It stripped assets away from entities that had previously provided credit support to lenders, into a superholdco entity — a non-loan party entity that was not only entirely outside the scope of the restricted box but also was not an unrestricted subsidiary — with assets and business value accrued directly to shareholders. It then was able to sell some of these assets and use the proceeds of the asset sales to capture discount via repurchases of a portion of its existing distressed term loan.

Steps one and two: As part of a business combination agreement, Orchid Merger Sub II, a shell subsidiary of System1 raised a $400m term loan, with a guarantee from and first lien over the larger System1 business, but not its majority stake in and assets of Protected.net (aka Total Security Ltd). It then up-streamed the proceeds from this debt to repay an existing secured (by assets and business of System1) term loan from Cerberus Capital and to purchase the remaining 49.9% stake System1 did not already own indirectly in Protected.net.

Steps three and four: System1 went public via a SPAC merger with Trebia Acquisition Corporation. Then, and under section 251 of the Delaware General Corporation Law (DGCL), Trebia, after renaming itself System1 Inc., employed an “Up-C” structure and dropped all assets of System1 into a holding company called S1 Holdco. System1 Inc. also merged another shell subsidiary, Orchard Merger Sub I, with System1 SS Protected Holdings, a subsidiary of S1 Holdco which ended up holding 100% of Protected.net. Thus, all assets and businesses of System1 and Protected.net were transferred to two separate subsidiaries of System1 Inc., while ensuring they remained free of liens securing debt at Orchid Merger Sub II.

As a result, the business reorganized with System1 Inc. as the holding company with four subsidiaries — S1 Holdco, Protected.net, Protected UK (Protected.net’s UK business), and Orchid Merger Sub II. Post completion of the merger, System1, Inc had an enterprise valuation of $1.4bn with a net debt of $390m and a net leverage ratio of ~3.5x at the end of December 2021.

2022 marked a significant change in the combined company’s plans and the management announced its ambitions to reach all-time high revenues by the end of 2023. These plans were supported by System1’s transition from bespoke consultancy work towards ‘scalable’ data products and partnerships with ITV and LinkedIn.

However, this pivot to data products proved to be less successful than envisioned. Post pandemic, the general ad environment and media landscape also changed significantly and the business slowed down. FY23 revenues clocking in at $402m, down 40% from the previous year. Margins worsened further and EBITDA dropped from $121m in FY22 to $29m in FY23. Leverage became unsustainable.

To reduce leverage and improve near-term liquidity, System1, Inc. divested Protected.net (but not its UK business) to another PE firm. The proceeds from this sale aggregated $340m and were used to repay part of the outstanding debt at Orchid Merger Sub II and to increase System1 Inc’s cash reserves, which improved the net leverage ratio from 12.0x to 7.5x.

The initial reorganization facilitated the asset sale and liability management exercise, helping alleviate the company’s capital structure issues. At 7.5x net leverage, the debt is well covered on an LTV basis considering peers trade at roughly 12.5x EBITDA. Nevertheless, worsening margins in 2024 have again caused concerns about the debt’s sustainability, with a possibility that System1 may need to soon take additional measures.

Company overview

System1, Inc. provides omnichannel customer acquisition services through its proprietary responsive acquisition marketing platform (RAMP) to brands, advertisers and publishers.

System1 owes its success as a platform to its RAMP technology, which has enabled it to process 175m daily advertising campaign optimizations and ingest over 13bn rows of data daily across around 41 advertising vertical categories. The purpose of this technology is to identify potential customers, determine their purchasing patterns, and monetize them through building a relationship with advertising networks. For a share of the revenue generated, RAMP helps advertising networks direct customer traffic to System1's website, then helps them monetize the traffic.

Source: Company filings

It operates through two segments — Owned and Operated Advertising, and Partner Network. Owned and Operated Advertising is engaged in directly acquiring traffic to its owned and operated websites and connecting them with advertising partners. Partner Network has sharing arrangements with network partners for the use of the RAMP platform and related services to help them acquire traffic and connect them with advertising partners on their advertising space.

Prior to the sale of Protected.net in November 2023, the company was also involved in providing antivirus software solutions on an annual subscription basis that allowed US customers a single packaged solution providing protection and reporting to the end users.

The company is currently headed by co-founder Michael Blend, who also serves as its CEO since 2021.

Merger under section 251 of the DGCL

In early 2022, System1 announced its intention to merge with Trebia, a SPAC formed by sponsors Bill Foley and Frank Martire Jr.

Pre-merger, System1 was held by OpenMail and Court Square Holdings. At the time, System1 held 50.1% of Protected.net and its subsidiary Protected UK. Pre-merger, Trebia was a SPAC owned by the two sponsors mentioned above and certain public shareholders.

Source: 9fin, Company filings

To complete this merger, Trebia filed a notice of deregistration with the Cayman Islands Registrar of Companies and filed a certificate of incorporation and a certificate of corporate domestication in Delaware, under which Trebia was domesticated and continues as a Delaware corporation.

Post Trebia becoming a Delaware corporation, it announced the proposed SPAC merger with System1. By the time the merger closed, under Section 251(g) of the DGCL, Trebia would change its name to System1 Inc. — a shell company with no assets — and would become the holding company. All of the company’s business and assets (other than those of the Protected business) would sit in S1 Holdco, with S1 Holdco managing the businesses and assets post-merger. The Protected business would sit in separate subsidiaries of System1 Inc.

Source: 9fin, Company filing

Post the announcement of merger (but before the actual merger and consequent reorganization), System1 started the process of acquiring Protected.net and its UK subsidiary.

For this acquisition, it raised a $400m term loan B at Orchid Merger Sub II, a subsidiary of the erstwhile System1 parent. Orchid Merger Sub II had no assets or business and was a shell financing company, but the loan has a first lien over and guarantee from the larger System1 business at S1 Holdco. The loan had/has no recourse to System1’s majority stake in and assets of Protected.net.

It then upstreamed these funds to erstwhile System1 parent, which then used $172m to repay an existing term loan provided by Cerberus Capital and down-streamed the remaining funds to subsidiary System1 SS Protected Holdings which at that time owned 50.1% of Protected.net.

With the proceeds from S1 Holdco, System1 SS Protected Holdings bought out the remaining equity stake in Protected.net and became a 100% owner of the entity and its subsidiary Protected UK.

Then, the System1-Trebia SPAC merger, which we discussed earlier, occurred via an Up-C structure, with Trebia renaming itself to System1 Inc. and becoming the ultimate parent.

Source: 9fin, Company filings

System1 Inc. then merged subsidiary System1 SS Protected Holdings with Orchid Merger Sub I and Protected.net and Protected UK, respectively housing the US and UK business of protected, became independent subsidiaries of System1 Inc.

Then as per the business combination agreement, the erstwhile parent System1’s name was changed to S1 Holdco, in which the larger business and assets (ex-Protected) were held, and S1 Holdco became a subsidiary of System1 Inc.

Source: 9fin, Company filings

The completion of the combination and reorganization resulted in System1 Inc. as the holding company with four subsidiaries — S1 Holdco, Protected.net, Protected UK (Protected.net’s UK business), and Orchid Merger Sub II.

The shareholding of System1 Inc. post-merger was as follows: (a) 51.93% shares were held by former System1 and Protected equity holders, (b) 40.26% was held by Trebia public shareholders and (c) 7.81% was owned by the sponsors of the SPAC.

The holding company, System1 Inc. then entered into two agreements.

The first was a backstop agreement with Cannae Holdings, an investment firm that owned a stake in Trebia, for up to $250m wherein Cannae purchased certain shares of the holding company for $10 per share of System1 Inc. from Trebia shareholders.

The second was a credit agreement and provided for a $400m first lien term loan at Orchid Merger Sub II, with $376m in net proceeds. The System1 and Protected equity holders also amended the original agreement and opted for a smaller upfront equity for a larger equity stake in the combined entity.

With these additional agreements, System1, Inc. gained a $1.4b enterprise valuation and was publicly listed. The shareholding pattern post these transactions was as follows:

• Former Trebia public shareholders: 1%
• Founder/sponsor shares: 6%
• Erstwhile System1 parent and Protected former shareholders: 68%
• Cannae shareholding as part of the backstop agreement: 25%

At transaction close, System1, Inc.’s capital structure was as follows:

Source: 9fin, Company filings

Sale of Protected.net and debt repurchase

Transitioning from bespoke consulting contracts to data products as a primary focus of business proved to be costly for System1.

Ad markets and the media landscape also changed significantly post-Covid and RPS (revenue per session of advertising, a unit used to pay platforms) declined by more than 40% from peak levels in mid-2021. This caused System1’s EBITDA to fall rapidly and net leverage reached 12x by Q3 23. To reduce its debt burden, the company decided to sell its US security subscription business.

In Q3 23, the company divested Protected.net for $340m. The transaction (depicted in the snapshot below) consisted of (a) System1 Inc. selling Protected.net to a group led by Just Develop It for $240m in cash, (b) the assumption and waiver of $60m of potential earnout payments due to Protected.net in connection with the business combination transaction in January 2022, and (c) the transfer to System1 Inc. of around 29.1m shares of System1 Inc’s Class A common stock held by Just Develop It (and related persons) worth around $40m based on the closing price of the stock on the date of completion of the transaction.

Source: Company filings

In January, System1 completed the repurchase of $63.7m in principal amount of its outstanding senior secured term loan for an aggregate purchase price of $40.9m, a 36% discount to par, leaving $301m remaining outstanding under the term loan due 2027. The rest of the cash from the Protected.net sale stayed on the balance sheet.

The liquidity provided by this transaction was used to further fund the development of new data products released during late 2023 and 2024. The transaction helped the company reduce its net leverage from 12x to 7.5x by December 2023 as shown below.

Source: 9fin, Company filings

System1’s net leverage of 7.5x post the transaction seems to indicate that its debt is well covered on an LTV basis, since its peers are currently trading at around 12.5x EBITDA (as shown in the chart below; midpoint of the mean and median of EBITDA for comparables for FY24). This seems to suggest that the company’s liability management exercise was successful in alleviating its capital structure issues.

Current business scenario

While the TAM of the online advertising industry is large, at around $237b in 2023, and according to some sources is expected to grow at 15%+ CAGR over the next 10 years, the serviceable addressable market for players like System1 is considerably smaller.

The majority of online advertising revenue is taken up by major players like Meta and Google, while the online customer acquisition industry is dotted with several smaller players, making it highly fragmented and difficult to gain a strong foothold in.

RAMP has helped System1 gain traction and make it comparatively more successful than its peers in targeting the right audience for a particular ad. In the last two years, however, most of the company’s new product offerings have not been as successful and the high cost of developing these products has stressed its balance sheet.

The media and ad industry is cyclical and post-pandemic it saw a downturn, which affected smaller players like System1 much more than the larger players, as seen in the chart below.

Source: 9fin, Company filings

There is still some optimism regarding this industry. Factors continuing to work in favor of System1 include (a) advertisers shifting to digital channels, (b) increasing online spending, (c) increased flexibility and scalability due to cloud solutions and (d) automation of ad buying. Moreover, the ad industry is expected to see an upturn by end of 2025, which can also be considered as a positive for the firm in the long term.

Along with the macro conditions and the failure of new data products, the sale of Protected.net (the US business) also hurt the company. The sale was generally viewed negatively by investors as System1 now operates as a pureplay digital marketing services provider and no longer benefits from the product and customer diversity and more stable subscription-based revenue stream that the security business provided.

Comparable valuations

While there is no clear comparable company, System1 can be compared with a bunch of other online digital platforms such as LendingTree, Everquote, Tech Target, etc., which are in the same range of revenues. On the higher end, we can also compare System1 to Taboola and Ziff Davis.

Source: 9fin, Company filings

Looking ahead

While the company was able to reduce its debt through the sale of Protected.net, worsening margins in Q4 23 and H1 24 have again put pressure on the company’s financials.

As seen in the chart below, the company’s RPS across its owned and operated advertising channels has been steadily decreasing QoQ for the last two years. While this can be attributed to a general slowdown in the ad markets, System1’s new products have been less successful in gaining traction and increasing the customer base. While improvements in costs per session (CPS) have been seen, they were insufficient to compensate for revenue loss, and gross profit per session has declined for seven straight quarters.

The term loan due 2027 is currently trading at 62.9c to a dollar from 73.8c when the sale of Protected.net was completed and certain portion of the debt was repurchased in Q3 23.

Source: 9fin, Company filings

The Partner Networks segment has seen good growth in the last few quarters but is still a minor contributor to overall revenues. If the ad market does not recover soon or new products don’t get sufficient traction over the next few quarters, the company may have to consider another liability management exercise or think about restarting its bespoke consultancy services offering.

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