Overstock Declares War on Online Retail

[Guest]

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.  

 

 

 

I agree.

 

Now, the company could make lots of money for Chou and Watsa, but I don't see the margin of safety.

 

If we look at the stock performance over since inception (almost 8 years), which should be plenty of time for the market to recognize the potentional, the company has underperformed s&p 500 and its industry. Now, strategies can change and whatnot, so this might change. However, it's still something to consider.

 

It has a p/e about the industry average (although it's underperformed the industry)

P/B of 20.5 vs 3.8 for industry average

it's cheap on the P/S and P/CF.

 

I know it's a technology stock and the old value metrics may or may not apply, but I don't think the stock is super cheap, given all the uncertainity...which one would think, since uncertainity tends to create great opportunities.

 

All, I don't think it's a great business idea to compete directly on price. Although, that can be a sucessful strategy, ie walmart. By and large though, it's not a great business to be in.

 

With all that being said, Chou and Watsa are much smarter than I'll ever be, so maybe it'll work out just fine.

[Parsad]

Al,

 

It's about scale.  Not an easy business when you've got Amazon already doing the same thing, and guys like Walmart and Costco online competing with just as slim margins.  Byrne is crazy and loves a challenge...win or lose!  He picked one of the hardest businesses to try and build a foothold in.  The easiest way to explain is below:

 

http://financials.morningstar.com/ratios/r.html?t=AMZN&region=USA&culture=en-US

 

http://financials.morningstar.com/ratios/r.html?t=OSTK

 

- Overstock is now profitable on a 12-month basis on less than a third of the revenue it took Amazon to do it in  

- Both companies had negative book until they hit a critical mass  

- Overstock has reached that critical mass faster than Amazon  

- Overstock's customer service numbers are on par with the best online providers in North America  

- Incremental improvements in margin will now have a full impact on net profits  

- Overstock has reduced their senior notes to $34M, while maintaining $76M in cash after leasing back their IT equipment

- Cash should exceed $140-150M at the end of the 4th Q, before current liabilities are paid

- Share count in the last three years reduced, whereas AMZN was still issuing stock

- Byrne will grow Overstock while undercutting everyone else's margins...dangerous, but the only way to build a moat...think Costco or McLanes!

 

The wildcard is can Byrne remained focused?  I think with Byrne Sr. and Sam there, it will definitely help.  This isn't like LVLT.  Alot of investors hoped LVLT would also hit a critical mass, but their debt servicing costs are too high and they will probably run into serious problems before that...unless their benefactors can continue to refinance them, and receive insane interest rates on that debt from cash flows...but it's just not sustainable with their debt load as is.  Overstock no longer has that problem.  Cheers!

[omagh]

Thanks for the comments, Al.  I'm not invested in OSTK, but watch it for enduring improvements in the financials.  What is noticeable is the improvement in OSTK's cash generation.  AMZN was in a similar position from a cash generation perspective around 2001-2003, but the market sales opportunity was there for the taking and they occupy a significant part of online retail as the incumbent with branding (moat) and customer loyalty at larger scales than OSTK.  There is a knee in the cash generation curve (i.e. an acceleration) where the freecash flows for online retailers leverage off a relatively small set of invested capital that scale slower than the cash is generated (a FCFRoIC curve).  OSTK has never achieved a significant acceleration in cash generation, but the trend is positive.

 

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.

Agreed.  Here volume and operating margin are the key factors.  If they can't get enough volume in the right product categories, then the thin operating margins (volume x gross margins - operating expenses) don't scale.  Clearly, size and scale matter for survival.

 

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.  

 

Analogy is debatable and the capex mechanics in that market are radically different.  But agree that all businesses need to adapt to changes in competition and those with moats survive longer and more easily.

 

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.

Agreed that switching costs are low, but consumers are creatures of habit for certain classes of purchases and trust and service are factors in customer retention.

 

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.  

 

Business model factors (moat, customer retention, volume/scale/margin) are a risk for sure.

So, some numbers for margin of safety from a valuation perspective.  At Dec 2009, OSTK traded for 7.7 x FCF and 38 P/E using current market cap ($300M).  The FCF number is interesting.  Over the trailing twelve months, they generated $34.7M operating cashflows and consumed $21.0M in capex (scaling for growth) for a net positive of $13.7M and trade at 22 x FCF and 23.5 P/E (current market cap).  Once the capex step up is completed, the cash flows will surge and that FCF multiple will look tasty again and better than 7.7 x.  If you go back and look at FCF generation over the last 5 years or so, the trend toward profitability and FCF generation is clear.  The difficult part in the valuation is the rate of FCF generation since the FCF is lumpy and affected by seasonality.

 

[Uccmal]

Omagh, Sanj., Thanks for all the metrics, articles, and thoughts.  It has been a long haul for OSTK holders although I know some who have profited by trading in and out - not me.

 

It is an interesting exercise in valuation at the very least. 

 

Omagh, It is true that customers keep going back to the same locations.  I have noticed this with Amazon in Canada even though Chapters/Indigo can be cheaper here.  My wife bought a set of DVDs from Amazon about three years back and had to send them back after we realized that there was a couple that were visibly damaged.  There was no issue with the refund including shipping and handling that I recall.  I have always had success with them. 

 

The free cash flow numbers are increasing, and I can understand where everyone is coming from. 

 

 

[Guest]

http://money.cnn.com/2010/11/18/technology/overstock_discounts_lawsuit/index.htm

 

Probably not a big deal, but I thought I'd let you guys know.

[Baoxiaodao]

It seems to me everybody wants to be a low cost etailer. Just wondering how low it can go with identical goods offering.