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Showdown at Cracker Barrel Case Solution

Solution Id Length Case Author Case Publisher
2787 1637 Words (8 Pages) Suraj Srinivasan, Tim Gray Harvard Business School : 114026
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Cracker barrel started as a restaurant and country store chain in South America and then expanded into other cities to serve customers healthy food. The company performed well from 2007 to 2010, with a 1.1% drop in sales in 2009 due to increased prices. At first, Biglari shared some letters to Board to criticize the company's performance and management for sharing the consolidated financial reports of the restaurant. 

The management, however, said that they were focusing on delivering the best possible value to the shareholders and declared a poison pill option to avoid Biglari from buying more shares in the company. This fueled the critique of Biglari that the Board is paying themselves bonuses based on terms that need to be updated. The management then let the proxy advisor decide their opine regarding voting Biglari. ISS voted against Biglari, saying that company is on the right track. Glass Lewis, however, supported Biglari's point that the company's stock has underperformed.

Following questions are answered in this case study solution

  1. What is your assessment of Cracker Barrel's ROE over time? What does largely drive Cracker Barrel’s ROE (ROA vs Financial leverage)? Why can high leverage be problematic?

  2. Do you agree with Biglari's critique of the company's performance? Which aspect of his argument resonate the most with you?

  3. Do you agree with Bigalri's choice of peer companies? If not, what peer group would you choose and why?

  4. How does Cracker Barrel's performance compare to your peer group? Fill out template (attached) and provide your inferences from the comparisons)

  5. Imagine the new CEO hires you as her advisor. What suggestions would you have to improve the performance of the company?

  6. How would you have voted on Biglari’s election – for him or against him? Why?

Case Analysis for Showdown at Cracker Barrel

1. What is your assessment of Cracker Barrel's ROE over time? What largely drives Cracker Barrel's ROE (ROA vs. financial leverage)? Why can high leverage be problematic?

Cracker Barrel has seen an increase in its ROE from 2007 to 2010. Since Cracker Barrel is financed through debt, its financial leverage is increased, giving rise to the company's assets due to excess cash. This increase in assets decreases operating ROA in return. But on the other hand, the company has higher leverage gain, which, along with the increase in spread, helps increase the ROE (Operating ROA + Spread*financial Leverage) of the company. Cracker Barrel had 1.1% financial leverage in 2006 and had 13.4% ROE which increased to 59.6% and 71%, respectively, by 2009. In 2010, when financial leverage dropped to 48.2%, ROE also dropped to 62.8%. However, ROA and ROE are not seen to be either negatively or positively correlated.

ROA is calculated by dividing the company's income by its total assets (Liabilities + shareholder equity). On the other hand, ROE is calculated by dividing the company's income by shareholder equity – liabilities. Thus, if the liabilities of a company are equal to 0, both ROA and ROE become identical. That is why the ROE of a company is highly dependent upon the financial leverage (Total assets divided by shareholders' equity) of a company. For instance, if the liabilities of a company become zero, ROE can still be different than ROA because of the financial leverage factor in the calculation of ROE. So, ROE becomes highly dependent upon financial leverage.

With the increase in leverage, the company is increasing the share of creditors in assets, which can increase the conflict between shareholders and management decisions. By law, company is responsible for maximizing the profit/share of shareholders. With increased leverage, company becomes highly cautious of their decisions to protect their creditors against high-risk investments, as the major share in assets belongs to them. The management decision to expand through debt can prove problematic as if the rate of return on these investments decreases, the company will face difficulty in paying off its obligations to creditors and will have to face dire consequences of the decision. So, increasing leverage is good but up to a specific limit which, in this case, I would suggest a 40:60 ratio of debt to equity.

2. Do you agree with Biglari's critique of the company's performance? Which aspect of his argument resonates the most with you?

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