For those looking for cheap eats and cheap stocks, Cosi (COSI) might be worthnibbling on if you have an appetite for risk and a little patience.
Cosi owns, operates and franchises convenience restaurants. Their restaurants sell hot and coldsandwiches, salads, fresh bagels, pizzas, s'mores and other desserts, a variety of coffees along with softdrink beverages, teas and alcoholic beverages.
Since going public in 2002, Cosi pursued a growth strategy that increased stores from 79 fast casualrestaurants in 11 states to 144 locations in 18 states, the District of Columbia, and the UAE today. Thecompany's goals have always been to build the brand equity, provide a menu offering full of creative, high-quality foods and beverages in an attractive store format, and deliver profits forshareholders.
On the goal of creating a quality product, Cosi gets rave reviews and feedback from customers (includingmyself) for having a fresh, innovative menu, and warm, comfortable dining environment.
As onecustomer I talked to at a recent store visit put it, "I like the fresh ingredients in the made-to-ordersalads, fresh bread, the free Wi-Fi access, and the feeling of a neighborhood cafe rather than a fast-foodchain."
Unlike competitors such as Subway, which have used aggressivepricing promotions such as the $5 foot-long promotion to lure in value-hungry diners, Cosi has steadfastlyheld its pricing so not to diminish its brand and to condition existing customers to a lower price point. Thisstrategy may benefit the company in the long run at the expense of the short term, where the marginalconsumer may be trading down to save an extra buck or two.
As for the objective of making money, Cosi has fallen woefully short and accumulated $80 million of netlosses from fiscal year 2004-08. The company's main issue is that it suffers from a high operating coststructure built for a much larger business model, with food, labor, occupancy and G&A expensesamounting to 100% of revenue in the last 12-month period ending June 29. This compares with amore typical expense ratio of 85%-90% of revenue for casual dining operators of similar revenue size.
This high operating leverage has exacerbated Cosi's problems due to its concentration in theNortheastern and Mid-Atlantic states (30 are located in the New York City and Washington, D.C., centralbusiness districts) where professional job losses have been concentrated. Cosi's total sales held roughlyflat in 2008, but net restaurant sales declined 13.9% in the first six months of 2009 vs. 2008, respectively,as its corporate catering business, in particular, was severely impacted by the pinch of tight corporateexpenses cuts.
In the current recession, the company curtailed its growth strategy and focused aggressively oncash conservation, closing underperforming locations, reducing G&A expenses and attempting toreduce food and lease expenses in a deflationary food and commercial real estate environment.
The board announced a strategic review in November 2008, and by March 2009, with the share price down to 20 cents from a high of almost $11 in 2006, announced it had reviewed various financingand acquisition alternatives, but determined that taking no action was in the best interest ofshareholders.
With the benefit of hindsight, it appears that management and the board made the rightdecision not to sell out shareholders at the nadir of the market. Instead, management and boardmembers astutely bought back shares in the open market and focused on tightly managing the business.
To the company's credit, it has operated at a near cash-flow break-even pace, due in part to its minimal fixed capital expenditure requirements that took place in prior years.
Now with the worst likely behind the company, Cosi has initiated a rights offering to shore up its already debt-free balance sheet. Assuming the rights offering is fully subscribed, the company currently expects to receive gross proceeds of approximately $5 million in a cost-effective manner that provides all of Cosi's stockholders the opportunity to participate and not be diluted.
Management and the board again are putting their money where their mouth is and committing up to 10% of the total capital raise -- an amount much greater than their current ownership of 2.6%. Delisting risk from its sub-$1 share price looms on the horizon if the company does not regain compliance by March 2010, and terms of therights offering have yet to be finalized.
Pro forma for a successfully contemplated rights offering, downside risk will be mitigated by an all cashbalance sheet of approximately $10 million, and may give investors more confidence to get the shareprice above the $1 threshold.
With a leaner operating structure in place, Cosi may finally have thepotential to generate profits when the consumer re-emerges.
At the time of publication, Axler's firm was long Cosi.
Ben Axler is managing partner and founder of Spruce Point Capital Management, a New York-based hedge fund. Prior to founding the company, Axler spent eight years as an investment banker advising, structuring and executing billions of dollars of financing, risk management and M&A transactions for leading Fortune 500 companies. Axler started his career with Credit Suisse in 2000, and from 2006 to 2008, was an associate director at Barclays Capital in the Diversified Industrials Group. Axler graduated from Yale University with a master's degree in statistics and received both a bachelor of arts degree in statistics and a bachelor of science in marketing and business administration from Rutgers College, where he graduated with summa cum laude and Phi Beta Kappa honors.