What is Overstock Really Worth?

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By NauticalSausage
August 25, 2005

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There has been more activity on this board than ever in the recent week discussing the new lawsuit, naked shorts, rocker, conspiracies, etc. It's been pretty crazy. I have now owned Overstock for almost 2 years, and although I do believe that there is something going on, I am very wary of owning a company whose CEO is disliked by a large portion of the financial media.

So last night I decided that I would really dive into the numbers and see what the future is likely to look like for OSTK and what that means in terms of earnings (both whether or not there will be any and if so how much).

So here's how I went about it. I looked at the last six quarters of data, and I re-read the most recent letter to shareholders from Byrne. Basically the business and its success or lack thereof comes down to a few key variables.

1) Growth of Sales - Last quarter was 75%.

2) Cost of Goods Sold - OSTK has two types of sales - Direct and Fulfillment. on the average direct order they average a cost of 86 cents per dollar of sales. On fulfillment they average slightly less cost of 85 cents per dollar of sales. This makes sense because they don't have to handle the merchandise.

3) Marketing Expense - Last quarter was around 9.5% of total revenue. It has varied from 10 to around 9 the two quarters before this one.

4) General and Administrative - This most recent quarter will be lower than the coming two quarters on this. Byrne notes in his letter to shareholders that the cumulative G&A and Technology expenses will probably be 60 million for the year. They have only had 25 million the last two quarters, so expect 35 million in the next two. I just divided that equally between the two categories. G&A of 3.7% of rev's for the year gets us there.

5) Technology - Again this will be up. It also is 3.7% of revs in my estimate. Important to note that in the most recent quarter they finished a lot of upgrades that could last them for up to 5 years. So they will have to grow into these expenses that they have taken on.

Interestingly, that's it. If you can make educated guesses about these numbers then you can get a good idea of what the company will make in the future.

I made some estimates and took my model out to 2010 to see what would happen. All of this is in a spreadsheet by the way that I will be happy to send to anyone who wants to look at it. The results are stunning and you can change the assumptions to see what happens.

1) Revenue. I assume growth the next two quarters will continue at 75%. Then for the next four years my growth rate for the year are: 50%, 35%, 25%, and 20%. Considering the rate the company has grown at I see these figures as conservative. They would fall in the bottom quartile of managements internal predictions of growth, and this would still be a company around 1/3 to 1/4 the size of Amazon. I feel pretty confident that these are solid assumptions.

2) Cost of Goods Sold. This is an area that has a lot of room for improvement and has been improving over the last several quarters. My assumption for the model is that every year they are able to reduce their cost of goods sold by 1 cent per dollar. This year their direct is .86 then in 06 it is .85. This seems very reasonable for two reasons. First, as they grow they will have more ability to influence and request things from suppliers. See Wal-Mart. Second, these numbers, even after five years of increases are still not nearly as good as Amazons .75-.76 per dollar costs. I feel pretty confident that these also are solid assumptions.

That Means that the sales would go (rounded to the nearest thousand)
814,000 FY 05
1,221,000 FY 06
1,649,000 FY 07
2,061,000 FY 08
2,473,000 FY 09
2,968,000 FY 10

The gross profit margin in these years would be:
14.6 FY 05
15.6 FY 06
16.6 FY 07
17.6 FY 08
18.6 FY 09
19.6 FY 10

3) Marketing expense is now being assumed to be 9.5% in 05. I have them lowering this to 9% by next year even though they have been there in the past and Byrne thinks that they can get there for the last two quarters. I then have them shaving of .2-.3% off of this cost every year as a percentage of revenues. The reasoning for this is pretty simple. First, they are going to reduce their growth rate going forward and are probably not going to spend as high a percentage to achieve that. Second, and more importantly, they will spend like $80,000 this year. Even with incremental reductions in this they still would have a budget of 237,000 by 2010. I think that this category could prove to be too conservative. I am very confident they can hit these numbers

So the percentage of revenue spent on ads looks like this

9.5% - FY 05
9.0% - FY 06
8.7% - FY 07
8.5% - FY 08
8.3% - FY 09
8.0% - FY 10

4 and 5) I will group these together because they are so similar. If there was one area where an online tech firm is able to reduce costs as a percentage as a result of scale, this is it. The company has already said that they have made improvements that might last for up to five years. The staff requirements should also drop as a percentage. I have both of these consistently falling over the next five years. If that doesn't happen then the company is trying to be too cutting edge or isn't being efficient enough with its staff. If there is an area that I am perhaps not being conservative enough this is it, but with marketing the way that it is I feel confident that combined my operating expenses are sufficiently conservative.

So the combined % of revs for General and Administrative is
7.4% FY 05
6.8% FY 06
6.2% FY 07
5.6% FY 08
5.0% FY 09
4.6% FY 10

What I found was VERY interesting. Drumroll please...

Earnings per Share
-1.02 FY 05
-.16 FY 06
1.46 FY 07
3.81 FY 08
6.93 FY 09
11.02 FY 10

For the short term I can honestly say you can EXPECT this company to lose money. Aside from a sustained growth rate in the 70% range this is going to happen. But for the long term there is a much different picture. Solid growth aided by incremental increases in margins will lead to MASSIVE increases in Net Income. This is a company that could grow earnings by 60% when growing revenues by 20% in 2010.

So it looks like in the short term that the shorts have a great point, this company isn't going to make money consistently for at least a year and a half. But in the long term the prospects for this company look bright.

Which brings up another point that I was thinking about this morning. I have now heard from Rocker (in the lawsuit PR), Greenberg (in his article), and Jeff Matthews (on CNBC) that they think this lawsuit is about Byrne trying to deflect criticism for the company missing estimates and analysts dropping their rating. This doesn't make any sense at all for two reasons. First, who is Byrne taking heat from? He founded the company and his inner circle owns a larger portion of the float. Second, He obviously knows that the results for the next six or seven quarters don't matter as much as the big picture of where the company is going. I don't buy the company line that they are all putting out there.

So, I'm in. For the long haul. Unless the company shows that they can't produce solid growth or incremental increases in margins. If they can do those things, this is a ten bagger from here.


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