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An Analysis Of Overstock (OSTK)
By John | July 15, 2010
Why is really a worth trader writing about an unprofitable world wide web organization? Because benefit investing is about discovering dollars that trade for fifty cents; using a marketplace cap of less than 75% of sales, Overstock.com (OSTK) appears like it may possibly be precisely that.
But isn’t it as well risky?
The best risk in any investment is the risk of overpaying. So, the genuine query is: what’s Overstock really worth? I consider it’s actually well worth a minimum of $1.five billion. With Overstock’s market cap at present sitting around $500 million, my valuation definitely looks far fetched. But, there’s only 1 solution to know for sure. Let’s take apart my argument piece by piece, and see if any of my assumptions are unreasonable.
Initial Assumption: Above the following 5 several years, Overstock will neither create really totally free cash flow nor consume hard cash. In other words, its free of charge money flow margin will average 0%. Cash generation in some many years will precisely offset money consumption in other several years. Obviously, this assumption is unreasonable, simply because there is certainly practically no chance the hard cash flows will specifically offset.
That’s not an issue if it turns out Overstock does generate some free of charge hard cash flow above the next five years. In that case, my assumption basically errs about the side of caution. If, nonetheless, it turns out Overstock really consumes money over the subsequent 5 many years, there’s a problem – possibly a extremely big trouble. So, which scenario is more likely?
Overstock’s revenues are growing rapidly. Gross margins appear solid at 13.3% in 2004 and 14.9% more than the final 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. Over the last twelve months, Overstock’s spending on cap ex has been 5.6% of sales. That number is an aberration. Within the lengthy run, spending on cap ex should not exceed 3% of sales. Contemplating the business Overstock is in and also the expected sales growth, the business will, much more likely than not, produce some totally free cash flow over the subsequent five years. Therefore, the assumption that Overstock will be money flow neutral more than the following 5 many years isn’t overly optimistic.
Second Assumption: Above the following 5 years, Overstock’s sales will grow by 15% annually. Is this an unreasonable assumption? Again, I don’t consider it is. Extremely few industries are expected to grow as fast as eCommerce. Overstock’s revenue growth in 2003 and 2004 was more than 100%. Inside the past year, that growth has slowed. However, it is even now closer to 50% than it is to 15%. Overstock isn’t in the cyclical business. So, there’s no reason to believe present sales are abnormally large.
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. While it’s a long, lengthy way from the Amazons, Yahoos, and eBays from the world (and will never reach individuals heights) Overstock is becoming a well known web destination. This fact was most clearly evident in the weeks leading up to Christmas. Shoppers who visited Overstock during the holiday season obviously know it exists, and may extremely well return at some other point within the year. Analysts are predicting very large growth rates for Overstock; however, they are also recommending you market the share. I don’t put any weight in their estimates. But, for the other factors given, I believe the assumption that Overstock will grow sales at 15% a year for the next 5 many years just isn’t unreasonable.
Third Assumption: Six to ten years from today, Overstock will have a free hard cash flow margin of 3%. Ten many years from today, Overstock’s free money flow margin will rise to 4% and remain at that level. Now, of all the assumptions I’ve created, this one could be the most questionable. Certain, Amazon has that kind of free cash 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. However, Overstock’s fixed costs will eat up a 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’ll see that if Overstock does experience strong sales growth, a 3% totally free hard cash flow margin six many years from now is not unreasonable. I assumed Overstock’s sustainable free of charge hard cash flow margin will be 4%. There’s a case to become made that 4% is as well large. I won’t make that case, because I do not believe in it. Remember, that 4% number comes ten many 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 years from today, Overstock will be growing sales by 12% a year; eleven to fifteen 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 really 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 – for those who have thirty many years to achieve it. To put that figure in perspective, Amazon.com at present has sales of about $8 billion. So, even right after thirty many years, these assumptions don’t lead to Overstock reaching the same size as today’s Amazon. Don’t forget these numbers assume some inflation. For instance, if inflation averages 3% a year over the subsequent thirty 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 over a period of thirty years. I consider that is pretty reasonable.
If you take these four assumptions together, you get a benefit of $1.5 billion for Overstock. Today, Mr. Industry is offering it for $500 million – that is why I’m writing about an unprofitable web company.
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