We're going long Overstock.com (OSTK). This is a company where a lot has changed in the last 2 years. There was a period of several years where we, as retail analysts, ignored OSTK due to its direct correlation with cryptocurrency prices. Now we think it's interesting for both the potential value of its crypto currency assets and the turnaround in the core ecommerce business. It is another company with relatively low sell side coverage, and seems misunderstood from the standpoint of consensus.
There are two core business opportunities to invest in here:
- Ecommerce Platform - Overstock.com is one of the original online retailers founded back 1999. The product assortment is broad, but is focused on the furniture, home décor, and home improvement segment. Top competitors include Wayfair, Ikea, Walmart, Amazon, Target, and Lowes/Home Depot. Despite that stout competitive set, Overstock remains relevant over 20 years after its founding and has recently been gaining share.
- Blockchain Assets (more specifically tZero) - As those who have followed Overstock over the years probably know, around 2014 CEO Patrick Byrne took a deep interest in cryptocurrencies and blockchain technology. Soon after, through Overstock, he started Medici Ventures and began making investments in blockchain assets. For a long time it was viewed as poor use of capital. However after the evolution of real world blockchain applications over the last 5 years, there are some real business opportunities for the assets today, and none more powerful than that of Tzero. Tzero is a leader in trading of tokenized digital securities.
Ecommerce
Despite facing some of the strongest competitors in all of retail, Overstock.com has stood the test of time. The Overstock ecommerce business has been transformed over the last few years. During the 'crypto' days of '15, '16, '17, much less attention was put into the execution of the ecommerce operation. Later there were some changes, like revamped apps and expanded 2 day shipping circa 2018. Then the new CEO Jonathan Johnson officially took the job in September 2019. Some investments were already starting to make the business better on the margin, but then Covid gave it a huge shot in the arm. The company took share in the pandemic (table below), and generated a ton of cash to help invest in talent and systems for the next leg of growth. A couple other new key managers have recently joined the company including the CFO which joined in Mar 2020 from Hertz and was former FP&A for BestBuy ecommerce, and the new Chief Marketing Officer Elizabeth Solomon that was head of marketing for Amazon's Private Brands joined in just March of this year. For 1Q OSTK's active customer base was up 92%, Wayfair was up 57%. The company is noting that 2Q could see a drop in customers YY given peak online penetration seen for home furnishings in 2Q of last year, but it expects to return to customer growth soon after. If we look at online interest from google vs 2019, OSTK looks to have opened a gap vs Wayfair (maintained its mind share gains) in the last few months. Ecommerce as a shopping channel has been reset to a new higher level, and we expect the home category growth to remain robust and online penetration will continue higher. Revenue growth will drive fixed and corporate cost leverage for OSTK and margin upside.
An additional opportunity for OSTK ecommerce is the revenue potential from its contract with the Federal General Services Administration (GSA) which was awarded in June of 2020. Adoption has been low so far, but the GSA has been making an effort to leverage ecommerce offerings for commercial off-the-shelf goods and Overstock is one of just 3 online platforms that the GSA is working with (along with Amazon and Fisher Scientific). The agreement allows the GSA to make purchases below a $10k threshold on the online platforms. The market opportunity here is significant as open market purchases on government purchase cards represent an estimated $6bn per year.
OSTK also recently handed over the investment decision making and board approval process of all Medici assets to Pelion Venture Partners via partnership. That frees up the OSTK management and board to put all of its attention towards growing and executing the Overstock.com business.
tZERO
tZERO is the leading platform for blockchain trading of tokenized securities. It is one of the few 'by the book' blockchain trading platforms that is a member of FINRA and SIPC and registered with the SEC as a broker-dealer. This means it's a regulated platform for token security and cryptocurrency trading. The company doesn’t even have an explicit competitor listed in the 10-K because it's currently difficult to identify one that is penetrating the market in the same way. It has 95% of the trade volume for digital securities. It has operated a private securities exchange with low fees, a cryptocurrency exchange, and recently got approved for NMS or standard public securities. As the tZERO name implies, it currently has same day settlement, planning to get to instant in the coming months. Securities trading settlement timing has of course been in the news due to the Robinhood clearing house capital requirements debacle in January. tZero provides a solution to the cause of that problem. In 2020 Tzero did $46mm in revenue, but the long term opportunity here could be massive. It’s has been adding new companies and securities and could start scaling rapidly. Tzero is currently working with an investment bank to do a capital raise to fuel growth. Prior valuations for tZero have been in the area of $1bn. We suspect this raise could be similar, but the ultimate value could be much higher. OSTK's stake in tZero is just over 80%, though that should be diluted some on the pending equity offering. Recall some other blockchain trading platforms like Voyager Digital (VYGR.CN) and Dapper Labs have seen recent valuations of $3bn and $7.5bn respectively. There is also rising scrutiny on certain classes of Non-Fungible Tokens (NFTs) by the SEC to potentially classify them as securities. That would open up a massive market opportunity for tZero where the competitors (current NFT marketplaces and platforms) that have not gotten SEC/Finra approval would be far behind. To that point, Dapper Labs was recently sued for NBA Top Shot sales being a violation of securities laws.
Medici Ventures
There are many other blockchain technology assets owned by Medici, they range from voting apps, to a farming commodity marketplace, and land records keeping. All could potentially be very value businesses over the long term, but we're assigning no current value to the Medici assets beyond tZero. However, the Pelion agreement mentioned above should help drive growth for tZero as well as the other Medici assets, and it will likely accelerate the value creation and monetization of all of the blockchain assets that Overstock has a stake in.
Valuation
OSTK is currently trading at just under 1x sales. Wayfair is at about 2x sales. If the Overstock.com business continues to grow and take share as we expect, we think it should easily be worth 1.5x sales today. That's about $4.5bn in value, then add in about $500mm in net cash, and a conservative value of the tZero stake of $500mm, that all gets you to a stock around $125 or a little over 60% upside from here. On a bull case we think you're looking at 6-7% Tail EBITDA margin $400mm+ in EBITDA that should trade 15 to 20x or upwards of $8bn in value, then tack on Medici Ventures getting a Dapper Labs type valuation and you're looking at $13bn to $15bn in value vs the current EV of $3.4bn. If we're completely wrong lets say Overstock ecommerce is only worth 0.5x LTM sales, Medici stake is only worth $200mm, plus the current cash, that would put the stock at about $49 or about 35% downside. That base case risk/reward looks very attractive given the call option on big best case scenario.
We like the pair here with Wayfair short. If we're wrong on Wayfair it will be because growth for the online home space remains much stronger than we expect, and that margin opportunity remains at levels far above pre-covid. In that scenario Overstock's retail business will likely thrive and we should see the valuation gap close with Wayfair. If we're wrong on Overstock, it will likely be from a year over year collapse in growth and margins that would be seen across the industry. In that scenario Wayfair likely has 50%+ downside, while the valuation gap means OSTK ecommerce value should find support sooner and it has the optionality of tZero/Medici as well. There is also the competitive element here. Wayfair earned it's enterprise value by gaining share with ample marketing, selling furniture at tight margins with top customer service/satisfaction, meaning losing money for years. Now after the best year in its history by far, managment is pitching a margin story for Wayfair and higher long term margin opportunities. We think Wayfair is unlikely to sustain the signaled margin levels if it wants to grow. So this could present a window for OSTK to be aggressive on price and service and take more share from W.
Why Is It Not a Best Idea?
There are a few things keeping this off the best ideas list for now. First is the fundamental trend, as we expect growth to slow significantly given the comparisons, and we expect YY margin pressure as well given a more normalized supply & demand environment for home furnishings. Second, ecommerce names like OSTK typically do not do well in Macro Quad4 (currently expected in 2H21), which could pressure the multiple even if numbers are relatively strong. Lastly, despite our belief in the blockchain opportunities for tZero and Medici, we have to see a lot dominoes fall before there will be clarity as to how big the fundamental opportunity will be on the P&L. The upside is great but then uncertainty is also high. There of course is also the recent high volatility in cryptocurrencies, which tends to spook investors considering blockchain related businesses. Though we think it's bullish that OSTK held up so well in the recent bitcoin collapse.
