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By NauticalSausage
April 26, 2005

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Disclaimer: I am long Overstock that I bought from 11-13 a share.

I am an owner in Overstock and I am also a big believer that it will be a solid to great long-term investment. It seems like the main argument going on over this company is about its ability to be profitable. I'll try and summarize some points that others have already made:

1) The company is losing money and hasn't made money in 11 of the last 12 quarters.

This is true. However, some things that are worth considering: As the company's revenue grows, its expenses grow as well, but not at the same rate as revenues. That means that the gross margins and someday, net margins, will increase with size. The larger scale the company is the more profitable it will be. This seems to be especially true in the area of technology. Eventually, the company will have to spend very little to maintain their infrastructure once it is totally built. Right now they are using stuff that Byrne has described as "bleeding edge."

Another point worth thinking about is that the company is spending money on new ideas constantly. A lot of these aren't working out. However, because they have been relatively cheap to try and because some of them are working out I am a big fan of this. If Overstock can test a lot of different markets cheaply then that is an advantage to them. One example of a creative business is Worldstock. This is not only a unique thing that you can't get anywhere else, but it is also a positive net income part of the business. We'll see what happens with auctions, but even if they can solidify themselves as a distant second to EBAY then that could lead to a lot of profits. EBAY is going to have to continue to grow to please its shareholders and that's going to continue to happen in the form of future price increases. At some point that could really benefit Overstock. Regardless, many of these ideas will fail, but the ones that work will add significant value and competitive advantages to Overstock.

Although it is losing money currently, it is an intentional move by management. If they really wanted to they could have produced a profit in this quarter. However, they seem to have more long-term plans. That makes many people skeptical that they will ever get there, and that's a fair critique. However, the longer they can hover around breakeven, the quicker that they will grow. Its not like they are going to have trouble getting funding if they need any. I'm a fan of their approach because I would rather them gain more customers today and grow Revenue at 100% and lose 4 million than grow revenue at 75% and make a couple million. Each of those customers acquired represents a possible future income stream.

2) They missed earnings.

This is the most irrelevant point to me, because the number that they were expected to hit was formulated by analysts that did not get guidance from the CEO. Ask yourself this question. Does the miss tell me more about the quarter that the company had or the ability that the analysts following the company have to estimate its earnings on their own?

3) Do they have any competitive advantages?

I've thought a lot about this subject. I would assert that customer awareness, customer loyalty, good customer service, unique businesses and products, and businesses that have the advantage of scale are the only sustainable competitive advantages in the online world. The main reason that Overstock seems to be compared to AMZN and EBAY is that those seem to be the three that have all of these competitive advantages.

Customer Awareness - Obviously increasing at a rapid pace. Already in the top 10 of online retailers.

Customer Loyalty - I buy online stuff from a lot of different places, but there are some things that I buy from Overstock and probably will for the rest of my life. One example is refurbished ink cartridges. I can get them at like 50% to 33% of the price that I would pay for new ones at Wal-Mart. Why in the world do I can if they are refurbished or new, they work just the same and I save some serious cash. Customer loyalty can also be increased by the next couple of competitive advantages.

Good Customer Service - I've never had any experience, but almost every survey or personal experience that I've read has said that it was good.

Unique Businesses and Products - This is why I like a CEO that will try things out. The more really unique things that they come up with like Worldstock, the bigger their competitive advantage will be. Also, no one else really does overstocked goods, and none of the big boys are going to jump in. So for them to get a competitor someone smaller is going to have to decide to move into that area. I would favor overstock in that kind of a match-up.

Advantage of Scale - They are getting pretty big. In a couple of years they are going to be REALLY big. That helps when negotiating with sellers, it helps fend off small would be competitors, and as mentioned earlier it leads to bigger profits.

4) The CEO is Unconventional.

I can see this one both ways. I just really like the pedigree. He really admires Buffet and his dad was the man who turned Geico around. Almost all of his wealth is tied to Overstock. Love him or hate him, he believes the things that he says, and the success or failure of Overstock is the most important thing to him.

5) The valuation is high.

Companies that are easy to predict earnings have less volatility than companies where it is hard to predict earnings. Thus, we have one of the most volatile stocks in the world in Overstock.

My main thought is that they are more profitable than Amazon was at this size (and they even have higher gross margins now if you compare the two in an apples to apples way). In fact, Amazon just turned in a profit last year. It took them getting to the 5.2 billion dollar mark to be able to make a yearly profit. It won't bother me if it takes Overstock that long as well.


Summary:

A company that is growing at a very fast rate, has the signs of all the competitive advantages needed to survive in the online world, and a creative CEO whose wealth is tied to the company's success. That's what you get with Overstock.

If this company ever gets to the 5, 10, or even 20 billion dollar mark in sales and you bought at this point you will be known by friends and family in the same way that we know people today that bought Wal-Mart near the bottom.


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