Wednesday
Jan072015

Investment Thesis: COSI

 

Price: $2

Enterprise Value: $63mm

Debt: $6.1mm

Cash: $23mm

EBITDA: -$12MM

 

 

Summary

●     We project $15.3mm in EBITDA based on improved revenues and gross margins. 

●     We believe COSI has medium-term upside to $5.10 with our best case-case scenario calling for a stock price of $7.28 using the Hearthstone metrics for the overall system. 

 

Background

We have been closely following Cosi ($COSI) since RJ Dourney took over as CEO in March of 2014. Dourney is a successful COSI franchisee, making profits at 13 locations in and around Boston. This is quite an accomplishment since COSI has accumulated more than $300mm in net negative earnings over its lifetime, a testimony to poor management of the parent company over that time period.

I first spoke to RJ back in June and in one conversation, I had confidence that he is the right guy to turn around COSI’s fortunes.  After we met him and his team and toured some of his Boston locations on August 20, it became clear to us that RJ has a formula for success in the fast casual arena.  His locations are clean, efficient, and profitable.

RJ Dourney began his relationship with COSI as a franchisee in 2005.  At that time he chose COSI because he believed there is a unique brand essence, with fresh baked bread and healthy menu options.  He and his corporate entity, Hearthstone, opened 5 stores in Boston and grew to 13 locations by 2014.  All of the Hearthstone locations are operating successfully and profitably.  In March of last year, Dourney became the new CEO of the company.

Dourney is wasting no time integrating his successful strategy into the company-owned locations. He mixes together fresh ingredients, clean and organized locations, and an efficient labor force to bake up profits. Long-term, if RJ and team are successful, COSI’s growth trajectory could match the growth of Chipotle ($CMG) and Panera ($PNRA).  This situation has strong potential.

RJ hit the ground running with his turnaround plan for COSI corporate.  In just a few short months, he hired a new VP of HR, an operations expert, and an  IT manager.  He began to implement the operating system from the Boston locations across the company-owned stores.  He is reviewing the culinary component and is happy with the results so far.  He moved the corporate office from a 27,000 sqft facility outside of Chicago to a 6,000 sqft facility near Boston.  He hired HILCO to help the company get out of some of it’s bad leases.

RJ’s formula for operational success at COSI involves cleaning up the stores, increasing labor efficiency, and making the brand more current in line with the Boston model. 

Market

Cosi operates in the fast casual dining market. This is a great space for two reasons.  First, fast casual is a growing area filling the void between low-quality fast food and higher quality restaurants that require a full hour for lunch.  At Cosi (and competitors Panera and Chipolte, to name a few), customers can get a delicious lunch in just a few minutes. Second, Americans are moving toward high-quality, healthy food. Cosi makes all its bread in-store, which means the bread contains simple ingredients and tastes fresh.  Most people could eat at Cosi almost 5 days a week due to the large variety of healthy menu options.  Check out this video to see what we mean: youtu.be/-A0eG0s2x9Q. 

Anecdotally, Cosi recently rolled out a more high-quality chicken product along with with a price increase to cover the cost. RJ said that not one single customer complained about the higher price.  They noticed it, but are more than willing to pay for the uptick in quality.  So clearly there is a need for high quality, fast, healthy food. 

So, we establish that Cosi has a great brand with a great management team in place and a business model that is proven in Boston. 

Financials

COSI currently has 66 company-owned locations (58%) and 47 franchises locations, for a total of 113 restaurants.  Here is a breakdown of revenues and costs for the company-owned stores during the first half of 2014:

COSI 1H2014:

 

$mm

% of revenues

Revenue

38

 

Food Costs

9.5

25.00%

Labor

14.5

38.16%

Occupancy

14

36.84%

 

 

 

Gross Profit

0.00

0.00%

 

Compare that to Chipotle and Panera 1H2014:

 

CMG

 

 

PNRA

 

 

$mm

% of revenues

 

$mm

% of revenues

Revenue

1954

 

 

1091

 

Food Costs

675

34.54%

 

302

27.68%

Labor

436

22.31%

 

298

27.31%

Occupancy

321

16.43%

 

227

20.81%

 

 

 

 

 

 

Gross Profit

522

26.71%

 

264

24.20%

A quick glance of the numbers shows you that Cosi's Labor and Occupancy costs are significantly above that of the competition, while food costs are significantly below.  RJ and team are focused on increasing labor efficiency as a critical piece of their turnaround strategy.  If they can get labor costs down to 30%, the picture looks like this:

COSI Target Labor Costs:

 

 

 

$mm

% of revenues

Revenue

38

 

Food Costs

9.5

25.00%

Labor

11.4

30.00%

Occupancy

14

36.84%

 

 

 

Gross Profit

3.10

8.16%

Now let's talk about Occupancy costs.  COSI is spending 35% of revenues on occupancy costs, this should be closer to 25%.  Now, occupancy costs are at least partially a fixed cost, so the problem can be broken out into (a) revenues per restaurant are too low, and (b) lease costs are too high.  RJ and team are clearly aware of both issues.  Let's start with revenues. 

COSI operates 63 restaurants and has an additional 47 franchise restaurants.  If RJ and team can successfully bring the Hearthstone (RJ’s corporate entity) AUV numbers to the entire organization, AUV would go from $1.1mm to $1.75mm system-wide.  That means $110mm in annual top-line revenues, plus another $4.1mm in franchise revenue, for a total of $114mm in revenues.  This is a 48% increase over the $77mm in annualized revenue based on the nine months ended September of this year.  Even if AUV increases to $1.6mm / store, that means $100mm in annualized revenues.

Now, to address (b), they hired a real estate workout company to help them terminate and / or renegotiate some leases and there is likely some wiggle room.  Between increasing revenues per store and renegotiating leases, management believes a long-term run rate for occupancy cost should be closer to 25% of revenues:

 

 

COSI Target Occupancy Costs

 

 

$mm

% of revenues

Revenue

100

 

Food Costs

25

25.00%

Labor

30

30.00%

Occupancy

25

25.00%

 

 

 

Gross Profit

20

20.00%

G&A

10

10.00%

EBITDA

10

10.00%

 

 

Now, how does this compare to the numbers Hearthstone is generating?  According to the Hearthstone numbers disclosed in the S-1 for the rights offering:

Hearthstone financials, $mm

$mm

 

9mo through 9/30/2014

12mo through 12/31/2013

Revenue

 

$12.6

$16.6

EBITDA

 

$0.5

$0.9

Franchise Fees

6%

$0.76

$1.0

Pre-Opening Expenses

 

$0.08

 

Legal Fees

 

$0.065

 

Pro Forma Contribution to Company EBITDA, 13 Stores

 

$1.4

$1.9

EBITDA Margin

 

11%

12%

 

So 11% to 12% EBITDA margin is where RJ is with Hearthstone.  Our target of 10% EBITDA margin for COSI corporate is reasonable.

When Dourney took over Au Bon pain in 2000 the AUV was $1.1mm and 5 years later it reached $1.7million. We expect a similar trajectory for current Cosi restaurants.

Additional Metrics

Here are some metrics that management has shared with our group. The High Street Boston location has an average peak transaction of 500 transactions an hour compared to 300 for the whole Hearthstone. The rest of COSI does a peak of 185-200 transactions an hour. A rock and rolling Chipotle peaks of 260 transactions per hour.

The Hearthstone average unit volume (AUV) is $1.75mm a year. the rest of COSI does $1.1mm.

The industry average employee turnover is 150% while Hearthstone has a turnover of 38%. The industry average management turnover is 35% while the Hearthstone turnover is 11%.

Cash and Capitalization

One of the biggest issues facing turnaround candidate companies is cash flow.  Change costs money, and companies with negative cash flow are typically tight on cash.  RJ views these capital expenditures as an investment in the future of the company, but he needed to get capital from somewhere.  In 2014, the team (led by CFO Scott Carlock) successfully raised over $25mm in debt and equity capital. 

●     On May 20, the company placed a $2.5mm note with AB Opportunity Fund and AB Value Partners. 

●     On August 19, COSI issued equity in a $4.5mm private placement transaction to Janus and an existing shareholder.

●     On December 12, the company completed a rights offering that raised $19.7mm from existing shareholders.

When we wrote our original thesis we believed that sufficient capital was needed for COSI to clean up its act outside Boston.  Clearly management agreed.

Balance Sheet

As of the 9/30/14 B/S, the company had $6.1mm in cash on the balance sheet and $6.1mm in debt.  Given proceeds of $20mm from the rights offering and an estimated quarterly cash burn of $3mm, they should have about $23mm in cash on the balance sheet at year end.  Here is the 9/30 balance sheet.

 

As of 12/31/14, the company will have another $20mm in cash from the rights offering, less cash burn of about $3mm.  We project the balance sheet will look something like this:

 

Balance Sheet, $mm

12/31/2013

9/29/2014

Projected 12/31/14

Projected 3/31/15 With Hearthstone

Cash

$6,021

$6,113

$23,113

$20,113

A/R

$594

$799

$799

$799

Inventories

$779

$768

$768

$768

Other Current

$1,899

$1,005

$1,005

$1,005

Total CA

$9,293

$8,685

$25,685

$22,685

 

 

 

 

 

FFE

$8,195

$6,768

$6,768

$10,226

Other LA

$1,115

$1,411

$1,411

$2,808

Total LA

$9,310

$8,179

$8,179

$13,034

Total Assets

$18,603

$16,864

$33,864

$35,719

 

 

 

 

 

A/P

$2,462

$3,023

$3,023

$3,023

Accrued Exp

$9,088

$6,591

$6,591

$6,591

Current Portion

$214

$515

$515

$515

Total SL

$11,764

$10,129

$10,129

$10,129

 

 

 

 

 

Long-term Debt

$0

$6,154

$6,154

$16,575

Deferred Franchise Revenue

$1,931

$1,966

$1,966

$1,966

Other LL

$2,189

$1,530

$1,530

$1,530

Total LL

$4,120

$9,650

$9,650

$20,071

 

 

 

 

 

Common Stock

$181

$245

$245

$245

APIC

$297,181

$303,571

$323,571

$323,571

Treasury Stock

-$1,198

-$1,198

-$1,198

-$1,198

Retained Earnings

-$293,445

-$305,533

-$308,533

-$317,099

Total E

$2,719

-$2,915

$14,085

$5,519

Total L+E

$18,603

$16,864

$33,864

$35,719

 

Notably, there is ample cash available for the capital improvements we know are necessary. 

Hearthstone Acquisition

As part of the deal to sign RJ as CEO of COSI, an acquisition of Hearthstone was contemplated.  The acquisition terms say that RJ gets 1.79mm shares of COSI in exchange for Hearthstone, plus RJ transfers anywhere between $6.9mm and $9.2mm in debt (depending on which paragraph of the S-1 you read).  Hearthstone has book assets of $4.85mm.  Total forecasted EBITDA of $2.3mm (pro forma for consolidation and 2 new restaurants). 

To value Hearthstone, we use EV / EBITDA ratios. PNRA trades at 11x and others are around 10-15.  We take a haircut to those valuations and use 7x $2.3mm EBITDA = $16mm EV.  Let's say $10mm in debt, which means the equity is valued at $6mm.  That corresponds to a “purchase” price for RJ of $3.40 / share.  In addition, RJ will receive both time-based and performance-based shares.  The time-based component consists of a total of 414,582 shares, 25% at each anniversary of his start date.  The performance-based component consists of 414,582 shares, 25% at each of $2, $2.50, $3, and $4 share prices.

 

We believe the deal serves to align RJ’s interests with shareholders, as RJ is trading his interest in a cashflow positive private company with a smaller share in a much riskier cashflow negative COSI corporate entity.  With 10 years experience with COSI as a franchisee and a long career in the chain / franchise restaurant industry, he is in a good position to evaluate the risks.  His decision was to take the opportunity.  This gives us comfort with our long position.

 

 

Valuation

Pulling it all together, we take our projected numbers:

Restaurant Net Sales: $100mm
Gross profit margin: 20%
Net Profit from Company-Owned Stores: $20mm
Franchise Revenue: $3.0mm ($3.8mm less $0.8mm from Hearthstone)
Total Gross Profit: $23mm
General & Administrative Expenses: $10mm
EBIT: $13mm
Corporate EBITDA: $13mm
Hearthstone EBITDA: $2.3mm
Total Projected EBITDA: $15.3mm

 

Competition’s EV/EBITDA multiples are at 11x for PNRA and 28x for CMG.

EV/EBITDA multiple: 10x
EV: $153mm
Total debt (corporate): $6.1mm
Hearthstone debt: $10mm
Total debt: $16.1mm
Total Cash: $23mm
Market cap = EV - Debt + Cash: $160mm.
NOL’s of $225mm: $44mm (Assuming 50% haircut to valuation)
Total Value: $204mm
Shares Outstanding: 40mm

 

Stock price of $5.10 with reasonable / conservative assumptions.  And that is without expanding store count at all.

Boundary Condition Valuation:

We have made some conservative assumptions.  Let’s now push it to the limit and see what the valuation looks like if RJ can get the rest of COSI to look exactly like Hearthstone in terms of AUV and EBITDA margin:

Restaurant Net Sales @ $1.75mm AUV: $110mm
EBITDA Margin: 12%
EBITDA from Company-Owned Stores: $13.2mm
Franchise Revenue @ $1.75mm AUV: $4.1mm
Hearthstone Contribution: $2.3mm
Total EBITDA: $19.6mm
EV @ 10x EV/EBITDA Ratio: $196mm
Total Debt (incl. Hearthstone): $16.1mm
Total Cash: $23mm
Market cap = EV - Debt + Cash: $203mm
NOL’s of $225mm (no haircut): $88mm
Total Value: $291mm
Shares Outstanding: 40mm
Stock Price (incl. NOL’s): $7.28

 

So it is theoretically possible for the stock to get to $7.28 without any expansion of store count.                                                               

How Big Can Cosi Become?

Now let’s talk about growing store count.  This is the fun part of the analysis because we get a glimpse into the long-term potential for the company.

Now, the first priority for RJ and team is to get the current store base in order, and get to both the revenue and EBITDA margins goals we discuss above.  But in the long-term, there is huge potential for growth.  Cosi has 113 stores currently with a mix of 60% company-owned / 40% franchise.  Panera has 1810 locations with a mix of 50% company-owned stores and 50% franchise locations as of July 2014.  RJ believes there are about 2000 potential locations nationwide.  So long-term, with a profitable operating model at the store level, there is significant room for expansion in terms of store count. 

Even with 5 x = 1130 total stores and the current 60/40 split between company-owned and franchise, the company could be worth multiple of our projected numbers.  It is going to take time and capital to get there, but the team is already laying the groundwork for this type of success.

We think the Cosi team will focus on implementing the Boston processes throughout the organization over the next year. Once all of Cosi is ready to serve up an amazing experience, we believe RJ will press the pedal to the metal from a public relations and marketing standpoint.

Conclusion

As you can see, we believe there is tremendous opportunity in COSI if RJ and team can right the ship and get it headed in the correct direction.  Based on our meetings, we feel confident in their ability to do so.

We have exercised our rights to purchase shares in the December rights offering.  In addition, we plan to increase our position opportunistically.

Tuesday
Jan062015

Abandon Your Intuition

I am reading Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations by Tobias E. Carlisle (Amazon Link). I came across this passage that I want to share with you. Enjoy!
 
Tobias Carlisle granted permission to Michael Bigger to publish this excerpt (click image to enlarge):
Friday
Dec262014

American Apparel Books and Records Request

Friday
Nov142014

Bigger Capital Delivers Second Letter To American Apparel's Board of Directors

Bigger Capital Delivers Second Letter To American Apparel's Board of Directors



States That the Board Must be Immediately Reconstituted to Replace Directors Danzinger and Mayer


Calls for Direct Representation of Minority Shareholders on the Board

NEW YORK, Nov. 14, 2014 /PRNewswire/ -- Bigger Capital Fund, LP, Bachelier, LLC and the Bigger Family, significant shareholders, collectively owning more than 2 million shares, of American Apparel, Inc. (NYSE: APP) ("American Apparel" or the "Company"), today announced that they have delivered a letter to American Apparel's Board of Directors.  The full text of the letter is included below:

November 14, 2014

Board of Directors
American Apparel, Inc.
747 Warehouse Street
Los Angeles, California 90021

Dear Members of the Board of American Apparel:

The Bigger Capital Fund, LP, Bachelier, LLC and the Bigger Family collectively own more than 2 million shares of American Apparel, Inc. (NYSE: APP) ("American Apparel" or the "Company"), which represents an ownership position significantly larger than the aggregate ownership of all members of the Company's Board of Directors (the "Board"), the CEO and the CFO.  We write to you to express our serious and growing concerns with the Company and provide the basis for our conviction that the Board must be immediately reconstituted to replace David Danzinger and Allan Mayer with direct representatives of American Apparel's minority shareholders.

In our letter to you of July 17, 2014, we demanded the immediate resignations of David Danzinger and Allan Mayer from the Board.  We did so because we believe that the lapses in judgment that led to the massive and continuing destruction of shareholder value following the abrupt ouster of the Company's former CEO Dov Charney, have discredited all the members of the prior Board.  Accordingly, Messrs. Messrs. Danzinger and Mayer must be held responsible and should not be allowed to serve as our representatives on the Board. 

We renew our call for the resignations of Messrs. Danzinger and Mayer for a number of reasons.  In the first instance, although we continue to be supportive of the replacement of five directors with three designees of Standard General L.P. and its affiliates ("Standard General") and two designees mutually agreed upon by Standard General and the Company, we are becoming increasingly concerned that the new Board, led by Co-Chairmen Danzinger and Mayer, is not as committed to protect the interests of all shareholders as we had hoped.  For example, this Board never bothered to respond to our July 17th letter or address our concerns in any form.  At a time when the Company is suffering ever widening losses, is embroiled in a much publicized investigation of its former CEO, is still absorbing changes in its senior executive team, and the stock is taking a beating, the Board has a heightened responsibility to soothe shareholder concerns and assure us that all is being done to protect our investment.  Such disregard of minority shareholders especially at this critical time is inexcusable.

We were concerned by Co-Chairman Mayer's statement in a CNBC interview that "The irony is the ally [Standard General] he [Charney] found…turned out to be our [Mayer and Danzinger] ally." We remind our representatives on the Board that their fiduciary duties are to serve the best interests of all shareholders.  In our view, this means addressing the concerns of shareholders like us.  It also means that the Board ought to provide full and fair disclosure of all material events to all shareholders.  There are a lot of questions about the state and the future of the Company and this Board has not done a good job of providing answers.

As things currently stand, American Apparel is continuing to sustain massive losses and erosion of shareholder value persists.  The Company has massively underperformed peers on a profitability basis for years.  For example, while American Apparel's Adjusted EBITDA margin is at 6%, its most comparable companies have significantly higher EBITDA margins on a trailing basis as follows:

Company

EBITDA Margin*

American Eagle Outfitters, Inc.

9%

The Buckle, Inc.

26%

The Gap, Inc.

16%

Hanesbrands Inc.

16%

Urban Outfitters, Inc.

17%

Zumiez Inc.

14%

* Source: S&P Capital IQ

We believe American Apparel stock is deeply undervalued because the Company has a terrific franchise capable of generating superior EBITDA margins.  Our analysis of the underlying value of American Apparel leads us to conclude that, absent all the uncertainty and extraneous factors that have impacted the stock negatively, the Company's shares could be worth more than $2 per share.  The Company's Board and management need to take a sober look at the valuation gap and the causes for value erosion and provide an honest account to themselves and to all the Company's shareholders of the actions within their control that can unlock value. The market's negative reaction to the latest earnings release is an indication that the market has no faith that the Board as led by Co-Chairmen Danzinger and Mayer would unlock this value.

Perhaps most outrageously the Company spent $5.3 million in legal fees in connection with the ongoing investigation into alleged misconduct by Dov Charney (the "Charney Investigation").  It is of great concern that the Board and its Sustainability Committee have failed to complete the Charney Investigation to date.  The Suitability Committee was supposed to use its reasonable best efforts to conclude the investigation no later than 30 days from July 9, 2014 (subject to extensions that the Suitability Committee determines in good faith are reasonably required).  Four months later no conclusion has been communicated and shareholders remain entirely in the dark regarding the status of the investigation.  The uncertainty surrounding the investigation, the role, if any, of Dov Charney with the Company going forward, as well as the composition of the leadership team, generally, have deeply depressed the price of the Company's stock.  Every day that this Board roils in indecision and fails to provide firm answers is a day that shareholders lose money – both in the markets and as a result of the exorbitant costs associated with the investigative process.  This situation is unsustainable and unacceptable. 

The continued Charney Investigation is not only unduly expensive but is also, in our view, clearly compromised.  We had previously expressed our outrage that Co-Chairman Danzinger, who directly participated in the controversial ouster of Dov Charney was named as one of the three members of the Sustainability Committee conducting the Charney Investigation.  In short, there is undisputed evidence that Danzinger's judgment regarding this matter has been compromised and that he should not in any way be involved in what is intended to be an unbiased and fair investigation. Further, Co-Chairman Mayer has gone on record publicly stating that he will resign if Mr. Charney is proven not guilty in the investigation.  American Apparel's shareholders deserve fair and quick answers to end the uncertainty and stop the value destruction.

It is apparent to us that addressing the issues facing American Apparel requires that the following actions be immediately taken by the Board:

  1. The two directors remaining from the prior discredited Board, Messrs. Danzinger and Mayer must immediately tender their resignations.  Messrs. Danzinger and Mayer, together with their fellow directors at the time, directly caused enormous economic and reputational harm to the Company and must take responsibility.
  2. The Board must promptly invite direct representatives of the Company's minority shareholders to join the Board and fill the resulting vacancies from Messrs. Danzinger and Mayer's resignations.
  3. The Sustainability Committee must act with the utmost sense of urgency to complete the Charney Investigation without further delay.

In summary, we want to stress our conviction that at this critical time for the Company, it is imperative that the Board must conduct itself in accordance with the highest governance standards, representing fairly and vigorously the interests of allshareholders, providing transparency and full disclosure of all material events and addressing the concerns of all its shareholders.  Our expectation is that the Board will immediately engage with us to work constructively towards a solution along the lines laid out in this letter.  Should the Board disregard us again, we stand fully prepared to pursue all available courses of action that we believe necessary to protect shareholder rights and value, including seeking the election of director candidates on the Board of American Apparel.  We look forward to a productive dialogue with the Board.

Sincerely,

Michael Bigger

Bigger Capital Fund, LP
Bachelier, LLC
631-987-0235

Thursday
Nov062014

Oppenheimer on Experimentation

In Something Incredibly Wonderful Happens, Frank Oppenheimer and the World He  Made Up, Frank Oppenheimer discusses the importance of play and experimentation:

So much time is spent just playing around with no particular end in mind," he wrote: "One sort of mindlessly observes how something works or doesn't work or what its features are, much as I did when, as a child, I used to go around the house with an empty milk bottle pouring a little bit of every chemical, every drug, every spice into the bottle to see what would happen. Of course, nothing happened. I ended up with a sticky grey-brown mess, which I threw out in disgust. Much research ends up with the same amorphous mess and is or should be thrown out only to then start playing around in some other way. But a research physicist gets paid for this 'waste of time' and so do the people who develops exhibits in the Exploratorium. Occasionally though, something incredibly wonderful happens."

 "He asked his friend Bob Karpus, a physicist at the University of California at Berkeley, if he thought there was anything a young person must learn before it is too late, and Karpus's answer was: "play."

 

Friday
Oct312014

Astrotech: Free Option on Game-Changing Technology

  • Recent sale of largest division

  • Market cap less than liquidation value (pending tax)

  • Remaining company has “game-changing” technology

  • Sale of the company (or the new unit) in the next 1-3 years could be extremely profitable to shareholders.

Astrotech as a company changed dramatically in August when the completed the sale of their largest unit to Lockeed Martin for $61mm.  Following the sale, the company retained two divisions: 1st Detect and Astrogenetix.  The current market cap of $47mm represents a discount to the cash value of the company (pending information about the tax consequences of the sale), which means the two divisions are essentially free options available in the marketplace.  One of them, 1st Detect, has significant value as a standalone entity or as an acquisition target.  

1st Detect owns potentially game changing mass spectrometry technology.  A Mass Spectrometer is a device used to analyze pretty much any substance and determine the unique chemical compounds that comprise it.  These devices are used in many different industrial and academic fields.  Traditionally, these devices are slow, heavy, and expensive.  1st Detect’s technology is fast (3.5 seconds as opposed to hours), portable (17lbs as opposed to 100+lbs), and cost effective ($50k as opposed to $100k+).  This means analysis can be done on-site and practically real-time as opposed to sending results to a lab to get results several hours to days later.  The company compares their technology to the change from mainframe to PC in computing.  This opens the market to potential applications from pharmaceutical manufacturing to military and TSA, to archeology.  The company estimates the market for just the devices is in the billions of dollars over a 10 year period.  

In addition to their game changing devices, 1st Detect has partnered with Spark Cognition to provide analysis and predictive analytics.  Using Spark’s analytical software allows 1st Detect to offer customers a full-service product.  

1st Detect is currently working with pharmaceutical manufacturers to test the mass spec product.  If the tests are successful, this industry appears to offer a huge market for the product.  Testing output regularly can mean spotting potential issues very early, before downstream processing and customer shipments.  This means cost savings but also reduction in product liability.  So the benefits are huge and obvious.  

If commercial pilot testing is successful, 1st Detect technology can be sold to a larger industrial technology company.  Management seems focused on testing the concept and then selling the technology rather than building out the infrastructure necessary to distribute the product on an international basis.  We see potential upside in this scenario as well as a near-term exit plan that could mean 2-3x the current market cap in a few years.  Typically we look for larger upside potential however in this case we view the downside risk as small.  The company received cash proceeds of $61mm from the asset sale over the summer.  We expect some clarity about the net amount during the next earnings release. NOLs will reduce the liability somewhat.  At current cash burn rates, $60mm is more than 6 years of operations before they have to raise capital.  We believe that gives the company ample time to prove the concept and sell the technology.  So while the upside is a little below our typical goals, the downside risk is dramatically minimized.  

Astrotech also owns a much smaller operating segment called Astrogenetix.  Astrogenetix is a biopharmaceutical company that develops vaccines.  While there is no current revenue, we view this as a free option.

We are accumulating a position and will add to it as we receive feedback regarding the industry testing.  

Written by Jennifer Galperin.  Follow me on Twitter and Stocktwits. 

Friday
Sep122014

Cosi: This Turnarnaround is Fully Baked

 

 

We first wrote about $COSI back in June after the first quarter earnings call.  In that post, we described the situation, our small trading position, and our desire to investigate the situation further.

At that time we decided to go to Boston to meet the Cosi team. We wanted to feel how the Cosi experience in Boston differs from what we are experiencing in New York. We wanted to determine if the concept is exportable outside of Boston. In addition, we wanted to determine how much capital the company needs to be funded to success.

We had already determine that if we were satisfied with our investigation we would approach the company to invest $1M directly into the company if it raised an additional $4M.

Unfortunately, our visit was delayed because a member of our team broke her leg. We rescheduled the meeting to August 20th.

On August 19th, the company announced that Janus and a then current shareholder invested $4.5M in the company directly at a price of $1.15 a share. We are happy for the company but bummed out for not having a chance to invest on the same terms...Especially after getting more comfortable that the company meets our criteria for a situation worthy of an investment.

We met RJ Dourney, CEO of Cosi, and many members of his executive team at the Cosi office in Boston on August 20th. Overall we were very impressed with RJ, his team, and the Boston Cosi locations we visited.

RJ joined Cosi as CEO back in March of this year. Prior to that, he was the most successful Cosi franchisee. He owns the rights to the Boston area and approximately 15 locations.  It is now clear to us that RJ has a formula for success in the fast casual arena. His locations are clean, efficient, and profitable. A hedge fund manager told us that he met RJ a few years ago, when RJ was an independent Cosi franchise operator.  He was so impressed by RJ’s franchise business in Boston that he offered to invest directly into RJ's corporate entity, Heartstone. RJ declined. Now that RJ manages Cosi corporate, the opportunity to make an investment in his leadership is available to all of us.

In his few months as CEO of Cosi, RJ has taken aggressive action to move the company towards profitability. He replaced almost the entire executive team, and moved the corporate office from the suburbs of Chicago to downtown Boston.  

RJ’s formula for success in Cosi involves cleaning up the stores, increasing labor efficiency, and making the brand more current in line with the Boston model.  Making these improvements costs money, and the most recent financing round goes a long way toward meeting that goal.  In addition, the capital infusion from Janus made it clear to us that RJ and new CFO Scott Carlock can raise capital to fund this turnaround.  

Overall, Cosi is in a great space for two reasons.  First, fast casual is a growing area filling the void between low-quality fast food and higher quality restaurants that require a full hour for lunch.  At Cosi (and competitors Panera and Chipolte, to name a few), customers can get a delicious lunch in just a few minutes. Second, Americans are moving toward high-quality, healthy food. Cosi makes all its bread in-store, which means the bread contains simple ingredients and tastes fresh.  Most people could eat at Cosi almost 5 days a week due to the large variety of healthy menu options (I don’t think the same could be said for CMG).  Check out this video to see what we mean: youtu.be/-A0eG0s2x9Q

Anecdotally, Cosi recently rolled out a more high-quality chicken product along with with a price increase to cover the cost. RJ said that not one single customer complained about the higher price.  They noticed it, but are more than willing to pay for the uptick in quality.  So clearly there is a need for high quality, fast, healthy food.  

So, we establish that Cosi has a great brand with a great management team in place and a business model that is proven in Boston.  

Currently there are 113 restaurants.  66 of them are company-owned, or 58%.  The balance, 47 restaurants are franchises.  Here is a breakdown of revenues and costs for the company-owned stores during the first half of 2014:

COSI 1H2014:


$mm

% of revenues

Revenue

38


Food Costs

9.5

25.00%

Labor

14.5

38.16%

Occupancy

14

36.84%




Gross Profit

0.00

0.00%

Compare that to Chipotle and Panera 1H2014:


CMG



PNRA



$mm

% of revenues


$mm

% of revenues

Revenue

1954



1091


Food Costs

675

34.54%


302

27.68%

Labor

436

22.31%


298

27.31%

Occupancy

321

16.43%


227

20.81%







Gross Profit

522

26.71%


264

24.20%

A quick glance of the numbers shows you that Cosi's Labor and Occupancy costs are significantly above that of the competition, while food costs are significantly below.  RJ and team are focused on increasing labor efficiency as a critical piece of their turnaround strategy.  If they can get labor costs down to 35% (slightly below the current 38% but a bit closer to PNRA's 22% and CMG's 27%), the picture looks like this:

COSI Target Labor Costs:

$mm

% of revenues

Revenue

38

Food Costs

9.5

25.00%

Labor

11.4

35.00%

Occupancy

14

36.84%

Gross Profit

1.2

3.16%

Now let's talk about Occupancy costs.  COSI is spending 35% of revenues on occupancy costs, this should be closer to 25%.  Now, occupancy costs are at least partially a fixed cost, so the problem can be broken out into (a) revenues per restaurant are too low, and (b) lease costs are too high.  RJ and team are clearly aware of both issues.  Let's start with revenues.  Each company-owned store is currently generating about $1.1mm to $1.25mm per year in revenues.  RJ’s Boston franchise stores are doing about twice that, closer to $2.25 or 2.5mm.  If company-owned store revenues can increase by around 30% to about $1.5mm / store (so a significant increase but still pretty far away from the Boston stores), we get to $100mm annualized in top-line revenues.

Now, to address (b), they hired a real estate workout company to help them terminate and / or renegotiate some leases and there is likely some wiggle room.  Between increasing revenues per store and renegotiating leases, management believes a long-term run rate for occupancy cost should be closer to 25% of revenues:

COSI Target Occupancy Costs

$mm

% of revenues

Revenue

100

Food Costs

25

25.00%

Labor

35

35.00%

Occupancy

25

25.00%

Gross Profit

15.00

15.00%

 

That puts gross profits a little closer to the competition, with about 10% additional room to improve even from there.

Given that the current market cap is $25mm, It seems like a tremendous opportunity to invest in a company with potential gross profit of $15mm from company stores + another $3mm of franchise revenues = $18mm.  And that is on the same store count, before we even consider growing store count.

Now let’s talk about growing store count.  Now, the first priority for RJ and team is to get the current store base in order.  But in the long-term, there is huge potential for growth.  Cosi has 113 stores currently with a mix of 60% company-owned / 40% franchise.  Panera has 1810 locations with a mix of 50% company-owned stores and 50% franchise locations as of July 2014.  RJ believes there are about 2000 potential locations nationwide.  So long-term, with a profitable operating model at the store level, Cosi could expand to rival Panera’s size in terms of number of locations.  Even with 10 x = 1130 total stores and the current 60/40 split between company-owned and franchise, the potential is huge:

$mm

% of revenues

Revenue

1000

Food Costs

250

25.00%

Labor

350

35.00%

Occupancy

250

25.00%

Gross Profit

150.00

15.00%

$150mm in gross profit from company-owned stores + $30mm in franchise revenues (10x current $3mm) is $180mm in total gross profit.  Even if net profit is half that, so $90mm, at a P/E of 10x (PNRA is at 20x), the company could be worth $900mm in the long-term.  That is about 30x the current market cap.  It is going to take time and reinvestment capital to get there, but the team is already laying the groundwork for this type of success. We think the Cosi team will focus on implementing the Boston processes throughout the organization over the next year. Once all of Cosi is ready to serve an amazing experience, we believe RJ will press the pedal to the metal from a public relations standpoint. It might take a year or two to bring revenues closer to its potential. At that point, we think Cosi will start expanding aggressively. This is a five years story at a minimum before the full bloom.

As you can see, we believe there is tremendous opportunity in COSI if RJ and team can right the ship and get it headed in the correct direction.  Based on our meetings, we feel confident in their ability to do so. Unfortunately, we are not the only ones confident in RJ and team based on the >100% run-up in the stock from $1.12 when we first started buying to above $1.80.  We plan to build our position over time at the right prices through open-market acquisitions and / or participation in a secondary offering if the opportunity arises.

Do you think Cosi's turnaround is fully baked?

Disclaimer: Bigger Capital and related entities own a small trading position in COSI which we plan to build. COSI is a highly distressed situation and a microcap stock, and therefore it is not suitable for the majority of investors. The likely outcome of this type of investment is a loss of principal. In other words, the probability of losing your entire investment in this situation is very high.

Written by Jennifer Galperin.  Follow me on Twitter and Stocktwits.

 

 

Friday
Jul252014

The Energy was in the Air at the Plug Power Annual Meeting

On Wednesday, July 23, Plug Power  ($PLUG) held it’s annual shareholder meeting in New York.  We attended, as well as some other new and long-time shareholders.  During the meeting, Andy Marsh, the CEO, gave a presentation that reaffirmed our bullish view on the long-term prospects of the company.  

In a nutshell, PLUG is currently in the material handling business (i.e. forklift truck batteries).  Specifically, PLUG built an industry to deliver GenKey and GenDrive, the turnkey solutions that can have a site up and running in a month flat.  PLUG provides the units, a service contract, and a source for hydrogen that makes the sales decision easy for the customer.  Andy gave two anecdotes that speak to the traction PLUG is gaining with customers.  First, $WMT announced earlier this year a 3 year deal to deploy PLUG products to 6 distribution centers.  They just deployed their second in July and have plans to deploy the third, originally slated for 2015, in September, more than 3 months ahead of schedule.  So WMT is moving fast to deploy PLUG products.  Second, Andy indicated that the sales department has started to receive in-bound calls from large competitors to WMT.  So success at WMT is making the sales decision easier for other potential new customers.

GenKey by itself is a $40Bn business total opportunity worldwide.  Expansion to Europe and Asia will be primarily through JV’s.  In Europe, HyPulsion (JV between PLUG and hydrogen producer Air Liquide) is driving success.  In Asia, PLUG is working with Hyundai to break into that market.

Beyond offering the GenKey solution, as we have all known for some time, there are other businesses that PLUG has on its horizon.  This year they completed a test run of airport tuggers powered by hydrogen for FedEx.  They are going live in Memphis during the 4th quarter. That is about a $500k to $1Bn market in the US.  A test of Transportation Refrigeration Units (TRU’s) powered by hydrogen is scheduled for the fourth quarter of this year at the Sysco facility located  on Long Island.  That is a $5Bn to $10Bn opportunity in the US.  

In addition, Andy discussed his blueprint to expand the GenKey offering to a large network of retail stores and small distribution centers.  Under the current model, a site needs about 100 forklift trucks or more to make a PLUG solution economical.  However, leveraging the hydrogen supply and distribution route provided by a nearby hydrogen powered distribution center, PLUG can bring hydrogen to a single truck at the store level.  This opens up the market tremendously within the material handling area.  

We still believe it is day 1 for the premier global hydrogen system integrator.  

We are looking forward to the earnings release on August 14.

Written by Jennifer Galperin.  Follow me on Twitter and StockTwits.

Thursday
Jul172014

Letter to American Apparel's Discredited Board of Directors

BIGGER CAPITAL DELIVERS LETTER TO AMERICAN APPAREL’S DISCREDITED BOARD OF DIRECTORS

States That All Current Directors Should Be Held Accountable For the Reckless Decisions of the Board

Demands the Resignations of Both Remaining Incumbents, David Danzinger And Allan Mayer

New York, NY – July 17, 2014 – Bigger Capital Fund, LP, Bachelier, LLC and the Bigger Family, significant shareholders of American Apparel, Inc. (NYSE: APP) (“American Apparel” or the “Company”), today announced that they have delivered a letter to American Apparel’s Board of Directors.  The full text of the letter is included below: 

July 17, 2014 

Board of Directors

American Apparel, Inc.

747 Warehouse Street

Los Angeles, California 90021 

Dear Members of the Board of American Apparel:

The Bigger Capital Fund, LP, Bachelier, LLC and the Bigger Family are significant shareholders of American Apparel, Inc. (NYSE: APP) (“American Apparel” or the “Company”).  We have followed the recent developments at American Apparel with a growing sense of puzzlement and concern.  We have become confident that American Apparel’s entire Board of Directors (the “Discredited Board”) -- all seven of its current members -- have caused serious damage to the value and reputation of the Company. American Apparel, a household institution with strong business fundamentals and great prospects has been brought to the brink of financial distress and all this, in our view, because of the reckless actions of the set of directors who were responsible for overseeing our business and protecting the value of our investment. 

We are extremely gratified to see that five of the current seven directors will be replaced with new members of the Board under the recently disclosed arrangement dated July 9, 2014 with Standard General L.P. and certain of its affiliates and Dov Charney, now former CEO of American Apparel (collectively, the “Standard General Group”).  However, there can be no justification for the two remaining discredited incumbents, David Danzinger and Allan Mayer, to stay on.  We firmly believe that Messrs. Danzinger and Mayer, who are supposed to remain as directors and Co-Chairmen of the Board, are directly responsible for the value erosion and reputational harm to the Company and as a result have lost the confidence and support of the shareholders and should immediately resign. 

The Discredited Board has taken a number of reckless actions that go directly against the best interest of shareholders.  Most shockingly, this Board engaged in an apparent coup stealthily and abruptly ousting American Apparel’s long-standing CEO and largest shareholder knowing that their actions will cause a near-imminent default under important contractual obligations of the Company and cause it to default on nearly $10 million in loans.  Worse, the Discredited Board kept shareholders entirely in the dark about its plans to change the effective control of our company.  The Discredited Board calculatedly waited until shareholders (including Mr. Charney with his then approximately 23% stake) had cast their votes to reelect them at the annual meeting on June 18 and then quickly reconvened just minutes after the closing of the polls and voted to oust Mr. Charney from his position as a CEO (and imminently under the terms of his employment agreement as a director of the Company, a position to which the shareholders of American Apparel had elected him on June 25, 2013).  Messrs. Danzinger and Mayer had fiduciary duties to do what is best for us, the owners of the Company.  Messrs. Danzinger and Mayer are bound not only by their responsibilities as our fiduciaries, but also by the proxy rules to inform shareholders of all information that shareholders may consider material to their voting decision prior to casting their vote.  It is mindboggling that Messrs. Danzinger and Mayer would not have thought that shareholders would want to know of their plans to uproot the senior leadership of our Company before voting on the election of directors.  In our view, Messrs. Danzinger and Mayer have breached their fiduciary duties to shareholders and withheld material information that should have been disclosed in the Company’s proxy materials for the annual meeting. 

To add injury to insult, on the heels of your unilateral decision to overhaul the Company’s leadership, this Board made another unilateral decision to adopt a shareholder-unfriendly rights plan a/k/a poison pill.  The effect of this shareholder rights plan was to stifle shareholder input by impeding the ability of shareholders to act together in engaging with the Company’s management and the Discredited Board on critical issues regarding the leadership of our business.  

It is unclear to us how the continuity of Messrs. Danzinger and Mayer on the Board is a positive for shareholders.  For example, during Mr. Danzinger’s tenure American Apparel’s stock price has fallen from $1.72 in 2011 to today’s $1.15. Similarly, during Mr. Mayer’s tenure which started in 2007, American Apparel’s shares have lost 92% of their value.  With such poor track record it is hard to see why directors Danzinger and Mayer should continue to act as stewards of the shareholders’ capital. Notably, leading proxy vote advisory firm, Institutional Shareholder Services (ISS) recommended a “withhold” vote last year with respect to the reelection of David Danziger as a result of his service on more than three public boards while serving as a CEO of an outside company.  Under ISS corporate governance guidelines there are serious concerns that Mr. Danziger may have too many board engagements to devote the proper amount of attention to American Apparel.  We share the concern. 

Furthermore, under its agreement with the Standard General Group, the Company has agreed to form a new committee of independent directors of the Board, the Suitability Committee, for the purpose of overseeing the continuing investigation into alleged misconduct by Dov Charney.  Mr. Danziger, one of the directors who made the decision to oust Mr. Charney in the first place, will serve as one of the three members of this committee.  We believe it is a clear disservice to shareholders and the integrity of the investigative process to place this decision partially in Mr. Danziger’s hands once again.  It is clear that Mr. Danziger’s decision has already been made and he never thought it necessary to see the results of a completed investigation before making it.  We firmly believe that any related investigation must be overseen solely by individuals who will have an open-minded, fresh perspective on the matter and will be able to render an impartial decision untainted by their prior involvement in Mr. Charney’s ouster. 

Directors Danzinger and Mayer and their fellow members of the Discredited Board should have informed shareholders of the investigation into Mr. Charney’s conduct from its outset. This is critical information that shareholders had the right to know.  Instead, the Board completely mismanaged the process by concealing the allegations and investigation from the investment public and then choosing to act unilaterally to oust Mr. Charney with no explanation to shareholders until after the fact, all mid-way through the ongoing investigation. 

It is also noteworthy, that this same Board that has felt compelled to oust Mr. Charney even if it means defaulting on close to $10 million in loans, chose to disregard the Company’s poor operating and financial results from 2007 through 2012 and reward Mr. Charney by extending the maturity of the Charney Anti-Dilution Provision which entitled him to up to approximately 20,416,000 shares of the Company’s common stock as anti-dilution protection (decision we criticized publicly at the time, see our letter to the Board available here, http://biggercapital.squarespace.com/biggercapital-investment/2013/10/10/american-apparel-memorandum.html  ).  

In short, Messrs. Danzinger and Mayer have made seemingly arbitrary decisions taking reckless risks with our capital and jeopardizing our business with little regard for shareholder interests or the future of our Company.  All seven current directors must be held accountable for this blatant disregard of shareholder rights and value.  Accordingly, we demand and expect that directors Danziger and Mayer immediately tender their resignations from the Board and all of its committees. 

We look forward to a new chapter for American Apparel under the oversight of a thoroughly new Board uncompromised by the current Board’s disastrous decisions of the recent and far past. 

Sincerely, 

 

Michael Bigger

Bigger Capital Fund, LP

Bachelier, LLC

Tuesday
Jun172014

New CEO Lights a Fire in the Ovens at COSI

On May 15, COSI Restaurants ($COSI) announced earnings for the first quarter, which ended on March 31.  In the earnings call, new CEO RJ Dourney enthusiastically described his strategy to improve discipline at the corporate level and return the company to profitability.  He plans to maximize the brand’s capacity, and he has the experience in the industry to do it.  He has worked to grow what he calls “best-in-class” companies Chilli’s from 16 to 890 restaurants domestically, and Applebees from 250 to 1300 restaurants domestically.  RJ was nice enough to give me 30 minutes of his time last Friday, and after speaking with him I am confident he is the right guy to turn around COSI’s fortunes.

RJ Dourney began his relationship with COSI as a franchisee in 2005.  At that time he chose COSI because he believed there is a unique brand essence, with fresh baked bread and healthy menu options.  He opened 5 stores in Boston and grew to 15 locations by 2014, all operating successfully and profitably.  In March of this year, Mr. Dourney became the new CEO of the company.

RJ has already started to deploy his successful franchise strategy at the corporate level.  He hired a new VP of HR, an operations expert, and an  IT manager.  He has imported the operating system from the Boston locations.  He has re-started the review of the culinary component and is happy with the results so far.  He moved the corporate office from a 27,000 sqft facility outside of Chicago to a 6,000 sqft facility near Boston.  He hired HILCO to help the company get out of some of it’s bad leases.

He plans to increase the percentage of franchises compared to company stores in the long-run by partnering with exceptional franchisees that can successfully own and operate multiple locations.  He cited the Applebees model, which consists of primarily franchises (about 80%).  

One of the biggest issues facing turnaround candidate companies is cash flow.  First quarter cash burn was $3.2mm, and cash on the balance sheet was $2.8mm at 3/31.  On May 20, the company placed a $2.5mm note with AB Opportunity Fund and AB Value Partners.  At the current cash burn rate, they have about 1-2 quarters before they will need to raise capital again.  RJ said on the earnings call that he plans to slow the bleed significantly in the second quarter, and he doesn’t believe there will be additional need for financing.  

In order to achieve a successful turnaround we believe the company should seek funding to allow it to execute its plan accordingly. A $5 million raise would give the company the much needed capital for achieving success. Our view on this subject differs from management’s perspective but successful turnarounds usually require more capital than expected. If the company decides to raise more capital, it is something we would be interested in looking at.

We have a very small position in the company but will build a meaningful position if we can convince ourselves that the success the company is achieving in the Boston area can be exported across the chain. We believe that the company will invest a material amount of effort and money in redesigning corporate policies to improve structure and discipline company-wide.  Management believes it can bring the overall performance of the company on par with Boston franchisee Hearthstone.  If they are right, COSI could join the ranks of best-in-class fast-casual companies like Chipotle ($CMG) or Panera ($PNRA).  COSI’s brand resonates with customers, and we think that if they can get it together at the corporate level with quality customer service and clean restaurants, the customers will return.  There is always execution risk, but we think RJ has the right mix of experience and attitude to get this done if the company is capitalized properly for success.

Do you think $COSI can survive and prosper?

Written by Jennifer Galperin and Michael Bigger.

Disclaimer: Bigger Capital owns a small trading position in COSI. COSI is a highly distressed situation and it is not suitable for the majority of investors. The likely outcome of an investment is a loss of principal. In other words, the probability of losing all your investment in this situation is very high. 

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