http://boards.fool.co.uk/Message.asp?mid=10336357&post=true gives my reasons for having nominated CFE as my entry in the 2007 PaulyPilot's Pub competition.

It reads as detailed below and is IMHO pretty conservative. Cheers, Martin
*****************

Having had CFE as my entry in the 2006 competition and having now chosen it as my entry in the 2007 competition, I thought I'd better explain why I think its significantly under-priced. Provided below is a brief introduction to CFE, followed by some analysis of the possible cash and P/L impact of the franchise roll-out process which is being very actively pursued.

Worth noting that the analysis excludes what IMHO is the most exciting part of the business, the Co-Branding, in which many potential deals would lead to a step change increase in the total number of outlets & profitability, but still suggests a company that will move to strongly growing profits in the years ahead.

Feedback welcome. Cheers, Martin
***********************************************************

Introduction
Last year, in my comp entry, I stated:

UK:CFE Coffee Republic

I currently have no shares in CFE although I've managed to lose money on them during 2005. CFE are in the relatively early stages of franchising their outlets. If it goes well they will probably multi-bag from the current SP. If not, they could well crash and burn.

Rather a lot has happened since then, including the shareprice more than doubling, with a shareholder group having ejected the waster who was CE, and two major shareholders having become Chairman & Chief Executive. Rather than re-invent the wheel in terms of describing the company's history, its probably better, and certainly easier, to direct you to CockneyRebel's excellent header to the current CFE ADVFN thread, http://www.advfn.com/cmn/fbb/thread.php3?id=13077807&from=1&to=1

Also worth noting that, having got involved in the shareholder action group and bought most of my stake at well below current levels, I'm very close to having a disclosable holding in CFE and therefore may be biased!!

Fundamentals

Share Price (Bid/Mid/Offer) = 2.8p/2.81p/2.82p
Market Cap 14.4M
Shares in Issue 513M
NMS = 75000
Based on current price 02/01/07
Dividend = None
Net Cash Flow = Negative
TBV = Negative
Debt = circa 2.4m
Major Shareholders:
Steven Bartlett (CE), through his 100% owned company, Plymouth Land, 13.65%
Peter Breach (Chairman), through his 100% owned company, Surthurst, 11.67%
The website address is www.coffeerepublic.co.uk
Profitability What's a profit? They've never made one of those... and have over 8m of tax losses that could be utilised going forward...but, under new management, that should change in the 07/08 financial year which commences in March 2007. Indeed the recent interim results, http://www.investegate.co.uk/Article.aspx?id=200612201406243505O from 20-Dec-06, include the statement... no amount is provided for the value of... ...for the value of the tax losses
which amount to around eight million pounds and which we intend to make good use
of before very long.


Analysis

Using the interim results as a template for detailing the various elements of the business, CFE comprises :
(a) Individual Bars
(b) Regional Development Franchises (RDFs)
(c) International Master Franchises (IMFs)
(d) Co-Branding/'Coffee Republic Served Here'

I expect (c) to be both cash flow positive and profitable and (d) to be, at worst, cash flow and profit neutral but, due to a lack of specific data, I am going to ignore them in terms of further analysis here. However, in this context, it is worth noting that:

(c) International Franchising,
The interims detailed that the Bulgaria Master Franchise has been awarded and, given that, as per the Interims, Negotiations are in hand for a number of territories., I expect more International Franchises to be announced in the near future and going forward.

(d) Co-Branding/Coffee Republic Served Here
The interims refer to being in discussions with a number of national retailers with regards to co-branding opportunities. Indeed three co-branding trials will be taking place with a national pub operator in the near future.. My suspicion is that this element of the business could enable CFE to rapidly and profitably expand its number of outlets.

The remaining elements of the business:
(a) Individual Bars, and,
(b) Regional Development Franchises (RDFs),
are much better defined in that many of the associated numbers are in the public domain.

Consequently, in considering the RDFs and the Individual Bars, my assumptions are as follows:

(1) RDFs will, on average, cost franchisees 200k, with 20-25 RDF areas in all, with 5 area-based RDFs having been awarded to date; since these are template agreements I anticipate the costs to the business of setting up an RDF to be fairly minimal, but have assumed costs of 20k per RDF to be on the safe side, giving 180k of pure profit per RDF, with:
- the cash normally receivable up-front and/or in the early part of the agreement
- the associated profit to be amortised over the duration of the RDF agreement, which I understand to be 20 years

(2) Based on I anticipate we will grant RDFs covering substantially the whole of the British Isles before the end of the next financial year. from the interims, I'll assume the roll-out of the remaining 15-20 RDF areas will be completed in Mar-08. This may be a tad optimistic but my impression is that the Chairman, Peter Breach, is a very conservative individual, so I'm prepared to be marginally more bullish, especially as we've seen 4 RDFs awarded in the 9 weeks since the new management team have been in post; these 4 RDFs included the non-standard FEC RDF detailed in http://www.investegate.co.uk/Article.aspx?id=200611100700038619L.

(3) Based on (1) and (2), overall I'll assume 17 further RDFs by Mar-07 with average net receivables of 180k each, with each RDF to be paid for in-full over the first two years of the franchising agreement. So, across all the 17 RDFs I've assumed, that means net up-front fee income to CFE of 3.06m, with the associated profit to be amortised over the 20 year period of each RDF.

(4) The company currently has 42 outlets. The interims state, During the half year nine existing bars were franchised and subsequent to the half year end we have franchised a further four existing bars bringing the total to eighteen. I am pleased to report that subsequent to the change in management there has been a significant strengthening in the pipeline of prospective franchisees including a strong demand for new sites both direct to the Company and through our Regional Development Franchisees. Given that the company is retaining three sites, one as a trial site and the two outlets at London Heathrow, where franchising is not allowed, I'm going to assume the remaining 21 existing outlets are franchised at a rate of two per month for 11 months. Again this may be marginally optimistic but I've been very pessimistic elsewhere.

(5) On the existing outlets, the standard 17.5k franchise fee is payable together with a business transfer fee which has been widely quoted on bulletin boards as being in the range 80k - 200k. However, the figures provided in the interim results suggest that either CFE has focused on disposing of loss-making/low-profit outlets first or that, when considering what an average transfer fee might be, the top end of the 80k-200k range is rather optimistic. Consequently, I'm going to assume an average business transfer fee across the remaining 21 outlets of 90k, a franchise fee of 17.5k and costs to CFE associated with each transfer of 7.5k. This would mean on average, in cash terms, that the franchise of a existing outlet leads to CFE receiving 100k in up-front fees. So, across, all 21 outlets remaining to be franchised, net up-front fees totalling 2.1 million could be anticipated. I do not have a clear picture of the likely profit/loss impact of franchising these outlets; however each individual profit or loss will be an exceptional item that will impact TBV (tangible book value) but will not impact cash flow.

(5) Once an existing outlet is franchised, an ongoing franchise fee of 7.5% of sales is payable to CFE. Assuming an average outlet takes 6k per week, or say 300k per annum, this is 22.5k per annum of fees payable to CFE. One nice positive here is that the marginal cost to head office of supporting an additional outlet is minimal, so that this 22.5k is virtually pure profit/'contribution to head office costs'. On top of this, no doubt CFE are making a small margin on the supply chain into the outlet. Let us say this is 2% of sales, meaning another 6k per annum to CFE. So, once we get to 39 franchised outlets, that would be 39 x (22.5k + 6k) = 39 x28.5k = 1.111 million per annum towards profit/'the cost of head office' all of which will come through as cash flow.

(6) However, this is not the whole story with respect to individual outlets. Specifically, the interims state that, With the new management and business generation processes being established I expect that, over the next year, the domestic portfolio will almost double in size and overseas Coffee Republic outlets will be starting to trade. So, in a year's time, one could reasonably assume there will be another 38 (say) franchised outlets in the UK. Some of these outlets will be direct to the company and the rest through the RDFs. In financial terms, CFE gains most from franchised outlets where the RDF is not involved, on which it gains all the franchise income, so I'll assume all these 38 outlets are via RDFs

(7) The initial franchise fee on an individual outlet is 17.5k. If its through an RDF, this fee is split 50:50 between the RDF and CFE. Given that the RDF does most of the associated work, I'm going to assume CFE's associated costs are minimal and that they make 8k profit from this. The associated cash flows are up-front so that's 38 x 8k = 304k of cash to CFE over the course of the year. The associated profit will be amortised over the duration of the franchise agreement, which I suspect will be viewed as 5 years as, although the agreement is normally for 10 years, a further franchise fee is payable after 5 years..

(8) From a franchisee's point of view, the fees payable are unaffected by whether or not an RDF is involved, meaning that 7.5% of sales are payable in franchise fees. Where this is through an RDF, the RDF receives 40% of this fee and CFE the remaining 60%, i.e. 4.5% of sales. Using the 300k per annum turnover number assumed above, this is 13.5k of virtually pure profit/'contribution to head office costs'. On top of this we have the profit on the supply chain into the outlet, which at 2% of sales would be another 6k per annum to CFE. So that's a total of 19.5k marginal profit per outlet. So, once we get to 38 franchised outlets via RDFs, that would be 38 x 19.5k = 741k per annum towards profit/'the cost of head office'. Given that none of these outlets is currently open, so that on average across the year, 19 will be open, and it will take time to ramp up sales, in year 1, it might be safer to assume that, rather than 741k, the franchise income would be a quarter of that, say 185k, ramping up to 2/3 of the 741k, say 494k, in year 2 and 741k in year 3

(9) Looking further forward, and given that each RDF is, in principal, meant to be opening 5 new outlets per year for the first 5 years of the RDF agreement, I think its reasonable to assume that, if CFE achieves 38 new domestic outlets in the next year, it would achieve a minimum of 60 new domestic outlets, more probably 80, in the subsequent year, and at least 100 new domestic outlets in the year following that. To be on the safe side, I've assumed 60 outlets in what I've called year 2.

Profitability and Cash Flow
So what does all this mean in terms of profitability and cash flow?

Well, before we get on to that, the one fundamental piece of information that is missing is head-office costs? Given that note 21 to the 2006 accounts identifies that 20 people were involved in Administration, including the directors, I am struggling to believe that Head Office costs, including what was historically circa 300k for the directors, is more than 1.5m per annum, especially as the Head Office is sited in a fairly unattractive location. I will try to learn more about head-office costs from the company, at the latest at the EGM on 8th February, but the figures below suggest to me that I'm not too far out

Anyway, back to profitability and cash flow, first of all cash flow.

Year 1 (2007)
Building on the assumptions above, the cash flow over the next year would be:

+3.06m Initial fees from 17 RDF agreements (see (1)-(3) above), albeit some of this may be deferred into the following year
+2.10m Initial fees (see (4) above) associated with franchising out 21 of the remaining 24 company-owned outlets
+1.11m Franchise income (see (5) above) on 39 franchised outlets direct to CFE
+0.10m Conservative estimate of combined profit of 3 outlets retained as company-owned
+0.30m Initial fees (see (6)-(7) above) on 38 additional franchised outlets via RDFs
+0.18m Year 1 franchise income (see (8) above) on 38 additional franchised outlets, via RDFs, opened in the year
-1.50m Head Office costs
-0.25m Bank interest and charges based on experience in the 2005/06 tax year
-----------
+5.09m
-----------

Profit would be rather lower and could well still be slightly negative:

+0.15 The 3.06m detailed above, amortised over 20 years
+0.00 A conservative view on the profitability on the transfer fees and franchise fees from franchising out 21 of the remaining 24 company-owned outlets
+1.11m Franchise income (see (5) above) on 39 franchised outlets direct to CFE
+0.10m Conservative estimate of combined profit of 3 outlets retained as company-owned
+0.06m Initial fees (see (6)-(7) above) on 38 additional franchised outlets via RDFs, amortised over 5 years
+0.18m Year 1 franchise income (see (8) above) on 38 additional franchised outlets, via RDFs, opened in the year
-1.50m Head Office costs
-0.25m Bank interest and charges based on experience in the 2005/06 tax year
-----------
-0.15m
-----------

I suspect this number is at the low-end of the likely outcomes, but it is perhaps more instructive to look at the numbers in year 2, and to reflect on the fact that two strands of the business are being completely ignored.

Year 2 (2008)
So, the cash flow in year 2 would be:

+1.11m Franchise income on 39 franchised outlets direct to CFE
+0.10m Conservative estimate of combined profit of 3 outlets retained as company-owned
+0.49m Year 2 franchise income (see (8) above) on 38 franchised outlets, via RDFs, opened in year 1
+0.48m Initial fees (see (6)-(9) above) on 60 additional franchised outlets via RDFs opened in year 2.
+0.29m Year 2 franchise income (see (8) above) on 60 franchised outlets, via RDFs, opened in year 2
-1.50m Head Office costs
-0.10m Bank interest and charges assuming some of the strong cash flow in year 1 is used to significantly reduce the debt.
-----------
+0.87m
-----------

The company would also move into profitability in year 2:

+0.15 The 3.06m detailed above, amortised over 20 years
+1.11m Franchise income (see (5) above) on 39 franchised outlets direct to CFE
+0.10m Conservative estimate of combined profit of 3 outlets retained as company-owned
+0.06m Initial fees (see (6)-(7) above) on 38 additional franchised outlets via RDFs, amortised over 5 years
+0.49m Year 2 franchise income (see (8) above) on 38 additional franchised outlets, via RDFs, opened in year 1
+0.10m Initial fees (see (6)-(9) above) on 60 additional franchised outlets via RDFs opened in year 2, amortised over 5 years
+0.29m Year 2 franchise income (see (8) above) on 60 franchised outlets, via RDFs, opened in year 2
-1.50m Head Office costs
-0.10m Bank interest and charges
-----------
+0.70m
-----------

It is from this point that the effect of the franchising starts to have a more and more significant effect, with profit more than doubling the following year... ...and worth remembering that all the above analysis is ignoring two rather important strands of the business where I'm expecting to see a string of positive RNSes in the coming months.

Take a look at this from the Motely Fool( all acknowledgement them).

It emphasises the value of the NAV which I keep on about.

Now I own 4 million + CFE shares and it bothers me not to reproduce this article here as I have faith in the very long term prospects of the company under its current management.

BESIDES WE SHOULD ALL DISSECT COMPANIES ON THESE BB NOT JUST RAMP THEM BECAUSE WE ARE IN THEM.

The management will pull CFE through even with little intrinsic asset base.

Sadly this cannot be said about some other coffee companies which I opine about here.

LET ME KNOW WHAT YOU THINK--from the Motely Fool.

What Not To Buy: Buying Ten Pence For A Pound

By Alun Morris | 14 June 2007
|
'I set off with about 40 quid to an electrical wholesaler just off Tottenham Court Road in London. To cut a long story short. I bought a load of car aerials and started selling them to trade customers. By 2pm I'd sold the lot and went back and bought more. By the end of the day I made 40.' Sir Alan Sugar

That's one way to make money -- buy something for less than it's worth to someone else. Now shares aren't car aerials, you can't turn a profit by driving a van round Docklands offering them to investment banks. It's both easier and harder than that. You buy them for less than you think the market will price them sometime in the future and you sit and wait.

Wheeler-dealer trading is the East End geezer equivalent of Ben Graham's "buying a Dollar for fifty cents." Graham would buy shares that were trading at big discounts to their realisable assets, figuring that Mr Market had temporarily mis-priced the stock.

Turning this on its head, if you pay far more than a company's net asset value (NAV) this may seem a sure-fire way to lose money. Well, not necessarily. There are great companies on large multiples of NAV. British Sky Broadcasting [LSE: BSY] trades at 98 times NAV, Reuters Group [LSE: RTR] at 52. These firms are profitable, are very strong brands and have large moats to fend off competition.

Filter coffee
A filter of lossmaking shares with high price to NAV ratios threw up a familiar name: Coffee Republic (LSE: CFE) . This would-be Starbucks emerged with new management last year after a disastrous run under its founder led to a shareholder revolt.

NAV is 1.8m but that's only because two share issues this year raised about 1.2m. It is a bulletin-board favourite, has vigorous management and has announced five franchise agreements since February. Unfortunately it has never made a profit and is trading at 11.7 times its NAV. The house broker is forecasting more losses for 2007 and 2008.

I've not drunk its coffee, but location and the colour of the sofas are way more vital for the Double Tall Amaretto Chai Latte Chiller drinkers.

Coffee Republic may succeed but it will take years. The market is becoming saturated, the share price is too high and the shares have no downside protection. It is well qualified for the What Not To Buy portfolio.

Here's the What Not To Buy table so far. Cost is the best quote from an online broker.

Buy date
Company
Cost p
Now p
Gain/ (Loss) %

March
Griffin Group (LSE: GFF)
2.5
2.12
(15)

April
British Airways (LSE: BAY)
507
436
(14)

May
Patientline [LSE:PTL]
4
3.63
(9)

June
CoffeeRepublic [LSE:CFE]
3.37




Warning: this is not a portfolio of companies to short sell. Luck and speculation may send values up sharply.

Coffee Republic arrives in Turkey
Saturday, June 9, 2007

Coffee Republic, the famous British coffee chain, will start operating on Turkey this summer by opening two cafes in Istanbul's Suadiye and Nişantaşı districts. The chain aims to open 20 stores in Turkey in the future

After Starbucks and Gloria Jean's, which open new branches one after the other, famous British coffee chain, Coffee Republic, has decided to open cafes in Turkey. The chain is expected to have stores all over the country after opening the first in Istanbul's Suadiye in July and the second one in Nişantaşı.

Hakan Tangand Selma Hisarlı are the ones behind the plan to introduce Coffee Republic to Turkish coffee lovers. Tang who has worked in the cosmetics sector for many years and Hisarlı, who is a meteorologist, work as the joint chairman team of Ada Coffee that brings Coffee Republic to Turkey. Their goal is to open 20 stores in Turkey in the next five years.

In addition to coffee, the chain will sell salads, sandwiches and pizzas. Foods and drinks will be prepared in front of the clients. It will be a rule to serve all food, except pizzas, to clients in at most three minutes. In addition to the original menu, Coffee Republic in Turkey will also sell local tastes like Turkish coffee and simit, said Hisarlı.

Tangsaid the coffee machines in their stores are manual and serving coffees will be a part of a show.

Before opening the first store, Tangsaid the company received many franchise applications. We received applications from Ankara, İzmir, Bursa, Antalya and Istanbul. There is also a British person interested in opening a Coffee Republic shop in Alanya. We are still examining the applications.

Hisarlı said that coffee consumption in Turkey is still minor when compared to Europe.

and the above is undoubtedly and advert/placement and also read the last line!

CFE is taking another hammering almost before the market opens.

I would not be surprised to see it fall below three pence as I indicated above.

UNFORTUNATELY CASH CALLS CAN GO BOTH WAYS, BUT INEVITABLY THERE IS ONLY ONE WHEN THEY COME IN QUICK SUCESSION.

My confidence in CFE is still high, but for short termers this may be the time to step out for breather.

Hisarlı said that coffee consumption in Turkey is still minor when compared to Europe.

And they are going to leave it in the hands of franchisees?

Not convinced at all so far. But good luck to all those that are brave enough to go with it.

I'm not clued up on how good the quality of the CFE product is, but it better be really good.

It is and the management is so motinated, they understand what business is all about thats why I back them

Yes, but...

What experience do they have in these new countries. What are they actually offfering these new franchisees apart from a pipe dream?

They are offering absolutely nothing apart from pipe dreams.

David

Ok Barty I have 100k to invest in this and I'm really keen to get started.

Barty

Your'e an astute man as your getting in at the very start of somthing that is going to be really big for CFE.

David

That sounds really exciting I just can't wait to invest, can you give me any figures on previous franchisees and how well they have done?

Barty

Well no not really, but we are a really aggresive company that is going to dominate the world in the next five years.
I know were a little strapped for cash but don't let that worry you.

David

No worries Barty, I'm convinced that your product offering and brand awareness is so superiour to all the other entrants to this maket, sign me up.

Well its all a gamnle in the end.

But look at Starbucks and then coffee retailing.

I would be happy saying that if a man like Barty cant make it tick then no one can.

As for franchising I believe its best left to those who know their areas and country well.

I would never have opened Disney France in Paris, Lyon would have been a better choice. Why? WEATHER AND ACCESSIBILITY

As for franchising I believe its best left to those who know their areas and country well.

Thats just the point I'm making David. They have absolutley no knowledge of these new countries they are targetting. On top of that they are going to put their faith in anyone who comes up with the money.

But look at Starbucks and then coffee retailing.

Great success story for Starbucks, but it's a different ball game today. The competition is massive.

CFE won't cry too much if a few inexperienced franchisees fail to make the grade, as they will have received their fees, but what about the brand image?

I was quite interested in these a while ago, but the more I think about it, it's only for the brave amongst us.

I agree Trigger they are for the brave.

All these coffee ventures abroad are high risk as RHPS mentioned about one specific share that I dont particularly like, but for the sake a peace will not mention.

However, I like a flutter on a few stocks away from my main portfolio and I think CFE may well be a winner---but its gonna take a lotta time.

Fair play david. It's not about knocking stocks you or anyone else holds. I have no holdings in these but they do interest me but maybe a little less than few days ago mind.

Lets see what happens.

Good luck

Talk on the other side of more news soon---an agreement to open franchises in UAE. plenty of scope over there if it does come off. First one in Turkey to start trading in July to include sales of pizza as well as the usual cfe offerings-then a roll out in all the main tourist resorts.

And a 1 mill plus buy just before closing yesterday.

Great if it comes off, moneyplus but we are still looking at the same senario. Agressive expansion in the hands of inexperienced franchisees in a market that is tried and untested where all the big players are moving in.
If I was head of CFE, I would want to test the market first with my own team to prove I had a business model that worked.
I feel I have made my point so lets see what happens. Wish all holders the best of luck, but feel you may need it.

Thats what I like to see here, an open honest debate no holds barred, warts and all---thats how we all learn.

And----help make this BB the best!

Re CFE.

I am getting a little concerned that CFE my be looking more to overseas than the well matured, yet still growing UK markets.

International expansion is fine, and its the ultimate way to go, but one never Sh&&&&hts in one's back yard, especially when then are many international companies that still consider the UK as a top market.

CFE still has many High Streets and raodsides to conquer here first.

Take a look at this.

http://business.timesonline.co.uk/tol/business/industry_sectors/leisure/article1976869.ece


If this is not telling you, and CFE, that the UK market is still wde open---nothing is.

10B .... tend to agree with you in principle if not in detail ..... it looks to me, perhaps wrongly, that neither CFE nor COH have a decent and strongly profitable home base from which to expand overseas, esepcially via franchise ...... would not be at all surprised to see some very cross and burnt investors in both formats within say 18 months

I was told by the Apple Centre to be in the Trafford Centre by 10am this morning to swap my new MacBook Pro for the latest model F.O.C. so I duly turned up at 10am only to find that they don't open up till 11am!!
So to while away an hour I thought I would have a coffee. Cafe Nero wasn't open and no-one else seemed to be bothered either, but guess what? StarBucks was!!
Perhaps this is the example other coffee chains should follow, not only aggressive marketing but agresseive operation of outlets as well. There's just about nothing that pi**ses me off more than shops being closed when you would expect them to be open.
I vote with my feet as I expect a lot of other potential customers would too.
I wonder if our company has the same agressive outlook as StarBucks?
Does anyone know?
David??
cynic??
UC.
P.S. I noticed that StarBucks has a deli as well. Is this new or have they always had deli's?

No, but its all happening and thats why CFE had better start looking after the home store, or someone like Starbucks, if not Starbucks will do it for them.

I do so agree with you on store openings.

UC COH have no outlets in the UK it was set up specifically to open and expand in Eastern Europe so your comment is totally without foundation or logic... UK is saturated compared to Eastern Europe, yes I will agree there are more risks but many more rewards also...