Interview with Ben Axler (Spruce Point Capital Management)

Member: Ben Axler
Title: Managing Partner/Founder
Firm: Spruce Point Capital Management
Focus: Cash-rich value equities and special-situations
Location: New York, NY
Undergrad: Rutgers College
Post Grad: Yale University
Recent Ideas: STVI.OB (long), DLGC (short), CIS (short)

Brief Bio:
Prior to founding Spruce Point Capital Management, Mr. Axler spent eight years as an investment banker with Credit Suisse and Barclays Capital. Mr. Axler has been a guest speaker at numerous investment symposiums, is a contributing writer to Sumzero, SeekingAlpha, and the Street.com, and was profiled in the book "The Happiness Advantage: The Seven Principles of Positive Psychology That Fuel Success and Performance at Work." Mr. Axler graduated from Yale University with a master's degree in statistics and received both a bachelor's of arts degree in statistics and a bachelor of science in marketing and business administration from Rutgers College, where he graduated with summa cum laude and Phi Beta Kappa honors.

SumZero: What current news event is having the most impact on your investing process?

Ben Axler: Not long ago, the U.S. was besieged by the nuclear arms race; today we are facing a nuclear debt race. The political will for governments in Europe and the U.S. to deal with escalating debt levels remains a major challenge for the global financial system. In particular, persistent news headlines out of Europe are constraining capital investment, risk taking, and investor confidence. Contrary to the theory of financial market decoupling, the system is heavily intertwined. One shock in China/Asia, Europe, or the U.S. is capable of causing an escalation of the financial crisis.

In the U.S., a gradual improvement in our economy is showing signs of stalling as corporate margin expansion has largely peaked, unemployment remains stubbornly high, and FED policy makers have exhausted nearly all traditional monetary policy tools to stimulate real economic growth.

Asia remains heavily dependent on China as its growth engine, but there are equal imbalances in the economy there with significant over-investment of infrastructure, high inflation, a large build-up in their shadow banking system, and high dependence on world exports.

Because of high correlation among asset classes, and the propensity of stocks to be driven by headline macro events, it has created a challenging environment to be a fundamental investor.

SumZero: What sector of the market is overvalued?

Ben Axler: With the FED artificially suppressing interest rates and investors shunning risky assets, high dividend paying sectors such as REITs and consumer staple companies have experienced large appreciation in their share prices. The FED has committed to keeping rates low for the foreseeable future, but low rates won't be permanent so these sectors are not immune to a large correction in the coming years.

We marvel at how certain restaurant and beverage stocks currently fetch premium valuations. Examples include names such as McDonalds (NYSE: MCD), and particularly ones with above market growth rates such as BJ's Restaurants (Nasdaq: BJRI), Buffalo Wild Wings (Nasdaq: BWLD), Monster Beverages (Nasdaq: MNST), and the Boston Beer Company (NYSE: SAM). Serving burgers, fries, wings, beers and energy drinks isn't a terribly complex business, and is extremely competitive, so we wonder how names like BJRI, MNST, BWLD, and SAM fetch a 40x, 28x, 25x, and 22x P/E, respectively. From a high level perspective, we worry what this implies about the long-term competitiveness in the U.S., when the most highly-valued stocks in our country sell unhealthy fast food products.

SumZero: What are your thoughts on shares of Facebook--Buy, Sell, Hold?

Ben Axler: Facebook is a transformative company, but its $100bn valuation (26x sales and 100x p/e) is pricing in high expectations. I am neutral on it until they can demonstrate a more robust and diversified revenue model. Currently, a majority of revenues come from advertising, which offers little in the way of price stability and recurring revenues. The company has also yet to figure out a way to monetize its mobile presence, which could offer a leg of growth if it doesn't cannibalize existing revenues. Facebook warned very clearly numerous times in its S-1 filing that user and revenue growth rates will decline in the future; investors buying into the IPO should heed this warning carefully.

SumZero: What is one of your favorite ideas?

Ben Axler: The Facebook and craze and investor euphoria reminds me of the lessons learned from the boom and bust of gold rushes, both past and present. It's not always the gold miners and explorers that produce the best long-term profits for investors; rather, it is the companies that provide the tools and equipment to the gold miners searching for the jackpot.

In the case of Facebook, I favor the application providers that are positioned to profit from its growing user base. One company I feel strongly about is Snap Interactive (STVI.OB). Snap is the leading Facebook dating application provider. The market for online dating has exhibited consistent 16%+ annual revenue growth and Snap has over 55 million users on Facebook who have opted-in to their dating application, giving it one of the largest dating pools online. The company also has 8 million monthly active users, making it one of Facebook's most popular applications.

Revenues are subscription-based, not advertising-based, and are growing faster than Facebook's and as fast as Zynga's. The company is well off the radar screen of most investors, because they did not come public through the traditional IPO route, and have no broker coverage or major institutional ownership. With only an $85 million enterprise value (trading around 3x revenues vs. 26x and 6x for Facebook and Zynga), a proven business model with existing mobile revenue sources, and rising M&A activity, Snap offers compelling long-term value and numerous catalysts in the years ahead as the company seeks to broaden its investment appeal, with a focused IR effort and potential Nasdaq listing, grow its core brand, and use its expertise for additional application development.