BEHIND THE NEWS: Steak n Shake troubles may cut chance of sale

Here’s a silver lining to The Steak n Shake Co.’s deepening woes: They might scare off potential buyers, keeping the locally based diner chain independent for the foreseeable future.

“While Steak n Shake continues to look at alternatives to increase shareholder value, we believe the business will need to be stabilized to attract any meaningful interest,” CL King & Associates analyst Michael Gallo wrote in a new report.

Indeed, getting the 491-restaurant chain back on track could take a long time and a substantial investment, added Conrad Lyon, an analyst with FTN Midwest Securities Corp.

That means the activist investors that have swarmed around Steak n Shake in recent months probably wouldn’t favor a quick sale, since they paid more per share than an acquirer likely would ante up, Lyon said.

Such are the complex dynamics surrounding Steak n Shake, which now has racked up nine straight quarters of declining same-store sales. Fiscal-fourth-quarter results, reported Nov. 15, were especially bleak. Same-store sales slipped 3.9 percent and profit tumbled 80 percent.

Worse, management warned not to expect much in fiscal 2008. Revised earnings guidance for the year is more than 30 percent below what analysts had expected. The scaled-back expectations stem from higher commodity prices, reduced store openings and weak consumer spending driven by soaring gas prices and housing woes.

All the bad news drove the stock down as low as $10.15 a share in late November. It later rebounded slightly to $11.25, but remains 35 percent off its February 2007 high and a hair above its four-year low.

Had Steak n Shake been performing a little better, and the buyout market been a little stronger, the company might have slid into a suitor’s arms by now.

The dynamics that investment bankers say often spawn a company’s sale are in place. For starters, there’s a leadership void. Steak n Shake CEO Peter Dunn stepped down under pressure this fall, and the company hasn’t named a permanent successor. Meanwhile, an aging board is running the show, led by the company’s chairman, 77-year-old Alan Gilman, who serves as interim CEO.

Then there’s the fact that Steak n Shake in August appointed a special committee of independent directors to “assist management in evolving the strategic plan and examining potential opportunities.” Notably, the committee hired Merrill Lynch as its financial adviser. Steak n Shake won’t discuss details of Merrill’s role, though Gilman said on a mid-November analyst conference call that “they are looking at all of the strategic alternatives.”

Often, companies hiring such advisers end up selling. In fact, the advisers typically have a financial incentive to encourage a sale, since they can earn a multimillion-dollar fee if a deal closes. It’s not clear what compensation arrangement Steak n Shake worked out with Merrill; the Indianapolis company hasn’t revealed terms.

Yet a lucrative sale to a high-flying private equity firm is far less likely today than it would have been a few months ago, before credit markets slid into turmoil and slowed the buyout frenzy.

And because Steak n Shake has devolved into a turnaround story, potential suitors likely wouldn’t be willing to pay much of a premium to where the stock now trades, analysts said.

All of which puts the two activist investor groups that now collectively own 18 percent of Steak n Shake in a tough spot. Regulatory filings show affiliates of the Austin, Texas-based Lion Fund and a separate investment partnership based in Dallas bought many of their shares for more than $15 apiece-a substantially richer price than they probably could reap in a quick sale, Lyon of FTN Midwest said.

Neither investor group is talking publicly, but analysts say they probably are looking for alternative ways to unearth value. One option would be to take on debt to buy back stock, which has the effect of reducing the number of shares outstanding, thereby boosting earnings per share. Another would be to sell off real estate. The company owns about onethird of its restaurant locations. It could sell properties, then lease them back.

Applying the most pressure publicly is the Lion group, which has nominated two candidates for the company’s board and purchased space on three Indianapolis-area billboards advocating their election. In a letter to the company this fall, Lion assailed the company for its “failed vision, failed strategy, failed execution and failed board.”

Ultimately, however, the activists share a common agenda with the company’s management and board. The best way for all to make money is for Steak n Shake to rapidly ratchet up its performance.

Unfortunately, Gilman acknowledged on the conference call, there are “no silver bullets.” He admitted that the company had lost its way by rolling out too many new products that added distracting complexities to food preparation. The rollouts of chicken sandwiches and other fare hurt customer service and took the spotlight off the company’s signature products-hamburgers and fries.

“We’re clearly disappointed with the operating results and we’re working with a sense of urgency to address these business challenges,” Gilman said, sounding up to the task.

Analysts have a show-me mind-set. There could hardly be a more difficult time to try to fix such deep-seated problems, Lyon observed, calling this “one of the worst consumer environments since we entered the new millennium.”