A Restaurant Turnaround in the Making

 | Feb 16, 2012 | 10:30 AM EST
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Cosi (COSI) is small-cap restaurant company with a beautiful concept that somehow went terribly wrong over the years. Before the recession kicked in, shares were trading north of $6, valuing the business at nearly $300 million. Today, shares trade for $1, for a market cap of $50 million.

Back in 2007, the company generated an operating loss of $16 million on $132 million in sales. In 2011, Cosi generated operating losses of less than $7 million on about $100 million in sales. (Full-year results will be announced on March 29, but the company has already preannounced fourth-quarter sales of $26 million.)

Leading the turnaround catalyst are a new CEO who has experience fixing restaurants and a former activist investor who has now decided to forgo his hostile efforts and instead work with the company as a consultant. This new management is a catalyst for change, and the result could be a significantly higher share price that could produce a triple-digit gain.

Cosi's beginnings were modest, starting from a single Parisian-style cafe that opened in 1996. It currently has 80 company-owned and 56 franchise restaurants operating in 17 states, the District of Columbia and the United Arab Emirates. Anyone walking the streets of Manhattan or D.C. is familiar with Cosi; the company's vibrant colors and visible interior stand out in any setting. The company's pitch is its food: Serve simple, elegant menu items that show the company's attention to detail, quality ingredients and great-tasting food in a relaxing environment.

The company serves breakfast, lunch and dinner and is known for its signature sandwiches, salads, coffee and desserts. At the heart of the Cosi experience is the freshly baked signature flatbread which it uses in its sandwiches and pizza. Cosi's diverse offerings include a grilled chicken breast, tomato, basil and fresh mozzarella sandwich and an adobo lime chicken salad. Over the past several years, as the company has grown, it has received recognition for its unique concept and flavors. Prices on its menu items range from $3 to $14.

While Cosi food may be tasty, owning the stock so far been anything but a pleasant experience. Last year, the company's valuation declined below $30. At the time, industry veteran Brad Blum acquired 6.8% of the company and announced his status as an activist shareholder. Last December, the company announced that Carin L. Stutz had been appointed CEO and president of Cosi. Stutz was formerly the president of global business development at Brinker International (EAT), where she was responsible for franchise development and operations of 240 Chili's and Maggiano's restaurants. Prior to that, Stutz was in charge of 1,900 Applebee's restaurants.

Upon the appointment of Stutz, a meeting between her and Blum led Blum to change his status from active to passive investor, and he was hired as a consultant to Cosi. Blum had served as CEO of Olive Garden from 1995 to 2003 and more recently was CEO at Burger King and Romano's Macaroni Grill. According to Blum, "I recognized the unrealized potential of the Cosi brand, and I believe there are positive steps being taken to reinvigorate the Cosi brand."

The Cosi concept draws many parallels with another highly successful restaurant concept, Panera Bread (PNRA), a $4.3 billion business with more than 1,500 company-owned and franchised businesses. Since Cosi has only 136 restaurants, its growth potential is enormous. The enormous growth of Panera and Chipotle Mexican Grill (CMG) demonstrate the growing appeal of fresh, fast, casual dining in the U.S., as opposed to typical fast food. Cosi is a part of that growing trend.

Now that Stutz and Blum are collaborating, I would expect very good things to come from Cosi. Stutz's deep experience in franchising restaurants suggests an objective of franchising more restaurants, an activity that can produce very high return on investment if done appropriately. Also, Stutz recently purchased $50,000 worth of Cosi stock, a small trade but a favorable sign nonetheless.

Cosi is in desperate need of a successful turnaround. The stock is down 80% over the past five years, and the company hasn't registered a profit since 2004. Leadership at the company has been inconsistent, with management coming and going over the years. The current leadership, however, seems to be rich in experience and incentivized to make the most of the Cosi brand. The risks are real, but I believe Cosi has a significantly better than 50/50 shot at getting it right. If so, the shares could easily double if not more over the next one to two years.


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