Description

Thesis

What happens when a company few believe in, led by a team few trust, fails to deliver on its major strategic objectives two months after announcing them? We are probably about to find out. Overstock.com (OSTK) won the COVID lottery and convinced itself that it’s a growth business, but wishful thinking isn’t a strategy. Fading COVID beneficiaries in consumer isn’t a novel theme, but OSTK is exposed to a special cocktail of headwinds that is already turning its COVID binge into a much deeper hangover than its competitors. OSTK gained more share than it fundamentally deserved during COVID because competitors ran out of inventory and struggled with supply chain issues, forcing consumers to turn to nobody’s favorite option due to a lack of alternatives. This windfall might have proven stickier for a different business in a different retail category, but OSTK is a competitive laggard, with no recurring revenue in a low-purchase-frequency industry. Therefore, it is already in process of losing these temporary gains. Management did itself no favors by misunderstanding (or ignoring) the underlying drivers of its business when issuing 2022 guidance. Their credibility is about to suffer another blow when they fail to deliver on their promised revenue and share gains.

Business history and description

Refer to regency435’s 2/7/2022 writeup. It is a good explanation of what the company does and its recent history. We have taken the other side of this trade based primarily on our data-driven view that revenue and market share has much further to fall than bulls/management realize.

OSTK before COVID

Prior to COVID, OSTK was a structural share loser in the home furniture category (falling to ~1.8% from ~2.5% in the 3 years prior to COVID) despite “Online” taking share from “B&M” rapidly throughout this period. This happened because Wayfair (W) took all of the available growth oxygen with its massive advertising spend, better website, better service, and wider assortment relative to OSTK (advantages COVID only deepened). See charts below:

How COVID propped up OSTK more than bulls (and management) realize

During COVID, online home furniture sales jumped massively. Wayfair and OSTK naturally both benefitted, but OSTK benefitted far more because stronger competitors ran out of inventory and suffered deeper supply chain disruptions. Consider this management quote from the Q4 call:

“Our supply chain continues to be a competitive advantage. As a reminder, our supply chain is broad and distributed with a vast partner network that reduces single source risks, shipping bottlenecks and supply chain kinks. Unlike some of our competitors, we don't pressure our partners to lock up inventory in our distribution centers. As a result, we tend to get favorable priority and pricing on inventory, particularly during periods of high demand and low supply.”

During the COVID supply crunch, OSTK had more slack in its supply chain because it came into the crisis with more underutilized capacity (in part due to being an industry laggard) and a more flexible sourcing model. This was certainly an advantage during the supply crisis, but as the crisis recedes, this advantage is evaporating.

As you can see in the charts below, during the COVID crisis:

-          Online took a lot more share from B&M

-          Native online competitors (W & OSTK) took share both overall and within Online

-          OSTK took far more share than Wayfair on a relative basis for the reasons explained above

Post-COVID trends … things are getting ugly

-          As online share of the home furniture category has stabilized at a higher “new normal,” many legacy B&M competitors have beefed up their eCommerce businesses, thereby clawing share back from Wayfair/OSTK. In the second chart below, online sales from Arhaus, Bassett, Crate & Barrel, Ethan Allen, La-Z-Boy, Restoration Hardware, and Williams-Sonoma (traditional B&M retailers) are continuing to gain share of the online home furniture market, as share dwindles for OSTK and W. 

-          While it appears that W share has stabilized in the last few months, OSTK online share continues to revert towards pre-COVID levels.

-          Cumulatively, this means OSTK’s revenue is now probably running dramatically below both guidance and consensus. In the chart below, we use 3-year growth to help normalize the anomalous behavior that occurred during the COVID period.

Why OSTK’s gains are already evaporating

1)  OSTK under-invested in its operations and marketing for the past decade. For example, Wayfair alone outspent OSTK by $3,228mm on advertising ($3,886mm vs. $518mm) and $518mm on CapEx ($559mm vs. $41mm) over the past 3 years.  

Additionally, OSTK lags market leaders in website design, assortment breadth, recommendation engine quality, and CRM.

2)  OSTK’s category is low-purchase-frequency. Companies with laggard brands must re-acquire customers from scratch during each purchase occasion. Below we observed nearly 100,000 households that made their first purchase at Overstock, Wayfair, Crate & Barrel, or West Elm during the first six months of 2020. The chart below shows what percentage of each group continued to make purchases in the subsequent seven quarters from initial purchase. Ideally, a retailer wants these percentages to be as high as possible as it implies strong brand affinity. In addition, companies that retain high percentages of first-time shoppers can spend less on customer acquisition to maintain and grow revenue.

For all furniture retailers, we found that only a small percentage of the original shoppers remained after almost two years. However, we found that even fewer shoppers continued using Overstock.com, 3.2% of the original cohort remained compared to MSD/HSD levels observed at other retailers. We believe this speaks to OSTK’s need to continue to reacquire customers, above and beyond its competition, given the significant likelihood that previously acquired shoppers will churn.

What likely happens next

OSTK management guided to “at least high single digit revenue growth in 2022,” premised on the expectation of a “market share growth for the third consecutive year.” Half the call was spent on promising sustainable share growth (Ctrl+F the transcript for “share”). It seems to me that management hasn’t thought or researched deeply what drove OSTK’s share gains in 2020-2021 and simply rolled recent trends forward. Failure to deliver on revenue and share growth promises this year should make it clear that management doesn’t fully understand its own business and doesn’t know how to project its category. This isn’t surprising because OSTK has never been in position to attract a top tier team, given its decade of mediocrity prior to COVID and its “colorful” founder.

As you can see from our data ensemble in the section above, we expect Q1 revenue of $555-575mm, missing consensus by $5-25mm. We are now ~20% through Q2 and revenue is tracking -17% to -28% y/y. $570-$655mm seems a reasonable 2Q estimate at this point, which is well below consensus of $751mm. The back half of course has a wide range of outcomes due to macro uncertainty, but we model a range of $1,090-1,255mm, implying $2.2-2.5bn for the full year or -10% y/y to -20% y/y. For our 2H estimate, we are holding the 3-year growth rates from our Q2 expectations constant through the remainder of the year. This is significantly below consensus expectations for 2022 revenue of +3.1% y/y and guidance of “at least” high-single-digit growth.

We expect management to temper expectations for Q2 and the full year on the Q1 call. However, given their history of ‘optimism’, we expect them to blame macro factors and the reduction of non-home categories for the weak first half. They will probably still call for a hockey stick back half improvement. It’s hard to imagine them fully capitulating on the year just a couple of months after sounding so confident. We also doubt they’ll come clean about the share losses. Therefore, we are expecting a miss/lower cycle through the rest of the year and see no reason to expect a rebound in 2023.

Valuation

We struggle to come up with a valuation framework that feels like something other than arbitrary so we’re not advocating for any specific price target. Prior to COVID, OSTK wasn’t growing and wasn’t profitable, so it was worth somewhere between nothing and option value (inclusive of crypto hype). Perhaps the overall step-change in furniture/home online share will allow OSTK to eke out positive EBITDA for a few years. Perhaps their crypto assets are worth something (we doubt it). We simply don’t think this stock has real long-term believers or a real constituency, so we believe it won’t have support this year once it becomes clear that it’s both no longer growing and is once again back to being a share donor.

A word on data

We make our revenue and market share projections via a proprietary data ensemble, which incorporates data from multiple independent transactional panels, eReceipts, web traffic, app intelligence, clickstream, and other sources.

Risks

-          Crypto asset “value”

o   I’m not smart enough to know how much value to assign to a furniture retailer’s crypto marketplace, just like I’m not smart enough to fathom the value of a theater chain’s silver mine and a video game company’s NFT initiative. You will have to assess this risk for yourself.

-          “Memability”

o   Short interest is elevated (~18%)

-          The possibility of M&A has been floated by some bulls

o   One can never discount this completely, but we would massively fade this logic. The business has very questionable fundamental value and while the founder is no longer there, we think there is still too much PR risk for any credible buyer to touch OSTK until there is far more distance.

-          Annual guidance

o   Management has already demonstrated a lack of sophistication in the understanding of the underlying share drivers of their business and an affinity for the “rose-colored glasses” school of annual guidance. It’s possible but they will reduce guidance on the Q1 print, but far less than sober reality warrants.

Catalyst

-          Q1 results and guidance update

-          Persistent miss/lower cycle driven by permanent resumption of share losses

-          Market’s appreciation (likely this year) that OSTK is on a path to be a share donor until revenue is back closer to pre-COVID levels than 2021’s high watermark.

Disclaimer: At the time of publication, the author of this article holds a short position in Overstock.com, Inc. (OSTK).  This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a short position in the company covered herein and stands to realize gains if the price of the stock declines. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information, or as to the results to be obtained from its use.  All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.