Friendlys Icecream

How did sleepy old Friendlys (FRN) restaurants land in the middle of a dramatic take-over battle? Here’s the “back-story” as I understand it:

Blake versus Smith: Founded in the 1930’s, the company was sold to Hershey’s, then spun off again. One of the founders (S Prestley Blake) owns over 10% of the latest version of the corporation, but has no part in management; indeed, he’s suing management. Meanwhile, Donald N. Smith, Chairman, who also owns over 10% has run Friendlys as part of a nearly unchanged 5-person board for about a decade.

Blake has accused Smith of mismanaging the company; e.g., trading in a $3 million aircraft for a more expensive $8 million one, running an office from Chicago when Friendlys has no restaurants in Illinois, paying staff at that office who do not do much for Friendlys (referred to as “FODs” — “friends of Don” by an employee in court testimony), and so on. These are all accusations, I do not claim them to be facts. Also, Smith has an interest in another company (“TRC”) that has various deals with Friendlys, and Blake accuses Smith of constructing these related-party deals for his own and TRC’s benefit, and not in the interest of Friendlys.

Blake also complains that Friendlys has taken on very expensive debt, and he has offered to lend the company $50 million at 2% over a specified floating benchmark rate, to pay off costly debt. The company responds that the pre-payment penalties would make that a bad idea.

Enter Biglari: Sardar Biglari runs the LionFund, and recently took over another restaurant chain (Western Sizzlin) in a hostile bid. Sometime in 2006, Biglari targeted Friendlys. Like Blake, he too criticizes the debt levels and management performance. (According to Yahoo Finance, in the last 3 years, FRN has had a cumulative near-zero cash-flow, a cumulative loss, and it has had negative net tangible assets. On the other hand, there have been profitable years, and the restaurants have a good reputation with customers.)

Management offered Sardar Biglari first one seat, then two, on an expanded board, but only if he agreed to conditions that would keep him in check for the next three years. This seems like an obvious attempt to buy time. Why would Biglari just sit on the board and nod? He rejected their offer. On March 6th, 2007, Biglari wrote a letter asking shareholders to vote him and an associate (Cooley) as directors at the next annual meeting. Biglari has billboards in Wilbraham, MA and Springfield, MA saying “Vote Biglari and Cooley”, and pointing people to his website.

Perhaps seeing the inevitability of Biglari winning two seats, Friendlys put out a March 7th press release (i.e. the very next day), indicating that they had “…retained Goldman Sachs & Co., as financial adviser, and Weil, Gotshal & Manges LLP, as legal adviser, to assist the Board of Directors in exploring strategic alternatives to enhance shareholder value,...” Then, they postponed the annual meeting!

Friendlys’ website says: “The Friendly Ice Cream Corporation shareholder meeting originally proposed to be scheduled for May 9, 2007 has been postponed due to the previously disclosed alternative strategic review being conducted by the company’s Board. When the Board sets the date for a rescheduled meeting of the shareholders, the new date and time will be posted here.”

Ownership pattern/Proxy fight: From Friendly’s site, I got the following ownership figures (as of May 21, 2007):

  • Biglari Capital Corporation: 14.6%
  • S Prestley Blake: 13.1% [Founder, now suing Friendlys and Donald Smith]
  • Donald N. Smith: 12.2%
  • Kevin G. Douglas: 10.4% (Not sure who he is)
  • Various mutual funds (approx): 23%

With this ownership pattern, and with the possible backing of a few big mutual funds, Biglari appears to be an almost certain winner if there’s a proxy fight. So, it appears that current management is in its final days. Their only hope in not being forced out, is to get an offer that Biglari cannot refuse. If this happens, current shareholders win too.

Who’s the bad guy?: Is Biglari really trying to get rid of mediocre managers who have a poor record, or is he pouncing on a company that hit a temporary bad patch? Friendlys did have net income in some recent years, but a large loss in one year wiped out the cumulative numbers. Friendlys management says Biglari wants to use their company’s free cash fkow to finance other ventures, not investing in the restaurants. Answering this would require more details, and I’ll defer that for now.

Is FRN a buy?: What if no suitors are found? Even if Biglari gets the company, it may take a while, and some court battles; in the meanwhile, fundamentals could deteriorate (particularly with management focusing on this battle, rather than on running the company); the company he finally gets may be in a worse state than it is today. The stock has jumped since Biglari got into the stock. From $8 before Sept 2006, it is $14 today. Having risen so much, is the good news already reflected in the stock-price? This too would require more details, and I’ll defer that to a future post.


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