Description

Overstock.com (OSTK-$49.72) is a very attractive long.

Forget what you think you know about Overstock……it’s very different than it ever was: 

• Controversial founder Patrick Byrne is gone

• Overstock is now a top five eCommerce home furnishings retailer – a smaller version of Wayfair

• 20%+ of mkt cap in net cash, nicely profitable marketplace-like business, highly cash generative  

• EV / FCF multiple on 2022e is 17.5x (valuing blockchain assets at $200m - vs. $330m book value)

• Blockchain investments on the books at $330m ($7 p/s) now externally managed – a nice call option  

Description.  From its origins as an online closeouts retailer, Overstock has grown into the fourth largest “home furnishings” online brand in the United States, after Amazon, Wayfair and Walmart (ahead of Target, Pottery Barn and Ikea) with about $2.6 billion in 2021e home furnishings revenue and a focus on “smart value” oriented customers.  Non-home furnishing products ($170m in 2021e revenue) like jewelry are being phased out and by the second quarter of 2022, Overstock will be 100% home furnishings focused.

This is a marketplace-like business, with about 3,000 third-party vendors/manufacturers/distributors selling product on the site.  For 2021, we expect that Overstock will have delivered 13.5 million orders with an average order value of $205.  Wayfair at $15 billion of revenue and with a significant logistics (i.e. distribution center) infrastructure is considerably larger than Overstock – that said, it’s a big industry and there’s room for multiple players.  Many of the vendors we spoke with who sell the same product on both sites are very happy that Overstock exists, they don’t like Wayfair’s forcing them to lock up inventory in Wayfair distribution centers and are wary about being bullied by the giant in the space.

Overstock books the full amount of revenue and COGS for the products it sells but doesn’t touch the product all that much (the Company has 3 distribution centers which fulfill about 5% of revenues).  On sales approaching $3 billion in 2021, Overstock had about $6 million in inventory on its balance sheet.  Gross margins are about 22% (slightly lower than Wayfair).  Overstock, being in growth mode, is managing the business to about a 5% EBITDA margin. 

EBITDA converts to free cash flow at about a 70% rate given minimal cap-ex and the positive working capital dynamic of a marketplace model that is growing (OSTK charges for a product immediately and remits payment to vendors later), no cash taxes (NOL’s) and de-minimis interest costs as there is essentially no debt. 

Background.  Overstock started out as an online closeout retailer led by Patrick Byrne who steered the company into a number of blockchain investments.  Byrne departed the company in August 2019 and no longer appears to be a shareholder.  Long time OSTK executive Jonathan Johnson took over as CEO from Byrne and based on our conversations with vendors, things started to change almost immediately…improved vendor relationships, better back-end technology, right sizing marketing spend, focus on profitability, de-emphasizing non-furniture products in the process becoming a pure-play eCommerce furniture business and very importantly outsourcing the management of the blockchain assets which are likely to eventually be sold.

No doubt, OSTK has been a huge beneficiary of Covid, but there’s also no doubt that the company is vastly improved in every way from the Byrne era.  Overstock likely could not have put up the results it did in 2020 and 2021 without it being a much better company due to its new management team.

eCommerce Furniture Industry.  Setting aside the tough comp this year (discussed below), eCommerce furniture is in an excellent spot and should grow double digits for the foreseeable future.  The overall furniture industry grows about 3% - 4% annually.  Overstock estimates that eCommerce represents about 33% of the overall furniture industry.  We see no reason why that doesn’t go to the 50% - 60% level over time.  Having gone through Covid, consumers have gotten accustomed to buying furniture online, millennials will almost certainly be buying furniture online.  Annual furniture spend growth of 3% - 4% plus 200 bps or so of increased online penetration annually would drive double digit eCommerce growth.       

Current Trends.  Overstock has been performing exceptionally well through the nine months 9/30/21, nicely outperforming Wayfair as shown below.  The Q2 and Q3 2021 performance was particularly impressive given how tough the comp was from an incredible 2020 during which many furniture stores were closed.

**Represents OSTK Home Furnishings revenue

Overstock is starting from a lower base as a smaller company, but very importantly, the business is being managed better and improvements are ongoing.  More categories/SKU’s being added to the site is the most obvious growth opportunity, but the company should also benefit from improved marketing, better search/discovery on the site, entry into Canada, and a GSA contract win (likely a 2023 impact).  Bottom line we are likely still in the middle innings of improvement here which means that Overstock should continue to post better than industry revenue growth.

OSTK’s stock is down 52% in the last three months (Wayfair down 43%).  Given very strong 2020/2021 performance (stay at home, stimulus monies etc.), there is an extreme sensitivity here to the tough comp created by great numbers put up in 2020/2021.

Our thoughts on 2022, a tough comp year:

2021 revenue/EBITDA/FCF should come in at $2.8 billion, $140m and $110m.

FWIW, the street is projecting 2022 revenue/EBITDA/FCF of $3.1 billion, $167m and $150m. 

Overstock’s CEO had this to say on the 10/28/21 Q3 earnings call…..”From our current vantage point, including our perspective on the macro environment, we are comfortable with consensus estimates for 2022 revenue growth and adjusted EBITDA margin. In fact, we think the annual estimate for 2022 revenue growth is a bit pessimistic, noting we have beaten top line estimates for 7 consecutive quarters. Our goal is to continue to grow our market share and to build the business in 2022 and beyond.” 

This of course might be optimistic and was stated before the market started trashing OSTK and W on fears of a lousy December, but it is certainly worth noting.  To be clear Overstock has already showed the ability to perform successfully versus a very tough comp in Q2 and Q3 in 2021. 

Our gut feeling is that 2022 revenue/EBITDA is flattish to slightly down versus 2021.  We would support that by going back to our estimate of $1.5 billion of home furnishings revenue in 2018 and growing that by 15% annually as if Covid never happened.  That would bring $2.6 billion in 2022 revenue, about flat with 2021 home furnishings revenue (non-home revenue was $150m in 2021, will probably be $50m in 2022 and then will be zero going forward).

On the $2.6 billion in 2022 home furnishing revenue, we assume about a 5% EBITDA margin which brings $130m EBITDA and $100m in FCF. 

With 2022 as a base, we’d assume 10% revenue/15% EBITDA growth going forward driven by eCommerce continuing to increase as a percentage of the overall furniture industry as well as Overstock specific factors (starting from a smaller base, numerous improvement initiatives etc.).  This would bring 2023 revenue/EBITDA/FCF of $2.9 billion, $150m and $120m.

Again, the street is at $170m of 2022 EBITDA, as there is lots in the background that could potentially outweigh any industry headwinds.  Our 2022 number could be conservative.   

Financials/Valuation.  On a market cap of $2.4 billion, there is close to $500m in net cash for an enterprise value of $1.9 billion.  If we were to assume 2022 EBITDA at $130m and FCF at $100m, the EV/EBITDA is 15x and the EV/FCF multiple is 20x – throwing in $200m for the blockchain investments the EV goes down to $1.7 billion, and brings the EV/FCF multiple to 17.5x.

On 2023 EBITDA/FCF of $150m and $120m, the EV/EBITDA is 12.8x and the EV/FCF multiple is 16x – throwing in $200m for the blockchain investments the EV goes down to $1.5 billion, and brings the EV/FCF multiple to 14.6x.

If you really wanted to get simplistic, assume at some point in the next few years OSTK achieves $3 billion revenue, put a 1x revenue multiple (vs. Wayfair at 1.2x – Wayfair is bigger and likely better…on the other hand OSTK should have a potential takeover premium in its valuation) add the growing cash pile and perhaps $200m for the blockchain, on 50m shares outstanding you’d have an $80 share price.  

Downside Scenario:  $75m - $100m 2022 EBITDA (down from $140m in 2021) at a 12.5x multiple + $500m net cash YE 2021 + plus $200m blockchain investments, on 49m s/o = $37 per share

Upside Scenario:  $200m street 2023 estimate in 2023/2024 time-period at a 20x multiple plus $700m YE 2023 net cash + $300m blockchain, on 50m s/o = $100 per share (blockchain could be much higher)

Blockchain Assets.  I have zero opinion on these assets, they are on the books at $330m.  OSTK management has handed over the management of these assets to Pelion and the assets are now held in a partnership with OSTK as the LP and Pelion as the GP.  Management fees are capped at $2.5m annually and Pelion will collect an incentive fee on any increase in value.  Link to the 8K is here…….

The lead asset here is tZero, which provides a platform for private companies and assets looking to digitize their capital table through blockchain technology and trade on a regulated alternative trading system.  tZero aspires to become the only trading platform where investors can efficiently and transparently trade security token offerings, cryptocurrency, and national market securities in a single site.  Compared to existing equity transactions that settle three days after a trade date (T+3), trades executed through the tZero platform settle on trade date (T+0), hence the name, tZero.

Summary.  While 2022 is tough to forecast, OSTK is an excellent asset with years of double-digit growth ahead and we believe an eventual sale to any number of larger retailers (eBay, Wal-Mart, Target, TJX etc.) is likely.  The blockchain assets seem like an interesting call option.

Some good Overstock CEO quotes from the Q3 earnings call:

“Before I jump into the specifics on the quarter, I'm reminded of a Warren Buffett quote, "Only when the tide goes out do you discover who's been swimming naked." Well, the pandemic tide that lifted all online home retail, home furnishing companies in 2020 has begun to go out. And Overstock continues to operate at over 2x our pre-pandemic sales level and to consistently deliver profits within our stated targets. This is because in the 6 months that preceded the pandemic and in the months since, this management team made and continues to make foundational improvements to our business operation. The pandemic tide is receding, and we are wearing an operational wetsuit, if you will. For the last 6 quarters, we've consistently delivered results well above our pre-pandemic numbers.”

“U.S. home sales continue to grow year-over-year and forecasted consumer spending remains strong. All these macro trends support category growth. Our supply chain is broad and distributed. Our vast partner network reduces single-source risks, shipping bottlenecks and supply chain kinks. In fact, we are proving that our supply chain works well in times of high consumer demand and low supply partially because suppliers don't want to tie up limited inventory in 1 or 2 distribution networks. 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 on inventory. Our asset-light business model aids in reducing gross margin pressure. We own almost no inventory.”

We continue to expand our extensive partner-supplier network. We can flex our distribution center footprint as demand fluctuates. And we work closely with our regional and national contracting carriers, providing them accurate and timely forecasts to improve our delivery accuracy and meet customer expectations. We have a great business model. There's a great business model and periods of high demand and low supply. It is a great business model, and there are kinks in the supply chain. And of course, we think it is a great business model in more normal business circumstances. All this adds up to long-term favorability.

We have had 20 months of sales performance that has been double or nearly double our pre-pandemic run rate despite numerous and varying supply chain challenges. I'm eager to see what we can do when the bottlenecks in the supply chain subside. I suspect we will be able to significantly grow the number of SKUs we offer as we increase the breadth and depth of our home products.

We believe online penetration continues to grow and will finish the year at a pre-pandemic growth rate. It's nice to again see nice growth in that penetration in 2021 even after the large surge we saw last year. Importantly, third-party forecasts project continued migration in 2022 and beyond as customers recognize the broad assortment available, value and ease of purchasing furniture and home furnishings online. Add to this online migration, the growth in the home market TAM and Overstock has 2 nice tailwind factors.

We've expanded our new home SKUs by 150% year-over-year, including showcasing exciting home brands like Casper and KitchenAid. Once supply chain kinks moderate, we expect significant new SKU growth as we add even more partners, and our existing partners bring new SKUs on site. We held the #1 traffic share in outdoor furniture during the summer months. That's a big deal. 94% of our sales were in home categories, a slight improvement from last year. As we continue to strategically remove nonhome products from our site, our goal is 100% of sales to be home-related by this time next year. Even with these wins, Overstock still does not have enough brand association with home. It's paramount that Overstock is seen as an online furniture and home furnishings destination and that we make finding our home products easy and fast. We know there is room for improvement, and our team is eager to continue to execute against this strategy.

As I've mentioned several times before, we believe we are in the middle of a secular shift where consumers are increasingly buying furniture and home furnishings online. We have intentionally set our near- and mid-term growth and margin targets with the desire to take market share during this secular shift while delivering profitability. When we feel the industry has reached its natural maturation point, we may consider revising our targets and establishing a different longer-term margin framework. We have consistently delivered against our financial targets, which are as follows: top line outpacing the market, driven by our technology, our customer focus and our business model; gross margins in the 22% range, which may fluctuate slightly from quarter to quarter; disciplined G&A and tech spending to continue to drive operating leverage; and adjusted EBITDA margins in the mid-single digits. Overstock has been operating within this framework for 6 consecutive quarters. And with the operational changes we continue to make in the business, we expect to continue to do this.

Catalyst

• Lapping of tough comp period

• Continued growth from overall industry growth and further eCommerce penetration