Description

Every few years, Overstock (OSTK) gives us the opportunity to short a sub-scale, structurally challenged e-com retailer at an insane valuation. Now is one of those times. Momentum in the stock has turned over with shares peaking at ~$130 in late August (up from <$5 pre-Covid) and now trading at $67 ($2.45B TEV). Borrow is available (25 bps borrow cost) and the stock is liquid, trading ~$500mm per day.

Prior to Covid, OSTK was a declining web 1.0 retailer that was consistently loss-making. Retail revenues peaked at $1.8B in 2018 and were $1.4B in 2019 – on par with results in 2013/2014. Before the recent surge in online ordering due to Covid, OSTK was expected to generate $1.4B in revs in both 2020 and 2021 (see below). 

[Source: atom.finance]

This 8 years of no revenue growth is against a backdrop of significant e-com share growth in OSTK’s most important category, furniture and home furnishings (see below). The market correctly recognized this, and the company traded for a partly EV of ~$100mm on this loss-making ~$1.4B of revenues (

With the surge in demand for home furniture / furnishings due to Covid, even OSTK saw a massive increase in sales in Q2. As a result, the company reported ~110% revenue growth / ~$770mm vs. the decline / ~$350mm that would have been typical of the company. This allowed OSTK to put up ~$50mm of quarterly EBITDA as opposed to the normal negative EBITDA of the trailing four quarters (see below).

In normal times, being an e-com furniture retailer with no owned brands is a terrible business. You pay extremely high CACs via digital marketing to acquire mostly one-time customers, and then need to pay expensive freight to deliver heavy, bulky items. This is how you wind up with OSTK’s 20% gross margins and zero EBITDA generation. Note that in Q2, sales and marketing spend was still 10% of revenues (in-line with history) – it’s not like the Overstock brand suddenly became cool, or that they introduced some new in-house items. You simply got a surge of new orders that will wild up being mostly one-time in nature. These customers will churn just like they have over the past 10 years. OSTK reported customer retention for this huge Q2 influx of new customers as being a modest 16% higher than prior quarters (see below). Decent, but nothing here to indicate any structural changes to the terrible unit economics of this business.

Consensus now has the business doing ~$2.1B in revs in 2020 (40% growth) and then growing another 16% off that base in 2021 to generate ~$2.4B in revs. If we are very generous and assume that half of the excess $400mm ($770mm Q2 less $350mm typical quarter) in Covid revenues are recurring, that would put the new quarterly run-rate at around $550mm or $2.2B annually. We would guess that the reality is well less than 50% is actually recurring. In this case, assuming similar incremental margins to the performance in Q2, the business would earn ~$125mm of gross profits (vs. $178mm in Q2) and ~$25mm of EBITDA (vs. $53mm in Q2) quarterly, and ~$100mm EBITDA annually. More likely, very little of this excess revenue generation in Q2 will persist as we move into 2021 and the company will see very minimal long term increase in intrinsic value besides the profits in Q2. 

At $67 per share, you a shorting the stock at 25x this favorable $100mm normalized EBITDA scenario with the share price momentum already decidedly negative. What’s a crappy no growth e-com furniture retailer worth? Maybe 7x EBITDA? That puts you at $25 per share. More likely, this was pretty much all one time and the company goes back to generating minimal profits. In that case, this stock will fully round-trip back to $5.

Catalyst

-Company puts up numbers more in-line with historical results

-Bubble momentum deflates