SST - A Joe's Pros Interview

On April 6, 2022, we interviewed a System1 Inc (SST) investor who sees visionary leadership stewarding exceptional revenue and EBITDA growth through an underestimated moat known as their RAMP network. He is expressing his view via long dated warrants he believes are meaningfully mispriced. 

The following is a lightly edited version of our conversation.

Joe 

Good morning, welcome to the Joe’s Pros Interview. It is Wednesday, April 6th, 2022, and I appreciate your coming to visit with me today. I understand you want to talk about a company that has recently de-SPAC’d called System1.

Pro 

That's correct. 

Joe

Why don't you give an overview of the company and what's attractive to you? 

Pro

Sure, I’ll give you some background first. The company's roots are about 20 years old, when the two founders got together. One was a pioneer in digital customer acquisitions. The other had a little company called BrainJuicer at the time, and was pretty obsessed with behavioral economics, which is an interesting background for this company. System1 is a programmatic advertising company, and they have a very, very defined moat or edge through their RAMP (Responsive Acquisition Marketing Platform) network. Whereas the vast majority of programmatic buyers and sellers are basically dealing with a level playing field in which they're all seeing the same inventory and buying and selling it at the same time, SST, because they have a lot of extra data sourced through the websites they own, have a competitive advantage that these other companies don't have. SST owns about 40 websites, from MapQuest.com to Startpage to a newly purchased site called CouponFollow. Essentially, what happens is at the moment that a consumer clicks on an ad, SST will in all likelihood obtain incremental data on that consumer, which will enable them to decide in real time whether or not they want to buy and monetize that ad. And it's a big, big edge. As I mentioned, they just bought CouponFollow, which automatically loads bonus and coupon codes to consumers, and is growing rapidly. But the point of the acquisition and most of their acquisitions is not so much to build up these websites to generate big revenue and cash flow, although they have a fabulous track record of doing just that. It's really a feeder for the RAMP network to improve the buying and selling of ads. RAMP can more predictably target ads to high intent customers.

Joe

Please go on.

Pro

SST is bidding for tens of millions of dollars of ads all the time. They have ads on Google, Facebook, Pinterest, you name it. They spend $500 million a year on advertising. They are one of the largest digital advertisers on the planet. SST basically lends their special sauce and processes to numerous strategic partners who compensate SST via a revenue share. 

Let me explain something to make it clear. SST is basically in the business of finding people with intent to purchase and selling those potential customer leads to clients. A good example that I like to use because they used it is, they'll call on GEICO and they'll say something on the order of, “We think we can provide you a huge number of potential customers at scale which will likely have a higher conversion rate than other avenues you might choose.” To further convince GEICO, SST will emphasize that they spend $500 million a year on search engines and other websites, and will provide many leads all day long, as they're buying and selling in 50 different verticals. They're all over the place.

Joe

Right, thanks for that example. What is the best way to explain why they have an edge, a moat, and / or why they're better or differentiated from any other programmatic advertising company? 

Pro

The RAMP algorithm provides better monetization opportunities and yields than competitors. An important adjunct to RAMP is their ~40 owned websites, which provides incremental real time data on as much as 90% of the country.

Joe

So why are consumers going to their various websites in the first place, why do they go to Startpage, info.com, MapQuest, How Stuff Works, etc…?

Pro

A consumer goes to Startpage because they want privacy vs. Google, they go to CouponFollow because they want to save money, they go to MapQuest because they want local directions, etc. They've got a hundred plus million unique visitors every month on their websites, so it's not like they're obscure at all. 

Joe

Ok, so let’s take Startpage. I understand it's similar to DuckDuckGo which allows search with privacy, correct?

Pro

Yes, although Bing is the underlying engine for DuckDuckGo, while Google is the underlying engine with Startpage.

Privacy is clearly a big deal, and this trend should continue to advantage SST. To be clear, they don’t collect or distribute any private data. They make money by selling a limited amount of advertising, and the consumer isn’t followed after engaging.

Joe

All right. So let's move on to the capitalization and operating results of the company. I know it was a Trebia SPAC, and as a group SPACs have been under an enormous amount of pressure for a lot of good reasons. And this one clearly has performed better than most lately. So please go through a little bit of financial background and then what you're expecting over the next couple of years? 

Pro

Ok. For starters, they have an extraordinary track record. They've compounded EBITDA in excess of 45 percent for many years. They just reported CY ‘21 revenue of $833MM & $127MM in EBITDA. They guided to $1B in revenue this year, which is 20 percent growth and $174MM in EBITDA, up 37%. I think that those numbers will both be low. The company has about 132MM shares outstanding, with a likely 15MM shares of dilution, primarily from warrants, and ~$350MM in debt. So call it a $3 billion enterprise value. And again, the guidance is for $174MM in EBITDA. And it's very much a legitimate 30 percent grower. Last year, (‘21 over ‘20) they grew revenue 47% and EBITDA 103% to $127MM. Top line has been growing 40 percent plus for a few years. EBITDA should grow at the same rate and at the same rate or faster than revenue. So, eyeballing it, I think the $174MM in ‘22 EBITDA will be up 30 percent plus to $225MM in ‘23 EBITDA on a $3B enterprise value. I model ‘24 EBITDA at $300MM. So, let’s say the stock trades at around 12 times next year's EBITDA. Anything you would benchmark this against trades at a substantially higher valuation, and typically operates in one vertical. LendingTree would be a perfect example. They're very strong in finance and mortgages. And you know, their fortunes rise and fall by that particular vertical. When SST management designed the business, they wanted to be in every major vertical. So they're in ~50 verticals, from hotels to cars to mortgages, you name it. And that's unique. It's the only company that does that. 

Joe

So you went through the cap structure and your near term financial outlook. I see Cannae Holdings owns 33 percent, followed by quite a few dedicated SPAC funds, etc.

Pro

Well, none of the SPAC holders took the stock, they redeemed. It is interesting that this company was a perfect candidate for a Morgan Stanley or Goldman Sachs IPO. It's a big company with a great track record, and it's got plenty of scale, could have been a hot IPO. Somewhere along the way, Michael Blend met Bill Foley and they talked, they liked each other. And if you ask Michael Blend why he did a SPAC instead of an IPO, he'll tell you wanted to do it with Bill Foley. So the shareholders are largely new. I mean, nobody participated in the SPAC. At the juncture when you can choose to cash out or go forward, nobody participated and Bill Foley provided a huge backstop. A few other private equity firms also invested. It's finding its shareholder base now. There's all sorts of conspiracy theories and short squeeze conversations happening among SPAC investors on Stocktwits and Reddit. Frankly, I don't think about it, I just know it is happening.

Joe

Tell us about Michael Blend.

Pro

Michael Blend owns a ton, as do the insiders. He’s the largest individual shareholder and owns about 50% of the business. He rolled 100 percent of his equity, and he could have gotten a lot of cash. 

Joe

Can you give us your impression of him as CEO? 

Pro

Michael Blend is awesome. Honestly, you should go to their website and look at the Canaccord Genuity fireside chat with Michael and you will get a good flavor for the guy, but he's got a big track record. Importantly, Michael is a true pioneer in digital customer acquisition, which he began working in circa 2001. He's bought and sold some companies successfully. He’s funded this whole thing on his own, he didn't need money. He got some venture capital a little later to make it bigger. But being in customer acquisition for 20 years, his company has a clear edge. By the way, of their ~310 people, ~140 are data scientists and PhDs. I mean, it's really a very high level Silicon Valley type organization from what I understand. 

Joe

All right. So why don't we wrap it up on what you think for the next year or so? 

Pro

Sure, if you consider the ecosystem, let's say digital advertising grows, I don't know, 12, 14 percent type numbers. I mean, it's growing pretty fast, but it's not growing 30 percent. These guys are gaining share because everybody wants to do business with them since they can either spend people's money more intelligently or they can monetize better. So they should be gaining a lot of market share. In addition, they've just entered international markets and that was up around 200 percent last year. That'll grow faster. Really, all that was involved was translating all the information they have where necessary. They clearly have aspirations to multiply the size of the company by a few times over the next five years, both organically and through bolt on acquisitions. They're going to keep doing acquisitions like they've done. The fact that they've got this RAMP platform technology gives them a huge edge to buy something. They buy these sites because it improves the whole ecosystem and that's great flywheel stuff. 

Joe

I want to understand one more thing about the RAMP technology. You talked about how the algo auto bids for high intent ads, right? 

Pro

That in and of itself is not special. Meaning, if I go to Google and buy certain AdWords, I'm just saying that the algorithm does a lot more than just that. The most important thing that the algorithm does is take all the data from their 40 websites that they own and overlay it in real time with whatever's going on in programmatic markets. It makes better choices and nobody else can do that. 

Joe

Ok, thanks. You had mentioned the warrants earlier. Why don't you spend a minute on that?

Pro

This is very interesting. It includes conspiracy theories to boot about deSPACing and short squeezes. But the warrants are like typical SPAC warrants, and almost all of them have two clauses, but only one is relevant in this situation. If the common stock trades $18 or higher for 20 of 30 trading days, they could be called for a penny, in which case the holder would exercise them and would receive .361 of a common share. Now, .361 of a share of SST is about seven bucks, and the warrants are about $3.35. And if you want a good reason for that, I don't really have one, but I do understand why. Sometimes when companies de-SPAC, and until shares are registered through an S-1, floats can be tiny. In the case of SST, which was Trebia, there was almost zero participation as we noted earlier, and the free float was about ~750k shares with a short interest of around 3MM shares. In the case of these warrants (Jan of ‘23) and pretty much all the SPACs, they're not exercisable for one year from the time of the deal. If you buy SST through the warrants today you're essentially creating the common at around $9.27 per share (3.35 / .361=9.27), assuming the common trade above $18 for 20 of 30 trading days. But it's all very standard SPAC stuff, and they're extraordinarily cheap. It's one of the most unusually mispriced securities I think I've ever seen. 

Joe

Thanks. Any parting thoughts that we didn't cover? 

Pro

No, I think it's kind of a diamond in the rough. Everything I've researched on this company comes up great, meaning, the advertisers love them, the employees love them. I’d recommend that an analyst read both customer and employee reviews, almost all of which seem to praise the CEO and team. Obviously, there's always a few people that are disgruntled and unhappy, but by and large the reviews are very positive on the company and management. It’s also worth going to their website to view the presentations they have with Michael Blend. He explains very clearly what they do, and as I’ve noted, he is incredibly impressive. 

Joe

Wonderful. Thanks very much. Appreciate your time today.