Geoff Gannon January 25, 2006

On Overstock (Again)

There is a good post over at The New Wall Street entitled: “Overpriced Overstock”. The post makes the case that (OSTK) is headed towards bankruptcy. I encourage you to read it.

Of course, I also disagree with it. Actually, I disagree with the conclusion reached. I don’t disagree with some of the reasoning used to reach that conclusion. For instance, I have visited Overstock’s website, and I do view it as poorly designed, intimidating, and just downright overcrowded.

I also agree that Mr. Byrne’s time could be better spent. However, I don’t agree with one statement:

“I would immediately sell any company whose President spends his time making excuses rather than seeing through the execution of his business plan”


There are two problems here. One, most CEOs of public companies make excuses in their public statements. I was just reading the annual report of a consumer products company that gave “electoral uncertainty” as one of the reasons for a “challenging environment” in the U.S. in 2004. Apparently, a close Presidential election keeps people from shopping.

Two, I don’t see evidence that Dr. Byrne has been doing any of this rather than seeing through the execution of his business plan. I think Overstock has been run according to that plan, and I think that plan is working, as I will explain below. All in all, I can think of candidates for the top job who are a lot worse than Dr. Byrne. In fact, I have had the pleasure of investing in businesses run by such men. My experience was rewarding enough, whenever their stock was cheap enough.

I don’t believe Overstock’s business plan is flawed. In fact, over the past two years or so, I believe Overstock has generated sales in excess of necessary associated costs. Most people will dispute this assertion. It is not borne out by GAAP. Even management’s own financial data suggests sales were below necessary associated costs in a few of these quarters. I think that has to do with the timing of certain expenses more than anything else. I believe sales are already ahead of variable costs, and are growing fast. That’s the formula for future profitability.

It will be interesting to see what Overstock reports for the fourth quarter, because, for Overstock, the Christmas shopping season is a little different from the rest of the year (as it is for many retailers).

The post at The New Wall Street also argues that Overstock is competing with eBay. I don’t believe this is true in any economically meaningful sense. I’ve discussed this kind of competition before, and will be discussing it in my upcoming podcast.

Overstock and eBay (EBAY) are listed in the same industry. I’m sure the management of each company thinks of the other company as a competitor. Still, I’m not convinced there’s much competition going on. The real sales potential for Overstock has nothing to do with eBay. The online retailing market is big enough to accommodate several large, profitable businesses. As outlined in my four assumptions, Overstock does not need to gain much market share in the industry to achieve profitability, or to be a bargain at these prices.

Most of Overstock’s future sales are likely to come from customers who do not use eBay, and would not seriously consider using eBay for what they do on Overstock. eBay has a great racket and a very wide moat. It is also a very expensive stock. Overstock isn’t. Just as there is room in the discount superstore universe for several profitable companies, I think there is room for several profitable companies in online retailing.

“Overstock has tried to take upon too much, it is not going to become an online Wal-Mart. They should have concentrated on finding a niche market and tailoring to them before taking on a product line as vast as they have. This has led to excess capacities, thus driving down margins.”

I have to disagree with this as well.

Overstock wants to become the Costco (COST) of online retailing. I think that’s an achievable goal. However, to achieve that goal, Overstock has to offer a wide range of products at deep discounts. Customers need to associate Overstock with the cheapest prices on earth for just about everything on earth. That doesn’t mean Overstock actually needs to have the cheapest prices or the widest selection. It just means Overstock has to appear to have those things. I think, right now, in the eyes of many, it does appear to have those things.

Of course, it also has the best name of any online retailer. Even that name suggests Overstock is not competing directly with eBay for many of its customers. Overstock is an offline name. The company has pursued an offline marketing strategy. I’m not sure that strategy has always paid off. However, I do think it gives us some idea of where management believes new sales will be. It sees new sales coming from people who have no interest in eBay.

“When taking into account all four of these points, I strongly advise against investing in Overstock. I do not believe that this company will ever generate sustainable profits. At the moment their business plan is flawed, and their President is more concerned with arguing with journalists, than fixing this problem. If you don’t currently own shares of Overstock, good. If you do, than sell them as soon as possible.”

I have to admire the strength of conviction present in this post; but, I also have to disagree with it.

Despite almost universal press coverage to the contrary, Overstock’s business plan is not flawed. It’s a very simple, very effective plan. There are already signs it will prove highly profitable. If you break out the quarterly numbers, you will see the profit potential in Overstock’s strategy. You will also see the progress it has made. If Overstock had sufficient financing for the next few years, there would be no doubt the company would survive. If you look at the financials, you see this isn’t an ailing business; it’s a young business.

There is a real financing problem. No one wants to back this company. At present, the company’s financial position is decent. It does not have a lot of liabilities. It has some cash. I do not foresee large negative cash flows in the years ahead, but I may be wrong. A lot of people are betting that I am wrong.

I think is one of the best bargains being offered today, and certainly the best bargain among internet companies. If you hold 5 – 12 stocks or more, Overstock should be one of them.

If you hold fewer than five stocks, you should probably limit yourself to more Grahamian plays. In a portfolio of four or fewer stocks, you need to eradicate business risks.

There are business risks associated with owning Overstock.Therefore, I do not believe Overstock is appropriate for such concentrated portfolios – unless, of course, you know more about the situation than I do.

The New Wall Street’s post is the best anti – Overstock argument to date. It’s a good post and definitely worth reading. The blog itself is also worth reading regularly, especially because it discusses companies that are rarely mentioned in this blog – and discusses them in an intelligent manner.

Read The New Wall Street’s “Overpriced Overstock”