Re: 9/1/05 - [OSTK] Fool.com: Dueling Fools: Overstock.com Bear; Bear Rebuttal
Dueling Fools: Overstock.com Bear
By John Reeves (TMF Bane)
September 1, 2005
Recently, we've heard talk of crooked hedgies, bent journalists, pure-hearted strippers, a former boxer turned CEO, and a murky mastermind a.k.a. "the Sith Lord." Is this an old episode of Spenser: For Hire or the story surrounding an online provider of overstock merchandise?
I'd like to step back from all the skullduggery of the past couple of weeks and address just one basic question. Is Motley Fool Rule Breakers pick Overstock.com (Nasdaq: OSTK) a potential multibagger or just another online high flier destined to crash in a heap of high expectations and zero profits? While investors might love a good noirish television show, we can safely assume they want something a little less scary when it comes to their investments.
The optimistic case for Overstock focuses on its remarkable revenue growth. Sure, the company is not profitable at the moment, but neither was Motley Fool Stock Advisor pick Amazon.com (Nasdaq: AMZN) when it started. Stock Advisor pick eBay (Nasdaq: EBAY) wasn't hugely profitable immediately after it went public, either. Continued meteoric revenue growth combined with cost-cutting and the benefits of scale will eventually return outstanding profits, according to the proponents of this view.
Not so fast. A closer look at some of the company's numbers raises some worrying concerns about this rosy scenario. In the table at the bottom of this article, we can see that, yes, revenues are increasing dramatically.
With spending for advertising and marketing going up by 120% year over year in Q2 and by 284% in the quarter before that, this rise in sales is understandable. Overstock's CEO Patrick Byrne admitted as much in his recent conference call, during which he stated: "What we're doing is ... trying to keep our growth up ... the dumb way, which is just with extra marketing spending."
Now, Byrne also went on to say that he thought CRM and personalization would eventually allow the company to grow while at the same time reducing spending on marketing. I think this assumption places considerable faith in technology, while also underestimating some of the problems with Overstock's business model. But more on this in a moment.
Despite rapid revenue increases over the past six quarters, the company continues to generate operating losses. In the most recent quarter, its operating loss doubled the shortfall from the previous quarter.
The optimists will dismiss the operating losses. Once the revenues get large enough, they'll argue, the profits will follow just as they did with Amazon -- which, by the way, delivered operating profits of $440 million in 2004 and $101 million in the most recent quarter.
With all due respect to the bulls, I think it's unwise for investors to bank on Overstock becoming the next Amazon. Whether it was the result of excellent branding or whatever, the latter company is the go-to place for non-shoppers like myself who now know where to go when they want a book, a CD, or a DVD. Overstock, on the other hand, doesn't yet appear to have the same brand strength to command the loyalty of ordinary non-shoppers.
At present, more than half of the company's sales come from what it calls its "fulfillment partner segment." This segment includes revenues from goods that are sold on the company's website but produced and delivered by third parties. These goods are, for the most part, readily available elsewhere by using a good search engine like Google (Nasdaq: GOOG) or Yahoo! (Nasdaq: YHOO).
In other words, there seem to be very few barriers to entry for what Overstock sells. This point is crucial, it seems to me, since the bullish case depends on exuberant revenue growth well into the next decade. What happens if those revenues slow because of an ever-growing army of online competitors? Will the losses get even bigger?
With Amazon or even Stock Advisor pick Netflix (Nasdaq: NFLX), you have companies that pursued a similar business model with a difference -- these companies were and remain far more likely to retain their loyal customers for the long term. I don't think Overstock will be so fortunate.
Let's face it. The odds of catching lightning in a bottle with any online retailer are long ones, and the risks of losing a considerable chunk of your cash are great. Remember Pets.com or Toysmart.com? Before investing your hard-earned cash in an unprofitable business, ask yourself how the company in question intends to win and retain a loyal customer base over the long haul. In the case of Overstock, I haven't yet heard a satisfactory answer to that question.
All that being said, I hope Patrick Byrne and his company are able to prove me wrong. As a former academic myself, it's good to see another one running the show at a $750 million company.
As for my take on the recent controversy regarding Byrne's allegations of unfair business practices? If he thinks that's a good use of his time, who am I to say otherwise? My own view is that his shareholders would be better served by his legal team handling this matter. And frankly, I can't imagine anyone being more likely to invest in this stock after the recent slanging match on CNBC between Byrne and Jeff Matthews.
Quaterly Figures for Overstock
Q1 2004 Q2 2004 Q3 2004 Q4 2004 Q1 2005 Q2 2005
Revenues $82,078 $87,792 $103,444 $221,321 $165,881 $150,638
Operating Profit (loss) ($2,294) ($2,403) ($3,045) $2,391 ($3,402) ($6,064)
*Dollars in thousands. Information provided by Capital IQ.
You're not done. This is just one part of a four-part Duel! Don't miss Jeff Hwang's bullish argument and rebuttal, or John's rebuttal.
fool.com
=====
Dueling Fools: Overstock.com Bear Rebuttal
By John Reeves (TMF Bane)
September 1, 2005
Hey, Jeff. As the guy who sits next to you at Fool headquarters, I know you enjoy a nice game of online poker from time to time, so I'm not surprised that you're also attracted to a risky stock like Motley Fool Rule Breakers pick Overstock (Nasdaq: OSTK). But before you bet the farm on this one, I think you might want to reconsider some of the "projections" that are being tossed around.
Currently, Overstock's 12-month trailing revenues are $641 million. As you report, management expects meteoric growth from here, with projections of $1.5 billion in sales for fiscal 2006 and $2 billion in sales for fiscal 2007. Apparently, this will all trickle down to the bottom line with $0.75-per-share profits slated for FY06 and anywhere between $3 and $5 per share to be delivered in FY07. In the best of all possible worlds, my dear Dr. Pangloss, I'd be the first to purchase some shares under this fanciful scenario.
Alas, this isn't the best of all possible worlds, because our world is always changing. In other words, "stuff" happens. I've already noted that competition in this arena is likely to intensify, which will put pressure on revenue growth. Most of the projections seem to assume a static business environment. We also don't know for sure whether the company will be able to offer the same level of customer service as it attempts to grow its business almost fourfold in two-and-a-half years. How would a deterioration in this area affect customer retention rates?
Another unknown relates to the company's technology. Will it be able to handle all of this forecasted growth?
Finally, will the company be able to continue losing money by going up against Motley Fool Stock Advisor pick eBay (Nasdaq: EBAY) in the auction business and Expedia (Nasdaq: EXPE) in the travel segment? There are many unknowns with this stock, so when I see rosy projections, my instincts are to be wary.
One thing we do know is that the company's operating loss doubled last quarter. Could that be the start of a worrying trend? Maybe. Maybe not. As the bulls seem to be asking investors to take a flier on an unprofitable company with an uncertain future, I feel that the burden of proof should be on them. Rather than rejecting the entire bullish case out of hand, I'd recommend the old Scottish verdict in response to Jeff's argument: "Not proven."
You're not done. This is just one part of a four-part Duel! Don't miss Jeff Hwang's bull argument and rebuttal, or John's original bear argument.
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. eBay is a Motley Fool Stock Advisor pick. For a 30-day free trial to Rule Breakers, click here. For a free trial to Stock Advisor, click here.
John Reeves does not own any of the companies mentioned above.
fool.com |
