Why is a value trader writing about an unprofitable web business? Simply because worth Investing is about discovering dollars that trade for fifty cents; having a industry cap of less than 75% of sales, Overstock.com (OSTK) seems like it may be exactly that.
But isn’t it as well risky?
The greatest chance in any purchase may be the chance of overpaying. So, the real query is: what is Overstock worth? I believe it is really worth a minimum of $1.5 billion. With Overstock’s industry cap at present sitting around $500 million, my valuation undoubtedly appears far fetched. But, there’s only one solution to know for sure. Let’s take apart my argument piece by piece, and see if any of my assumptions are unreasonable.
Very first Assumption: Above the following 5 many years, Overstock will neither produce genuinely totally free cash flow nor consume cash. In other words, its free of charge hard cash flow margin will average 0%. Cash generation in some many years will specifically offset cash consumption in other many years. Obviously, this assumption is unreasonable, mainly because there’s practically no chance the hard cash flows will precisely offset.
That’s not a problem if it turns out Overstock does produce some totally free money flow over the next 5 many years. In that case, my assumption merely errs for the side of caution. If, nonetheless, it turns out Overstock really consumes hard cash over the next five many years, there is certainly a problem – possibly a very big issue. So, which scenario is a lot more likely?
Overstock’s revenues are growing swiftly. Gross margins look solid at 13.3% in 2004 and 14.9% above the last twelve months. Overstock’s unprofitability is the result of its promoting, common, and administrative expenses (SG&A) which have been growing exponentially. Will these expenses continue to grow? Yes, but not as fast as revenues. More than the last twelve months, Overstock’s spending on cap ex has been 5.6% of sales. That number is an aberration. In the lengthy run, spending on cap ex should not exceed 3% of sales. Considering the business Overstock is in and also the expected sales growth, the business will, a lot more likely than not, produce some free of charge hard cash flow above the following 5 years. Therefore, the assumption that Overstock will be money flow neutral over the following five many years just isn’t overly optimistic.
Second Assumption: More than the next five years, Overstock’s sales will grow by 15% annually. Is this an unreasonable assumption? Again, I do not think it can be. Really handful of industries are expected to grow as fast as eCommerce. Overstock’s revenue growth in 2003 and 2004 was above 100%. In the past year, that growth has slowed. Nevertheless, it is even now closer to 50% than it would be to 15%. Overstock isn’t in the cyclical business. So, there is no reason to think present sales are abnormally high.
Also, all that spending on advertising is increasing consumers’ awareness of Overstock. A review of Overstock’s traffic data shows it has not only been gaining a lot more visitors; it has also been climbing the ranks of the most popular web sites. Although it is a long, lengthy way from the Amazons, Yahoos, and eBays of the world (and will never reach those heights) Overstock is becoming a well known internet destination. This fact was most clearly evident in the weeks leading up to Christmas. Shoppers who visited Overstock in the course of the holiday season obviously know it exists, and might very well return at some other point within the year. Analysts are predicting very higher growth rates for Overstock; however, they are also recommending you market the share. I don’t put any weight in their estimates. But, for the other causes given, I think the assumption that Overstock will grow sales at 15% a year for the next 5 several years is not unreasonable.
Third Assumption: Six to ten several years from today, Overstock will have a totally free money flow margin of 3%. Ten several years from today, Overstock’s free of charge money flow margin will rise to 4% and remain at that level. Now, of all the assumptions I’ve produced, this 1 may be the most questionable. Sure, Amazon has that kind of free cash flow margin, but Overstock isn’t Amazon, and it never will be Amazon. Overstock’s gross margins are less than Amazon’s. In fact, Overstock’s gross margins are much less than Wal – Mart’s. However, Overstock’s fixed costs will eat up a very much smaller portion of its sales than may be the case above at Wal – Mart.
If you compare Overstock to other online retailers, you may see that if Overstock does experience strong sales growth, a 3% free of charge cash flow margin six years from now is not unreasonable. I assumed Overstock’s sustainable totally free cash flow margin will be 4%. There’s a case to become created that 4% is as well large. I won’t make that case, simply because I don’t think in it. Remember, that 4% number comes ten many years out. That gives Overstock plenty of time to grow sales and thus reduce SG&A as a percentage of sales.
Fourth Assumption: Six to ten years from today, Overstock will be growing sales by 12% a year; eleven to fifteen many years from today, Overstock will be growing sales by 8% a year; thereafter, Overstock will grow sales by 4% a year. Let’s see what this really means. According to these assumptions, Overstock’s sales will be as follows:
Today: $707 million
2011: $1.59 billion
2016: $2.71 billion
2021: $3.83 billion
2026: $4.66 billion
2031: $5.67 billion
2036: $6.90 billion
Seven billion dollars just isn’t an unreasonable target – when you have thirty many years to achieve it. To put that figure in perspective, Amazon.com presently has sales of about $8 billion. So, even right after thirty years, these assumptions do not lead to Overstock reaching the exact same size as today’s Amazon. Do not forget these numbers assume some inflation. For instance, if inflation averages 3% a year more than the following thirty many years, Overstock’s projected $6.90 billion in sales only translates to $2.84 billion in today’s dollars. So, these assumptions only lead to some fourfold increase in Overstock’s real sales more than a period of thirty many years. I believe that’s pretty reasonable.
In case you take these four assumptions together, you get a worth of $1.5 billion for Overstock. Today, Mr. Industry is offering it for $500 million – that’s why I’m writing about an unprofitable world wide web company.
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