An Analysis Of Overstock.com (OSTK)

Why is a value investor writing about an unprofitable web organization? Mainly because worth investing is about acquiring dollars that trade for fifty cents; having a industry cap of much less than 75% of sales, Overstock.com (OSTK) seems like it might be precisely that.

But isn’t it too risky?

The best chance in any expense could be the chance of overpaying. So, the real question is: what’s Overstock really worth? I believe it’s actually worth a minimum of $1.five billion. With Overstock’s market cap currently sitting around $500 million, my valuation definitely looks far fetched. But, there’s only a single way to know for certain. Let’s take apart my argument piece by piece, and see if any of my assumptions are unreasonable.

Initial Assumption: More than the next five many years, Overstock will neither produce really totally free cash flow nor consume hard cash. In other words, its totally free cash flow margin will average 0%. Cash generation in some several years will specifically offset hard cash consumption in other many years. Obviously, this assumption is unreasonable, mainly because there is practically no chance the cash flows will precisely offset.

That’s not a problem if it turns out Overstock does produce some totally free cash flow more than the subsequent 5 many years. In that case, my assumption basically errs about the side of caution. If, however, it turns out Overstock in fact consumes hard cash over the subsequent 5 years, there is certainly an issue – possibly a very large problem. So, which scenario is much more likely?

Overstock’s revenues are growing quickly. Gross margins appear solid at 13.3% in 2004 and 14.9% more than the final twelve months. Overstock’s unprofitability could be the result of its marketing, basic, and administrative expenses (SG&A) which are already growing exponentially. Will these expenses continue to grow? Yes, but not as fast as revenues. Above the last twelve months, Overstock’s spending on cap ex has been 5.6% of sales. That number is an aberration. Within the lengthy run, spending on cap ex should not exceed 3% of sales. Considering the business Overstock is in and also the expected sales growth, the organization will, much more likely than not, generate some free money flow over the subsequent five years. Therefore, the assumption that Overstock will be money flow neutral more than the subsequent 5 years isn’t overly optimistic.

Second Assumption: Above the following 5 several years, Overstock’s sales will grow by 15% annually. Is this an unreasonable assumption? Again, I do not think it’s. Very couple of industries are expected to grow as fast as eCommerce. Overstock’s revenue growth in 2003 and 2004 was above 100%. In the past year, that growth has slowed. Nevertheless, it’s still closer to 50% than it is to 15%. Overstock isn’t in a cyclical business. So, there’s no reason to believe present sales are abnormally higher.

Also, all that spending on advertising is increasing consumers’ awareness of Overstock. A review of Overstock’s traffic data shows it has not only been gaining a lot more visitors; it has also been climbing the ranks from the most popular web sites. Although it’s a long, long way from the Amazons, Yahoos, and eBays with the world (and will never reach individuals heights) Overstock is becoming a well known web destination. This fact was most clearly evident within the weeks leading up to Christmas. Shoppers who visited Overstock throughout the holiday season obviously know it exists, and might really well return at some other point inside the year. Analysts are predicting really higher growth rates for Overstock; nonetheless, they are also recommending you sell the investment. I do not put any weight in their estimates. But, for the other causes given, I feel the assumption that Overstock will grow sales at 15% a year for the subsequent 5 several years is not unreasonable.

Third Assumption: Six to ten years from today, Overstock will have a free of charge cash flow margin of 3%. Ten many years from today, Overstock’s totally free hard cash flow margin will rise to 4% and remain at that level. Now, of all the assumptions I’ve made, this a single could be the most questionable. Certain, Amazon has that kind of free cash flow margin, but Overstock isn’t Amazon, and it never will be Amazon. Overstock’s gross margins are much less than Amazon’s. In fact, Overstock’s gross margins are much less than Wal – Mart’s. Nonetheless, Overstock’s fixed costs will eat up a very much smaller portion of its sales than may be the case over at Wal – Mart.

In case you compare Overstock to other online retailers, you may see that if Overstock does experience strong sales growth, a 3% free hard cash flow margin six several years from now just isn’t unreasonable. I assumed Overstock’s sustainable free of charge hard cash flow margin will be 4%. There’s a case to become made that 4% is as well high. I won’t make that case, simply because I do not believe in it. Remember, that 4% number comes ten years out. That gives Overstock plenty of time to grow sales and thus reduce SG&A as a percentage of sales.

Fourth Assumption: Six to ten years from today, Overstock will be growing sales by 12% a year; eleven to fifteen several years from today, Overstock will be growing sales by 8% a year; thereafter, Overstock will grow sales by 4% a year. Let’s see what this actually means. According to these assumptions, Overstock’s sales will be as follows:
Today: $707 million
2011: $1.59 billion
2016: $2.71 billion
2021: $3.83 billion
2026: $4.66 billion
2031: $5.67 billion
2036: $6.90 billion

Seven billion dollars just isn’t an unreasonable target – if you have thirty many years to achieve it. To put that figure in perspective, Amazon.com currently has sales of about $8 billion. So, even following thirty years, these assumptions don’t lead to Overstock reaching the exact same size as today’s Amazon. Don’t forget these numbers assume some inflation. For instance, if inflation averages 3% a year more than the next thirty many years, Overstock’s projected $6.90 billion in sales only translates to $2.84 billion in today’s dollars. So, these assumptions only lead to a fourfold increase in Overstock’s genuine sales over a period of thirty many years. I think that is pretty reasonable.

In case you take these four assumptions together, you get a worth of $1.5 billion for Overstock. Today, Mr. Industry is offering it for $500 million – that’s why I’m writing about an unprofitable internet organization.

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