An Analysis Of Overstock.com (OSTK)

Why is a worth investor writing about an unprofitable internet organization? Mainly because benefit investing is about acquiring dollars that trade for fifty cents; with a marketplace cap of less than 75% of sales, Overstock.com (OSTK) seems like it might be exactly that.

But isn’t it as well risky?

The greatest risk in any purchase is the chance of overpaying. So, the actual question is: what exactly is Overstock well worth? I consider it’s actually well worth a minimum of $1.5 billion. With Overstock’s marketplace cap at present sitting around $500 million, my valuation certainly seems far fetched. But, there’s only one solution to know for certain. Let’s take apart my argument piece by piece, and see if any of my assumptions are unreasonable.

First Assumption: More than the next five several years, Overstock will neither generate truly free cash flow nor consume hard cash. In other words, its free hard cash flow margin will average 0%. Cash generation in some many years will specifically offset cash consumption in other many years. Obviously, this assumption is unreasonable, simply because there’s nearly no chance the cash flows will precisely offset.

That’s not a problem if it turns out Overstock does create some free of charge hard cash flow more than the subsequent 5 years. In that case, my assumption simply errs about the side of caution. If, however, it turns out Overstock actually consumes hard cash over the subsequent 5 several years, there is a problem – possibly a extremely large issue. So, which scenario is a lot more likely?

Overstock’s revenues are growing quickly. Gross margins look solid at 13.3% in 2004 and 14.9% over the last twelve months. Overstock’s unprofitability may be the result of its selling, common, and administrative expenses (SG&A) which happen to be growing exponentially. Will these expenses continue to grow? Yes, but not as fast as revenues. More than the final twelve months, Overstock’s spending on cap ex has been five.6% of sales. That number is an aberration. Within the lengthy run, spending on cap ex must not exceed 3% of sales. Contemplating the business Overstock is in and also the expected sales growth, the business will, more likely than not, generate some totally free money flow above the subsequent five several years. Therefore, the assumption that Overstock will be hard cash flow neutral over the subsequent five many years isn’t overly optimistic.

Second Assumption: Over the subsequent 5 several years, Overstock’s sales will grow by 15% annually. Is this an unreasonable assumption? Again, I don’t believe it is. Very few industries are expected to grow as fast as eCommerce. Overstock’s revenue growth in 2003 and 2004 was above 100%. Inside the past year, that growth has slowed. Nonetheless, it can be even now closer to 50% than it would be to 15%. Overstock isn’t in a cyclical business. So, there is no reason to believe current sales are abnormally high.

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 much more visitors; it has also been climbing the ranks of the most popular web sites. Whilst it is a lengthy, long way from the Amazons, Yahoos, and eBays from the world (and will never reach those heights) Overstock is becoming a well known world wide web destination. This fact was most clearly evident inside the weeks leading up to Christmas. Shoppers who visited Overstock throughout the holiday season obviously know it exists, and may really well return at some other point in the year. Analysts are predicting extremely large growth rates for Overstock; nonetheless, they are also recommending you sell the stock. I don’t put any weight in their estimates. But, for the other factors given, I think the assumption that Overstock will grow sales at 15% a year for the following 5 many years is not unreasonable.

Third Assumption: Six to ten years from today, Overstock will have a free cash flow margin of 3%. Ten years from today, Overstock’s free of charge hard cash flow margin will rise to 4% and remain at that level. Now, of all the assumptions I’ve made, this 1 may be the most questionable. Sure, Amazon has that kind of free money flow margin, but Overstock isn’t Amazon, and it never will be Amazon. Overstock’s gross margins are 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 of charge cash flow margin six years from now isn’t unreasonable. I assumed Overstock’s sustainable totally free hard cash flow margin will be 4%. There’s a case being produced that 4% is as well higher. I won’t make that case, simply because I do not feel in it. Remember, that 4% number comes ten several 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 several years from today, Overstock will be growing sales by 12% a year; eleven to fifteen many 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 presently has sales of about $8 billion. So, even after thirty several years, these assumptions don’t lead to Overstock reaching the exact same size as today’s Amazon. Do not 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 some fourfold increase in Overstock’s genuine sales more than a period of thirty years. I consider that is pretty reasonable.

If you take these four assumptions together, you get a benefit of $1.five billion for Overstock. Today, Mr. Marketplace is offering it for $500 million – that’s why I’m writing about an unprofitable internet company.

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