Spruce Point Capital founder alleges that FIGS execs are ‘exaggerating financials'

Spruce Point Capital’s Ben Axler joins Yahoo Finance Live to discuss the company’s report on FIGS that claimed the apparel company exaggerated metrics and its total addressable market.

Video Transcript

- Shares of FIGS are a bit higher today. That's after they fell last week on a short report from Spruce Point Capital. That report claimed the health care apparel brand has a, quote, "troubling history of exaggerating financial and business metrics." Yahoo Finance reached out to FIGS. They declined to comment directly on that report. Joining us now to discuss is Spruce Point Capital Management founder and CIO Ben Axler. Ben, thanks for being here. In looking through this report, you look a lot at the sort of background of the founders of the company. What specifically are you concerned about in terms of sales of FIGS because the sales have been growing at a decent clip.

BEN AXLER: Well, thank you very much for having me. I don't know how you trust sales when there's a clear factual evidence that when this company was private, they exaggerated their sales by almost to 2x, meaning they were out touting that they had $100 million of sales, but when they filed to go public, they stated that the sales were closer to $50 million. So that forms the basis of our concerns here. How do you get confidence with the financials when you have a pattern and a history of the management even exaggerating their backgrounds and maybe not being as forthright as possible?

- So Ben, if I may, so you're basically accusing this company of fraud?

BEN AXLER: No. I'm not using that word. I'm not a lawyer. I'll let the lawyers opine on that. What I'm accusing the company is of exaggerating financials. And not only that. They're exaggerating their total addressable market. So this is a company that would have you believe that they can sell their scrubs to every health care worker in America and touch a $12 billion TAM. But what we find is that this product is more of a niche product, not necessarily geared towards health care workers and hospitals that have to change their scrubs after every surgery and where hospitals are under cost pressure not wanting to pay a premium for their scrubs. So we think the addressable market's closer to $5 billion.

We also have concerns with the gross margins of how they allocate costs. And gross margins we believe were overstated by 2000 basis points. So again, it's all having confidence in the management confidence in the numbers. If you don't have confidence in the numbers, I don't know how you can assign a rational stock target here on the share price.

- In response, you had seen Oppenheimer also push back against your report that you had put out saying that they studied the short report and they came away with the belief that the price is predicated-- or the piece, rather, predicated on largely conjecture and innuendo, raises no new concerns not already part of the investment narrative on FIGS. What would your response to that be?

BEN AXLER: I mean, there's no conjecture here. Again, we're looking at the numbers. The numbers are telling us that this business is under strain. Look at the inventory very carefully. The inventory is growing double digits, whereas the revenue growth is decelerating. This company was a big beneficiary from COVID and the health care workers needing more scrubs. That's behind us. So we believe inventory is piling up. We believe their margins are going to have to come down.

Look very carefully at the forward looking statements. The company revised them. They removed reference to profitable growth. Again, we think this is them sending a signal to one spring bear. The days of inventory grew 50% year over year. So, again, we're focused on the numbers. We're focused on channel checks, talking to former employees. We get a color of a business here that is not poised to grow and grow internationally and become the next Lululemon, so to speak, that the bulls would have you believe.

- And Ben, I'm wondering about your timeline here, especially when you consider the cash flow and the cash position that the company is in. It's about a $2 billion market cap. Came to market a little over a year ago at a time when interest rates were a lot lower than they are today, although historically depressed. How does a company like this, or in particular this company, look as we experience this rising interest rate environment?

BEN AXLER: Well, look interest rates, increased cost of capital for all businesses, FIGS included, I mean, they did raise capital at a great time. And the stock price since the IPO has gone down. But we think that there's more downside. I mean, you don't see the company using its excess cash to buy back its stock.

I mean, if the stock were truly undervalued, management would be buying it hand over fist. They're not. Instead, what we see is evidence that insiders were selling stock and they want to divert their capital towards internal growth. But that we think is challenging. One of the things we really press management on is to disclose what is your CAC, your cost of acquiring new customers. Because based upon our analysis, it's going up dramatically.

And so acquiring new customers at a higher price point is going to drag down your margins. The cash flow is already negative here. We think that's going to go further negative as their cost of acquiring new customers going up and their customers have more choices. The landscape here is dramatically different from when they came public. And even prior, we acknowledge, hey, they were a leader in premium scrubs years ago. But those competitive advantages are gone. The market's more saturated. And we think they're going to have a very tough time profitably growing.

- Ben, I'm looking at-- we've talked to you in the past about some of your other short ideas as well. And so I'm just kind of looking and getting myself updated on them. Oatly, which we talk to you about, certainly the stock has gone down since you introduced your short on that. WD-40 went up, went down again. So I guess kind of flattish. Church and Dwight is up about 6% since I think you came out with your short thesis. Any kind of update you want to give us on those and if you think still Church and Dwight is a good short and if it's going to end up going down?

BEN AXLER: Well, I mean, we put a-- memory serves me, probably three years ago. So for a stock to be up 6% in three years, I would argue that's been a dramatic underperformer. And in fact, we've seen them continue to acquire businesses. And I think we proved through our short thesis that they've been a terrible acquirer. So we still have an underweight position on that. We don't see anything optimistic going on there.

In terms of the other ones, WD-40 obviously another underperformer, a company dramatically overvalued that had some COVID benefit from people staying at home and fixing things and using their magic lubricant. But no. I mean, you look at our track record, I think it speaks for itself. We've been one of the few resolute firms to issue strong sales all throughout the pandemic, Oatly included, which is down over 80%. And a majority of our other calls are down over 80% in the past year. And we expect FIGS to follow suit. And we see at least 60% downside risk from here in that security as well.

- Spruce Point Capital Management founder and CIO Ben Axler joining us here this morning. Ben, thanks for the time.