Overstock Underdelivers Again

Anyone on the receiving end of the increasingly desperate-sounding "free shipping" emails from Overstock.com (Nasdaq: OSTK  ) could have seen this coming. It's hard to find anything good in today's earnings report.

The Internet "close-out" retailer -- whose head honcho, Patrick Byrne, is now better known for his vocal "jihad" against short sellers -- turned in a much more dismal quarter than those of ostensible competitors such as Amazon.com (Nasdaq: AMZN  ) and eBay (Nasdaq: EBAY  ) .

At Overstock, Q3 revenues actually dropped 6% for the quarter, to $159 million. (So far, Q4 seems to be grim as well.) Gross margins shrank by 1.2 percentage points, and the net loss was nearly double last year's. The $24.5 million worth of red ink came to a loss of $1.19 per share. That's not quite double last year's per-share bleed, because in addition to seeing Overstock's results wilt, shareholders have also watched their stake get watered down by a 9% increase in share count.

Of course, Overstock wouldn't be Overstock without the wit and wisdom of Byrne, but even he couldn't put enough lipstick on this pig. To his credit, this time around, investors were spared the attempts at Far East philosophy. Instead, he discussed increasing expenses in online advertising and the inability of external marketing, especially radio, to translate brand recognition into sales.

But he still seems fixated on Amazon, as in, "a remarkably powerful brand with the same level of brand awareness as Amazon." This just in: Overstock is not Amazon. I happen to think Amazon is a crummy investment, too, but at least its top line isn't shrinking. But I guess I can't blame Byrne for making this mistake. Lots of people have overestimated the fleeting value of Internet brands in the past.

Remember Pets.com and the sock puppet? Webvan? Web stuff comes and goes, and some businesses just don't work that well on the Internet. I'm suggesting to you that Overstock's attempts at "close-out" retailing are among them.

The competitive landscape here is brutal, and Overstock's got no real edge that I can see. (Begging people to buy stuff and promising cheap shipping ain't an edge in my book.)

After all, what's name recognition worth when shoppers can choose from any number of online merchants, all of whom are racing to the bottom on price? Major search providers like Google (Nasdaq: GOOG  ) and Yahoo! (Nasdaq: YHOO  ) , as well as dozens of smaller outfits, make it click-click simple for anyone to find the best deals out there. In other words, anyone can sell anything, and it doesn't take a genius to do it at a loss, as Overstock does.

This company also fails what I now call the Pier 1 (NYSE: PIR  ) test. Would anyone out there really care if Overstock.com disappeared from the face of the Earth tomorrow? (OK, maybe the conspiracy theorists . or maybe that would be even better for them.)

Where does that leave shareholders today? Holding a mostly empty bag, since the stock is down about 80% from the hype-driven highs of December 2004. It's down 61% since August 2005, when Byrne started hitting the short-conspiracy stuff full time and I suggested investors get out.

Time was, Byrne would answer the "When will you be profitable?" question with something along the lines of "When would you like us to stop growing the top line at 60%?" Well, now we now know what no revenue growth looks like at Overstock, and it's still unprofitable.

From here, who knows? Byrne's prepared remarks in the press release say that the company may or may not need to raise cash in 2007. I'm betting on "may." This is just what I have been warning investors about for months now, and I believe it explains a lot of Byrne's bellyaching about short attacks. It's plenty easy to raise dough for a money-burning business by floating shares when everyone loves the stock. When the company is hitting the skids and the stock responds by tanking, this isn't as great an option.

If this were such a great business, I believe Byrne would just take it private. The fact that he hasn't indicates to me that he needs the public market in order to keep this thing afloat as long as he can.

I continue to believe that the smart money out there is short Overstock, and that regular investors (who probably can't find shares to short anyway) would do best to just grab a tub of popcorn and watch the wrecks. But Overstock hasn't been an "investment," in the regular sense, ever since the Sith hit the fan. In my view, it's now a twisted political fight, with the anti-short brigades holding shares as a matter of pride, or honor, or something.

Unfortunately for people who hold stocks hoping to help stick it to the shorts, days like today show that companies are eventually priced based on the economics of the underlying business. Overstock's crummy results burned believers for 15% today (as of this writing), and it can always get worse.

Amazon.com, eBay, and Yahoo! areMotley Fool Stock Advisorrecommendations, while Overstock was a former Rule Breakers pick.

Got a different opinion on Overstock? Bring it to our new stock-rating service, Motley Fool CAPS, where Seth Jayson's virtual shorts help keep him in the 99th percentile of more than 12,000 players.

At the time of publication, Seth Jayson had no positions in any company mentioned here. View his stock holdings and Fool profile here. See what he's Digging these days. Fool rules are here


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