The crux of John's bear case is that Motley Fool Rule Breakers pick Overstock.com
Overstock has posted a nominal GAAP loss of $23.1 million over the past three years. Over the same period, gross merchandise sales (GMS) -- even excluding contributions from the new auctions and travel businesses -- have climbed a whopping 694% to $699.3 million over the past four quarters, from just $88.1 million in the 12 months ending Q2 2002.
Overstock's Profit Scale
|Last 12 Months:||
|Q2 2004||Q2 2003|
|Sales and Market.||$125||$95||$60.9||$24.7||$12.6|
|Total Op. Expen.||$200||$155||$104.5||$46.1||$28.0|
|GAAP Net Profit||--||--||-$7.2||-$11.3||-$4.6|
**GMS excludes travel and auction contributions.
N/C: Not comparable because of revenue accounting change.
What John is suggesting is that no amount of revenue growth will make Overstock profitable given its cost structure. But the fact is that the company could be profitable today if it wanted to be -- that is, if it wanted to slow its growth. Up until this point, it is the company's expenses (investments) that have fueled and supported the company's hypergrowth rates. Comparing Overstock's relatively minute losses over the past three years to its rapid revenue growth, the company clearly has a lot more control over its costs than John is giving it credit for.
The argument for Overstock comes down to scale: As gross profit growth outpaces linear growth in G&A, operating profits will rise exponentially. This is already being played out. From the table above, you can see that gross profits have jumped 10-fold over the past three years, while G&A expenses haven't quite tripled.
And given the info that we have, it is pretty easy to project the mere existence of operating profits in the near term. My theoretical model above has revenue growth slowing from 83% over the past four quarters to 64% to $1.05 billion next year and 38% to $1.45 billion the year after -- and I believe conservatively so. I have gross margins -- a figure well within the company's control -- increasing slightly to 15.2% over the next year and 15.5% in the following year.
CEO Patrick Byrne also suggested in the second-quarter earnings report that the company can grow at its current rates with marketing expense at 8%-9% of revenues, as opposed to the 9.5% level seen over the past four quarters. For reference, marketing expenses were 7% of revenue in the prior year. And we'll assume G&A growth accelerating from 35% last year to 43% this year and then back down to 38% over the following year.
And so, even after throwing in generous technology spending (that should be nearly complete by now) over the next couple of years, the model still yields an operating profit of $5 million over the coming four quarters and $25 million over the following year. With net profits roughly tracking operating profits for the next few years until the company has to pay taxes, earnings roughly come out to $0.25 per share over the next four quarters and $1.25 over the following year.
In other words, despite showing nominal annual losses throughout its existence, Overstock is on the verge of showing a rapidly growing bottom line profit -- one that will also be pretty sizeable. Extrapolate a bit, and Overstock as a company with net margins in the 3%-5% range when it reaches $2 billion in annual revenues doesn't seem so unlikely.
As I was saying before, investors can probably do without the recent distractions and the drama. But again, buyers aren't the only bulls in town.
When you're done, you're still not done. You can vote and let us know who you think won this Duel. Overstock.com was recommended last year in our Rule Breakers newsletter service. Try a 30-day free trial by clicking here.