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Why Spruce Point Is Short U.S. Concrete?
Why Spruce Point Is Short U.S. Concrete?
Ben Axler founded Spruce Point Capital Management in 2009 following a decade as a banker at Credit Suisse and Barclays. Spruce Point runs a short activist strategy, and since its founding has exposed multiple frauds, forced over a dozen CEOs and CFOs to resign, and caused several companies exposed as frauds to delist from publicly trading. Empowered by the internet, short activists disseminate their hard hitting research instantly to online communities of investors. Axler has shared 66 ideas to SumZero, and they on average have returned 15.97% versus their respective benchmarks.
This performance is especially remarkable given the recent bull climate. A rising tide lifts all boats, and serves as a strong headwind for any short focused fund.
Carla Gottgens/Bloomberg
Axler recently posted a short idea on U.S. Concrete (USCR) to SumZero. I sat down with him to discuss the piece and more generally, his thoughts on short activism.
Luke Schiefelbein, SumZero: What about US Concrete initially caught your eye as an activist short-seller? What catalyzed your entrance into the position?
Ben Axler, Spruce Point Capital: USCR is a roll-up in a commodity industry. Spruce Point has had significant success identifying and shorting roll ups in the past when the evidence suggests that they are struggling. We came to the opinion that USCR’s roll-up was showing signs of financial strain when we observed its operating cash flow was declining over a three year period, and its Non-GAAP results were become increasingly “adjusted” with more add-backs. We also felt that USCR was become more dependent on larger and more questionable acquisitions fueled by leverage to keep its growth ambitions alive
Schiefelbein: What is the market missing? Why are sell side recommendations on USCR almost universally positive?
Axler: Analysts and investors are being left to fly blind in the dark by USCR. They offer no firm financial guidance. The limited guidance they’ve given on capital expenditures over the past few years has been horribly missed. Over the past three quarters, USCR has been missing analyst earnings estimates by a wider and wider margin. Analysts have been slowly cutting long-term estimates, but we think they are still too high and have room to come down further. Analysts remain universally positive on USCR because they are incentivized to do so. USCR’s liquidity situation is becoming worse every quarter. We look at its cash and borrowing capacity relative to its trailing 12 month revenues and find that its liquidity is worse today than years before when it headed into bankruptcy in the prior financial crisis. By remaining positive on USCR’s share price, brokerage firms are positioned to earn lucrative capital raising and M&A fees down the road
Schiefelbein: Why has sell side research generally positively covered companies at which you’ve exposed corporate malfeasance and fraud? Is this representative of a structural deficiency in the sell side research model?
Axler: Yes, we think there needs to be more independent research, free of conflicts that arise when research providers seek to do business with the companies they publish research on. We are not compensated by the companies we write about. We make money when our research is accurate and our thesis plays out.
Schiefelbein: What key metrics should investors be paying attention to as your thesis matures? What will catalyze US Concrete’s 60-90% negative price correction?
Axler: Investors should follow USCR’s free cash flow carefully. It has been declining since 2013 and there’s no reason to believe it won’t continue to decline. USCR is levered almost 4x Net Debt to a “highly adjusted” EBITDA. Its highly adjusted EBITDA is also showing signs of stalling. Realized YoY pricing growth for ready-mix concrete is also slowing, and hit a multi-year low of just 2% in Q1’18. This suggests to us that supply/demand are coming into greater balance. If and when the construction cycle turns, and prices and volumes decline, USCR’s leverage will rise rapidly and its share price decline will be swift.
Schiefelbein: Part of your USCR thesis alleges that the stock price is being driven up by ‘indiscriminate buying’ of the stock by passive investors like Blackrock and Vanguard. What broader impact do you think that the rise in passive management is having on the market?
Axler: Passive or index investing certainly has its critics. Barron’s cover story this week entitled “Jack Bogle’s Battle” focused on some of the issues. We agree with most of the concerns. We’re coming across too many situations where we find passive investors own >20% of the shares of mediocre companies. In some of these situations we are finding insiders fleecing investors with poor performance being masked by aggressive accounting or financial presentation, unjust compensation, and dumping of shares at inflated prices. Who’s speaking up about this? Certainly not the passive investors. This creates an opportunity for Spruce Point to highlight these companies with our activism to try to correct the problem.
Schiefelbein: Your thesis alleges that USCR may be overstating organic growth and using capital leases to inflate adjusted EBITDA. Did you come to these conclusions before or after you saw that management was compensated based on adjusted EBITDA growth?
Axler: We always like to understand what are the metrics that motivate management the most. In the case of USCR, it is clear that the sole factor driving management is Adjusted EBITDA. Therefore, we took a critical look into the levers management could pull to inflate this metric. Capital leases provide more benefits to Adjusted EBITDA than operating leases. Not surprisingly, we found evidence to suggest management has been more aggressively pursuing capital leases, while at the same time disclosing less information about the leases
Ben Axler founded Spruce Point Capital Management in 2009 following a decade as a banker at Credit Suisse and Barclays. Spruce Point runs a short activist strategy, and since its founding has exposed multiple frauds, forced over a dozen CEOs and CFOs to resign, and caused several companies exposed as frauds to delist from publicly trading. Empowered by the internet, short activists disseminate their hard hitting research instantly to online communities of investors. Axler has shared 66 ideas to SumZero, and they on average have returned 15.97% versus their respective benchmarks.
This performance is especially remarkable given the recent bull climate. A rising tide lifts all boats, and serves as a strong headwind for any short focused fund.
Carla Gottgens/Bloomberg
Axler recently posted a short idea on U.S. Concrete (USCR) to SumZero. I sat down with him to discuss the piece and more generally, his thoughts on short activism.
Luke Schiefelbein, SumZero: What about US Concrete initially caught your eye as an activist short-seller? What catalyzed your entrance into the position?
Ben Axler, Spruce Point Capital: USCR is a roll-up in a commodity industry. Spruce Point has had significant success identifying and shorting roll ups in the past when the evidence suggests that they are struggling. We came to the opinion that USCR’s roll-up was showing signs of financial strain when we observed its operating cash flow was declining over a three year period, and its Non-GAAP results were become increasingly “adjusted” with more add-backs. We also felt that USCR was become more dependent on larger and more questionable acquisitions fueled by leverage to keep its growth ambitions alive
Schiefelbein: What is the market missing? Why are sell side recommendations on USCR almost universally positive?
Axler: Analysts and investors are being left to fly blind in the dark by USCR. They offer no firm financial guidance. The limited guidance they’ve given on capital expenditures over the past few years has been horribly missed. Over the past three quarters, USCR has been missing analyst earnings estimates by a wider and wider margin. Analysts have been slowly cutting long-term estimates, but we think they are still too high and have room to come down further. Analysts remain universally positive on USCR because they are incentivized to do so. USCR’s liquidity situation is becoming worse every quarter. We look at its cash and borrowing capacity relative to its trailing 12 month revenues and find that its liquidity is worse today than years before when it headed into bankruptcy in the prior financial crisis. By remaining positive on USCR’s share price, brokerage firms are positioned to earn lucrative capital raising and M&A fees down the road
Schiefelbein: Why has sell side research generally positively covered companies at which you’ve exposed corporate malfeasance and fraud? Is this representative of a structural deficiency in the sell side research model?
Axler: Yes, we think there needs to be more independent research, free of conflicts that arise when research providers seek to do business with the companies they publish research on. We are not compensated by the companies we write about. We make money when our research is accurate and our thesis plays out.
Schiefelbein: What key metrics should investors be paying attention to as your thesis matures? What will catalyze US Concrete’s 60-90% negative price correction?
Axler: Investors should follow USCR’s free cash flow carefully. It has been declining since 2013 and there’s no reason to believe it won’t continue to decline. USCR is levered almost 4x Net Debt to a “highly adjusted” EBITDA. Its highly adjusted EBITDA is also showing signs of stalling. Realized YoY pricing growth for ready-mix concrete is also slowing, and hit a multi-year low of just 2% in Q1’18. This suggests to us that supply/demand are coming into greater balance. If and when the construction cycle turns, and prices and volumes decline, USCR’s leverage will rise rapidly and its share price decline will be swift.
Schiefelbein: Part of your USCR thesis alleges that the stock price is being driven up by ‘indiscriminate buying’ of the stock by passive investors like Blackrock and Vanguard. What broader impact do you think that the rise in passive management is having on the market?
Axler: Passive or index investing certainly has its critics. Barron’s cover story this week entitled “Jack Bogle’s Battle” focused on some of the issues. We agree with most of the concerns. We’re coming across too many situations where we find passive investors own >20% of the shares of mediocre companies. In some of these situations we are finding insiders fleecing investors with poor performance being masked by aggressive accounting or financial presentation, unjust compensation, and dumping of shares at inflated prices. Who’s speaking up about this? Certainly not the passive investors. This creates an opportunity for Spruce Point to highlight these companies with our activism to try to correct the problem.
Schiefelbein: Your thesis alleges that USCR may be overstating organic growth and using capital leases to inflate adjusted EBITDA. Did you come to these conclusions before or after you saw that management was compensated based on adjusted EBITDA growth?
Axler: We always like to understand what are the metrics that motivate management the most. In the case of USCR, it is clear that the sole factor driving management is Adjusted EBITDA. Therefore, we took a critical look into the levers management could pull to inflate this metric. Capital leases provide more benefits to Adjusted EBITDA than operating leases. Not surprisingly, we found evidence to suggest management has been more aggressively pursuing capital leases, while at the same time disclosing less information about the leases
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