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Overstock Declares War on Online Retail


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Not really a war yet, but Nick Nejad writes an interesting article on Overstock.com's future...will they be the low-cost retailer for overstock goods or will they disappear into the sunset. 

 

http://www.fool.com/investing/general/2010/08/27/overstock-declares-war-on-online-retail.aspx

 

While we're still five months out, I will go on the record and make a little bet...I think Overstock.com is going to make a substantial profit this 4th Q in 2010.  I think people will be surprised by the swing in operating cash flow.  Cheers!

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Their margins are lower than Amazon's and their customer satisfaction scores are on par or better. Overstock's affiliate business is where the money is on a consistent basis.  The direct business was giving them some problems earlier because it accounted for too much of their business when the economy was humming...direct inventory prices provided lower profit margins in a good economic environment, while in a depressed economy overstock inventory prices are cheaper and negotiable...companies want to unload excess inventory. 

 

The business now runs on a profitable 1st Q, break-even 2nd Q where they start to ramp up inventory and infrastructure, slightly profitable 3rd Q as they continue to ramp up, and then a massive swing in operating cash flow during the big 4th Q...similar to See's ramp up where they generate most of their revenues and profits in the 4th Q.  So far, we are seeing huge spikes in Overstock's revenue growth...30%+ growth quarter over quarter, year over year...I expect that trend to continue through the 3rd and 4th Q's. 

 

They have a long way to go to make a dent in Amazon's business, but that's not really the point.  Kind of like Walmart and Costco...they aren't necessarily competing with each other, but stealing market share away from Krogers, BJ's, Safeway, etc. where they are less competitive on cost and do less volume.  Overstock's long-term rival may be Amazon, but right now their primary rival are all the other online retailers with less competitive business models.  That's who they are going to take share away from.  Cheers! 

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owner of overstock but relatively small position

 

powerful brand and building an entrenched position as the low cost retailer on the internet; potentially powerful business model economics -- requires only small amounts of invested capital to support enormous revenue base

 

ceo is no doubt quirky but extremely smart, operates from owner perspective, and learned at the knee of buffett and munger

 

would have a very large position if the company had a stronger balance sheet -- overstock business would be affected by a sharp downturn in consumer spending and at this point not clear balance sheet is strong enough to get the company to other side if economy gets ugly...there is a scenario where the company runs extremely low on cash resources

 

barring a complete collapse in consumer spending during 4Q (which i'm not expecting but is possible), the company will deliver positive FCF/owners earnings but much will come from working capital dynamics, which doesn't represent a permanent increase in the cash base...accounts payable and accrued expenses get paid in 1Q, immediately draining much cash from the balance sheet

 

news from the world of retail has been ominous of late...j crew report/commentary was not good...so be careful

 

 

 

 

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Impressive revenue growth numbers.

 

I shop quite a lot on Amazon.com and after hearing about Overstock decided to comparison shop several times. Each time I've been disappointed with the results and ended up using Amazon (because of price, convenience, availability). I'm really surprised to hear OSTK's customer satisafction numbers are better than AMZN's.

 

Does anyone here prefer shopping at OSTK rather than at AMZN? Care to share your reasons why?

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Overstock's long-term rival may be Amazon, but right now their primary rival are all the other online retailers with less competitive business models.  That's who they are going to take share away from.

 

Overstock's long-term online rival is much more Ebay than Amazon.

 

Overstock has been and will continue to take share from mall based close out retailers that have much higher structural costs and ultimately will not be able to compete with Overstock, at least on price.  

 

Overstock gets hammered if consumer spending proves much lower than expected and traditional full price retailers get stuck with excess inventory and consequently have to price at a deep discount in order to liquidate -- a transitory environment (liquidating the excess inventory) but Overstock would struggle mightily during such an environment and the stock would likely get crushed as concern about the company's liquidity remerged.  

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In the online retail business, I'm seeing winners in successful e-commerce giants like Amazon/eBay and traditional retail giants having online presence (Walmart.com, etc).  If I remember correctly, Amazon and Walmart.com have leading e-commerce market share in the U.S.  It's also interesting to notice traditional retailers have been catching up faster in the last couple of years when it comes to online business, with the help of search engine and other tools.  Can Walmart eventually out-comptete Amazon in this space remains to be seen due to economy of scale and selection.  But I think they can both do well.

 

Another set of winners are the vertical sites like Zappos (focus on shoes), Newegg.com (focus on IT products).  These sites try to focus on certain verticals and they seem to be doing OK as well.  

 

In the case of overstock.com, I still struggle to see how they can effectively compete in the long run.  I absolutely agree that they don't need to make a dent to Amazon in order to do well for themselves, but do they need to have some sort of a niche in order to consistently earn FCF?  However, I've never shopped at overstock.com, and my online product search engines experiences don't usually lead me to overstock.com either.  Maybe it's that I'm not familiar with the business enough....So please bear with me if I've made dumb comments... :P

 

 

 

Nevertheless, Overstock.com seems more like a Lilu pick rather than a Buffett pick?   ;D  

 

 

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  • 2 months later...

Last 12 months FCF

Q409: OPEX of $66.4M- Capex of $1.3M

Q1-Q3 10: OPEX of -$31.7M - Capex of -$19M

 

LTM FCF of $14.4M.  Currently trading around 20X FCF or 5% FCF yield.  Doesnt sound too cheap when you consider revenues have only increased at a 5% CAGR from 2005-LTM.

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One of Watsa's other mistakes was buying into LVLT from what I can tell.

 

 

 

Let's look at a few comparisons between LVLT and OSTK. Although, I'm sure someone better versed on Watsa's history can find similar stories that worked out wonderfully.

 

I think part of the reason he bought it was because of the Kiewits, who were Buffett's friends.

OSTK is ran by Bynre, another of Buffett's friends.

 

Both companies are based around technology.

Both have high debt. OSTK does at least compared to peer.

Both are related to Buffett's circle of people.

 

It may very well work out for Watsa, but technology is a hard thing to figure out!

 

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One of Watsa's other mistakes was buying into LVLT from what I can tell.

 

This is often stated, but never backed up.  There was a Level 3 thread several months back which I shared (among a garbage ridden thread) LVLT's total IRR on their Level 3 involvement of >14%.  I just reran the numbers real quick, and I get a ~7% IRR with the stock at $0.90.

 

I do not know Fairfax's thesis, I have never heard an intelligent thesis on why to own LVLT equity from this board or anywhere else.  I do however struggle when people think something is bad when it is not actually bad.  As with most equity investors, we tend to ignore the big money that FFH has made on LVLT bonds.

 

I do not believe that you can focus on just the LVLT common investment by FFH and claim that is was a failure, I believe you have to have a view of the whole capital structure that they invested in.

 

When the underlying assumption you use to generate a "lesson" (in this case the assumption being that LVLT did not profit from and or made a mistake in investing in LVLT) is wrong, I think you have to ask yourself whether the lessons you think you are learning are the right ones.

 

No offense intended to you Stahleyp.

 

Ben

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One of Watsa's other mistakes was buying into LVLT from what I can tell.

 

This is often stated, but never backed up.  There was a Level 3 thread several months back which I shared (among a garbage ridden thread) LVLT's total IRR on their Level 3 involvement of >14%.  I just reran the numbers real quick, and I get a ~7% IRR with the stock at $0.90.

 

I do not know Fairfax's thesis, I have never heard an intelligent thesis on why to own LVLT equity from this board or anywhere else.  I do however struggle when people think something is bad when it is not actually bad.  As with most equity investors, we tend to ignore the big money that FFH has made on LVLT bonds.

 

I do not believe that you can focus on just the LVLT common investment by FFH and claim that is was a failure, I believe you have to have a view of the whole capital structure that they invested in.

 

When the underlying assumption you use to generate a "lesson" (in this case the assumption being that LVLT did not profit from and or made a mistake in investing in LVLT) is wrong, I think you have to ask yourself whether the lessons you think you are learning are the right ones.

 

No offense intended to you Stahleyp.

 

Ben

 

I appreciate the commentary, Ben. No offense taken. However, as you stated, I was strictly looking at the common. They may have very well made a lot of money on the whole capital structure. I don't see how they could've ever made money on the common, though!

 

With that being said, I hope they make a ton of money on OSTK and LVLT common eventually. But, the similarities are something to think about!

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Not sure you can call it a turnaround story when they've arguably never really been successful.

 

I just don't see how they have any long-term competitive advantage. They compete almost only on price and have little to no margins. Their fulfillment business has some value, but that's still a business with tons of competition and very little barrier to entry. They spend a lot of money on advertising, and their business would probably dry up if they stopped their heavy advertising.

 

Lastly, I buy a lot of stuff online, and don't think I've ever found something I was looking for on their site.

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Lastly, I buy a lot of stuff online, and don't think I've ever found something I was looking for on their site.

 

I've never bought anything from Walmart or Costco Online either, but they both seem to be doing ok!  ;D  Overstock is trying to create their barrier to entry, by becoming profitable on the thinnest of margins and providing a high level of customer service.  Byrne picked a doozy of a sector to try and become dominant in, but they have a fighting chance.  Cheers!

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It's always the same story with Overstock. They have a couple of good quarters and you think they are resuming growth and profitability and then bingo it's another poor quarter with lower growth or lower margins... I think they are still struggling to be disciplined operators....

 

Having said that under $13, it is very cheap.... Especially with the historical volatility of that stock.

 

Sanjeev, do you still have a position?

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I have never understood this business.  Why would anyone who is purportedly so smart (Byrne) try and make a go of it in a business that is so complex and competitive.  The lessons learned at Buffett's knee seemed to have gone right past him.  I know I am going to get flamed for this but so be it. 

 

It is a lousy, capital intensive, business concept, competing against gargantuan competitors, who generate more cash flow, in a few hours, then this thing generates in a year.  If you want to define value trap then this would be it.

 

No matter how you try to value it you will come up with zero. 

On a net asset basis what would it be worth if it was wound up? 

On a discounted cash flow basis what would it be worth? 

Where is the margin of safety? 

Where is the dividend?

Where is the years of profitable growth?  (I forget - just around the corner)

 

I vote for sunset....

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Uccmal,

 

I know I am going to get flamed for this but so be it.

 

You're right I'll flame you arrrgghh  ;)

 

You bring some valid point. From memory (could be wrong), his father Jack said to him when he talked about that idea something like "Why not bring a pile of money and burn in the middle of the street instead?".

 

That being said, while it's a tough business, Overstock.com has some competitive advantages like mindshare, high customer satisfaction, etc. In the online world, overall people are getting smarter, and it becomes more expensive to generate qualified trafic to sell your products. When you have mindshare, people can just type your name on Google and get to your website or better yet type your URL and go directly to your website, wich is far less expensive than bid on keywords or try to have a better ranking in organical results on Google, Bing, etc. I'm sure there is some other stuff that I could talk about, but in the end you have to generate profits and I agree with you that it is very difficult to do so in that business. But, Patrick is a fighter, and I would prefer by far to be on his side than on the other side. I admire him a lot for what he has done both in the business and against the naked short sellers.

 

That being said, I don't have any OSTK shares, but I will certainly not short any!

 

Cheers!

 

 

 

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Al,

 

The valuation model to value an online retailer is all about the net cash on the balance sheet, the amount of invested capital (net over time), and the free cash flow generated per dollar of invested capital.  It's capital intensity is surprisingly low given that it has resumed generating cash from the balance sheet.

 

Here's a typical earnings call transcript from Amazon where you can pick off the key metrics for how they measure the progress of their business.  They built a successful franchise with hawk-like focus on these metrics.  Bezos is the genius that Byrne aspires to be.

http://seekingalpha.com/article/62375-amazon-com-q4-2007-earnings-call-transcript

 

Seasonality is a huge factor in retail, so trailing twelve month blocks are the best way to look at any set of numbers.  Quarterly numbers are for headlines, TTMs are for valuation models.

 

Mike Mauboussin who taught at Columbia Business School lays out the ground work for a valuation model in an older paper here.  It lays out the mechanics of the cashflows for online retail, including generation of cash from the balance sheet (which is atypical for most businesses).  After a couple of reads, it makes sense. 

http://www.capatcolumbia.com/Articles/FoFinance/Fof9.pdf

 

With a bit of grunt work, you can build out a similar model.  Given the progress in OSTK's cash flow generation and the recent drop in valuation based on the headline numbers, it's trading below intrinsic value.  How much depends on your own estimates of future scenarios of cash generation.  It's not a high certainty trajectory, but the pattern of increasing free cash flow generation is obvious over the last four years.

 

-O

 

I have never understood this business.  Why would anyone who is purportedly so smart (Byrne) try and make a go of it in a business that is so complex and competitive.  The lessons learned at Buffett's knee seemed to have gone right past him.  I know I am going to get flamed for this but so be it. 

 

It is a lousy, capital intensive, business concept, competing against gargantuan competitors, who generate more cash flow, in a few hours, then this thing generates in a year.  If you want to define value trap then this would be it.

 

No matter how you try to value it you will come up with zero. 

On a net asset basis what would it be worth if it was wound up? 

On a discounted cash flow basis what would it be worth? 

Where is the margin of safety? 

Where is the dividend?

Where is the years of profitable growth?  (I forget - just around the corner)

 

I vote for sunset....

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If I were to pick an online retailer to watch out for, it would be csnstores.com.  I believe it is privately held.

 

I recently built a new house and ended up making many online purchases for the house (fireplace, ceiling fans, plumbing fixtures, porch swing, etc.).  I had never heard of CSN before, but stumbled upon their website as I searched for things.  They have a very broad selection of products and their prices were consistently lower than most other retailers (traditional or online only, including overstock).  I also found that they had excellent customer service.

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Overstock is trying to create their barrier to entry, by becoming profitable on the thinnest of margins and providing a high level of customer service.

 

So is every other online retailer selling products they don't create.

 

Online retailers reselling products will all continue have a very hard time competing with Amazon and WalMart, as they can't match their scale. It's not like Brick & Mortar stores that can still compete with companies like WalMart with convenience.

 

Online retailers can be successful selling their own products. Company's like Apple and Coach (and many others) will continue to do fine since they manufacture and sell their own products.

 

Reselling products at very low margins is a very tough business model, especially when you take into account all the expenses around operating warehouse, taking on inventory risk, shipping, (and add in all the $ they poor into advertising at OSTK) etc.. I'm not saying Overstock can't have some good quarters along the way, but I think they'll continue to have a hard time building any real competitive advantage over the long term.

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Omagh,  I guess the problems I have are two or three fold:

 

1)  Discounting:  The online presence of all retailers is leading to price leveling across the board.  We just went through a home reno and added several appliances.  We product and price compared online and then went to a couple of B&M stores and ended up buying all the products from Sears Can.  (SHLD shareholders take note).  They price equalize to any retailer you can legally buy from.  I dont see how OSTK can compete in this space and actually make much or any money.

 

2) Online retailing:  I go back to the 90s to address my concerns.  Everyone recalls when there were hundreds of ISPs.  In a few years the upstarts got whittled down to one (AOL) and then big cable/phone providers with their deep pockets took the space from the hundreds of ISPs.  I see the same thing happening as online retailing matures.  You have two online only survivors in Ebay, and Amazon, and sevaral B&M stores who will move in and excel in the space.  

 

3)  Loyalty: Combining the above is the notion of loyalty to OSTK.  Pure conjecture on my part but when you can move across multiple retailers in a matter of minutes comparing the prices of a Samsung LCD 34" TV, you may well take the lowest price, period, including shipping and handling.  I would bet that WMT, Costco, and BBY will equal or beat OSTKs prices everytime in the near future.

 

 

I still dont see a margin of safety.  The brand is not strong enough to provide it.  There are no tangible assets to back up the stock price.  

 

 

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