Solid quarter for OSTK, a headline EPS and revenue beat, though with the expected slowing trends and YY margin pressures. The big question was could the company deliver revenue growth on top of that massive rip to 109% growth in 2Q last year, and OSTK delivered with 4% revenue growth. That represents a 1200bps acceleration on the 2 year trend. On the negative side of revenue metrics were some lost customers (which the company expected/guided) but OSTK still grew revenue, that likely implies 2Q of last year saw some random order wins (vs customer wins) when the big online competitors (AMZN, WMT, TGT) were not focused on the category. We think this is a bearish signal for W as it likely sees a similar dynamic.
Management noted softness quarter to date for the industry with some summer spending shifting away from the home “cocooning” trend seen during the pandemic. That is driving sales down single digits (note the 3Q compare is slightly harder than 2Q). It also commented that certain competitors have gotten aggressive on advertising spend, to the point of inefficiency. Perhaps that slightly pressuring OSTK near term share. We would guess that is W trying to accelerate its customer acquisition, maybe that means incremental margin pressure for W in 2H.
On the margin front, OSTK gave back a little less than a third of 2020 2Q gross margin gains, but was right in line with management’s new longer term 22% target. Wayfair we think has higher gross margin risk on an NTM basis as about 440bps of its gross margin expansion in 2020 was driven by elements outside of cost leverage which we think are less sustainable. With likely YY sales declines, W also has deleverage risk to boot. OSTK EBITDA margins were also in line with management guidance of MSD at 5.6% this Q, but down 70bps YY. Management has its strategy... profitable growth just ahead of the industry sales trend with 22% GM% and MSD EBITDA margins. It doesn’t seem overly hard to do long term, though with a lot of noise and vol likely on YY trends in the upcoming quarters. With the high asset returns delivered by the ecommerce platform model run by OSTK and W, if the companies are growing and profitable the stocks deserve solid multiples. On a sales basis we'd say these both should probably be in the 1-1.5x range today, perhaps the lower end of that range given the current industry direction (slowing/YY decline). For OSTK the near and long term opportunity for growth is similar if not better, Wayfair does not deserve twice the EV/sales multiple. We continue to think Long OSTK and Short W is a quality alpha trade in ecommerce. The absolute return for OSTK is under pressure near term given the rate of change of the industry, the macro Quad pivot out of Quad2, and the market style factors being weaker for high beta, and small cap. These dynamics are exactly what kept OSTK off our Best Idea Long list and why we expressed the pair with W. (See our note OSTK | New Long Idea. 60% Base Case Upside)
Meanwhile, we still have essentially zero value embedded in OSTK for the Medici Ventures assets (particularly tZERO). Positive catalysts remain for tZERO to demonstrate significant value, presenting the call option in owning OSTK. For more details see our OSTK presentation from last month CLICK HERE. tZERO management will be holding its own investor update next month.
The market is definitely waking up to the W short trade a week ahead of its 2Q print. Wayfair earnings events are always volatile and management is great at reassuring investors in the face of weakening numbers, but the multi-quarter setup is getting more and more bearish.
We remain Long OSTK and Short W.
