not want Biglari on the Board, but it’s plainly clear that CBRL’s shareholders need him on it.

Sincerely,

Ragupati Chandrasekaran

Ragupati Chandrasekaran

Kirkland’s Inc. (KIRK) recently reported fiscal 2011 first quarter earnings. Same-store sales (SSS) for the quarter took a beating, down 8.4% on a year over year (YOY) basis, while gross profit margins fell, as well. The decrease in gross margins was attributable to higher inbound freight costs and increased levels of promotions and markdowns.

Before we get to valuation, we’ll take a look at the business itself. KIRK sells home décor items. The business is particularly competitive, with listed competitors including Bed, Bath and Beyond (BBBY), Pier 1 Imports (PIR) and Williams Sonoma (WSM).

How does KIRK differentiate itself from these players? Of all the reasons listed in the latest 10-K, the following is the one that is likely key for KIRK:

“Strong value proposition. Our customers regularly experience the satisfaction of paying noticeably less for items similar to those sold by other retail stores or through other retail channels. This strategy of providing a unique combination of style, quality, and value is an important element in making Kirkland’s a destination store. While we carry some items in our stores that sell for several hundred dollars, most items sell for under $20 and are perceived by our customers as very affordable home décor and gifts.” (emphasis supplied)

Based on the note above about low-priced items, it would seem reasonable to expect that KIRK turns over its inventory faster than its competition. Does it?

Here are some inventory turn numbers for the last three fiscal years:

The numbers look consistent with what might be expected based on what KIRK says about their business. The declining numbers for KIRK are well worth keeping an eye on, however.

How about pre-tax operating margins compared to the competition?

Again, here are the numbers for the last three fiscal years — leaving PIR out, seeing as they had an operating loss for two of the last three years:

Operating margins improved dramatically (understatement) in 2009, right in the middle of the worst recession in a long, long time. What gives?

KIRK originally located its stores within malls, not a particularly appropriate location if your goal is to target value-conscious shoppers. They then began the experiment of moving some of their mall stores to off-mall locations.

The economics of the new off-mall stores are also extremely attractive, with an initial return on invested capital of 50%. Not surprisingly, the move worked, with the attendant margin and earnings improvements.

As of the end of the last quarter, 19% of KIRK’s stores still remain in mall locations, with plans to move them off-mall over the next few years. So, all other things being equal, there is at least one source of high-probability — and value-enhancing — growth in earnings for KIRK.

Finally, how efficient is KIRK in utilizing its retail space for sales?

Here are some numbers for average net sales per square foot for the last three fiscal years. The comparison is with BBBY, which has operating margins closest to KIRK for the last couple of years:

KIRK has some work to do to match BBBY in this regard.

Valuation

Finally, we can move on to valuation. This is a tough business, not one that is impossible to make money in — but it is hard.

However, the financials are attractive. KIRK’s return on equity for the past three years, starting with fiscal 2008 and ending with the latest, are 19.6%, 49.1%, and 25.6%.

As of the end of the last quarter, KIRK had a very strong balance sheet, with cash and equivalents of $90.3 million on an equity base of $122.3 million and no debt.  Unfortunately, KIRK’s management has shown a lack of willingness to put the cash to use by buying back KIRK stock at any point during the stock’s decline from the middle of last year.

What about buy backs?

On a specific question on buy backs during one of the conference calls last year, the CEO said he’d defer to the board. Not an answer you’d want to hear from the person who ought to be responsible for all capital allocation decisions. However, there was some talk about putting the cash to use for the benefit of shareholders during the most recent conference call. We’ll see.

With 19.2 million shares outstanding and a price of $12.05/share, KIRK is selling for about $240 million, which is roughly two times book. This isn’t silly cheap, especially with the sales troubles that KIRK is facing currently. However, if management can do intelligent things with the cash – which we have not seen evidence of so far — and execute the remainder of the move from mall locations to off-mall successfully – which is likely based on past history — today’s price will likely turn out to be cheap a couple of years out.

Disclosure: I have no position in KIRK.

Follow us on Twitter @CompleteGrowth!

Ragupati Chandrasekaran

Biglari Holdings (BH) announced second quarter results at the end of last week.

What’s to like?

Continued same store sales (SSS) gains at Steak n Shake (SNS) for one thing. Guest traffic increased 5.2%, but lower prices — by design — meant SSS gains were 4.3%. The debentures issued in connection with the Western Sizzlin (WEST) merger were repaid this quarter.

Although book value (BV) fluctuations in a single quarter are meaningless, it is nevertheless useful to keep an eye on it. Going on reported numbers, BV has risen by 3.8% year-to-date over the first two quarters. Is that right, however?

Remember that BH makes investments in the Lion Fund as a limited partner. These investments –- worth $51.06 million at the quarter’s end — don’t show up on BH’s consolidated balance sheet. In addition, the Lion Fund holds shares of BH, which are recorded as Treasury stock, and decreases reported BV. Adjusting for these accounting quirks to reflect economic reality, BV growth for the past two quarters is a reasonable 8.1%. Not bad at all, and much higher than if you just went on reported numbers.

What’s not to like?

Subsequent to the end of the quarter, BH sold its interest in Mustang Capital. John Linnartz, the principal at Mustang Capital, has been around since the WEST days, so it’s not particularly welcome news to see him go.

To be fair, though, this was coming. Mustang Capital sold its shares of BH after the new compensation plan for Sardar was announced. The limited partnership at Mustang became separately managed accounts in the quarter prior. The end, if you will, was a natural progression of these events.

There was no progress in terms of new SNS franchise openings in the quarter, although we did have one company store opening — presumably the one in San Antonio. If this is simply a matter of finding the right franchisees and suitable locations, I’m all for patience.

I wonder, however, if the existing franchisees’ tiff with Sardar has a part to play in this delay in expansion. If so, it will be instructive to see how Sardar handles this.

Valuation

Adjusted book value at quarter end: $400.1 million

Shares outstanding: 1.432 million

Book value per share: $279.4

Per share price today: $393.34

Price-book: 1.41

Here’s what Sardar had to say about BH’s valuation in his last shareholder letter. You can find it towards the end of pg. 8 in the section titled “Accounting Rules Regulating Affiliated Partnerships.”

“Factor in BH’s investment in TLF (fair value of $38.6 million), ignore reductions to shareholders’ equity and long-term debt, and calculate per-share numbers using the shares outstanding (1.434 million) on the cover of our 10K. If you take that view, be sure not to use the shares outstanding on the balance sheet or income statement; otherwise, your analysis will be misleading.” (emphasis supplied)

Making the adjustments that Sardar recommends to adjust for the “invisible stuff” on BH’s balance sheet, and using prices as of the last trading day before the letter, gets us to a price-book multiple of 1.64 at the end of the last fiscal year.

What is interesting, however, is the note that the analysis would be misleading if we were to use the shares outstanding on the balance sheet (1.227 million). Using that number gives us a price-book multiple of 1.4.

The use of the term “misleading” clearly indicates that different investment decisions would result from the calculations above. While I can’t be certain, I’d suggest that the implication of Sardar’s words is that a price-book multiple of 1.4 falls within a buy range, while a multiple of 1.64 is closer to hold than buy. Phil Cooley’s purchase of 100 shares at $401.5 at the end of March lends some support to that interpretation.

As a reminder, today’s price – book is 1.41.

Disclosure: BH is my largest position.

Ragupati Chandrasekaran

Biglari Holdings (BH)
The restaurant operations are humming along with the first five of a proposed 1,000 new franchised Steak ‘n Shake restaurants already open. The potential? Franchise fees from the 1,000 new restaurants at 5% of the expected $1.5 million in annual sales would be  $75 million per year, about twice as much as Steak ‘n Shake’s pre-tax operating earnings last year. Can’t wait? Me neither. If Biglari stays healthy for the next two to three decades, I suspect a fair number of today’s shareholders are going to have an adequate retirement.

Fairfax Financial Holdings (FRFHF)
A soft insurance market combined with market hedges that haven’t yet paid off, combined to produce a seemingly less-than-stellar year for FRFHF. However, in insurance, as in investing, one-year results are hardly indicative. FRFHF’s strong capital position, a top-class acquisition in Zenith, and an extremely talented investment team all make for a terrific long-term investment. If FRFHF gets close to their stated goal of 15% increase in book value per share, today’s price around book ($380/share) will turn out to be cheap.

Kirkland’s (KIRK)
Home-décor retailing is a tough business. However, at the time of purchase, I felt that KIRK was sufficiently differentiated in inventory and price levels. How many home-décor retailers do you know that have an average check of $30? The business was worth owning, especially if management did intelligent things with their excess capital. Unfortunately, there’s no sign of that. Because they’re sufficiently conservative, however, KIRK is worth holding at its current price of $15.21/share.

Premier Exhibitions (PRXI)
With a court ruling anticipated in August at the latest, and the 100^th anniversary of the Titanic’s sinking coming up next year, I believe the odds are good on a sale of the Titanic assets by the end of the year. There is a good discussion on the Forum with respect to the value of the assets here, with estimated values ranging from higher to much higher than today’s prices ($1.85/share).

Sonic (SONC)
Things are looking up at SONC, with the latest quarter reversing 11 straight quarters of same store sales (SSS) declines. While management has indicated that it is unlikely that SONC’s company-owned restaurants will get back to the 20% pre-recession margin levels, 16% to 17% margins are possible — which will lead to meaningful earnings increases from today’s levels. SONC is not a long-term buy and hold, but the investment prospects at today’s prices of $9/share, looking out two years, are decent. More on SONC’s most recent quarter here.

Winthrop Realty Trust (FUR)
FUR wouldn’t be interesting if not for its CEO, Michael Ashner, dubbed the “Warren Buffett of Real Estate” by Bruce Berkowitz.  While it’s hard to pin down a number for FUR’s value, there is likely tremendous optionality in their recent investments in distressed debt. FUR is worth holding at current prices, which is slightly above its book of $11.94/share.

Ragupati Chandrasekaran

Sonic Corp. (SONC) announced fiscal 2011 2^nd quarter earnings last week. Same-store sales (SSS) were up, for the first time in 11 quarters. Yes, you heard that right. SSS were up, with a 1% increase at franchises and a 2.2% increase at company-owned drive-ins.

SONC reported pre-tax income of $6.95 million this quarter as compared to a loss of $393,000 in the same quarter last year. Even given the inherent operating leverage in the business, the improvement in SSS numbers is not big enough to merit such a large difference in earnings. What gives?

SONC reported that it had purchased $62.5 million of its variable funding senior notes at a discount in the quarter. The gain on the purchase of this debt was $5.2 million pre-tax ($3.3 million after-tax). The reported numbers need to be adjusted for this one-time, and therefore non-recurring, gain before meaningful analysis.

Making that adjustment, pre-tax income for the quarter would’ve been $1.75 million, a number that’s much more in-line with the SSS increases when compared to the results year-on-year (y-o-y). If you don’t wish to deal with these adjustments, simply compare pre-tax operating income numbers – $9.74 million this quarter vs. $8.98 million y-o-y. Be careful, however, to ensure that the operating income numbers don’t include any one-off items of revenue/expenses.

An unofficial transcript of the conference call is here. Management indicated that they had $30 million in unrestricted cash following the debt repurchase and that SONC was comfortably in compliance with the debt covenants.

More than analyst asked (badgered?) the company for SSS “guidance” for the next 2 quarters. Guidance of the – “Please tell us that the SSS will be positive for the next 2 quarters so we can go tell our clients that they can safely buy the stock” – type that they so crave. Management did say that they expected positive SSS comparisons through the rest of the year.

Not that Mr. Market cared. Yawned was more like it. However, value will out, as it always does.

admin

Prem Watsa’s annual letter to shareholders of Fairfax Financial Holdings (FRFHF) was released a couple of weeks back. As usual, it’s candid and makes for good reading.

In 2010, FRFHF celebrated its 25^th year. Book value per share at inception: $1.5/share. Book value per share today: $379/share, representing a compounding rate of 25% per year for 25 years. Compounding is the first wonder of the world.

There is an excellent discussion of FRFHF’s run-off acquisition of GFIC. FRFHF paid a discount to book, $367.1 million for the acquisition of a book value of $385.8 million. More interestingly, the payment called for $100 million to be paid in cash, with the rest as a note payable over a six-year period.

The note had a key feature that provided protection to FRFHF — the note would be written down in the amount of any adverse reverse developments. Sure enough, $65.7 million of the note payable has already been written down as a result of increase in claims reserves.

Watsa discusses the appointment of former Odyssey Re CEO Andy Barnard to the position of President and COO of Fairfax Insurance Group. It’s hard to argue with the numbers that Watsa cites – book value per share at Odyssey Re compounded at 20.4% since 2001. He goes on to say:

• “As I have mentioned in the past, in the reinsurance business, a few good men or women can have a huge impact on the business.” (emphasis supplied)

Management matters, folks.

Watsa also discusses Zenith, one of FRFHF’s acquisitions for the year, describing it as the “Rolls Royce” of the workers’ compensation specialist writers. High praise, indeed! By the looks of it, those accolades look well deserved.

As pricing has gotten competitive — Zenith might label it “inadequate” — they have cut exposure to almost 50% of where they were a few years back. To keep pace with the trends in loss costs, they have also increased their loss reserves by $24 million. Per Watsa, the California workers’ comp marketplace is an accident waiting to happen. When it does, you can be sure that Zenith will be well placed to take advantage.

The most interesting portion of Watsa’s letter is reserved for the end. Here’s that section in its entirety, for it represents a significant change in FRFHF’s acquisition strategy:

• “While our primary objective is to expand our insurance and reinsurance operations worldwide, our investing skills could provide us with opportunities to buy, in whole or in part, excellent companies in other industries which generate strong free cash flows and will contribute to our objective of achieving a 15% per year increase in book value per share over the long term. For entrepreneurial founders who have built their companies over long periods of time, Fairfax will be an excellent owner, allowing the founders to continue to run their business, unfettered by the head office, and we are open to these opportunities.” (emphasis supplied)

This is terrific news for FRFHF shareholders. Good stuff, and I am glad to see FRFHF’s thinking evolve in this regard.

Ragupati Chandrasekaran

Winthrop Realty Trust (FUR) announced 4^th quarter and 2010 annual results recently.  Per my calculations, FUR made investments totaling $53.8 million in mortgage loans, notes and bonds secured by properties, and land in just the fourth quarter alone.

New investments for all of 2010 were over $160 million, although FUR’s CEO Michael Ashner indicated that they over-weighted risk in their evaluation. Consequently, FUR missed some investment opportunities. Better mistakes of omission than those of commission, of course.

FUR’s balance sheet continues to be strong and liquid, with cash and equivalents at year-end of about $45.3 million. REIT securities, consisting predominantly of REIT preferreds that are likely to be sold in 2011, were carried on the books at around $33 million at year-end.  Add another $9.6 million in available liquidity under their line of credit, and FUR has enough in the tank to make additional investments that they consider attractive.

Property occupancy is improving — up to 92.3% of all consolidated operating properties at year-end — compared to 84.6% at the end of last year.

FUR increased its credit line from $35 million to $50 million with a maturity date of March 2014. This increase was used to pay off a couple of mortgage loans that leave FUR with no mortgage loans on its books that are due in 2011.

Book value accruing to FUR’s shareholders at the end of 2010 was $295.8 million. At 27.03 million shares outstanding, that’s a book value of  $10.94/share. At today’s price of $12.06/share, that’s a price-book multiple of 1.1. Little wonder, then, that Ashner makes the comment that he does about FUR’s valuation. The following is from the conference call, whose transcript is here:

• “Further, we are presently considering additional proposals to improve the company’s financial transparency in order to assist you in better evaluating our assets, their performance and our collective underlying value.
• “The board’s and management’s intention in 2011 is to significantly but judiciously grow the company and its investment portfolio in this manner in order to maximize our potential and increase our value long-term. As our value proposition becomes better appreciated through our efforts to become more visible and transparent to the investment community, we anticipate that the market will respond in kind and allow Winthrop to improve its valuation.”

It’s clear that Ashner thinks that the market doesn’t get FUR. In general, I am no fan of a company that wants to be more “visible” to the investment community. However, Ashner and co. are sufficiently focused on the long-term that I don’t view this as a negative. Not a big one, at any rate.

Ragupati Chandrasekaran

Warren Buffett’s annual letter to Berkshire Hathaway shareholders was released the Saturday before last. There was very little by way of a sermon from Buffett this time about what’s broken in corporate America or in the financial industry — save for a tiny bit about focusing on, and gaming the reported numbers. This is probably why this letter didn’t get the media headlines that it usually does.

Unlike last year’s letter, this one was very good. My sense was that Buffett was slightly miffed that there is little understanding of Berkshire’s real value. And he set out to correct it.

For the first time that I can recall, Buffett actually provided his own estimate of Berkshire’s current normalized earnings power — about $17 billion pre-tax, and $12 billion after-tax. More interesting than the numbers are the assumptions that Buffett and Munger use in their estimation of Berkshire’s earnings power: No mega catastrophe in insurance, and a business climate slightly better than 2010, but certainly weaker than 2005 and 2006.

Not surprisingly, the Burlington Northern Santa Fe (BNSF) acquisition is off to a good start. There is more reiteration of the advantage that rails have over trucks in terms of operating costs as a consequence of their fuel efficiency – they’re three times more efficient. The part about society benefitting when traffic travels by rail is really targeted at regulators, especially the potentially overzealous ones.

Also in the report was a marked change in language regarding future expectations for change in Berkshire’s per-share book value versus the S&P 500. Buffett writes:

“Looking forward, we hope to average several points better than the S&P – though that result is, of course, far from a sure thing.” (emphasis supplied)

Standard answers from Buffett in the last decade have consistently seen the use of a “couple of percentage points advantage over the S&P.” Buffett is extraordinarily careful with his written word, and especially so when it comes to talking about Berkshire’s future growth. This change in language is particularly telling.

Through his letters in the relatively recent past, Buffett has endorsed the application of what is referred to as the “two-column” approach to valuing Berkshire. The insurance operations are worth the size of the investments — funded by both shareholder equity and insurance float. This number was $158 billion in market value at the end of 2010, or $94,730 per ‘A’ share.

Valuing the insurance operations in such a manner makes the assumption that Berkshire’s float will not shrink over time, and will also cost nothing. It also ignores deferred tax liabilities on Berkshire’s long-term stock holdings. If it weren’t for the fact that the majority of the stock holdings are held in the insurance subsidiaries, I’d have imagined that Buffett’s complete overlooking of the deferred tax liabilities would indicate that a tax-free spin-off of these shares to Berkshire shareholders is a possibility at some point.

Clearly, the assumptions underlying Buffett’s estimation of the value of Berkshire’s insurance operations are not what would conventionally be labeled conservative. Not for nothing, though, does Buffett consider Berkshire’s insurance operations the “best in the world.”  Ahem.

The second source of Berkshire’s value comes from the earnings of the non-insurance subsidiaries. The pre-tax earnings for this group in 2010 were $5,926 per ‘A’ share. Buffett’s already told us that normal earnings for Berkshire involve a business climate slightly better than 2010, so there’s no reason to believe that these are unsustainably high earnings.

At today’s market price of $128,000 per ‘A’ share, these earnings are being valued at a pre-tax multiple of — wait for it — 5.6. That’s right. And for a collection of businesses handpicked by Buffett and Munger, no less. Forget a Buffett premium in Berkshire’s stock, there’s likely a Buffett discount, thanks to his age and “succession uncertainty.” I sneer at the issue of “succession uncertainty” — the only uncertainty is who it is going to be, not whether he/she is going to be capable. S/he will be, and David Sokol’s the betting favorite.

Of course, the  “two-column” approach provides a method to estimate Berkshire’s intrinsic value today. The long-term shareholder of the business, however, is concerned with the future. And, for a company like Berkshire, and any other business that retains all its earnings, that future will be heavily influenced by the ability of the CEO to allocate capital. Buffett, as usual, puts it very eloquently. I reproduce a large portion of the section below, simply because it’s so important and well worth remembering over an investing lifetime:

“This ‘what-will-they-do-with-the-money’ factor must always be evaluated along with the ‘what-do-we-have-now’ calculation in order for us, or anybody, to arrive at a sensible estimate of a company’s intrinsic value. That’s because an outside investor stands by helplessly as management reinvests his share of the company’s earnings. If a CEO can be expected to do this job well, the reinvestment prospects add to the company’s current value; if the CEO’s talents or motives are suspect, today’s value must be discounted. The difference in outcome can be huge.“ (emphasis supplied)

Buffett also provides an excellent illustration of how book value can far understate intrinsic value. The example: GEICO. Read all about it on page nine on the letter. Then, finish the rest of the letter and see whether you want to get aboard the train with the Buffett discount. (So sorry, I know that’s really lame, but I can’t resist.)

Ragupati Chandrasekaran

Only one week after we sold our stake in KVH Industries (KVHI) at an average price of $14.85, Netherlands-based Vroon announced it was converting its 125-ship fleet to KVHI equipment. In the press release, Vroon lists all the reasons we were interested in KVHI: cost, bandwidth, global coverage.

So, are we reversing course and buying back our shares at the current $13.99/share price? No, we didn’t sell because KVHI was one good order away from success, but rather because it appeared to be several good orders away.  That said, if the price dropped back to our original buy-in price and more fleet sales occurred, we would reconsider, but KVHI still needs to scale to have a bright future. While the Vroon order is a good win, it’s not enough by itself to change our forecast.

Since we acquired the Eagle Rock Energy warrants (EROCW), Eagle Rock Energy Partners (EROC) is entering its second MLP ETF Index. EROC restores its distributions, it is becoming more attractive to MLP index funds that need to replace acquired MLPs such as Penn Virginia GP Holdings (PVG) with new members.

With high-yielding MLPs currently red hot, this trend is bringing new buyers into Eagle Rock Energy Partners common stock.  Eventually, the whims of the market will change, and membership in these ETFs will cause net selling — especially in a rising interest rate market.  For now, it only helps our cause, and our warrants are up 22% in six weeks.

Fairfax Financial Holdings (FRFHF) upped the ante in its lawsuit, in 2006, against certain firms that were short FRFHF right before that period. The latest allegation: Third Point’s Dan Loeb “lied” to his investors about having done extensive research on FRFHF prior to shorting. Wow. More in the article here.

Ragupati Chandrasekaran

This was a fairly quiet week for our portfolio.

Biglari Holdings (BH) announced last week that it would redeem all of the debentures, in the amount of $22.6 million, issued in connection with the Western Sizzlin’ acquisition on March 30th. Intriguingly, BH announced a couple of days later that Steak n Shake (SNS) had obtained a five-year term loan in the amount of $20 million at an effective fixed rate of $3.25%. Basically, BH has exchanged debt at 14% for debt of 3.25%. Also worth noting is that the new debt will be an obligation of the SNS subsidiary only, with no guarantees from the parent holding company.

Has Winthrop Realty Trust (FUR) found itself in another real estate legal wrangle? That’s what it looks like based on this report. This time, FUR is invested alongside John Paulson, taking control of the properties this January. No details on the amount of capital investment by FUR in this instance are available.

Ragupati Chandrasekaran