Why is really a benefit buyer writing about an unprofitable internet company? Because worth Investing is about discovering dollars that trade for fifty cents; with a market cap of much less than 75% of sales, Overstock.com (OSTK) appears like it may possibly be specifically that.
But isn’t it as well risky?
The greatest danger in any expense could be the risk of overpaying. So, the real question is: what exactly is Overstock well worth? I believe it’s actually worth no less than $1.5 billion. With Overstock’s marketplace cap presently sitting around $500 million, my valuation definitely looks far fetched. But, there’s only one solution to know for certain. Let’s take apart my argument piece by piece, and see if any of my assumptions are unreasonable.
First Assumption: More than the next five years, Overstock will neither produce truly free money flow nor consume money. In other words, its free money flow margin will average 0%. Money generation in some years will precisely offset money consumption in other years. Obviously, this assumption is unreasonable, mainly because there is almost no chance the cash flows will exactly offset.
That’s not a problem if it turns out Overstock does produce some free of charge money flow above the next five many years. In that case, my assumption merely errs for the side of caution. If, nonetheless, it turns out Overstock really consumes hard cash more than the next five several years, there is a problem – possibly a really large problem. So, which scenario is much more likely?
Overstock’s revenues are growing swiftly. Gross margins look solid at 13.3% in 2004 and 14.9% more than the last twelve months. Overstock’s unprofitability is the result of its promoting, general, 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 final twelve months, Overstock’s spending on cap ex has been 5.6% of sales. That number is an aberration. Inside the lengthy run, spending on cap ex must not exceed 3% of sales. Thinking about the business Overstock is in and also the expected sales growth, the company will, much more likely than not, generate some free money flow over the next 5 many years. Therefore, the assumption that Overstock will be hard cash flow neutral more than the next 5 years just isn’t overly optimistic.
Second Assumption: More than the following five several years, Overstock’s sales will grow by 15% annually. Is this an unreasonable assumption? Again, I don’t think it is. Extremely couple of industries are expected to grow as fast as eCommerce. Overstock’s revenue growth in 2003 and 2004 was over 100%. In the past year, that growth has slowed. Nevertheless, it’s nevertheless closer to 50% than it is to 15%. Overstock isn’t in the cyclical business. So, there is no cause to believe present sales are abnormally large.
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 from the most popular web sites. Whilst it’s a long, lengthy way from the Amazons, Yahoos, and eBays from the world (and will never reach those heights) Overstock is becoming a well known world wide web destination. This fact was most clearly evident inside the weeks leading up to Christmas. Shoppers who visited Overstock throughout the holiday season obviously know it exists, and may extremely well return at some other point inside the year. Analysts are predicting extremely large growth rates for Overstock; nonetheless, they are also recommending you sell the investment. I do not 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 five many years isn’t unreasonable.
Third Assumption: Six to ten many years from today, Overstock will have a free money flow margin of 3%. Ten many years from today, Overstock’s totally free money flow margin will rise to 4% and remain at that level. Now, of all the assumptions I’ve made, this a single is the most questionable. Sure, Amazon has that kind of free of charge hard cash flow margin, but Overstock isn’t Amazon, and it never will be Amazon. Overstock’s gross margins are much less than Amazon’s. In fact, Overstock’s gross margins are much less than Wal – Mart’s. Nonetheless, Overstock’s fixed costs will eat up a very much smaller portion of its sales than is the case more than at Wal – Mart.
Should you compare Overstock to other online retailers, you’ll see that if Overstock does experience strong sales growth, a 3% free of charge cash flow margin six several years from now is not unreasonable. I assumed Overstock’s sustainable totally free hard cash flow margin will be 4%. There’s a case to become made that 4% is as well higher. I won’t make that case, because I don’t feel in it. Remember, that 4% number comes ten several 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 many years from today, Overstock will be growing sales by 12% a year; eleven to fifteen several 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 isn’t an unreasonable target – if 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 many years, these assumptions don’t lead to Overstock reaching the very same size as today’s Amazon. Don’t forget these numbers assume some inflation. For instance, if inflation averages 3% a year over the subsequent 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 a fourfold increase in Overstock’s actual sales over a period of thirty years. I believe that is pretty reasonable.
If you take these four assumptions together, you get a worth of $1.five billion for Overstock. Today, Mr. Market is offering it for $500 million – that’s why I’m writing about an unprofitable world wide web company.
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