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Barel Karsan

Overstock.com Oversold?

June 12, 2012 | About:

Shares of Overstock.com (NASDAQ:OSTK) are held by value investor extraordinaires Prem Watsa and Francis Chou. But the stock has languished as of late, having lost 2/3's of its value since 2010 and half of its value over the last year. As a result, you have a chance to get in on this stock at better prices than have these wise gentlemen.

At a market cap of $160 million, Overstock trades for just 15% of sales. But if you subtract the company's relatively large net cash position from the market cap, Overstock trades for just 10% of sales! Yet the company operates in an industry (online retail) that is expected to continue to grow.

And grow this company has; sales have increased from $92 million in 2002 to over $1 billion today. Even more impressively, Overstock has managed to do this while barely growing assets! Assets are lower now than they were eight years ago! The firm has managed to do this by migrating towards a model whereby Overstock sells the goods to consumers, but the orders are fulfilled by "partners". As such, Overstock doesn't need a ton of warehouses and employees and doesn't even touch the inventory (save for returns) for goods that are sold via this method.

Recently, however, revenue has stagnated. Part of this (though probably much less than 10%) can be blamed on a Google initiative that penalized Overstock's search results. This issue was corrected last year, however, and sales are still stagnant.

But of course the major problem is that the company has hard a time sustaining profits. High litigation expenses hurt results last year, but as those have come down, profits have increased. Furthermore, the company recently rationalized its work force, which helped swing its most recent quarter from a loss last year to a profit. Though still slightly negative, revenue trends have picked up significantly, with the CEO proclaiming on the company's latest conference call that "I think that you will see revenue accelerating this quarter."

But profits aren't the only problem. Overstock has had to undergo numerous financial restatements (described here), and is still involved in a great deal of litigation. (It took me a long time to read through the company's legal issues, and not because I read slowly!)

The company's CEO (who goes by the title "Doctor" at company presentations as a result of his PhD in philosophy, from what I gather) seems rather eccentric, which may be getting him and/or the company into hot water at times. There is a special section of Overstocks' investor website where the doctor speaks out, acknowledging that he is often in the news due to his attempts to "curtail injustice". There, he details his crusades against major brokerage houses, a hedge fund, and naked short-sellers (among other things).

Obviously, some heavy hitters in the value investing community believe in this company. Do you?

For more on this company, check out the bull case made by portfolio manager Glenn Surowiec on Great Investors TV.

Interested in another opinion on Overstock, or any other stock for that matter? One of this site's sponsors has offered our readers a free analysis of a stock of their choosing here.

Disclosure: No position

About the author:

Barel Karsan
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 3.4/5 (11 votes)


Ramands123 - 5 years ago    Report SPAM

This is exactly my thesis of buying into OSTK.

One point that i would like to add is that CEO owns 30 % of company stock and did exaclt what a responsible owner would do, paid off all the debt.

Its a debt free company.

A Debt free company owned by owner , Prem Watsa , Francis Chou selling at 1/3 of the price at which Francis Chou bought and which has grown as fast as amazon on percentage basis. Value investing doesnt get better than this.

For this very resoan when Francis Chou started his small equity fund in US last year. He made OSTK single biggest position in the protfolio (11 %).

Bohara14 - 5 years ago    Report SPAM

What a load of hype you peddle, sir. Overstock's ev/sales multiple is completely misleading and you know it. You argue for the brilliance of a model in which they take no ownership of the goods they sell, and then you try to give them value for the gross sales figures on those same goods that they've never

touched. If you were a real value investor you wouldn't spout this junk. You would reference cash flow which amounted to 12.6mn for the past four quarters. Overstock's current market cap of 152mn is 12x that cashflow! That's hardly cheap!

Further you make use of this deceptive enterprise value. Why do you give them credit for the cash on the balance sheet while claiming they have no debt? A second grader would blow you out of the water by going to Edgar and looking for himself. The company has a $9mn working capital deficit. No debt? Sure!

This company is in a very tough situation. It cannot grow without compromising margins and it can't improve margins without compromising growth. It is being demolished by amzn, ebay, and all of the other online/offline retailers. It has posted negative growth for three consecutive quarters while the industry has grown at a 14 percent clip. The CEO said that they were seeing traffic growth of ten percent on their last earnings call, but he was still comparing vs. a period in which the company’s traffic was suffering because of the Google penalty. In the first quarter Overstock shrank its top line y/y despite the fact that it was comping vs. the Google penalty – this highlighted the fact that conversions were miserable for the company, something that Patrick Byrne cited on the conference call.

The company is shrinking its opex to match its shrinking top line. This may not be an effective strategy to employ in competition vs. amzn and ebay, but at least it yielded some short-term relief last quarter. The problem is that expense cuts are impacting OSTK’s ability to bring consumers to its site. Traffic looks to be down y/y this quarter and if conversions continue to be problematic we could see an acceleration to the downside on the top line.

Buyer beware!

Ramands123 - 5 years ago    Report SPAM
@Bhohra14 You are right you cannot net the cash always to arrive at favourable valuation unless cash pile is very excessive. Cash is required for running operations.

You are also right that they are going to manage opex more tighly tobe profitable on GAAP basis.

Howvever i would not aggree with you on valuation. Somewhat like JC Penny, managment did a mistake by reducing spend on coupons and increasing spend on O.co brandiing. They realize thier mistake and are very likely to correct it. So you cannot take last 12 months cash flow as basis for valuation.It should be normalized longer than that.

A better way to evaluate i think is price to sale basis. They sell at 0.10 of thier sales.Compare that to Amazon which sells at 1.9 times. So overstock on revenue basis sell 19 times cheaper.

I know OSTK is no Amazon or Ebay. But it is extermly cheap on relative basis. If you look revenue growth rate of OSTK over last 10 yearson percentage basis , it is as amazing as Amazon.

A negative working capital is not always bad. If managed prudently it acts as a float or "free money". Vendors are in effect financing thier operations.

I would suggest that instead of quater to quater comparison of site traffic why dont you do a 5 and 10 year comparison and let us know your findings. You will surprized to see what they have achieved over two business cycles ( dot.com and financial crises).

Also Prem Watsa's chief investment officer sitson Overstock's Board. Always a big plus.

Bohara14 - 5 years ago    Report SPAM

Ramands, You have missed my point(s). The author is netting out cash to make his valuation argument. There's no other way to describe this than to say it's just plain wrong. It's poor financial analysis, that's all. Overstock owes more to its creditors than it has on its balance sheet in short-term assets. Why would you then claim the benefit of that cash to reduce market cap in making a valuation call? It's mickey mouse analysis.

Sales multiples don't mean a lot when you're not able to generate profits and cashflow from the sales. To claim the company is cheap on a sales multiple basis is very misleading. When a value guy starts making excuses about why you can't use cashflow to value a company, make sure you have a firm grip on your wallet.

You can go look at a 5 or 10 year traffic comparison if you want, but I'm not going to waste my time with that. No one is denying the fact that OSTK has grown over the last ten years. The point is that the environment has become much more competitive and the firm is going to have a tough time growing much going forward. If it is able to grow, it would likely be at the expense of what little profit they are able to generate.

Vgm - 4 years ago    Report SPAM
Good call Karsan and Ramands! A 5-bagger within a year.

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