The markets have been melting down over the past 5 day with the S&P 500 down 5.5%, while COSI is up 11.8%. I would argue that the stock is not reflecting the bunker mentality that management and the board has adopted, but the realization that there is a real plan in the market place that suggests COSI has a bright future.

Yesterday, the WSJ revealed that there was a war of word between the management of COSI and Brad Blum. It appears that management hurled the first diatribe in a memo to employee's and Franchisees. Which begs my first question; why did management leave out shareholders in communications about the issues its has with Mr. Blum?

What I'm asking is really a rhetorical question, because its unlikely that management has many shareholders on their side and, more importantly, their shareholder base is not naive enough to believe the rhetoric implied by the WSJ article.

Management may be able to rally the troops internally but doing so externally is a different proposition. I believe that COSI shareholders hold management to a high standard of accountability. Finding the right solution will hinge on the financial performance of the company and, on that score, management gets a failing grade.

Given current trends and management's lack of a cohesive plan, COSI seems somewhat like Greece at this juncture: one cannot rule out the possibility of outright failure of the company. Should the company meet that fate, it will not be entirely due to the poor economic environment; some of Cosi's peers are managing through, and even thriving in, the current malaise. In my view, the most significant threat to Cosi going forward is management neglecting to recognize the real issues facing the company: the need for leadership and additional capital.

The company continues to make progress on several fronts, including the new catering menu, online ordering, and a remodeling initiative but, as yet, sales have not rebounded as strongly as many had hoped.

What is management doing to enhance shareholder value?

The Board of Directors recently engaged The Elliott Group to work with the search committee towards the goal of finding a new CEO. I would question the wisdom of this decision. Alice Elliot, founder and Chief Executive Officer of The Elliot Group, has extensive experience in the restaurant industry and is surely aware of the credentials of one person – Brad Blum – that is actively seeking the job and willing to work for $1. Maybe that low salary is somewhat of a disincentive for the search firm, but irrespective of that, the company will find it very difficult to find a candidate as well-suited for the CEO position as Mr. Blum.

I would doubt that the Elliot Group can find another candidate that has done as much research on the company, has as comprehensive a plan to reinvigorate the business, will work for free and – as a bonus – has access to capital that the company desperately needs. Additionally, Blum is a major shareholder of the company. As things stand, the company is not facing a bright future. This is despite the tremendous potential of the brand; I would think that a solution as offered by Blum would be a blessing for the interim CEO and the board.

Instead of this obvious solution, the company is going to pay money that it doesn't have to a search firm to find a CEO when a highly qualified, major shareholder of the firm is willing to do the job for free. Blum owns 6.75% of the shares out while the board (collectively) owns less than half of that percentage. What shareholder would not want a CEO with Blum's credentials and strong financial interest in ensuring the firm's future success?

Time is ticking for the current management team. If decisive actions are not taken immediately, by June 2012 the market will have determined the future of the company and it will not look good for the current management team. Based on the assumption shown in the chart below, the company's cash cushion will be worn thin in early 2013 unless some capital is injected into the company. If sales soften, the process could be shortened. Additionally, our assumption does not factor in the company's need of $5-7mm of additional to remodel the company's restaurant base.

Even if a quality CEO not named Bradley Blum is found in the near-term, it seems likely that the first order of business for that individual will be raising capital. Unless the person in question has similar access to capital that Blum has, it is likely that the capital raising process will be time-consuming and costly, and perhaps extremely dilutive to current shareholders.

Yet, another conversation that management does not want to have with its shareholders!

Like Greece, Cosi needs capital fast. The $8mm of cash on the balance sheet looks like a net positive but the company needs a significant level of reinvestment; the asset base has been starved of capital for the last three years.

If I were to the strip out the $0.16 of cash on the balance sheet, the stock price is currently valuing the company at $30.2 million. Given that the company has no assets on the balance sheet, has not made money in years and is on schedule to lose money again in 2011, the $30.0 million would appear to represent a fair value for the goodwill in the COSI brand name.

The company's contention that Blum is making a low-ball offer for the company may not be entirely accurate when considering the scenario described above.

There is no guarantee that Mr. Blum will be successful but he has a better shot than most, in my view.

One really has to wonder what the discussions are like in the COSI boardroom today. While not an ideal scenario for management and the Board, Mr. Blum has offered multi-pronged solution to fix the company. Any objective outside observer of this situation is surely wondering if management and the board is putting their interests ahead of employees, franchisees and shareholders.


Howard Penney
Managing Director
HPenney@hedgeye.com
646.455.0992