Sardar Biglari: Recommendation Shareholders Of Cracker Barrel

The purpose of this memo is to recommend shareholders of Cracker Barrel (CB) concerning their votes determining whether or not Sardar Biglari should obtain a seat on the board. Also, we recommend practices need to improve CB’s performance in the future.
Biglari, as the largest single shareholder, has the right to test resolves and examine the fiduciary duty of the board. Challenges he brought up have made the board take changes. Although alarming effect of his actions, shareholders should not vote in favor of Biglari. First, current directors’ working relationship and balance might be jeopardized. There is no doubt that the board has done a satisfying job making CB survive the recession and continuing to grow. The integrity of CB’s board must

be maintained to ensure continuity. Second, tact and aggressiveness Biglari has shown are of concern. His track record of disruption and role as CEO of CB’s competitor could cause negative sentiment so that the objectiveness required to make sound judgments of CB’s future would be biased. What’s more, Biglari attempts to force reform. Forcing changes is seldom motivational. At last, Biglari intends to expand CB, which is centered on the U.S. South, overseas into emerging markets. Expanding overseas would overextend the company into markets that may lead to eventual failure.
In order to improve CB’s performance, we recommend the board following practices.

First, forming an audit committee to reinforce a high road accounting measure. Segment wise reports for restaurant and retail operations are recommended. Second, establishing a compensation committee to review CEO goals, evaluate performance and determine compensations. Current executive compensation plan was based on 1994 standard and need update. Third, the threshold of poison pill should be raised to 20%. The 10% trigger might restrict investors without hostile intent in ISS’s perspective. However, activating poison pill is not recommended. At last, a nomination committee should be established to nominate independent directors. This committee would also recommend appropriate service tenure for independent board

members.
CB’s financial performance has been mediocre.

Between 2005 and 2011, its operating income has declined by 0.5% and customer traffic has decreased at an average pace of 2.2% annually. However, 75 successful new retail locations and paying down some long-term debt are signals of CB’s not-so-bad performance. Revenue and operating income growth has been challenging for the past years. Even if revenue has increased by $244 million, CB’s operating income has decreased by $1.6 million. CB’s strategy for revenue increases has been to open new restaurants, an attempt seemed to inflate financial results rather than solve real problem. Declining operating income growth indicates the ineffectiveness of this strategy. In terms of the longevity and proximity to CB and directors, aside from adding new members in 2011, the board has remained fairly constant with some members even back to 1971. After Biglari announced his intentions, four new directors replaced three existing directors and Mike Woodhouse stepped down and was replaced by Sandra Cochran, who then announced a six­point plan to improve sales and profits and to update pricing strategy. This change got positive market response with CB’s stock price rebounding from an 18­month low, subsequently increasing by over

25%.
Peer group was selected to evaluate CB’s performance. Biglari’s comparison of CB to the S&P 500 index is inaccurate. First, Biglari only considered large companies (Chipotle, Darden, McDonald’s, Starbucks, and Yum! Brands). However, CB is a small cap restaurant chain with approximately 600 locations, all located in the U.S. The S&P 500 Index primarily includes restaurant chains with an international presence and thousands of locations. Second, fast food restaurants were excluded. Although CEC Entertainment and Red Robin were labeled as “Quick service”, we found them “casual dining” and “family restaurant” (similar to CB), thus should be included in the peer group. Third, only family restaurants without a main business focus on alcohol service were included in peer group. We included restaurants serving alcohol, but avoided comparing CB to pub/bar- style peers, as they catered to entirely different customers. At last, we only consider restaurants in the low to moderate price range. Higher­end restaurant chains were excluded because targeting customers are different. Our selection of CB’s peer group include: Biglari Holdings, Bob Evans Farms, CEC Entertainment, Cheesecake Factory, PF Chang, Ruby Tuesday, Texas Roadhouse. Biglari’ selection only served his purpose of making CB’s performance appear worse than it actually is. For example, CB’s ROA (15.4%) seems quite low compared to Biglari’s peer group (33.9%), but relatively high compared to our peer group (11.8%) (Exhibit 1). A similar situation occurred when comparing 1-7 year returns (Exhibit 2). Biglari’s peer group earns a 235% return over this period, while our peer group actually loses 21%. CB’s 7­year return of 27% actually seems quite attractive comparing to our peer group. When comparing same­store sales growth, gross margin, and EBITDA margin, and revenue growth, same situations occurred (Exhibit 3-4).