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Overstock

This article is available, too, on GuruFocus (it came on the 4th place for 
Dec-2011, Value Idea Contest). 
You may wish to read the comments expressed on the article at GuruFocus - some present a bear stance.
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“A share of stock is a slice all the way through the company”

Recently, OSTK traded for less than $8 per share and visited the 52low list. I think the company makes a worthwhile investment proposition and the share price offers an attractive entry point. 


The PSR (price-to-sales ratio) of Overstock calculated as Enterprise Value/Net Revenues (x0.13) or Marketcap/ Net Revenues (x0.17) indicate lower ratios than some competitors, or the industry's or sector's average.  The research performed by James p. O' Shaughnessy (What Works on Wall Street) concludes the following about the PSR: "Low PSRs beat the market more than any other value ratio and do so more consistently, in both the 50-stock portfolios and decile returns... ....The decile analysis confirms that of all the value ratios, PSR is the most consistent and best guide for future performance".

Of course, a low PSR ratio is no guarantee that an entry price of $8/share would make an investment in Overstock successful. Nevertheless, as one element in the analysis of the investment opportunity, it delivers a statistically good premise - if one considers the reversion to the mean.  I do not venture to map a voyage (forecasts) regarding the future value of the company. One may assume that if the company makes progress and grows even moderately, at a pace not necessarily faster than during the last four years there are good chances for an increase in both: the multiple and the applicable revenues. Based on the current entry price the downside is probably limited whilst upside is more likely.

Before anything else, an entry ticket of $8/share is only valuable for the ones who trust the crew is able and the ship is fit to sail safely and in due course across the ocean, despite the headwinds. The thesis that follows presents my perception of the crew, of the ship (Overstock) as well as of some areas which I think constitute value drivers, require management action and, if properly addressed, may create value for Overstock. You owe, for a fact, to make your own judgment before endeavoring to invest. 


Top Quality Institutional Sponsorship

Together the Byrne family and two renowned value oriented institutional shareholders own close to 70% of the outstanding shares of Overstock. The Chou funds own approximately 19.5% of the company - lately Francis Chou kept adding to the funds' positions. Fairfax Financial Holdings holds approximately 14.6% of Overstock. Mr. Samuel A. Mitchel a Board member of Overstock is the Managing Director of Hamblin Watsa Investment Counsel (wholly-owned subsidiary of Fairfax Financial Holdings).

Size and availability of capital would provide the bargaining power to secure acquisition of discounted merchandise and could draw the line between winners and outgoers of the crowded marketplace. Here is where the long-term shareholders of Overstock and the value driven management style of Overstock may make a difference. I look forward to observe how the latest 424B3 will materialize.


Righteous Family/Successful Entrepreneur - controlling shareholders

The Byrne family controls about 34% of the shares. John Byrne (Board member, CEO's father) used to run GEICO and Patrick Byrne (Founder, CEO) used to run Fechheimer Brothers (before Overstock). Warren Buffet himself let the young Patrick Byrne have some advice:

“Look. You buy a share of stock if and only if you would buy it even if the market were shutting down for 10 years tomorrow. Would you still buy that share of stock?” And by running it through that mental filter, you stop thinking of it as this piece of paper that you’re trying to buy at an uptick. And you think of it as a slice of a company. You’re getting a slice all the way through the company. And is that a slice . . . Would you want to own a chunk of that company for the next 10 years? So that goes for both stock investing; but also when you run a company, you run it as if there was no public market. You don’t worry about the public market. You focus on building the real intrinsic value, and that value should get expressed over time.” (source available here).

Although he was only thirteen at the time, that advice seems to have taken well with Patrick Byrne who amased a $100 million portfolio as CEO of High Plains, a personal investment fund through which he bought Overstock.com. According to an article by Fortune (By Nicholas Stein, 2000):

"Buffett would go on to develop such an admiration for the younger Byrne that in 1998 he brought him in as temporary CEO of Fechheimer Brothers, a Cincinnati uniform manufacturer owned by Berkshire Hathaway. Fechheimer badly needed rejuvenation, says Mike Fralix, director of (TC)2, a garment industry think tank that consulted for Fechheimer: "The company still did things the same way it had 50 years before." So in a turbulent 18-month tenure, Byrne made sweeping changes in infrastructure and personnel. Still, some felt Byrne was "too quick on the trigger," as a former Fechheimer executive puts it. 

Certainly, Byrne's tenure didn't lack for drama: He once challenged union leaders to a fistfight to resolve a labor dispute. No one volunteered, and the union later backed down. Despite that bellicose episode, argues Karla Bourland, who worked with Byrne at Fechheimer and is now Overstock's chief operating officer, Byrne is the greatest motivator she's ever seen. When Byrne announced he was leaving Fechheimer, she recalls, many of the seamstresses cried."

The "great motivator" theme is acknowledged by Patrick Byrne in an interview to Big Think were he says: 

"Well I think of my role very much as being like a teacher, like a professor... And stepping back and giving people a lot of room to grow . . . In fact that’s, say, the difference between, in my view, middle management and upper management, is a middle manager is suffocating to his people. He may get a lot done, but he’s suffocating. And sometimes you have to accept a tradeoff that you’re going to be less suffocating and things might not be done as well or as quickly; but more people will learn. And the idea is to build a learning organization..."


Value Oriented Culture

Management Compensation – I encourage you to read the latest Proxy Statement as well as the transcript of the 2011 Stockholders’ Meeting. In the meantime, I present here a few excerpts:

  • After ten years of service without any salary or bonus, Patrick Byrne, agreed to accept a salary of $100,000 for 2011;
  • The other Executive Officers’ salaries stay at the same rates paid in 2010, as follows: Mr. Johnson: $350,000; Mr. Chesnut: $300,000; Ms. Simon: $300,000; and Mr. Peterson: $300,000;
  • the Compensation Committee approved the recommendation of the Executive Officers that they be paid no bonuses relating to 2010 (according to the transcript of 2011 Shareholders’ Meeting they gave up their bonuses so that the employees could have theirs);
  • The number of restricted stock units granted to Executive Officers were as follow: Dr. Byrne: 15,000; Mr. Johnson: 15,000; Mr. Chesnut: 15,000; Ms. Simon: 15,000; and Mr. Peterson: 15,000;
  • Substantially all employees of the Company are expected to be eligible to participate in any bonuses ultimately paid under the 2011 Bonus Plan. The total bonus pool under the 2011 Bonus Plan is expected to be an amount equal to 20% of post-bonus ‘‘Measurement Amount’’, with 20% of the pool expected to be allocated to the members of the executive team (18 people).
I believe decency is a word that describes well the management compensation at Overstock.

The fact that 80% of the bonus pool is reserved for employees suggest a certain management attitude towards them which in turn might explain the 9th place occupied by Overstock in Glasdoor's  Employees' Choice Awards for Best Places to Work.

Candid disclosure - “Dear Owner, I wish to set a gold standard in communicating with candor your firm's results ...”.  A concise explanation of the metrics used by management to manage the company follows. All that is written on the CEO Owner’s Guide tab, under the Investor Relations section of Overstock.com website. I liked the fact that all quarterly presentations (starting 2003) are easily available on the web site and that they also present meaningful operational information. 

There is always room for better disclosure (see more comments under the section "Value Drivers" down below) but all in all I am satisfied with the candor exhibited by Overstock.


The Naked Short Litigation - White Knight or a King's Man with a posture?
(The King is the Lamb offers the grasp of this title)

In 2005, Overstock sued Gradient/Rocker Partners Lawsuit for libel, unfair business practices and tortuous interference. Gradient settled in 2008 (some media coverage here) and Rocker Partners settled in 2009 when it paid Overstock $5 million.

In 2007, Overstock filed an unfair business practice lawsuit against some prime brokers over the practice of naked short selling. “I didn’t want to fight this fight. ... I'm telling you there is a crack in the financial system. It's filling up with phantom shares until they so warp the market ...” declared Mr. Patrick Byrne, on a conference call (Q1-2006, page 3). An article from Bloomberg Markets (here) explains some elements of the “crack” that made Patrick pick that fight.  

The Prime Broker Lawsuit with Goldman Sachs and Merrill Lynch/BAC as the remaining defendants (some other prime brokers have settled, see OSTK 10-K, 2010, page 33). This trial, David vs. Goliath type of story, might raise a lot of public interest –  and a great deal of goodwill and name recognition for Overstock.com.

I believe there is a strong likelihood that Overstock will prevail somehow on this matter: trial or settlement. If it goes all the way in front of twelve, hopefully, Overstock will harvest a substantial amount. Originally, Overstock has asked for $3.48 billion in damages from the prime brokers. 

Information on Overstock's and other comparable "Phantom Shares" legal proceedings is available here. More specific information on Overstock's litigation is presented here.


Other Litigation

The company faces some headwinds from district attorneys in California who filed a suit in 2010 and claim that Overstock made  "misleading statements ". The Consumer Affairs.com provides more details. An excerpt is below:

"Overstock made "misleading statements "which accompanied virtually every product listing on its site," according to the suit. By way of example, the complaint points to a patio set that Overstock claimed had a "list price" of $999. The website offered the set for a seemingly rock-bottom $449. But a consumer who bought the set on Overstock found a Wal-Mart sticker listing the sale price as $247 -- a full $200 cheaper than the price at which Overstock offered the set. Mark Griffin, Overstock's vice president and general counsel, said in a statement that "no one is perfect but also that Overstock "[does] deny the allegations and we deny the interpretations." Griffin said that misrepresenting prices would be devastating for a company that has plenty of competition. "The bottom line is that people shop our website in large part because of the prices we offer," he said. "So we have to be as accurate as possible because we know that our customers can easily check the prices that are available elsewhere." As for the patio set, Griffin said it was a misunderstanding between Overstock and its vendor."

This suit is in the discovery stage and Overstock intends "to vigorously defend this action".  The latest 10-Q provides more information about the outstanding litigation.




Business Description

A very informative history of the company is available here as well as on the Overstock's own web site.

Overstock is an online retailer offering discount brand name, non-brand name and closeout merchandise, including bed-and-bath goods, home décor, kitchenware, furniture, watches and jewelry, apparel, electronics and computers, sporting goods, and designer accessories, among other products. The web site operates five tabs:  Shopping, Cars, Travel (a partnership with Priceline starting 2012), Insurance, B2B ( www.overstock.com, www.o.co and O.biz). Under the Shopping tab/Worldstock the buyer can procure merchandise from craftsmen in many world's countries. For the time being about 99% of the revenue is generated in the USA but the company could deliver many products to a great deal of international destinations. The company differentiates between:
  • the "Direct business - sales from the company's 1.04 million sqf warehouse in Salt Lake City;
  • the "Fulfillment partner" business -  the sale of merchandise of other retailers, cataloguers or manufacturers (“fulfillment partners”) through the company's websites.  But third-party fulfillment partners perform essentially the same fulfillment operations as Overstock's warehouses, such as order picking and shipping; however, the company handles returns and customer service related to substantially all orders placed through its Websites. Revenue generated from sales on the Shopping site from both the direct and fulfillment partner businesses is recorded net of returns, coupons and other discounts.
The 10-K's description of the company's business evolved as follows:

2002 - 2007 Our Websites offer our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventory liquidation distribution channel.
2008 onwards Our Website offers our customers an opportunity to shop for bargains conveniently, while offering our suppliers an alternative inventory liquidation or sales channel.

It rings that in addition of being an inventory liquidation middleman Overstock became a sales agent, too, expanding its universe. The press release, regarding the partnership with Barnes and Nobles, confirms, I think, the "sales agent" dimension added to the business. Whilst the "overstock" concept might resemble a never ending series of "cigar butts" the o.co might be viewed as the foundation of a building whose construction started in 2008.

Via Club O, Overstock offers membership benefits. Various other programs are employed to increase attractiveness of Overstock to customers. I found their latest idea of unloading returned goods through an auction open to the public very good. It may even become a tradition and a brand strengthening tool - the word of mouth must have been something and x cents per dollar plus that publicity must be better than x cents less publicity (if returned merchandise would have been sold directly to liquidators instead of public auction).  ("Dec. 15, 2011, in Salt Lake City. Over 600 people registered to bid on pallets of returned items during the company's first auction of this kind", an interesting article here)

The entire on-line retailing industry faces headwinds due to the local states tax issue whose resolution is not predictable. In no instance, I believe, this tax will destroy the industry or Overstock but it might make days cloudier for many of the  weaker players - which in the end may benefit the stronger ones.

The company tried various models such as operating various website tabs, operating more US warehouses and local presence in Mexico. One of its promotion initiatives was penalized by Google in 2011 so it was given up (but that might have costed 5% in lost revenue). In the past its systems failed to invoice properly some of the costs which should have been born by Overstocks' fulfillment partners so the company chose, in the end, to bear some of them itself. 

The balance sheet is tightly managed. The convertible debt of $ 120 million issued in 2004 has been retired fully (there were two capital raises of $64.4 million in 2006). In Q3-2011 accounts receivable are 4% of net sales, inventories 8% and prepaids 7%. 


Consolidated Balance Sheets (USD 
In Thousands
Sep. 30, 2011
Dec. 31, 2010
Current assets:  
Cash and cash equivalents$ 79,138$ 124,021
Restricted cash2,3832,542
Accounts receivable, net8,44513,560
Inventories, net19,21032,114
Prepaid inventories, net1,4152,082
Prepaids and other assets15,25411,651
Total current assets125,845185,970
Fixed assets, net27,08527,800
Goodwill2,7842,784
Other long-term assets, net2,2611,405
Total assets157,975217,959
Current liabilities:  
Accounts payable42,55267,311
Accrued liabilities37,68440,751
Deferred revenue21,18024,027
Convertible senior notes, net of debt discount - $0 and $141 34,484
Finance obligations, current5,8443,922
Capital lease obligations, current185729
Total current liabilities107,445171,224
Capital lease obligations, non-current3113
Finance obligations, non-current14,48512,219
Long-term debt17,000 
Other long-term liabilities3,0343,175
Total liabilities141,967186,731
Commitments and contingencies (Note 5)  
Redeemable common stock, $0.0001 par value: Outstanding - 0 and 46 570
Stockholders' equity:  
Preferred stock, $0.0001 par value: Authorized shares - 5,000 Issued and outstanding shares - none  
Common stock, $0.0001 par value Authorized shares - 100,000 Issued shares - 26,237 and 25,877 Outstanding shares - 23,277 and 23,01522
Additional paid-in capital352,728349,747
Accumulated deficit(258,356)(242,327)
Treasury stock: Shares at cost - 2,960 and 2,862(78,366)(76,764)
Total stockholders' equity16,00830,658
Total liabilities and stockholders' equity$ 157,975$ 217,959


Current liabilities (excluding current debt) are perpetually larger than current assets (excluding cash). 


 
Source of data: Morningstar and Sep 2011, 10-Q


This negative working capital makes an interesting perpetual for Overstock, almost like an insurance float, which provides a nice cushion to finance inventory, etc. As of September 30, 2011 the company has federal net operating loss carry forwards of approximately $190.5 million and state net operating loss carry forwards of approximately $174.3 million, which may be used to offset future taxable income.

***

Moving to the P&L brings some discontentment. Sales in 2011 are somewhat lower than in 2010 - the beginning of year O.co abrupt replacement of overstock.com and the Google penalty concurred to this negative performance. Earnings are no better yet in putting a smiles on the management's face. 

But as one may note the Sales and Marketing expenses are well in excess of the Operating loss which is refreshing (they consist primarily of online and offline advertising, public relations and promotional expenditures, as well as payroll and related expenses for personnel engaged in marketing and selling activities).


Consolidated Statements of Operations (USD $)
In Thousands, except Per Share data
3 Months Ended9 Months Ended
Sep. 30, 2011
Sep. 30, 2010
Sep. 30, 2011
Sep. 30, 2010
Revenue, net    
Direct$ 34,749$ 47,508$ 116,353$ 140,458
Fulfillment partner204,989197,912623,847600,545
Total net revenue239,738245,420740,200741,003
Cost of goods sold    
Direct(1)32,47243,174105,733124,192
Fulfillment partner168,893160,868506,240486,583
Total cost of goods sold201,365204,042611,973610,775
Gross profit38,37341,378128,227130,228
Operating expenses:    
Sales and marketing(1)13,82215,62642,90244,084
Technology(1)17,17114,18650,63942,312
General and administrative(1)15,32114,74250,03244,151
Restructuring   (136)
Total operating expenses46,31444,554143,573130,411
Operating loss(7,941)(3,176)(15,346)(183)
Interest income2355121111
Interest expense(662)(668)(1,968)(2,230)
Other income, net5533879621,410
Loss before income taxes(8,027)(3,402)(16,231)(892)
Provision (benefit) for income taxes(240)(44)(202)78
Net loss(7,787)(3,358)(16,029)(970)
Deemed dividend related to redeemable common stock (23)(12)(99)
Net loss attributable to common shares$ (7,787)$ (3,381)$ (16,041)$ (1,069)
Net loss per common share-basic:    
Net loss attributable to common shares-basic (in dollars per share)$ (0.33)$ (0.15)$ (0.69)$ (0.05)
Weighted average common shares outstanding-basic (in shares)23,27623,06023,25323,006
Net loss per common share-diluted:    
Net loss attributable to common shares-diluted (in dollars per share)$ (0.33)$ (0.15)$ (0.69)$ (0.05)
Weighted average common shares outstanding-diluted (in shares)23,27623,06023,25323,006

What makes me more optimistic is the evolution of the operating margin and the stabilization of SG&A as a percentage of revenues:


 
The company generates positive cash from operations with the seasonally high fourth quarter making up for the ones that precede it. As visible in the Sep-2011 cash flow statement the company has a positive net income line for the twelve months ending Sep. 30, 2010 (an encouraging sign for the future). On average, during the last three years the company used about $15 million/year for capital expenditures offset by approximately $16million/year of depreciation (three year average again).

Consolidated Statements of Cash Flows (USD $)
In Thousands
9 Months Ended12 Months Ended
Sep. 30, 2011
Sep. 30, 2010
Sep. 30, 2011
Sep. 30, 2010
Cash flows from operating activities:    
Net income (loss)$ (16,029)$ (970)$ (1,170)$ 11,757
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:    
Depreciation and amortization12,47210,47116,58113,312
Realized loss on marketable securities   9
(Gain) Loss on disposition of fixed asset 14(14)13
Stock-based compensation to employees and directors2,4113,7703,6975,092
Amortization of debt discount77306162367
(Gain) loss from early extinguishment of debt54(346)54(346)
Restructuring reversals (136)(433)(136)
Changes in operating assets and liabilities:    
Restricted cash1591,8721591,743
Accounts receivable, net5,1153,252(57)1,012
Inventories, net12,904(11,018)15,183(12,358)
Prepaid inventories, net6671681,296905
Prepaids and other assets(3,218)(1,176)(1,674)(852)
Other long-term assets, net12(474)271(514)
Accounts payable(24,775)(30,837)(3,253)12,056
Accrued liabilities(3,507)(6,649)5671,098
Deferred revenue(2,847)854301,550
Other long-term liabilities205(54)(55)(54)
Net cash provided by (used in) operating activities(16,300)(31,722)31,74434,654
Cash flows from investing activities:    
Purchases of marketable securities(119)(100)(155)(100)
Purchases of intangible assets(7)(380)(23)(380)
Sale of marketable securities prior to maturity   (9)
Investment in precious metals (1,657) (1,657)
Expenditures for fixed assets, including internal-use software and website development(6,344)(19,317)(7,538)(20,583)
Net cash used in investing activities(6,470)(21,454)(7,716)(22,729)
Cash flows from financing activities:    
Payments on capital lease obligations(654)(422)(722)(472)
Capitalized financing costs(121) (121)(245)
Proceeds from finance obligations1,42914,5773,23514,577
Payments on finance obligations(3,390) (4,231) 
Paydown on direct financing arrangement(160)(146)(211)(205)
Proceeds from long-term debt17,000 17,000 
Payments to retire convertible senior notes(34,615)(24,865)(34,615)(24,865)
Purchase of redeemable stock  (26) 
Purchase of treasury stock(1,602)(821)(1,606)(828)
Exercise of stock options 1,504(1)1,530
Net cash used in financing activities(22,113)(10,173)(21,298)(10,508)
Net increase (decrease) in cash and cash equivalents(44,883)(63,349)2,7301,417
Cash and cash equivalents, beginning of period124,021139,75776,40874,991
Cash and cash equivalents, end of period79,13876,40879,13876,408
Cash paid during the period:    
Interest paid1,8141,5982,7502,898
Taxes paid260187260187
Non-cash investing and financing activities:    
Fixed assets, including internal-use software and website development, costs financed through accounts payable and accrued liabilities270910155910
Equipment acquired under finance obligations5,077 5,676 
Equipment and software acquired under capital lease obligations 6  
Lapse of rescission rights of redeemable stock582 842 
Issuance of common stock from treasury for 401(k) matching contribution $ 87 $ 256


The company served more than 25.7 million customers, processes between 8,000 - 25,000 orders per day (2010, 10-K), offers about 960,000 SKU's and works with approximately 1,900 suppliers. The chart below informs on the evolution of the SKU's managed by the company. 



The table below presents a bundle of meaningful indicators (click to enlarge):


Source: quarterly presentations

I strongly suggest to read the presentations posted on the company's website for more insight.
In the table above you may note some operational improvements.



The Web Estate

According to Internet Retailer's Top 500, Overstock is no 27 in the list of Top 500 business-to-consumers retailers in the US and Canada, based on on-line sales.

Google's Doubleclick Ad Planner Top 1000 sites (as of July 2011) estimates Overstock to hold position 431 globally, among all websites: 

  • 10 million unique visitors;
  • a global reach of 0.6%;
  • 250 million page views. 

I determined (the chart below) that Overstock sits on a global 32 position in a list that includes: Mass Merchants & Department Stores, Auctions, Shopping Portals and Engines, Apparel, Clothing Accessories, Beauty & Fitness, Bed & Bath, Office Supplies, Footwer, Fashion & Style, Book Retailers, e-books and Crafts that were ranked by Top 1000 sites.



I believe that being no 32 on this list makes a very good platform for sustainable growth. 

Another encouraging sign is that, in terms of 2010 sales growth, Overstock outpaced 39 of the top 55 retailers ranked by Internet Retailer's Top 500:


***

According to Alexa, on Dec 18, 2011, Overstock's global rank is 558 and its US rank is 99 (among all sites in Alexa's universe).

Source:  http://www.alexa.com/siteinfo/overstock.com

The fall in the first part of 2011 coincides with the rather sudden replacement of www.overstock.com for www.o.co, a mistake acknowledged and repaired by management as the graph's subsequent evolution points out. 

I also note that www.buy.com (owned by Rakuten) has the benefit of a dedicated long term shareholder, grows and competes for Overstock's customer and probably supplier pool. 

***

Overstock's management keeps comparing their company's performance to Amazon which suggests ambitions are pointed in the right direction (a few years ago they compared revenues, lately the contribution margin seems more dear as an yardstick, as well as the customer service scores).

Competition

Famously, the online retailing makes an easy entry business.

Easy entry (technically) does not necessarily mean that a new entrant can build easily web estate, traffic, customer base, etc. One must consider that Overstock's business model consists of two distinct business lines: a) selling the overstock of others; b) helping others sell their merchandise (travel, books, insurance, etc). Trade relationships (+1900 supplier base), customer relationships (more than 2 million quarterly orders), technology and web estate are not that easy to build for a new entrant in the current market environment. 

An online business model is better positioned to succeed if it employs: 

  1. brand/traffic;
  2. heaviest discounter reputation (which is probably part of the brand equity); 
  3. low cost operations.

Is Overstock a great brand yet? 

It is difficult to know how Overstock divides its marketing budget between different lines (Sales and Marketing expenses consist primarily of online and offline advertising, public relations and promotional expenditures, as well as payroll and related expenses for personnel engaged in marketing and selling activities) but they do spend money on marketing at the expense of net profits:


"O.co also known as Overstock.com"

USD 363 million of cost during the last six years clearly shows the Overstock's management is aware of the importance of brand. Yet, interestingly, they chose to suddenly replace Overstock.com with O.co in February 2011 (!...). The cold shower which followed sent a strong message and now they try to work it out properly (O.co is catchy but Overstock stands for something).

The closer proxy for brand value may be Internet Retailer's Top500 and Alexa rankings which position Overstock as no 27 or no 16 online shopper in the US. Indeed, though, there is long , long distance to Amazon. 

Still, this rank is a position to work with. 

Is Overstock the heaviest discounter of them all? 

A look in the table below, which outlines COGS as a % of revenues for some players, provides a rough general picture:


Overstock's COGS as a % of net sales, shows that they are either a heavy discounter or they do not control the purse strings when buying merchandise. The former might be closer to the truth and in 2012 COGS is ~83% of sales as compared to 85% the average of previous 9 years. That shows an improvement. Hard to say based on public data if it is due to: a) increased bargaining power with suppliers?; b) closure of warehouse in Indiana (2007)? c) increased fulfillment partner weight in total revenues? d) higher sales prices?

Is Overstock a low cost operator? 

The adjusted SG&A presented in the table below consists of the sum of the SG &A and R&D percentages, as provided by Morningstar for each player. Again the analysis is rough but it glimpses at the competitive landscape:


In terms of SG & A Overstock looks worse than some competitors, and better than others. The trend is positive (with ups and downs but decreasing).

Industry Position

Overstock is a far cry from Amazon but it employs a bundle of assets that position the company better than many of its competitors:

  • web estate
  • critical mass
  • sustainable capex
  • supportive, resources-full, long term controlling shareholders
  • focus on expense control and web technology improvement
  • value oriented management & private company management style
Will these assets be managed properly for domestic growth and profits?
Can Overstock become a global player?

The next five years shall prove the evolution of its business model one way or another.


Customer Service

The fact that every management presentation and 10-K address this aspect of the business shows that management is aware of its utmost importance. Overstock provided a more detailed view on its customer service metrics in 10-K 2008:

"Our team of customer service representatives assists customers by telephone, instant online chat and e-mail. Our customer service staff answers approximately 98% of phone calls within 60 seconds, and responds to approximately 93% of e-mail messages within one business day. For our consumer business, we include a return shipment label in our customer's shipment to facilitate product returns and, subject to certain conditions, we allow customers to return most purchased merchandise for a refund. In addition, we continually update and monitor our Website to enhance the shopping experience for our customers."

I raised a point with the Overstock's customer service they answered back to me by e-mail in less than 24 hours (10-K claims that 93% of e-mail inquires are answered within 24 hours) and the matter I pointed out to them was resolved. The company measures the so called Net Promoter score. 

Sources: Company's presentation Sep-2011 and NetPromoter.com (for definition of NPS)

A score of 59% is good even by comparison with Google (53%) but lags behind Amazon which is a better performer (70%)If out of diligence one checks on NetPromoter.com the Industry Average NPS are made available upon registration:

Source: NetPromoter.comMore information on Net Promoter Score, rankings and other is available here (you need to register for some interesting downloads). 


Indeed, Overscore ranks better than the on-line shopping industry average which stands at 47%. 




CONCLUSIONS

Although Overstock did not become larger than Amazon (once Patrick Byrne stated this objective) it continued to grow and establish itself as a visible player in its industry - 27th according to Internet Retailer.

Will it do better?  I feel encouraged to believe that the strengths of Overstock:
  • a credo: " Bargains "
  • strong leadership and concept of leadership (learning organization)
  • value driven management and controlling shareholders
  • expertise and creativity
  • established critical mass (web estate, customer & supplier base, $1billion sales mark, technology)
  • perpetually negative working capital
  • value drivers with room for employment
... offer a germane platform for sustainable growth. 

Not an easy task with all that competition, but Walmart & Amazon started the same way: credo, solid foundation then great building. I think that on the way they had to overcome as many difficulties as the ones which confront Overstock today. 

As my analysis points out under the "Value Drivers" section, many of the areas which could be improved are controllable by Overstock. The lag between the company and its top competitors, as measured by the charts in the previous section, suggests a measure of the growth opportunities available to Overstock if it plays its cards well. 



VALUE DRIVERS

During my private equity years we searched for good companies with improvement prone areas -  the very places where most of the "juice" is concocted. If Improvement is possible results a source of value adding... 

"value drivers with room for employment"... so to speak. 

The mechanics and the driver can achieve wonders by working the engine, the shape of the car and the pit stops... 


Groupthink?

Could the O.co rather abrupt re-branding decision be an example of "Groupthink"? 

I had the opportunity to note "Groupthink" at some of the companies I used to work with. Usually, there was either a Founder or a strong CEO who possessed sharp business acumen and inspired respect and trust to co-workers. The general rule is that such individuals make the best choices. Can anyone assertively, rightly and consistently challenge their thinking? Does it make sense to do so?

Patrick is the Founder/CEO, possesses a sharp business acumen and I would bet he inspires respect and trust to co-workers. He seems himself as a teacher who tries to build a learning organisation (which is an awesome goal). Despite the goodwill, there are favorable premises for the "groupthink" to occur  (who of the students challenges successively the teacher?). 

***

The book Groupthink: Psychological Studies of Policy Decisions and Fiascoes makes a very interesting reading for any manager. An edifying summary as well as a downloadable presentation of the concept are available here. A short paper written by Michael Mauboussin on investment committees (full paper here) notes that Janis observed three broad symptoms of groupthink:

  • overestimation of the group, including its power and morality;
  • close mindedness - groups ignore or dismiss information that might sway the collective opinion;
  • pressure to conform - members employ self-censorship or pressure nonconforming individuals to adopt the group’s view. 

My own observations are that for co-workers it is very difficult to consistently pose a challenge to people in a seniority position, whom they trust and who usually are right in their decisions. The group's consensus may often be the leader's opinion due to the fact, among others, that in time, co-workers, the inner group, tend to rely on the leader's thinking. Abandoning an opinion that challenges the leader or the group is often accompanied by a relief/relinquishment of responsibility - a mistake generated by the leader's prevailing opinion is not your mistake but the leader's (or the group's). Courage to express an opinion can become consistent assertiveness only if the "Contrarian" finds in his/her inner self the serenity to assume a different stance than the leader (or the group). That serenity could be provided by experience, knowledge and independence.

Some quotes from Mauboussin's paper beam a better light on the matter:

"A number of years ago, I was on a committee that was voting on whether to bring a person into the organization. After hearing the balance of the evidence on the candidate, I was in favor of bringing him in. The committee chair then started going around the conference table, asking for a verbal “yea” or “nay” on whether we approved of the candidate. It so happened that the man sitting next to me was a physicist who had won the Nobel Prize and is probably the smartest person I have ever met. He was to vote right before me, and offered a nay when the chair called on him. So here I was, set to say yea, but faced with the world’s smartest man saying nay only seconds before. Feeling seriously conflicted, I said nay and slumped in my chair. Diversity is one of the key ingredients in group decision making. But by going around the room as he did, the chair invited social conformity and reduced independence. To get the best possible results from the committee, the chair must ask for independent votes. Submitting and tallying ballots is a quick and easy way to do this. Even if the chair skillfully surfaces the group’s knowledge, a faulty aggregation process will undermine the effort. The chair should not ask for opinions sequentially, and should not reveal his preference until after the process is over, if at all."

...To extract information, a committee leader must first suppress his own view. He must then ask other committee members to offer their point of view. And he also must make sure to watch the group members. For example, introverts often don’t speak unless asked to, while extroverts frequently think aloud, taking up air time. Neither is right or wrong, but both represent management challenges for the committee chair. Finally, the leader should determine the best way to decide. Votes should be independent, to avoid the temptation of social conformity. Generally, establishing a majority is sufficient to ensure a good decision.

... Studies by Chip Heath and Rich Gonzalez, psychologists who study decision making, add an additional twist: even though interaction is relatively ineffective for information collection, it does produce “robust and consistent increases in people’s confidence in their decisions.” As relevant, the psychologists found that the boost in confidence wasn’t because the individuals had better information, but rather because of the social environment. The group creates a positive illusion that fuels individual confidence, even if that confidence is unwarranted. 

A final pitfall is too much reliance on outside advice, especially when advisors have incentive based bias. For example, some pension consultants are also registered investment advisors, which present a possible conflict of interest. A recent study by the U.S. Government Accountability Office found “lower annual rates of return for those ongoing plans associated with consultants that failed to disclose significant conflicts of interest.” Committees that rely extensively on outside advice must take the time to carefully and thoroughly assess the incentives and potential conflicts of their advisors."

***

If there is or not a case of "Groupthink" at Overstock it is for the company's management to decide. I do not know. But what makes it a difficult one is the fact that most often, entrepreneurs, great leaders (or great investors) take the opposite side of the prevailing wisdom.  So maybe "Groupthink" inspired by a person with solid business acumen is the right think to do in more than 51% of the cases.

Maybe that ratio would increase if the leader/management team makes a habit from obtaining assertively expressed opinions - maybe not only by the co-workers but by board members, unbiased outsiders, etc., before important decisions are made. 

***


International Expansion

I try to imagine some nitty-gritty questions, that management can run via cost/benefit judgments and an effort to look at the competition's already existing offer, whose answer may facilitate international growth. A first would be: What needs of the international customers can we address? A possible answer (beyond strategic investment objects such as local presence, local suppliers, etc) is that the successful expansion on the international markets will depend a lot on:

  •  the shipping options/costs;
  •  meaningfulness of information offered to international Customers. 

What are the international shipping options?

Since I am based in Romania I had a look at the options offered by Overstock to have a book delivered over here. There was only one option: 5-9 business days delivery, $31 for shipping plus 3.66 duty and taxes. Amazon was providing three options:

  • $  7.98 (18-32 business days);
  • $12.48 (8-16 business days)
  • $30.48 + $4.02 import fee deposit (2-4 business days).

Barnes and Nobles was also providing three options. 

I have not yet checked other countries in which Overstock might have more (potential) customers than in Romania. Maybe (I hope) Overstock offers three options, too, to Brasil, UK, France, Germany, China, etc. so the customers have choices. Most often (I guess) urgency might not be the priority but price.

It was nice to note that for clothing there is an "International Clothing Sizing Guide".

What about other areas:

US standard measurements - a hurdle for the international customer?

An examplethe buying guide for each product is very useful except that I was not able to find information on "Standard US plumbing connections". Would US standard connection fit in Romania, India, Brasil? The company may best evaluate if such explanations or technical specifications shall be provided on the product page for the suitable products.

US Dimensions only - Inches?

An example: The Red Shou Two Drawer Cabinet - nice piece of furniture. Dimensions: 28 inches high x 24.25 inches wide x 13.75 inches deep. It would be much easier for Overstock to add a line in for centimeters than for the potential international customer to perform that transformation. China and Japan use metric system, too. How many other countries?

Tables of Content for Books

How important are them?  Bread and butter. I will argue that they are a must (international and domestic customers alike) for sites dealing in professional books (business, engineering, manuals, etc). 


Technology

I like a lot the Overstock web shelf. Neat and nice. Clear. Buying Guides. Customer ratings. Very good pictures. The "Hello..." message in the search bar. Beautiful.

What else I would like to see?

The dynamic Zoom In feature offered by Amazon which is nice and allows more control for the customer. Take a look at these links 12. Makes a difference does it not? Probably it will become widespread on shopping sites.

And what else I like a lot at Amazon is the "Look Inside" feature provided for the books - extremely useful. Barnes and Noble provided the same for a few books which I tested (I could not find, at all, those business books on O.co). 

Products' Tables of Contents are a must for sites dealing in professional books (business, manuals, engineering, etc) - this is why I almost always must visit Amazon's web site when investigating the purchase of a book.


The Affiliate acquisition policy

"The best time to plant a tree was 20 years ago. The next best time is now", Chinese saying

This web site (www.davyjones.ro) is by all means a start up. Nevertheless, I was able to become an affiliate of Amazon, Barnes & Nobles and Buy.com as soon as I applied for it (same day approval). I thought that the Overstock search box could have been a nice addition to this page but my application to become an affiliate of Overstock.com is still pending approval. 

Will Overstock approve my application? Ever, sooner, later - why then and not now? Now that I scratched the wall let me try some mending: maybe Overstock is very cautious after Google has penalized them early this year. Or maybe is just a policy that needs consideration (why not have as many affiliates as possible?)...

Is Overstock itself pursuing to become a fully fledged Affiliate where appropriate and possible? The latest partnership with Barnes and Nobles looks like a step in this direction (the next step could be to have the ability to provide access to the entire BN library).

***


Customer Sevice

Let us look again at the NPS evolution for Overstok. Is it not impressive?


Source: quarterly presentations of Overstock


"In each of the last five years Overstock ranked in the top five companies in customer service rankings among all U.S. retailers, according to rankings published in the NRF Foundation/American Express Customer Service Survey." Quote from Overstock's 10-K-2010.  
  • NPS is better than US average;
  • The NRF foundation is giving Overstock high marks - they are well regarded and even quoted by management.
Still, Amazon achieved a Net Promoter Score of 70 (according to NetPromoter.com).

The leaders in customer service according to Foresee holiday report are presented in the table below (please note that the scores presented in the table are not NPS but a score created by Foresee.com. Check their website for more information on methodology and more).


How do they do it? Based on my interaction with the customer service personnel of Overstock I think they have the right attitude and are trying to please the customer. Does the business model that involves managing the fulfillment partners add an additional layer of complexity?

















Where lay the opportunities to raise the score then? 
  • fulfillment partners?
  • the Salt Like City Warehouse?
  • product descriptions?
  • technology's handling of orders and information?
  • return policy? the way it is explained for each product?
  • effective customer guidance information available to customer service personnel?
No doubt the internal statistics will help. We know publicly the company measures time to answer the phone, e-mails, happy and unhappy customers, etc. Probably there is much more information which could provide some answers and lead Overstock's satisfaction scores closer to the leaders. 

Customer service is a key value driver and I think Overstock strives to become a leader in this area.

Foresee.com produces and makes available (free of charge) some very interesting customer satisfaction reports. In the 2011 spring edition Overstock scored 78 points (up 1 point from 2010). This score puts the company on position 52 in a list of 100 surveyed retailers. The lowest score was 70 (RueLaLa) and the highest was 86 (Amazon). In 2010 and 2011, nearly one-third of all measured sites score 80 or higher (!). 

Overstock scored 78 in the spring (lower than 1/3 of all measured sites) and then 72 during the holiday season (down from a score of 76 in 2010). Just to put things in some prospective Amazon, which is no 1, scored above 82 points since 2005 while the average for the top 40 retailers is 79. As such Overstock's score is slightly lower than average. 

The Foresee holiday report which performed an analysis of customer satisfaction during prime holiday shopping time between Thanksgiving and Christmas 2011 shows that Overstock fared 72 in 2011, a score which made it the bottom performer of the survey's 40 online retailers during holidays in 2011:

Source: Foresee.com

 The Foresee report offers other details so reading it will provide more information. 

***

According to Foresee Overstock always scores much lower during the holiday season than it does in the spring, suggesting that Overstock may not be meeting the needs of first-time visitors and seasonal shoppers. Still, this year, Overstock was 4 points even below the company's performance in 2010 which shall raise some eyebrows with the company's management.

Remember that Overstock was no 52 out of 100, scored 78 (+1 as versus the previous year)  which compares to Amazon's 86 in the spring report? Then Overstock scored 72 during holidays (versus 76 a year before) which compares to Amazon's 88?

The fact that there is room for improvement is a source of value adding.

Some erratic numbers

I liked the fact that all quarterly presentations (starting 2003) are easily available on the web site. They also present meaningful operational information. There is a point I did not like though - some of the data (which should be the same) changes from period to period. Look at the table below:

USD thousand 2004 2005 2006 2007 2008 2009
Revenue 490,621 794,975 780,137 765,902 829,850 876,769
Gross Profit (1) 66,239 116,883 94,800 128,916 144,236 164,800
Gross Profit (2) 66,438 116,473 89,804 124,550 144,236 164,752
Contribution (1) 25,706 39,733 23,903 73,255 91,000 109,200
Contribution (2) 25,879 39,318 18,907 69,092 86,568 109,203
OCF (1) 24,685 (6,108) (26,211) 10,089 2,000 46,100
OCF (2) 24,685 (6,063) (26,293) 13,660 6,444 46,117
FCF (1) 15,951 (50,848) (49,652) 7,291
FCF (2) 15,951 (50,705) (49,734) 11,017 (12,263) 38,842

... for the same indicators I collected a version 1 and then a version 2 - both supplied by the presentations published on Overstock's site. Version 2 is represented by numbers collected from the latest presentations and as you see it does differ a bit from version 1. I wonder if the management could use notes to inform the investors that some of the data might be subject to change. Probably there are various adjustments determined by revenue collection, returns and things like that.

***

With that I conclude my article and I hope Overstock will provide a safe voyage for those on-board or embarking. 



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