Saturday, July 31, 2010

Link to HR 3534 with amendment for pooling by small operators

House Speaker Nancy Pelosi (D., Calif.) and other members of the Democratic leadership had heard all week from oil-state Democrats that the legislation went too far, prompting Democratic leaders to make a number of concessions. The most visible sign of the dealmaking came when the Democratic leadership allowed a vote on an amendment that would allow smaller companies to meet financial responsibility requirements by pooling of resources or through joint insurance coverage. The amendment passed.

WASHINGTON -(Dow Jones)- The U.S. House of Representatives on Friday voted to overhaul the entire system of offshore drilling, responding to the worst offshore oil spill in U.S. history with new drilling safeguards and the elimination of a cap on damages that companies must pay for such spills.

The 209-193 vote came more than three months after a rig leased by BP PLC (BP, BP.LN) exploded, killing 11 workers and dumping tens of millions of gallons of into the Gulf of Mexico. But oil-state Democrats broke ranks with their party to join Republicans in warning that the response goes too far and will put independent oil and gas producers out of business. The defections suggest that spill legislation is running into obstacles as action moves to the U.S. Senate, where it is unclear that Democrats have the votes to move forward.

"It will kill jobs and increase our reliance on foreign oil," said Rep. Gene Green (D, Texas), who voted against the bill and had estimated that about 30 Democratic lawmakers were in opposition.

House Democratic leaders are pushing to change every aspect of the offshore-drilling business, from the time a company bids on a lease to the point when it designs deep-water wells and puts safety equipment on drilling rigs. The most contentious part of the legislation involves eliminating the cap on economic damages paid to residents and businesses harmed by oil spills.

Democrats want to discard liability caps, currently set at $75 million, in order to avoid putting taxpayers on the hook for damages that go beyond the costs of clean-up. On Thursday, the White House called liability limits an "implicit subsidy" for the oil and gas industry, and said it "strongly supports" repealing the limit on economic damages claims.

But independent oil and gas producers fear being put out of business. Insurers have indicated that they will not offer offshore-drilling insurance without a cap on damage claims. The result would be to leave offshore drilling to state-owned and giant corporate oil companies, which can self-insure against damages.

"It's unfortunate that the House has now taken action--I might say by a very slim margin--that has the potential to destroy jobs and threaten the economic recovery," said Jack Gerard, the president of the American Petroleum Institute. "Liability is clearly one of the largest issues because it has such an immediate adverse impact on the industry."

House Democrats also used the bill to deliver a message that the U.S. is willing to take away drilling privileges from companies with poor safety records--a measure that would likely hit BP especially hard.

Under the bill, companies seeking leases or permits would have to certify that no more than 10 safety-violation related deaths had occurred at their facilities over the prior seven years. With 11 deaths on the Deepwater Horizon rig in April, BP faces the risk of being disqualified. BP has asked House leaders to soften the legislation, warning that the measure "could result in the loss of thousands of jobs."

Sentiment is running against BP, even among Republicans. Rep. Steve Scalise (R, La.) told reporters, "I don't have any problem" with the safety-record measure. "BP has got a long track record of not playing by the rules."

The clash between Democrats and Republicans reflects has a broader fight about the role of government in offshore drilling. Where regulators under the Bush administration and later under the Obama administration had deferred decision-making to the oil industry, the Democratic-controlled House is proposing that the government become involved in the design of safety equipment and procedures for constructing offshore wells.

"Big oil was writing their own rules," said Rep. Nick Rahall (D, W.Va.). "The industry should take a look at the spill in the Gulf to see how an overly permissive attitude can turn into a real horror story."

Under the bill, companies would be required to conduct a cement bond log test when drilling wells. BP decided not to conduct the test at its failed Macondo well, even though Halliburton Corp. (HAL), which was contracted to do the cementing work, has said the test was the only way to ensure the quality of the job.

Drilling rigs would also have to have two sets of blind shear rams on blowout preventers. Blowout preventers are supposed to shut off wells in the event of a catastrophic disaster, with the shear rams the last line of defense because they are supposed to cut and seal the drill pipe. BP was unable to activate its blowout preventer. Officials are looking into whether the single set of shear rams on BP's blowout preventer failed, something that will not be known until the blowout preventer is pulled from the sea floor.

House Speaker Nancy Pelosi (D., Calif.) and other members of the Democratic leadership had heard all week from oil-state Democrats that the legislation went too far, prompting Democratic leaders to make a number of concessions. The most visible sign of the dealmaking came when the Democratic leadership allowed a vote on an amendment that would allow smaller companies to meet financial responsibility requirements by pooling of resources or through joint insurance coverage.

The leadership also allowed a vote on ending a six-month ban on deepwater drilling. Both amendments passed, but weren't enough to keep oil-state lawmakers from voting against the overall bill.

Friday, July 30, 2010

Peak Oil Guru Matt Simmons Losing Credibility

I still believe in peak oil production. But Matt Simmons has lost his credibility with many people, me included.

Thursday, July 29, 2010

Universal Power (UNX on TSE) - big potential off Namibia

Way too early to buy any, but starting some notes on Universal Power.

Unrisked 2 billion BOE for a $100mil mkt cap company. Recent insider buying.

Note from rigzone

Cobalt International (CIE) - Best pure play on the Deepwater GOM

As the emotion over the BP spill subsidies and sensible thinking takes over Cobalt could return to favor with investors.

Jeremy Grantham - We are running out of resources

Warnings from a respected value investor.

Wednesday, July 28, 2010

Energy Bills Appear Manageable for Small Deepwater Producers

Financial responsibility limits suggested appear reasonable.

Tuesday, July 27, 2010

Thoughts on Risk Management - Zeke Ashton Centaur Capital

I've followed Zeke and Centaur Capital since they started up a few years ago. I've found them to be thoughtful investors with an intelligent approach to portfolio management.

Here are some interesting thoughts of his:

Monday, July 26, 2010

Microsoft - So Cheap you almost have to buy it ?

It is getting hard to ignore Microsoft as an investment.

Here is some analysis I did recently:

I'd also recommend you check out Whitney Tilson's recent presentation:

Corridor Resources - Limited Downside, Huge Potential Upside

Here is a link to an article I wrote about a debt free small cap sitting on a shale gas resource in Canada with 50 trillion cubic feet of gas in place. That is not a typo.

Thursday, July 22, 2010

Two Investing Legends Say Quality Large Cap is Cheap

Grantham echoes Miller. Comments here.

Wednesday, July 21, 2010

GOM Containment System Fact Sheet

Further to the announcement today from XOM, COP, Chevron and Shell.

Here are details of what they are proposing.

Praetorian Capital - Investing in the GOM

Concentrated value investor. Holds ATPG.

American Large Caps - Opportunity of a Lifetime ?

Recap of Bill Miller rather dramatic comments.

Monday, July 19, 2010

Tilson Funds - Portfolio recap

As an equity investor a great place to look for ideas is in the portfolio holdings of other successful investors.

Whitney Tilson has become a well known value investor. Some would suggest that he is more successful in marketing himself than anything else, but the performance of his hedge fund T2 Partners is excellent since inception.

Tilson also has a mutual fund that is available to Retail investors. It's performance has not been as good as his hedge fund (which has used short selling to greatly enhance returns), but is has beaten the overall market.

For the cumulative period since the Funds’ inception on March 16, 2005, the Tilson Focus Fund returned an annualized 5.47% return versus a 2.88% annualized return over the same period for its benchmark (Dow Jones Wilshire 5000).

As per his end of April 2010 semi-annual report Tilson is not bullish on equities:

"In our opinion, we are in uncharted waters – yet the stock market is priced as if the seas are calm and the skies are clear. As this chart shows, the market is currently trading at a 21% premium to historical levels, which makes no sense to us based on the fundamentals and is instead most likely explained by a combination of likely-to-be-short-term factors: great year-over-year comparisons (it’s easy to show growth vs. the near-Armageddon conditions a year ago), unsustainably low interest rates, excess liquidity, and momentum investing"

Recently Tilson has been on CNBC getting a lot of attention for recommending and disclosing a current position in BP.

Here is what his fund was holding at April 30, 2010. Note that the top 10 holdings make up 65% of the funds assets. As almost always they have a large position in Warren Buffett's Berkshire Hathaway.

Largest Holdings (position size)

1) Stock of General Growth Properties (GGP) 16.1%
2) Stock and calls of Berkshire Hathaway (BRK.B)13.4%
3) Stock and warrants of Iridium (IRDM)9.6%
4) Stock of AB Inbev (BUD)5.5%
5) Warrants on Liberty Acquisition (LIA-WT)4.9%
6) Stock of Resource America (REXI)4.7%
7) Stock of Sears Canada (SCC.TO)3.0%
8) Stock and warrants of Two Harbors (TWO)3.1%
9) Stock of dELiA*s (DLIA)2.7%
10) Stock of American Express (AXP)2.4%

General Growth is up 284% in the last 6 months and has been a homerun for Tilson and his pal Bill Ackman from Pershing Capital who Tilson piggybacked into this one.

I'll write more later on both Iridium and Two Harbors which are both interesting.

McMoran CEO Comments on Moratorium and Liability Cap

Interesting commentary from MMR CEO in their earnings call. Should be an interesting earnings season as we learn how the industry sees the moratorium and future offshore drilling playing out.

Okay. Okay. Very good. And then, I guess, just kind of big picture, Jim Bob, just drawing on your experience in the Gulf over these years, I mean, how do you see the drilling moratorium playing out? Just the new regulations and the impact on insurance costs and just the whole landscape?

Jim Bob Moffett

Well, okay, let me see if I can summarize that. First of all, there has been so much information on the BP thing. We’ve had the testimony of CEOs, it’s clear that there is some issues as to how the well was drilled and operated. I’m not going to spend a lot of time on that other than to say, clearly, I’m sure everybody, including BP would go back and do things differently than they did.

I’ve seen this thing compared to all kinds of deals. Some people are calling it the Chernobyl of the oil and gas business and of course, that’s an interesting comparison because once Chernobyl took place, you haven’t had an accident in the nuclear basin similar to that in 34 years. So with the regulatory issues that are being dealt with and you’ve seen on the shelf, we’ve been operating that there for 40 years.

And the containment of a spill and whether that would be because of production facility damaged in a hurricane or some a well out of control, we do five drills around here all the time that the MMS basically conduct on the shelf where you get a phone call and people say this is war games and your Platform A has got a spill and you have to take all this equipment and deploy it. And we can contain a spill around these wells on the shelf immediately because all the equipment is there.

The blowout preventers that everybody talks about -- they are going through some additional scrutiny and we’ve actually had to do some additional actual tests and prove that these rams, these break up series of rams you have can sever the pipe. We’ve had to recently go back to the lab and even on these new rigs demonstrate that you can actually sever a 5-inch drill pipe a 6 and 5-inch drill pipe, all of which has been done.

So there’s so much of that that’s going to take place. But the fact is the cap that’s now on the well, if you say what should have happened, since you’ve had 5,000 wells drilled out there, probably that cap should have been sitting on the shelf or you can use a computer and design what you would do to a damaged tree subsea. But that’s spilt milk, I can assure you, at least in my opinion, that those caps will be designed because all those subsea completions, it’s not like every one of them is unique. The stacks may have some different dimensions but since we are not deepwater experts, I won’t try to be a deepwater expert.

But I can tell you that what’s been learned from this incident is that the equipment that’s been experimented with over the last 87 days, three months that won’t ever happen again because they’re going to have the stuff on the shelf before everybody goes back to work. So that if you’ve got a problem you go out there and put the right cap on the first time instead of experimenting.

But, the revenues from the deepwater or from the royalties period in the Gulf of Mexico, I don’t know if it’s $10 or $12 billion a year, but it’s a revenue source for the government, the second only to probably the IRS collections. And you’ve got future bonus proves that come in and depending on the activity and the new exploration, just since deepwater has been discovered. I don’t know how many billions of dollars have flowed in to the government from these bonuses. And what will happen with this new trend that we’re talking about today on the shelf because you’ve got all kinds of new interests. You have people coming back in to the last lease sale, spending $40, $50 billion -- million on new leases.

So the answer is that will get sorted out and as far as insurance is concerned enough, there will have to be a risk pool, everybody thought they had it figured out with the proves that were in place. But first we have to really sort of get out of this emotional period whether this well is going to cost $200 billion or $2 billion, I mean, the numbers I’m saying to land because of the enormous amount of pain that’s been felt.

So to answer your question, I think it’s, until we get some of the emotion of getting this well killed, it’s not going to be as easy to define as it will be once people start to ration. But at least in my opinion, there will be an insurance pool, a high risk pool. If this was an earthquake or a hurricane, we’ve seen insurance groups for both. You could say, well, that’s going to happen again. There is going to be another hurricane. There’s going to be another earthquake. But this isn’t going to happen again. This wake-up call for this subsea intervention from a mechanical failure will all be on the shelf and computerized as to how you deal with it. There won’t be the experimental stuff as things have gone on the last three months, at least in my opinion.

And you’re going to have to have that because nobody is going to operate in an environment where you have to throw into your goal factor as to whether or not to bid on a lease or drill a prospect if you’ve got a liability that’s totally unlimited. There’s not a prospect out there in the Gulf of Mexico deepwater that’s good enough for people to say, well, the prospect is a wildcat and you’ve got to bid on it and drill it to find out if it’s productive. Nobody is going to bid on a lease or drill an exploratory well that’s got in the formula for your rate of return a possible loss because of the kind of losses that are being thrown out right now. The answer is, nobody is going to do that.

So between the government and the industry, there will have to be a risk pool type concept whether you, again, whether you buy into the comparison of Chernobyl to this situation, everybody’s got their own opinion about that. But again, I don’t want to take become a (inaudible) here but those are kind of my impressions of what’s going to flow as people start to become rational and deal with the real economics and realities of how you keep the Gulf of Mexico as a resource for the U.S

Biglari Holdings - Starting to look tempting

Biglari Holdings is a holding company that young value investor Sardar Biglari has created. The main piece of Biglari Holdings is Steak N Shake which Biglari gained control of and has turned around remarkably quickly.

Biglari and his board of directors recently put forward a unique compensation plan for Sardar which will have him paid for performance. This plan although designed to align Biglari's interests with shareholders is also quite controversial for various reasons that I will examine later. This plan being announced has resulted in a rather large sell off of BH shares from $400 down to $280.

So the question for today is are they an interesting value at these prices ?

Back of the envelope valuation to see if more work is warranted:

Cash flow from operations at current run rate - $60mil

Annual maintenance capex - ($10mil)

Cash flow available to owners - $50mil

Assign a 10 multiple as a fair price $50mil x 10 = $500mil

Add cash and securities of - $81mil

Less long term debt of - $25mil

And the resulting value of the enterprise is $500mil + $81mil - $25mil = $555mil

Value per share is $555mil / 1,431,608 shares = $388 per share

Current share price is $280 which is $280/$388 = 72% of the rough estimate of fair value. Or an upside of about 39% to reach fair value.

Conclusion: Given the track record Biglari has as an investor investing with him at a sizable discount could be quite attractive. This is just a rough valuation though, so more work is required. As is some soul searching and analysis of that compensation package.

Saturday, July 17, 2010

Biglari Holdings Annual Meeting Notes

With Biglari Holdings falling a long way ($400 per share down to $278) I'm getting myself back up to speed. I found Biglari through Western Sizzlin in 2007 and took a big position in Steak N Shake in 2008 that I sold last year as I thought it was pretty close to fairly valued.

His new compensation plan is the reason for much of the selling. I'm going to do the work to see if it might be getting close to time to buy BH again.

I've compiled a few different sets of recent annual meeting notes that are available on the internet from generous writers as a starting point:


Notes (albeit incomplete and not verbatim) from the Steak and Shake annual hoopla. All responses are Biglari’s unless I note “Phil:” in which case the vice chairman answered.

Official business portion of annual meeting Lasted ten minutes. Name change was approved Now Biglari Holdings (BH).

Opening Comments by Biglari:

Biglari likes non capital intensive businesses. Examples given included investment management, franchising, and insurance.

Biglari is actively hunting insurance companies.

No dividends will be paid by BH to shareholders However, Biglari anticipates lots of dividends to be sent upstream from subsidiaries to parent.

Future unit growth for Steak and Shake will come via franchising. SNS has thus far been slow to grow the franchising end of things. One reason for slow growth in this area has been unfavorable R.O.I. numbers for potential franchises. The Steak and Shake prototype restaurant was unveiled via a movie. It makes franchising more attractive. The old SNS restaurant averaged over 4000 sq ft with 97 seats and carried a price tag of 2.2 mil. The prototype SNS is 3200 sq ft at an estimated cost of $1.5 mil while still having almost the same number of seats. (94 instead of 97)


Fellow from Humane Society of America requested cage free eggs be used. Biglari stated customer wants will dictate SNS.

Management compensation at store level is done via a recently developed formula. Sounded rational.

Expected cash flows from Western Sizzlin are expected to be enough at a minimum to pay off the interest on the debt.

Q: How does Biglari differ from Buffet?
Biglari is open to share repurchases for Biglari Holdings. (However, he will not be doing any repurchases at current prices. He encouraged meeting attendees to stop bidding up the stock.)

Q: Will synergy come about in WEST-SNS merger.
Yes due to supply chain efficiencies.

Q: Is the insurance field within Biglari's circle of competence? Is Biglari targeting short tail or long tail businesses?
Biglari didn't really know the restaurant business when he got into it. But he was still able to analyze it. Same with insurance. He has a CEO elect for Freemont insurance at headquarters in San Antonio to help him along the process. He plans to start small in insurance so a mistake won't be catastrophic.

Q: Does Biglari still think SNS can grow to 1500 units domestically?
Yep. Most unit growth will come from franchising.

Phil thinks the revenue/capital investment of the new SNS prototype will be less than 1 and this metric will attract franchisees. (Personally, I don't think this metric is worth 2 cents. I care about owner earnings/investment. Even earnings/investment would be acceptable. But revenues/investment?)

Q: What are you doing that your competitors are not doing?
A: They don't lock in beef prices because they have the financial flexibility to avoid having to pay for hedges. (Just a 10cent increase in beef prices would mean a $2.5 million dollar hit to pretax income.) They have this flexibility because they have squeezed cost out. Phil noted that they are like the Wal-Mart of burger chains. (I happen to think this is a horrendous analogy. Wal-Mart is the cheapest place to buy stuff. SNS is NOT the cheapest place to get a Burger. Burger King will give you a double cheeseburger for $1. Same with Wendy's. Same with McDonalds. Arby's and Taco Bell have also jumped on the $1 wagon. In my opinion SNS is a middle of the road burger joint - a step above the bottom wrung of food places. You can take a date to SNS but you shouldn't take a date to Burger King.) Sardar Biglari jumped in and said he thought SNS was the Neiman Marcus of burger chains. (I didn't think this was quite right either - that label belongs to Fuddruckers or Red Robin)

Q: Have you considered selling SNS branded food products in supermarkets ala Nathan's Famous?
A: They are doing a little of this by selling chili in Wal-Mart stores in Florida. They have not done a good job at this. (They only have time to do so much) In time this area will be built out.

Q: Follow up question about cage free eggs.
A: If consumers want cage free eggs SNS will get cage free.

Q: Multiple Franchise question
A: 1 franchise at a time. If the proprietor proves successful than approval for a 2nd with be given and so on.

Q: Does SNS have plans to delist and become a partnership?
A: No.

Q: Does SNS have any plans to do sale leasebacks?
A: Sale leasebacks rarely make sense to someone who owns 100% of a company. (Rather, they are done be CEOs who have a short term time horizon with a company and want to play accounting games) SNS will never do a sale leaseback just to do one.
Q: How is Biglari's health? (He looks much better now than in 2008)
A: Even though he works 80 hr weeks he feels great. He loves what he is doing.

Q: A while back WEST made a tender offer for Jack in the Box shares. Why was this withdrawn?
A: WEST shares became cheap enough to warrant repurchase. It does not make sense to have a tender offer involving shares and repurchases occuring at the same time.

Q: Does SNS (now BH) own shares in other restaurants?
A: Yes.

Q: Are there any public companies you'd like to own outright at current prices?
A: Stocks have soared. Several bad restaurants are currently grossly overvalued. Patience is urged. Insurance on the other hand looks undervalued. However, be careful as book value can be an illusion.

Mustang Capital may be folded in to BH.

Q: Compare yourself to Buffett. Do you prefer Cigar Butts or Great Companies at ok prices?
A: Obviously great companies, with great management, and great prices is best. Unfortunately, great prices are almost never available on great companies. Biglari is willing to do unfriendly deals. Unfriendly deals are only unfriendly to management - not the owners. Also, Biglari is willing to liquidate a business to get at its value.

Q: What effect will the recent health insurance legislation have on SNS.
A: That ain't goin' be cheap.

Biglari recently made a decision to downgrade the napkins provided to SNS drive-through customers. This move will save the company 400k a year.

Q: Tell us more about the Freemont Insurance bid.
A: The "CEO elect" has been hired. BH is only in the first inning of this transaction. Michigan politicians are working on a law aimed to "protect" Freemont from BH. (The law will protect management not shareholders. Biglari stated many jobs would be added in Michigan if BH took over. Freemont would lose just one job - that of the current CEO) Freemont was chosen because it was fairly small and had a clean book of business.

Q: Any thoughts about refranchising?
A: It doesn't make a lot of sense at current prices.

Q: Do you think your 900k salary is a bit high - especially relative to Buffett's 100k salary.
A: Goizueta the former head of Coke was the first executive to earn over $1 Billion as an exec. During his tenure he took Coke from a market cap of $4Billion to a market cap of $150Billion. If anything Goizueta was underpaid for his masterful performance. People don't mind highly paid executives so long as they're performing well. High pay alongside poor performance is the problem.

Q: What has performance been like at Mustang Capital.
A: No comment.

Q: Mr. Biglari, you have stated you plan to own your BH shares forever. If tomorrow, BH was selling way above intrinsic value (say $2 billion market cap) would you sell your shares? [This was one of my questions]
A: Biglari skirted this issue a bit. I get the feeling he would sell his shares if the price was way above intrinsic value. He did state he will try to maintain a reasonable price/value ratio through communication if the ratio becomes too out of whack. He also said there are ways to manage irrational exuberance. (I get the feeling he might issue shares of BH if the price trades at a significant premium over intrinsic value)

Q: Mr. Biglari, you current manage two pots of money – the Lion Fund and Biglari Holdings. Who has priority on your best ideas? Do Lion Fund partners come first or do BH shareholders? Don’t you feel the conflict of interest present? [Again, my question]
A: Biglari danced around this question. The board of directors of BH has talked about buying part of the Lion Fund from Biglari. (BH might receive the incentive fee while Biglari retains the management fee) Phil said I was making the BH lawyers nervous.

Q: Will cap ex be under $10 million on a regular basis
A: Biglari thinks so

No plans for a rights offering currently.

Ground leases don’t make sense to a long term owner.

Q: Tell us about your mistakes of commission vs. omission
A: To date there have not really been mistakes of commission. At some point there will be. Mistakes of omission happen all the time. Would, coulda, shoulda, type stuff.

Q: How do you guard against hubris?
A: Biglari likes to ask “what all can go wrong?” Phil: A successful CEO will have both pride and ego. Hopefully it isn’t overweening pride.

Q: Book recommendations?
Distant Force – about the Teledyne Corp. Made in America – Sam Walton. Think twice – Malcolm Gladwell.

Q: What have results been like for franchises vs. company owned stores?
A: Franchises have lagged because they were slow to adopt the aggressive pricing strategy. They are now jumping on board. It’s easy to follow success. Pricing is going to be uniform throughout the country. Previously, SNS paid 200k a year to “pricing consultants” to figure out what each restaurant should charge for every item. As a result locations close to each other had slightly different prices. The pricing consultants have been fired and the savings passed on to the consumer.

Q: What effect will inflation have on SNS
A: It will likely be helpful. An increase in prices will be passed along to consumers. Ultimately, it comes down to how efficient SNS can manage the business vs. the efficiency of the competition. Biglari thinks they manage the business better than the competition. Phil: The transition is the tough part. He does believe inflation is coming.

Q: Do you see franchising internationally?
A: Yep.

Q: Do you see buying an internationally based insurer? (Cayman Islands, British, etc.)
A: No.

Q: Does the Lion Fund have an offshore fund?
A: No. (This was just about the only piece of information we learned about the Lion Fund)

In about a year the SNS prototype will be built as a company owned store in San Antonio. Biglari got a good deal on some prime land. (I-10 and 1604 in San Antonio)

In the last 60 days Biglari submitted a bid for a company in the $200 million dollar range.

Q: How do you define your circle of competence?
A: Do we have the ability to learn about the company in question? Looking for companies with predictability.

Q: What is the CEO situation for SNS?
A: Biglari almost hired a well known exec as CEO. The deal didn’t happen and it has been a blessing in disguise. Biglari is now going to be CEO.

Q: Has the 23% increase in customer traffic been uniform?
A: The growth in sales is obviously not sustainable. The growth has not been uniform.

Q: Has BH looked at the Title Insurance arena?
A: No comment.

Q: Has BH looked at non-public insurance companies?
A: A bid was recently made on such a company. BH was outbid.

Q: How was the meeting location selected? (We met in an expensive looking room just off 5th avenue in Manhattan)
A: Biglari had business to attend to in New York. Annual meetings will at some point be held in San Antonio.

Q: How do you measure employee satisfactions?
A: Biglari told a story about surveys being sent out to employees of a different company. They came back negative and to try and boost morale management sent checks out. Next time surveys went out they came back even lower! Success will drive employee morale.

Q: You have a relatively low ownership stake in BH. Care to elaborate?
A: I’m 32. Over time I will be a net purchaser of BH shares.

Q: How do you spend your day?
A: Wearing 3 hats. (CEO of BH, Chairman of BH, Lion Fund Manager) He relies on people in the field to bring him info. He constantly looks at investments. He works 80-90 hrs per week.

Q: You have stated a goal is to outperform the S&P 500. Any specific target?
A: Nope. Just above.

Q: What has your record been like at the Lion Fund?
A: The fund #’s can’t be disclosed.

Q: Is book value or a % change in book value a decent measure of intrinsic value and intrinsic value growth for BH?
A: No.

Phil: I never quite understood why Buffett used the long term treasury rate for discounting cash flows when calculating intrinsic value. Using 4% leads to overvalued companies.

Q: What % of changes are left at SNS
A: Changes will be never ending.

At 5:30p.m. I had to leave to catch a flight. I would love if someone would tell me what I missed.

My Personal Conclusion:

Biglari is just as arrogant as I expected. He has a giant ego. He also has conflict of interest issues by managing both the Lion Fund and Biglari Holdings. However, he is both a great capital allocator and a great manager. (He shrewdly cut expenses and was therefore able to cut prices. This increased the value proposition to customers and as a result SNS posted phenomenal numbers in the very tough year of 2009.)

I think the SNS prototype will increase the value proposition to franchises and will create a real source of long term value via royalties.

Biglari is no Buffett. If I were alone on a dessert island I much rather be stranded with Buffett.
That said, I think Biglari is going to make the shareholders of BH rich. (Note: Biglari will become richer at a rate faster than the common shareholder. Again, he's no Warren Buffett)

Sardar’s comments about the business:
BH exited 2009 with a cash generating asset (SNS) and a new, holding company business model. Going forward, they’re interested in investing in/acquiring others, with an eye to maximizing their return on capital per unit of risk. They’re mantra is the creation of sustainable and substantial shareholder value.

To this end, the first move is the well-known takeover of WEST, which brought its predominantly franchised restaurant operation, the 51% stake in Mustang (with ~$66MM in assets under management), and other investments including a 9% stake in publicly-traded ITEX (which I’ve never understood the attraction of, and anyway, it’s too small to move the BH needle, even if they owned the whole kit and caboodle...which they don’t – plus I’ve also met the CEO and, well, let’s just say he’s not a Biglari fan). Also included in the assets WEST brings to BH is that land parcel in San Antonio, part of a mixed-use development area – 23 acres owned by BH with 1,400 linear frontage on highway (interstate?) 10, intersection with 1604 (?). Reason they bought – were dealt with cranky people and in cleaning up a mess in order to acquire the asset. A good buy because of those factors. Eleven (11) acres of that land plot is deemed ‘useable’. A development plan is ongoing, and BH should have an architectural plan delivered to them within a year. Tom Jacobs of Motley Fool Special Ops lives close to San Antonio, and is familiar with the location of this land. He seemed quite satisfied as to its utility and value, so that’s good.

BH is being managed for cash flow, not earnings, and capital is being allocated to create value. Not going to be strictly a restaurant company going forward, but rather, are training their efforts on acquiring businesses that generate/not consume, cash.

In the past, SNS (and many other restaurant chains...or indeed, many other businesses – have blindly re-invested capital, even if the cash returns are inadequate. The BH approach will be straightforward – all cash generated will be sent from the holding companies to the parent. The parent will then reinvest at the highest-available risk-adjusted return on invested capital; if that means reinvestment in the same subsidiary that sent up the cash in the first place, no worries. But they want to have the happy problem of having a constant stream of cash coming into the parent. Sardar opined that he sees BH as a ‘liquidity provider’, and that this cash stream will be the source of their competitive advantage.

Note – this should remind you of a couple of Berkshire Hathaway-themed items. First off, the famous example of Buffett being wheedled to invest in new loom equipment for the legacy textile mill business – which he refused on the grounds that the competition would do the same thing, no one would create any value in the aggregate, and the capital would be sunk. No return on capital above the cost of that capital. Second, this is yet another example of BH being set up to emulate Berkshire – Biglari may or may not be Buffett (he’s best, he may be described as ‘Buffett-like’ at a very early stage in Buffett’s career...we objectively can’t call him ‘the next Buffett’ for a good twenty years or so, so the discussion is rather moot), but he’s very much seeking to emulate a well-proven and profitable business model beloved by value investors. We could do far worse.

As to what they want to fold under the BH umbrella, it’s another page from the BH (the original...not Sardar’s iteration) playbook – they want businesses that can produce far more cash than they need. They like businesses that are comprehensible an uncomplicated. (Anyone ever listened to Buffett and Munger praise the business dynamics of See’s Candy? I imagine that’s the template here). Some immediate examples presented by Sardar and Phil Cooley as ‘attractive’ include the franchising of restaurants (demands the use of other people’s money – good economic traits in that there’s low need for reinvestment, and a negative cash conversion cycle), insurance (a leveraged investment portfolio with zero or negative cost on non-callable debt – get the premiums up-front, pay the claims later, invest the float for your benefit – demand is recession resistant; liabilities are diversified), and investment management (“A wonderful conduit for investible cash”.) And again, if this sounds somewhat familiar, it’s because Buffett has nice things about the attractiveness of zero-cost insurance float for years.

On the subject of capital allocation, a quick review of potential uses was given. Cash/capital spun up from the operating business(es) will be either invested back into the operating business (CapEx, working capital, joint ventures), or used for acquisitions/investments – including whole businesses, stocks, bonds, or other unconventional assets. In theory, it can be used in the service of the shareholder via dividends, share buybacks, or debt-repayment (though I wouldn’t get too anticipatory of any of these happening at SNS/BH any time soon). SNS generates far more cash than it needs and pays a dividend to BH.

Sardar said that they would have an ‘unyielding allegiance’ to their returns strategy, not on any fixed capital allocation strategy. Their mindset is flexible – capital will go wherever the best opportunity lies. Corporate Performance, as measured by the cash from the operating businesses combined with its deployment via Sardar’s capital allocation work, – must beat the S&P.

BH is going to maintain a strong balance sheet. As of FY10-Q1, there was $71.4MM cash at the parent; with $18.5MM debt at the SNS subsidiary level. Subsidiary capital structure will require each sub stand on its own – the capital structure will be inversely related to the business risk of the subsidiary (hence, the line of credit debt at the SNS level – the restaurants are more than capable of producing the required servicing cash flows). The only obligation of the holding company is the $23MM note for the WEST purchase (hands up who has a piece.) Debt is to be, at a minimum, offset by the cash held, and the company will rely on internal cash financing. One wonders what this might portend for the potential for those 14% debentures to be called early.

At this point in the meeting, there was the obligatory PowerPoint review: Financials (find in the 10K/10Q – revenues, EBT, restaurant count, et cetera). Showed a pretty bar graph of the SSS by quarter – with the pre- and post-Sardar era called out. The most recent quarter featured 14% SSS growth and 23% traffic growth (i.e. SNS sacrificed cheque for traffic), and while the sustainability of the increased cash flows is the main concern of BH, Sardar flat out stated that the current SSS trajectory cannot continue. Also took a moment to again highlight the capital allocation record of prior management, and the associated ‘lost decade’ for shareholders (lost money/lost opportunity). If you ever read any of the ‘Committee to enhance Steak n Shake’ materials, or the previous SNS annual letters to shareholders, you’ve seen this stuff.

They’re still looking for a CEO of the SNS operations. They almost hired a CEO whose name you’d recognize. Had the package put together. Then got the call from a recruiter – prospective CEO turned it down. It was a good offer (Phil: “Too much”). Originally thought this was a major setback, but turned out to be a blessing in disguise. Things would not have turned out right, knowing what they know now. Sometimes when you think you have setbacks, they’re truly blessings. It was a big lesson.

Talking ‘bout Expansion
It was reiterated again that the future of SNS is in franchising. Since taking over the reins of management, the focus has been on fixing the unit economics of new, franchised, outlets. Last year, we heard that this was where they were going. This year, we’ve got some actual milestones to compare against.

First up, we got our first glimpse of the new concept store. There was a 3-D computer-rendered video of the new concept, complete with walkthrough. And while I thought it looked good enough, some of the ‘oohs and ahs’ from the assembled investors suggests they’ve not spent time with too many drawing packages, or played many video games in the past decade (take that with a grain of salt...former engineer with 3-D design work experience, including such renderings, speaking here...though ours didn’t usually have Coldplay as an accompanying soundtrack...).

Anyway, the new concept is reduced in size to an average 3,200 square feet (versus current concept of ~4,200 square feet). Seating in the new stores numbers 94, versus 97 in the older concept. Development costs are roughly $1.5MM, versus $2.2MM for stores opened under prior management. Importantly, the cost for a new-build store is expected to be at or above a 1:1 ratio for revenues and capital cost; so, substantially cheaper.

At the Nov-2008 Investor Day, spoke of a potential future with 1,500 franchised units domestically. Still believe that; nothing has changed. That said, (with 400+ company- operated stores), they’re not going on a massive refranchising program. It really is about how much cash they’d be getting for the business sold. And since they intend to grow the underlying cash flows, and they’re rational sellers (i.e. want to sell at high price), don’t see too many potential transactions. Franchising will be new stores, and the means the get the desired RoC and to grow the brand. We already know of a number of franchise units under construction (Rome and Athens, Georgia are the ones that spring immediately to mind; Sardar listed another couple – I think Virginia was in their too...there are other sets of notes that surely list these better than I).

Any potential franchisee will need to stand on their own feet. SNS is not extending credit, nor are they waiving franchise fees. No credit problems with their franchisees, though, in fairness, it’s not like SNS is trying to grow by leaps and bounds at present.

The Colorado franchisee has committed to do 5 units, but Sardar/Phil are keeping a close leash on-hand. The franchisee needs to demonstrate that he can do one...then they’ll let open 2nd, then a 3rd, cetera. They’re not doing franchised openings for the sale of openings. WEST may have all sorts of operating standards – but SNS does not. One system – one brand – disciplined - want them all the same. The same will apply to any new company-operated stores.

Yes, that’s right, for the first time since Sardar/Phil took over, they explicitly said that they are going to open some new [company owned] units...but that new growth will not from there. I think that’s an interesting admission, and I wonder why the shift.

Still, Phil characterized them as “excited by the prototype” and by the unit economics. The new concept was termed “Exciting for potential franchisees”. They’ve also been looking at strip stores – inline versus end-cap. (This was also talked about last year – no word of any real progress...certainly, no swank video was shown of a new Steak n Shake in a strip mall)

What About Capital Spending Today?
There’s been a lot of talk around the investing universe (both Foolish and otherwise) about the post-Sardar takeover, and the perceived starving of capital spending to maintain their stores. The argument being that, the recent low rates cannot continue. One point, made last year and reiterated again this year, was that there is a plethora of activity that could be construed as maintenance activity, that is just now getting done under Sardar et al, but that is not being compartmentalized as CapEx (so-call ‘maintenance CapEx’ or otherwise). So, things like, painting, replacement of booths, et cetera – essential non-discretionary expenses – are just being expensed, and thus never reach the current D&A charges. Sardar indicated that these expense items are far higher than capital required to maintain the present outlets. CapEx at SNS will stay permanently lower, since the primary growth conduit will be via franchising going forwards, rendering to SNS (and BH) a somewhat non-volatile stream of revenues.
This maintenance expense versus ‘CapEx’ argument is actually one I can sympathize with. In my prior engineering life, we occasionally had spots where the CapEx completely dried up. But yet, we needed to get things done. So strange and exciting ways were found to slip various things into pre-approved expense budgets. Is something similar going on at SNS/BH? Maybe – I would certainly be unsurprised, given that I expect the “No CapEx but what is absolutely essential” order has gone far and wide.

The main line is that they are re-investing enough in company-owned stores (both via CapEx and expensed items). The challenge was to ‘go to the stores and see for yourself, and then look at SSS and traffic’. They don’t spend money for sake of spending – they’re spending with the intent to get good return. Marketing expense actually went up in FY09 under Sardar - $33.3MM in FY09, versus $28.7MM in FY08 (although – note, FY09 was a 53-week fiscal year versus 52-weeks in FY08). Still incremental revenues and cash flows were greater than incremental marketing spend. Frankly, this came across as somewhat ‘Buffett-like’ in his particular habit of talking up how much their spending on advertising at GEICO. (Full caveat...yes, I realize that Steakburgers ain’t auto insurance...)

Bottom line, maintenance CapEx for the existing 412 company-operated restaurants is anticipated to remain below $10MM annually for a while. Doesn’t mean that other items don’t drop to the PP&E line on the statement of cash flows – properties and the like. Example of Q1-FY10, where PP&E was about $3.1MM – BH was buying some properties in there (and plan to continue doing so). The comment was made, “Don’t understand folks who build a unit, but lease the land”. They’re more than willing to spend money, provided they get the desired target returns.

Of course, the D&A line is much higher than CapEx at present – a function of prior management’s expansion-without-consideration strategy. Sardar indicated that he thought the D&A curve had already peaked, and would be falling back towards CapEx over time...but that it would be an awfully long time.

On the Restaurant Business
If we (Sardar and Phil) were asked if they wanted to be restaurant investors in 2003 – would have said “no way”. They were attracted by franchising – the royalty on the name, the real estate possibilities, the potential to be a cash cow...and then realized how myopic so many other restaurant executives were (implicit statement, and how much opportunity for them there was...which may be read as a statement of arrogance or confidence...your choice). As per Phil, their experience with restaurants when they joined the board at WEST was that, “We’d eaten in a lot of them.”

Store-level management are incentivized based on store-level cash flows, and it flows up the food-chain (i.e. the store and general managers graded based on that particular store – the district managers graded based on the stores under their perview). Incentives are based on cash flows, but with modifiers (i.e. complaints per 10,000 visits). If good cash flows, but complaints are too high, it could be that good marketing is trumping the negative experience put forth by management. Or, if there are good cash flows, but lousy food costs, again, need a modifier to further incentivize improving the things that matter (Scuttlebutt Note: Know that several districts in Q1-FY10 had portions of cash bonuses for management escrowed due to high food costs...will eventually pay out if corrected...but now incentive to do so). It’s an ongoing challenge - not been a static system. Sardar has had a learning curve – and arguably, you can’t design the perfect system, you need a culture change.

On staffing – sending un-necessary bodies home early – Sardar insisted that was the right of the company – they have to be productive. If they have too many on-staff it’s hurting whole organization. One extra hour of unnecessary store staffing per day per restaurant adds up to an incremental $1MM/year in excess cost. They can’t ignore that because it’s “rude”. That said, they want to be better at scheduling. Phil Cooley chimed in (playing Munger to Sardar’s Buffett...except he sat on Sardar’s right, Charlie’s usually on Warren’s left), “Running a restaurant is no big thing – it’s 1,000 little things.”

Minimum wage laws a headwind for past couple of years – will continue to be so. Of perhaps greater import, costs associated with new national healthcare could run to the “several millions”. The number thrown out by Sardar was an $8-to-$9MM impact to pre-tax earnings. But they’ll do the best they can to manage and control costs. Recent example, they changed the napkins in drive-thru – saving $400K per year (but now I have unsightly ketchup stains in my car!) So there are lots of things to do to save money.

All associates are getting constant training, and they’ve revamped training processes. Their incentive system to help the associates is to emphasize that it’s ALL about the customers. Good customer experience, good for associates. Sardar talked about beefing up muscle at the store level. No district manager gets hired that doesn’t go through a maze, and Sardar signs off on all of them. The litmus test employed (which is a variant on what I’ve heard Tom Gardner espouse before, concerning corporate managements of companies where he might choose to invest), is whether all of our personal money was tied up in the few restaurants under the district manager’s care, would I want that individual running them? If answer is no – they don’t get hired. And just to show how picky they are, of the last 10 new district managers hired, they’ve fired every single one of them (funny, but perhaps an unintended message there too...are you eager to apply for such a post at SNS?)

On the subject of what SNS/WEST might be doing that their competitors aren’t, Sardar said, “We don’t want to tell them! (But even if we did, they probably still wouldn’t do it)”. The main point, “Focus on customer and think about them first.” Have to give perceptibly more value than paid. Reasonable unit economics don’t hurt either. There are several competitors with new store opening economics of Sales/CapEx < 1 (wouldn’t identify them). Yet some competitors have made strategic error over-leveraging (**cough** DineEquity anyone? **cough**).

Another issue – SNS doesn’t hedge beef prices – why? It’s largely a quarterly results management issue. They’re not playing that game. They will hedge if it leads to lower prices over time – a $0.10/lb change in beef prices is a $2.6MM impact pre-tax for SNS. But they are willing to take that hit/benefit....and not many else are.

One of the worst lessons learned at Harvard was on the folly of ‘cost-plus’ pricing – basing your pricing on the willingness of the consumer. Encourages a mindset of not “leaving money on the table” if you’re not charging all the market will bear. This is not the way they’re doing it at SNS. They’re continually asking, what is the lowest possible price they can charge and get their desired ROIC. They want their average cheque to go down...not up. You can tell competitors that...but they may not listen.

Example – the guacamole steakburger - could have chosen to bring in pre-made guacamole instead of making fresh daily – but they think their way is the best and puts the customer first. Provide maximum value, try to charge the least for it. As an aside, this reminded – in a dichotomous sort of way – how they talked at previous meetings about switching out cherry tomatoes for chopped tomatoes in the salads, and thus saved themselves a bunch of money. So I’m wondering whether house-made guac is the cherry tomato, or the chopped tomato here? Or put another way, is it cheaper? Do customers flock to SNS for the house-made guac? Maybe I’d buy that argument from Chipotle or Qdoba...but SNS? Not sure I’m aligned with this particular example.
Phil’s takeaway – want to produce a high quality product at low price. Cut costs...unless it touches the customer, then it’s a ‘no-no’. Otherwise, “cut the damn cost!”

It’s funny where costs have been stripped though. Company had formerly been paying $200K to consultants annually to tell them how prices should change from different stores ($4 at one...$4.20 at cetera). Got rid of consultants – saved $200K – and instead listened to their customers, streamlining their numbers. Franchisees need to set prices consistent with company. Illinois franchisees – don’t see different pricing than Florida. If something is $3.99, it’s $3.99. Period.

Inflation is anticipated – it’s been widely reported and discussed. Basically, there will be inflation, and it will be passed along to consumer. Franchising business will help a great deal. Really, it will come down to competitive nature of the industry – how well SNS does versus competitors. Believe that help the company.

On Seeking Insurance Company Targets
Insurance company(ies) is on the short-list of acquisition targets. Purchases in the space will be opportunistic and depend on what’s available. They would not want to be “strong and wrong” in insurance, and would be seeking a low combined ratio for either short or long-tail risk.

But they see a lot of folks in insurance – and see a lot of mistakes happening - jerking around reserves, earnings management, et cetera. It’s happening at a lot of places. That said, would like us (BH) to get in there so long as it’s with the less complicated end of the business. They’re agnostic as to long or short-tail risk, though their recent actions have suggested a preference for short (i.e. Fremont). They’ll never put the company in a situation where a catastrophe can impact long-run performance.

That said, Sardar indicated that he thinks insurance companies are trading at attractive prices (albeit, with a few carrying some hairy books of business). It was phrased as the “Menu of investments” having improved over past few years. They’re willing to be patient in bagging their quarry.

Wouldn’t take about their valuation of Fremont (recall, SNS bought just a tad shy of 10% there). Termed the battle for Fremont as being “in the first inning.” They’ve already hired the prospective CEO (terming him the “CEO-Elect”) of Fremont. They’re obviously steering down the ‘hostile takeover’ path, and, being an insurance company – the insurance commissioner must approve.

The Michigan commissioner referred to the required senate hearing as a ‘proctologist exam’. Introduced in the senate was a bill that alters the shareholder approval requirement, now stipulating that 2/3 of shareholders must approve change in board composition if the incumbent board does not approve – BUT this only applies to companies with <200 employees. Seems a little convenient, no? Phil called this “politicians playing games”. They’re not looking to take any jobs (**cough** besides one) out of Michigan. BH will continue to actively pursue.

The senate committee – voted for 4:3 for the bill. Senate also voted in favour. Essentially, this is Fremont spending shareholders money on lobbyists to effectively entrench management. The board are apparently also looking to change the law such that they can be a mutual company again. The original reason to go public was to raise capital...but that comes with risks, and now the board/management are seeing some of this risk. They have staggered board, poison pill, now want more. I don’t think Phil was more animated during the meeting than when this discussion took place. He played his Munger-role well.

Why Fremont? Because it’s relatively small, has a clean book of business, carries primarily short-tail risk, and was easy for Sardar et al to evaluate. It’s a simple as that.

Looking only at US-facing insurance investments – “If we can’t figure out in US...we ain’t gonna figure it out in the UK.”

General Buffett-Speak by Sardar and Others
“We have a circle of competence that excludes a lot of things” --Phil Cooley

When asked if they anticipate any further sale-leaseback transactions (you’ll recall there were a bunch of sale-leasebacks done right after Sardar and Phil were elected to the board), or other cash-raising activities, Sardar indicated no – not for the sake of capital-raising. Perhaps surprisingly, he indicated they were “Adverse to sale-leasebacks,” calling them, “Financial engineering tools”. There were some sale-leasebacks in the past that were “pinned on him – but it wasn’t him”. They don’t feel like ruining a bunch of money. That said, they had one where they paid 5% and had the option to repurchase a unit, and they intend to exercise that option in Q3-FY10 – which will be a $1.5MM spend.

From here, Sardar diverged into saying how he loves his work, and that he “Doesn’t use an alarm clock” I suspect this is the Sardar Biglari version of Buffett’s “tap-dancing to work” oft-repeated comment. Work is fun - what’s not fun are conference calls...road they’re not going to do them.

Phil: “Success is an aphrodisiac!”

Sardar (deadpan): “You wanna elaborate Phil?”

The question was asked – you want cigar butts, or great businesses (don’t you just love a false dichotomy in the morning?) Their wish list was expressed as them wanting great businesses, with great management, and bought at great prices...doesn’t often work that way. (Ya don’t say!) They have no problem going hostile, and are quite willing to be combative. They look at a prospective business and price it assuming the changes they have in mind. Not an issue if they have to change things, but look at Mustang – where they got a great person/business combination. Sometimes they only have to change the very top person (**cough** Fremont **cough**).

Phil: “We are cheap...that precludes a lot of deals”.

Sardar called investment banking fees a waste of money. BH could be looked at as a hedge fund structured as a corporation...Sardar has capital allocation; his responsibility

Look at the business through the lens of full ownership – they don’t have a strategic plan...not having one IS the plan. They’re opportunistic.

On the subject of BH’s valuation, Sardar indicated their desire to communicate in ways such that shareholders properly value the company. They’re hoping for a rational price-to-value relationship (a very Buffett-like hope). In periods of extreme valuation, they’re probably not selling, but may engage in a little jawboning of the price (kind of felt like they did a little of that at the meeting). But it can be difficult sometimes – still, Lion Fund has never sold a share, and, in Sardar’s words, “I don’t plan to.”

Their preferred culture is one of entrepreneurial ownership, versus bureaucracy. They want truth-tellers; admit problems quickly, bring up worst-case situations up-front. Don’t fear decision-making such that they’re not making decisions. Bring up the risks – then we’ll choose. The same story is being told at all levels of SNS. Don’t know how to do it any other way. Don’t want people exhibiting behaviours we find ruinous.

Want to build a family of wholly-owned businesses under the BH umbrella. In doing so, you’re making promises to people; promises that you need to honour. Sardar envisions BH as a ‘buy-and-hold’, particularly for things like the SNS operations, citing Buffett’s aversion to ‘playing gin rummy with companies’. BH will not be selling the SNS sub no matter the price; best not to offer (easy to say, I suppose, when it’s your one sub of substance).

Dissimilarity to Bershire/Buffett – they’re willing to get in on unfriendly terms, using social avenues – 13D, letters, tender offers (unsolicited). Buffett is at a different size...and of a different personality. What works for Buffett, works for Buffett. What works for Sardar/ for Sardar/Phil. Demand value – willing to get involved in many dimensions to extract that value.

Phil: “Think how Warren has changed over the years. Not so sure that Warren is still Warren.”

At one point, Sardar actually said that, with BH, they’re “painting a portrait of sorts”. If you’re playing the Buffett drinking game, take a swig.

The subject of mistakes of omission versus commission arose. Sardar stated that he didn’t believe there had been any mistakes of commission (though there would be plenty going forward...hopefully not in large magnitude, but they were ‘inevitable’). But he allowed that there had been mistakes of omission - SNS needed to be turned, and then holding company structure implemented. Along the way, a number of stocks could have been purchased – they were obvious buys – didn’t (‘sucked our thumbs’ anyone?) They’ve now advanced significantly. One could argue it was a mistake of omission to not have moved stronger.

‘Circle of competence’ to them means companies that can be evaluated. Can they learn enough about it? Can they understand it? It’s a nice catch phrase, but people often miss that circles of competence are elastic – you can go to the borders of your circle of competence by hiring competent people to help you. Take insurance – they’re not exactly babes in the woods here, but they’ve also brought in great people to help them understand.

The WEST Merger
One individual asked why, if the free cash flows at WEST appear more difficult, why BH bought WEST, and did not repurchase SNS shares instead. This actually touches on a particular bugaboo of mine – I’ve seen the notion that WEST doesn’t generate FCF trotted out several times. And it’s somewhat in error, due to the some of the obfuscations of the investment activities (obfuscations that are, largely, Sardar’s fault in the first place). Talked a little about this here:

I wrote elsewhere the following (members of Million Dollar Portfolio can just follow the link – the rest of you will have to pine for the fjords...):

“[N]ote that these are debentures to pay ~$22.9MM in 5 years. The net after-tax actual cash outflow for SNS will be about $2MM annually - if that number seems familiar, it's approximately the annual FCF of WEST.

So, one could argue that SNS is engaging in a little "I'll pay you Tuesday for a hamburger today" kind of thinking, and deferring the actual payment for WEST by five years (when, presumably, SNS will be bigger, healthier, and with considerably more capital at their disposal). And in the meantime, WEST's present shareholders (which include me) will see WEST's FCF essentially diverted, via interest on the debentures, back to them. And over this time, WEST will, hopefully, be folded into the company such that areas of synergy (marketing, operations, et cetera) will be realized, and FCF in five years will be larger (not enough to repay the debentures, of course, but maybe to contribute a little).” --written 13-Aug-2009

I’m not real sure where the ‘WEST has no FCF’ theme started, but it was nice to see Sardar say at the meeting that (paraphrased), “The cash flows of WEST are actually strong – but obscured. The franchise operations generate more than sufficient cash to pay the interest on the debt.” He was quite militant on this point – WEST produces enough cash to more than pay interest on the new debt (the potential for self-dealing with that debt, I leave for you to decide).

This is not to say that WEST has not been challenging in certain aspects (I think it fair to say you’re not getting much growth in FCF from WEST going forward...). WEST has never been run by Sardar – they’ve always hired someone (and had that high level of turnover consistent with their SNS district managers...hmm...anyone noticing a trend?) They’ve definitely made mistakes. Their franchising business has had difficulty enforcing their policies, and their franchise agreements haven’t been as strong as, say, at SNS.

Still, a number of franchisees have exited – and expect to lower WEST’s cost structure via SNS. Food costs will come down via the levered strength of SNS. Also levered from SNS will be franchising expertise for WEST (though, I might be more comfortable with the word ‘expertise’ if they actually franchised a number of successful new stores, before using the word...just sayin’) They’re looking to gain 1-to-3 Wood Grills per year – such operations are termed ‘a good business’. Plus, WEST came with real estate and other investments.

Investment Management under the BH Umbrella
The purchase of WEST gave them 51% of Mustang. The BH board of directors met the day before the annual meeting to talk about the Lion Fund being potentially folded into BH. Moreover, they’re going to attempt to raise capital for in investment management purposes. One of the triumvirate of named businesses that Sardar/Phil specifically called out as desirable (the others being franchised restaurants and insurance).

Now this is interesting from a number of perspectives (and I’m trying to remain agnostic as I mull these things over). How is any potential acquisition of Lion going to be played? Lion owns a not-insignificant number of SNS shares. Will those shares be first disgorged to the investors in the Lion Fund, a la the WEST acquisition? If not, is this not limiting to the fund? What message will be sent if the Lion Fund starts selling shares once subsumed within BH? (‘Course this argument stands today...don’t think folks would take kindly to Sardar selling now with Lion Fund standalone). Will Sardar continue to manage Lion Fund separately under the BH umbrella? (Admittedly, I find it less potentially off-putting than Sardar managing both a standalone Lion, as well as the cash/capital of BH and having to choose which entity gets to buy into his latest idea...and in what order, and with what volume...)

And will Sardar maintain a piece of the general partner of Lion Fund after it’s in the sweet BH embrace? That’s potentially a great deal for him, but it opens up some more questions – capital-raising for what purpose? Questions as to the activities within Lion Fund being done to benefit Sardar personally, et cetera?

Guess we’ll have to see how this is done (if it is done).

But this is a natural segue to Sardar’s compensation; because he has designs on more than the $900K currently paid him. And he sees himself getting paid for performance (how you measure that performance is, of course, the rub). Sardar brought up former Coke CEO Roberto Goizueta (who I’ve always had a soft spot for, since he coined...or at least popularized...the phrase, “The one with the biggest cash flows wins”.) When Goizueta took over Coke, the market capitalization was $4B. Fourteen years later, it was $150B. Goizeuta got $1B for his troubles. The question posed...would you rather have Roberto Goizueta running Coke, or all those (lesser paid) who followed him?

Want us to look at BH as akin to a hedge fund; that’s how it’s managed. His (Sardar’s) name is now on the company. He’s ‘all in’, emotionally, economically, he’s not a “transient CEO”, he’s “here until I die”. Looking to create value – enjoy working with people I like. It’s a fun situation, but he’s not looking to be the lowest paid CEO along the way. The pay for performance is a mindset and philosophy is the one believed in. Roberto got paid for performance. Buffett got paid for performance. It’s when you get paid for failure, that it’s an issue.

So we’ll watch how this plays out. But any ill-formed concerns of mine would be alleviated if we saw the Lion Fund brought in ‘clean’ with no lasting ties giving Sardar a ‘taste’ of performance in perpetuity.

It was rightly asked how they guard against hubris. Sardar answered that “We know how bad things could get. What could go wrong – ask yourself.” They’re not looking to do the ‘one step forward/two steps back’ two-step. Phil cut in to define hubris as ‘overweening pride’, but every CEO needs pride (just doesn’t need ‘overweening’ pride).

But with Lion perhaps under BH, and Sardar’s compensation on the table, it was pointed out that, without Lion, Sardar’s personal stake in BH is fairly low. How to look forward? Sardar wouldn’t talk about the corporate structure going forward, but would only say he’d be a net purchaser of BH over time. He’s 32 and doesn’t golf, instead putting in 80-90 hrs a week doing what he loves. So I guess we stay tuned to see how Lion Fund is folded in.

On Being “The Next Buffett”
I’ve long maintained that Sardar is not Buffett, is most likely not “the next Buffett” (whatever that means), and that, anyway, if we’re going to reasonably compare his capital allocation skills to that of the original, we’re going to need about twenty more years before we can make a well-reasoned argument.

What I think is fair to say, is that Sardar has visions of building a company in the mold and model of Buffett. On that front, so far, I think he’s done a pretty decent job with a couple of caveats (he lives a little less austerely than St. Warren, for example).

Sardar argued that his salary ($900K) should not be compared to the salary of Buffett today ($100K since that was actually a big number). He suggested using Buffett of the partnership years, and of a real comparison at that time. Comparison to Berkshire should not be made – since he views it as a disservice to Buffett who took over Berkshire in 1965 when the company’s book value the preceding year was $22MM (and they made $176K). The 1964 Fortune 500 aggregate profit was ~$20B – yet in 2009, Berkshire made a $21.8B aggregate gain in book value. If BH’s performance surpasses that in 45 years, then comparisons are warranted. But otherwise, BH is in an embryonic stage – if comparing to Berkshire or anyone else, you are going to be very disappointed

On Share Repurchases
For something that was touted heavily in the campaign by ‘The Committee to Enhance Steak n Shake’ two-and-a-half years ago, I have to say, I’m somewhat shocked that there’s been little push-back on the lack of share repurchases. I mean, even after the Pru debt was retired, and the cash started to really pick up speed, you could still have retired a meaningful chunk of the company at around $220/shr ($11 pre-reverse split). Go back and read some of the filings at the time in the war of Biglari/Cooley vs. Steak n Shake incumbent management.

Yet, nary a share was repurchased. And now, you’ve got Sardar making comments at the meeting to the effect of, “You people need to stop bidding up the stock – there aren’t going to be any repurchases here” Uh-oh...that sounded like he called the stock over-valued (at ~$400, or $20 pre-split). But then, went on to reveal that a limited partner (of Lion Fund? Mustang? Don’t remember) has about $900K of BH shares and is looking to get out. So that BH would buy and retire the shares (earning fees on the appreciation too). Still, a million bucks of repurchases of a no-longer-undervalued stock is hardly what was advertised during the original proxy battle. From the perspective of judging capital allocation – was an opportunity missed here (retire more shares earlier)? Discuss.

On Market Valuations in General
A lot of restaurants are moderately to over-valued; prices have blossomed even though the economy hadn’t recovered – it’s an obvious phenomenon. And it holds true for even under-performing chains, some of them are grossly overvalued. It’s a little difficult to play the [buy cheap acquisitions] game. They recommend patience; they’ll do better later.

The Humane Society of America tried a couple of times to press the point on SNS using ‘cage-free eggs’ in their restaurants. It’s an argument I sympathize with (my eggs come from a local farmer, and are bought at the town’s farmer’s market), but the method I do not. Frankly, the HS representative cited a few misleading statistics, and framed his argument as if to say that competitors like Burger King, Denny’s IHOP, et cetera, or even large grocery retailers (Wal-Mart, Target) were all on-board, and offering 100% cage-free eggs (when really, they might have self-imposed standards for, say, 10% eggs being from non-caged birds. It was much more speechifying, than questioning, frankly.

Sardar gave the right answer, in my opinion, saying that they don’t run the business for what others want – they do what the law says, they do what shareholders want, and they’ll do what is best to get more consumers. Beyond that, they don’t exercise any other judgement. They can’t use their personal judgement to make the decision. They don’t have a mindset that cannot alter course. If the market dictates they’ll have more customers from using cage-free eggs...they’ll use cage-free eggs. If not, they won’t. And it will be a wholesale switch, if it ever comes to that – no 10% quotas for them. They’ll run the business for shareholder returns.

On the sale of SNS-branded products in supermarkets, Sardar reiterated that they selling chilli in a number of Wal-Mart’s, and they’re love to see SNS brand out more in marketplace. They’re looking at all sorts of opportunities, but it’s challenging; they don’t want to leave money on the table. Basically, it’s on the radar screen, but they’re not yet doing a good job of it.

On the past offer by WEST to buy a tiny portion (1%) of Jack in the Box (JACK), Sardar indicated they don’t comment on interests, whether they have them or not – but as to the reason why they withdrew the offer, WEST’s share price declined to point that we wanted to repurchase shares. The rules don’t let you have open tenders stock-for-stock and do repurchases at same time. So they cancelled the tender and repurchased WEST shares.

The question of whether SNS owns undisclosed positions in restaurant shares was raised. The answer, a simple “Yes”, but unless they’re required to make a filing (i.e. over 5% beneficial ownership), they don’t disclose. Personally, I’ve opined several places before that I’d be shocked if some of the unknown $6MM in investments on the most recent balance sheet wasn’t DENN stock, given Sardar’s running buddy Jonathan Dash is the front-man trying to pull the ‘Sardar Manoeuvre’. I even half-expect Sardar/BH to perhaps join Dash’s 13D group if that fight goes into overtime, similar to what the Aramian family, Tim Taft, Wayne King, et cetera, did with Sardar and SNS. We’ll see – my insight and $2.50 buys you coffee at Starbucks...

Opportunistic. Never give a timetable. Don’t know how things will look in 10 months, let alone 10 years from now. But are in it for the long haul. SNS will produce cash far in excess of its needs, and that cash will be suitably redeployed for the benefit of all stakeholders. Interesting tid-bit – BH recently made a $200MM bid for another company, but was rejected (cue speculation engine...)

Asked what they look for in faltering restaurant chains. Gave something of a non-answer, but Phil did say the biggest thing to look at is how G&A costs expand over time – most companies bloat up G&A 30% higher than required – a result of human behaviour. I might add my own observation that, in addition to that (witnessed at WEST, SNS, and FRN), the long-term mindless expansion trend without regard to ROIC vs WACC would be a good pointer...but that’s my words, not Sardar/Phil’s.

Finally, someone (drunk?) asked, if, in 10 years, BH fails, why? Phil quipped, “It means we went insane”. Sardar was a little more diplomatic, saying that that would mean they’d taken actions that would be against their operating principles. Daily, they seek to reduce risk. They’re looking for now home runs – they’re in this for the very long term. Phil’s response, “There’s no bet-the-company risk here”.

Thursday, July 15, 2010

Early Warren Buffett Investment - Sanborn Maps

The early Buffett partnership letters are available in many places on the internet. I find ths story of his success with Sanborn Maps to be very interesting. Here it is as told by WEB to his partners.

Sanborn Map:
Last year mention was made of an investment which accounted for a very high and unusual proportion (35%) of our net assets along with the comment that I had some hope this investment would be concluded in 1960. This hope materialized. The history of an investment of this magnitude may be of interest to you.

Sanborn Map Co. is engaged in the publication and continuous revision of extremely detailed maps of all cities of the United States. For example, the volumes mapping Omaha would weigh perhaps fifty pounds and provide minute details on each structure. The map would be revised by the paste-over method showing new construction, changed occupancy, new fire protection facilities, changed structural materials, etc. These revisions would be done approximately annually and a new map would be published every twenty or thirty years when further paste-overs became impractical. The cost of keeping the map revised to an Omaha customer would run around $100 per year.

This detailed information showing diameter of water mains underlying streets, location of fire hydrants, composition of roof, etc., was primarily of use to fire insurance companies.

Their underwriting departments, located in a central office, could evaluate business by agents nationally. The theory was that “a picture was worth a thousand words” and such evaluation would decide whether the risk was properly rated, the degree of conflagration exposure in an area, advisable reinsurance procedure, etc. The bulk of Sanborn’s business was done with about thirty insurance companies although maps were also sold to customers outside the insurance industry such as public utilities, mortgage companies, and taxing authorities.

For seventy-five years the business operated in a more or less monopolistic manner with profits realized in every year accompanied by almost complete immunity to recession and lack of need for any sales effort. In the earlier years of the business, the insurance industry became fearful that Sanborn’s profits would become too great and placed a number of prominent insurance men on Sanborn’s board of directors to act in a watch-dog capacity.

In the early 1950’s, a competitive method of underwriting known as “carding” made inroads on Sanborn’s business and after-tax profits of the map business fell from an average annual level of over $500,000 in the late 1930’s to under $100,000 in 1958 and 1959. Considering the upward bias in the economy during this period, this amounted to an almost complete elimination of what had been sizable, stable earning power.

However, during the early 1930’s Sanborn had begun to accumulate an investment portfolio. There were no capital requirements to the business so that any retained earnings could be devoted to this project. Over a period of time about $2.5 million was invested, roughly half in bonds and half in stocks. Thus, in the last decade particularly, the investment portfolio blossomed while the operating map business wilted.

Let me give you some idea of the extreme divergence of these two factors. In 1938 when the Dow-Jones Industrial Average was in the 100-120 range, Sanborn sold at $110 per share.

In 1958 with the Average in the 550 area, Sanborn sold at $45 per share. Yet during that same period the value of the Sanborn investment portfolio increased from about $20 per share to $65 per share. This means, in effect, that the buyer of Sanborn stock in 1938 was placing a positive valuation of $90 per share on the map business ($110 less the $20 value of the investments unrelated to the map business) in a year of depressed business and stock market conditions. In the tremendously more vigorous climate of 1958 the same map business was evaluated at a minus $20 with the buyer of the stock unwilling to pay more than 70 cents on the dollar for the investment portfolio with the map business thrown in for nothing.
How could this come about?

Sanborn in 1958 as well as 1938 possessed a wealth of information of substantial value to the insurance industry. To reproduce the detailed information they had gathered over the years would have cost tens of millions of dollars. Despite “carding,” over $500 million of fire premiums were underwritten by “mapping” companies. However, the means of selling and packaging Sanborn’s product, information, had remained unchanged throughout the years and finally this inertia was reflected in the earnings.

The very fact that the investment portfolio had done so well served to minimize in the eyes of most directors the need for rejuvenation of the map business. Sanborn had a sales volume of about $2.5 million per year and owned about $1 million worth of marketable securities. The income from the investment portfolio was substantial, the business had no possible financial worries, the insurance companies were satisfied with the price paid for maps, and the stockholders still received dividends. However, these dividends were cut five times in eight years although I could never find any record of suggestions pertaining to cutting salaries or director’s and committee fees.

Prior to my entry on the Board, of the fourteen directors, nine were prominent men from the insurance industry who combined held 46 shares of stock out of 105,000 shares out standing. Despite their top positions with very large companies which would suggest the financial wherewithal to make at least a modest commitment, the largest holding in this group was ten shares. In several cases, the insurance companies these men ran owned small blocks of stock but these were token investments in relation to the portfolios in which they were held. For the past decade the insurance companies had been only sellers in any transactions involving Sanborn stock.

The tenth director was the company attorney, who held ten shares. The eleventh was a banker with ten shares who recognized the problems of the company, actively pointed them out, and later added to his holdings. The next two directors were the top officers of Sanborn who owned about 300 shares combined. The officers were capable, aware of the problems of the business, but kept in a subservient role by the Board of Directors. The final member of our cast was a son of a deceased president of Sanborn. The widow owned about 15,000 shares of stock.

In late 1958, the son, unhappy with the trend of the business, demanded the top position in the company, was turned down and submitted his resignation, which was accepted. Shortly thereafter we made a bid to his mother for her block of stock, which was accepted. At the time there were two other large holdings, one of about 10,000 shares (dispersed among customers of a brokerage firm) and one of about 8,000. These people were quite unhappy with the situation and desired a separation of the investment portfolio from the map business, as did we.

Subsequently our holdings (including associates) were increased through open market purchases to about 24,000 shares and the total represented by the three groups increased to 46,000 shares.We hoped to separate the two businesses, realize the fair value of the investment portfolio and work to re-establish the earning power of the map business. There appeared to be a real opportunity to multiply map profits through utilization of Sanborn’s wealth of raw material in conjunction with electronic means of converting this data to the most usable form for the customer.

There was considerable opposition on the Board to change of any type, particularly when initiated by an “outsider,” although management was in complete accord with our plan and a similar plan had been recommended by Booz, Allen & Hamilton, Management Experts. To avoid a proxy fight (which very probably would not have been forthcoming and which we would have been certain of winning) and to avoid time delay with a large portion of Sanborn’s money tied up in blue-chip stocks which I didn’t care for at current prices, a plan was evolved taking out all stockholders at fair value who wanted out. The SEC ruled favorably on the fairness of the plan. About 72% of the Sanborn stock, involving 50% of the 1,600 stockholders, was exchanged for portfolio securities at fair value. The map business was left with over $1.25 million in government and municipal bonds as a reserve fund, and a potential corporate capital gains tax of over $1 million was eliminated. The remaining stockholders were left with a slightly improved asset value, substantially higher earnings per share, and an increased dividend rate.

Necessarily, the above little melodrama is a very abbreviated description of this investment operation. However, it does point up the necessity for secrecy regarding our portfolio operations as well as the futility of measuring our results over a short span of time such as a year. Such “control situations” may occur very infrequently. Our bread-and-butter business is buying undervalued securities and selling when-the undervaluation is corrected along with investment in “special situations” where the profit is dependent on corporate rather than market action. To the extent that partnership funds continue to grow, it is possible that more opportunities will be available in “control situations.”

JP Morgan Analyst Makes $9 per share error on ATP - a stock trading at $10 !

I snuck out early today for a round of golf. When I got back I found ATP had jumped 11% in the last 30 minutes of trading.

Why ? A correction came out from JP Morgan relating to their Monday downgrade of ATP for which they placed at $10 price target.

And to say the correction is material is a wee bit of an understatement.

On Monday JP Morgan had warned investors that ATP would need an additional $500mil of external capital over the next 2 years. JP Morgan explained that the market did not understand just how much of ATP's revenues over the next 2 years would be going to pay for net profits interests the company had sold to 3rd parties. When you consider that the entire market cap of ATP is currently $500mil......well them needing another $500mil of cash from external sources is rather disturbing.

After this news ATP shares dropped 15% on Monday and Tuesday.

Fast forward to today and it turns out that it is JP Morgan who doesn't understand how much of ATP's revenue would be going to it's net profits partners. JP Morgan issued the following correction which I found on a message board on the internet:

"On Tuesday, July 13, we published a note on ATPG titled, “Trading at a
Premium; Financing Needs Likely Greater Than Market Thinks;
Downgrading to Underweight.” In that note we made an error of
approximately $450MM in our calculation of ATPG’s financing needs.
• Double counted re-payments for overrides and net profits interests.
We model ATPG’s overrides (ORRIs) and net profits interests (NPIs)
and attempt to calculate the cash flow impact of these financial
transactions. ATPG re-pays a "principal" portion and an "interest"
portion for these financings. We double counted the principal portion of
repayments for years 2010 and 2011. The magnitude of this error is
around $450MM.
• Adjusted model for error. The attached model adjusts for the above
mentioned error. In our July 13 note, we stated that it appeared that
ATPG would need $500MM of external capital. This model corrects
that error and reduces that need to $50MM"

Are you kidding me ? You double counted something that is the size of the entire company market cap ? You made an error that is equal to the size of the entire market cap of the company !! Instead of needing $500mil, ATP actually only needs $50mil ? In other words, they basically do not need any help from anyone in funding capex ? That is quite a mistake.

Coming up with $50 mil shouldn't be much of a problem as ATP has a refinancing deal for the Titan that should occur in the near term which will provide the company with at least $200mil or more. They also have recently revised a debt facility that allows for an additional $350mil of room under it.

I will give JP Morgan credit though for doing the right thing and correcting this error. They could easily have let it fade away and come out with a new report in 6 months. And hey, everyone makes mistakes.

Speaking of mistakes. The same JP Morgan analyst made another whopper in April when they issued their first report on ATP. In that report they used a production profile that was dated before ATP discovered 30 million barrels of proved reserves at Mirage.

How big was that error ? Well they took 30 million barrels of oil that were going to be produced in the 4 year window that the Titan is at Mirage and ignored them. And then also moved up the capex related to the Titan relocation by 3 or 4 years which also had a material impact on their value per share. I'll let you calculate the PV impact of this, but it is safe to say it is an even larger error than the one today.

So I guess lesson for the day is don't trust anyone else's analysis no matter what company letterhead it is written on.

With this correction getting circulated tomorrow, the BP well being capped, the Titan monetization happening soon, the MC941 #3 well set to come on in weeks (and raise production by up to 33%) and a 30% plus short interest.........ATP shares could have quick move up in the next couple of months if the government can stay out of the way.

Disclosure: Long ATPG

ATPG - Thanks for your help BP

Just unbelievable. Almost every day this thought goes through my head.

I remember very clearly an evening in mid-April this year when I noticed on a message board that ATP had fully replaced it's existing long term debt facilities. I thought to myself, finally I can relax.

I started writing about ATP in the spring of 2009 with the stock at $5 or $6. Around that time I took what I thought was a fairly well thought out risk and made ATP a very large holding.

At that time the company was short on cash and needing to complete a major Deepwater project at their Telemark hub. The market thought that they were done for, I thought that they could sell off pieces of assets to squeak through to the completion of Telemark.

And although it didn't go exactly as I thought it would, the company was able to raise cash through selling pieces of infrastructure, issuing some equity, and using creative vendor financing. And the reaction in the share price was rewarding. ATP reached first production from Telemark and replaced an unfriendly debt structure. From as low as $2.78 in March 2009 the stock price hit $23 immediately before the BP spill.

Since then.......down, down, down as the drilling moratorium has and government threats of liability and financial responsiblity caps have frightened investors.

Without government intervention I believe ATP shares are worth considerably more than $30 per share. I've written numerous times explaining that valuation, so I won't repeat again. The problem is that I have no idea what the government is going to do, and therefore I have no idea what the value per share is.

Here is an update with my current thoughts/information:

1) MC941 #3 well is the second Telemark well that will come on production. Based on conversations the company has had with investors it will come on production in August. This well should be at least 7,000 BOE per day and will likely be closer to 10,000 BOE per day as they are pulling from a thick zone with more than 200 feet of pay.

2) Titan monetization is still a go. Again based on conversations the company has had with investors I would look for this some time in August. I was expecting that ATP would net about $350mil in cash from this refinancing (it is a refinancing, not a sale).

3) Step 2 to Titan monetization. When the time is right (depends on market conditions) the equity interest of the Titan SPV will be taken public thereby raising more cash for ATP parent to develop the oil and gas properties.

4) Octabouy topsides construction cost deferral. I believe ATP is speaking with the manufacturer of the Octabouy (the floating unit from their UK Cheviot field) about deferring the construction costs for the remainder of the Octabouy as they did for the hull. The plan would be to roll the Octabouy directly into a Titan like SPV which would fund the construction cost. This would eliminate a huge amount of capex from ATP's 2011 capex budget.

5) The third and fourth Telemark wells. Currently the government's 2nd moratorium means these can't have their drilling completed until after it expires in November. If that is when they can be finished, really isn't a big deal as it is just a couple of month delay. But who knows what the government will do.

6) The proposals to raise the liability cap and financial responsibility cap. This is the elephant in the room because these could force operators like ATP out of the Deepwater. However, there seems to be a real issue that the government has to consider and that is that trying to apply these changes to existing leases is a pretty clear breach of contract. Breaching these contracts could make the government liable for tens and tens of billions of dollars from companies who incurred costs under the terms of the original contract.

7) Smaller operators have already been speaking off line about pooling together to address these cap issues. I'm sure there will be all kinds of ideas that could come forward to work around whatever the government comes up with.

8) Don't forget Gomez. Everyone focuses on Telemark and how they are being impacted by the government issues but this is going to hurt at Gomez as well as there were two wells scheduled for late 2010 early 2011 that would also be big producers. And most importantly was an exploration well to be drilled on MC710 that could have added significantly to ATP's reserves.

9) There is another well to be completed at Gomez MC754 that is having a pipeline laid. It is already fully drilled so not impacted by the moratorium.

10) There is potential for a partner to be brought in at Cheviot. ATP was discussing doing this with an interested party earlier in 2010. Should they do this it would greatly reduce capex requirements, although certainly give away some value per share.

What am I doing with my shares ? Nothing. Just holding. If we find out that existing leases won't be impacted by any government changes or if the noise about making changes dies off after BP plugs the well ATP shares really have no reason to be below the $23 that they were at in April. On the other hand who knows what the government might do, and with the debt ATP carries any negative actions are amplified.

The short interest here is now enormous. If things do take a turn for the better the share price move upwards could be very dramatic.