Since I can’t afford to spend that much time investigating individual trees, I’ll stick to sharing my thoughts on what I perceive to be an extraordinary forest.
A tale of two retailers – part one, the importance of inventory turnover.
The guy selling used cars needs an inventory of, say, 20 cars to sell 1 today. That’s an inventory of $200,000 for $10,000 of revenue. After buying a replacement car to top-up his inventory, paying the rent etc., he takes home $1,000. That’s a 10% margin on an inventory turnover of 5%.
Our guy is married to a baker. She needs an inventory of about $20,000 (flour, yeast, etc.), to sell $10,000 worth of bread today. After buying some new flour and paying for costs, she too takes home $1,000. Her margin too is 10% but the inventory turnover is 50%.
The couple decides it’s time to expand. They need just $1,000 per day to live on. They can invest the other $1,000. The wife tells him she can open an extra bakery within a month without going to the bank for a loan. He just can’t believe it. His dad spent a decade repaying the loan they needed to setup the family business.
Overstock’s numbers are unbelievable
Overstock’s inventory turnover is better than the other retailers combined. Unbelievable! I'll be writing about it in part two of my "tale of two retailers."
Days payable is an indicator of how quickly a company pays its creditors. Overstock is beaten (just) by Costco (NASDAQ:COST). Both companies, on average, pay their creditors within a month. In this business it's not unusual to keep your creditors waiting for two months or more. Overstock and Costco are the exceptions.
Assuming Internet retail is a commodity, it stands to reason that Overstock should be able to raise gross margins to about 20% without losing a lot of market share to Amazon, Blue Nile or for that matter, Bluefly. Overstock has untapped pricing power.
So now you know why Francis Chou is long Overstock and why Costco is Charles Munger’s favorite company.
A tale of two retailers - part two, Overstock.
Overstock is a couple (pun intended) of retailers.
Fifteen percent of revenue and roughly 100% of the inventory is carried by the direct business, a “classic” retail operation. They buy stuff (mainly closeout lots) and sell it (hopefully) at a profit.
The other 85% of revenue is from the fulfillment partner division. This is not a classic retailer, this is a broker. Overstock sells merchandise of other retailers, cataloguers or manufacturers ("fulfillment partners") through their website. This is a retailer without inventory! Here too, Overstock deals with closeout lots. The original manufacturer (say, Calvin Klein) doesn’t want last year's watch to compete with this year's model. They won’t be touting it on their own website or in their own shop — that’s where Overstock comes in. Calvin Klein will list last years unsold watches on Overstock.com.
This division is growing at a fair clip. Again, this is a broker. Customers pay for the purchase upfront and Overstock pays the supplier later. This is inherently a negative equity business. The business model is not unlike Dell a decade ago.
Are they going bankrupt?
$100 million of cash on $20 million of debt.
Should they choose to extend their “days payable” from the current 30 to a more normal 60 days, at least 1/12 of annual revenue converts into cash on the balance sheet: 1/12 * 1 billion => $85 million.
The “direct” business is in decline. Assuming it continues down that road, that inventory, at 0% gross margin, converts into $25 million of cash.
Unlike a typical retailer, they don’t need that cash to build seasonal inventory. It’s truly excess cash.
Why is revenue flat? Why aren't they profitable?
As discussed, they don’t need the cash. For now, they are content to invest for growth and kill the competition with low margins. Direct competitors are Bidz.com (toast) and Bluefly (no cash and negative FCF).
Sixty percent of revenue is from "home and garden" and 99% of revenue is from U.S.
Growth is tied to the housing market.
So what is the company worth to me today ?
I would pay $ 160 million ($ 7 per share) for the entire company in an instant. I would defer payment of the creditors for an extra month (that would bring it in line with the competition) and use the $ 85m of cash thus generated plus the $ 100m that's already on the balance sheet to pay myself a $ 180 million dividend next month. I would then distribute ownership of the company to the employees and go fishing.
Prem Watsa says I'm a terrible analyst and a worse LBO artist. He says it's worth more, much more.
Sam Antar and Gary Weiss
Gusto Duel submitted OSTK for the value ideas contest
Anh Hoang discussed OSTK
Citron Research covered the space; NOT bearish on Overstock !
Geoff Gannon on Overstock in 2006
This is not a recommendation to buy or sell anything. At the time of writing, I had no position in any of the stocks mentioned. Any and all questions welcome as usual.