Overstock | A Special Situation

Overstock (OSTK) currently presents a Special Situation Investment Opportunity. As Overstock’s founder has turned his focus on blockchain investments, the sale of the company’s eCommerce operations is imminent. A review of recent M&A multiples in the eCommerce space suggests that at its current price, shares of Overstock are significantly undervalued.

Overstock Decides to Sell Itself

In 2014, Overstock became the first major retailer to accept Bitcoin as a payment method. That same year Overstock formed a subsidiary called Medici Ventures, an investment company specializing in investments in blockchain technologies.

As Bitcoin prices shot up at the end of 2017 and cryptocurrencies started to get hyped up in more mainstream media,  speculators took note of Overstock and crammed into the stock. The company’s share price shot up from under $20 up to $84, where it peaked at the end of 2017. Coinciding with a dramatic fall in Bitcoin prices, Overstock common stock has reverted back to around $20, where it currently trades. Nonetheless, trading volume is still significantly higher than before the spike.

Overstock price

In December 2017 Overstock founder and CEO, Patrick Byrne told The Street that “by February or March you will see an announcement on a course taken either selling [Overstock] to a bricks-and-mortar retailer or someone taking a strategic investment.” According to Byrne, the gods of economics longed for the synergies that such a combination would bring. Fast forward to November 2018 and we are still to see any communication from the company regarding a potential sale.

Potential Overstock Acquirers

Byrne has stated in no uncertain terms that he prefers Overstock to be a  seller rather than a buyer in a potential combination with a physical retailer. To grow the online retail operation would require growth capital, which would require diluting the current equity by issuing new stock.

With Overstock venturing into blockchain related businesses, diluting the equity to grow the eCommerce business, would subsequently dilute the ownership of Medici Ventures for current holders.

A number of retailers have been mentioned as potential buyers that could strategically add Overstock as a bolt-on acquisition to complement their existing business. These include:

  •  TJX Companies
  • Costco
  • Bed, Bath and Beyond
  • Target
  • Kroger
  • Pier 1 Imports
  • QVC Group

With over 20 million monthly visitors on overstock.com and annual revenues in excess of $1,7 billion, Overstock might be a solution to the online efforts of many of these physical retailers.

Recent eCommerce M&A Multiples

The investment banking advisory firm Tully & Holland published their U.S. eCommerce Industry Update in April. According to Tully & Holland, public company valuation multiples of U.S. based eCommerce companies have risen from 1.71x EV/Revenue and 14.42x EV/EBITDA in 2017 to 1.83x EV/Revenue and 15.94x EV/EBITDA in April 2018.

At the same time valuation multiples in M&A Transactions have been considerably lower, or at a 15-30% discount below public company multiples. Most of the M&A targets in the eCommerce sector are private companies and are therefore smaller and less liquid.

As eCommerce companies tend to cost account much of their growth-related expenditure (as opposed to capitalizing those costs), they tend to be compared through Enterprise-Value-to-Revenue multiples (as opposed to EV/EBITDA). In 2017, there were a number of eCommerce transactions with known EV/Revenue multiples, most notably WalMart’s acquisition of Bonobos and Samsonite’s acquisition of eBags (see below).

M&A activity in ecommerce 2017
eCommerce M&A Activity in 2017 with known Transaction Multiples

Of those transactions in the Tully & Holland report with known multiples, the highest one was at 2.5 times EV/Revenue (WalMart’s acquisition of Bonobos) and the lowest was at 0.66 times EV/Revenue (Samsonite’s acquisition of eBags). The median EV/Revenue multiple of those seven transactions was 1.3x and the weighted average multiple was 1x.

The Overstock versus Wayfair Thought Exercise

Imagine for a minute that you are the CEO of an imaginary physical retailer, Bunk, Tub & More, Inc. It’s early 2015 and the Board of Directors decide that it would be prudent to find bolt-on acquisition targets for Bunk, Tub and More in the online retail spaceGiven the overlap in product assortment, you quickly turn your gaze towards Overstock and you decide to take a closer look.

Perhaps the closest rival to Overstock is Wayfair (NYSE:W). Primarily an online seller of home goods, the company was founded in 2002 and went public at the end of September 2014. The Initial Public Offering of Wayfair was at a price of $29 per share but the stock rose to $36 during initial trading of the share. At the same time, Overstock was trading at $29.60 per share.

At the beginning of 2015, both stocks are prices significantly lower than they were at the time of the Wayfair IPO. Wayfair, by now, is priced at $20.45 and Overstock at $23.99. The companies are of similar size, with Wayfair generating revenues of $1.3 Billion in 2014, compared with just under $1.5 Billion of revenues at Overstock.

When you start comparing multiples, however, you realize that these two companies differ drastically, and for good reason. First of all, Wayfair is growing much faster than Overstock. They also have a bigger war chest. At the end of 2014, Wayfair had over $300 million in shareholders equity, compared to the less than $130 million of shareholders equity at Overstock.

You try dividing the revenues with the share count of both Wayfair and Overstock, which you find to be $15.9 per share and $62.3 per share respectively. You then divide the price per share with the revenue generated per share to find how much you have to pay for each dollar of revenue. You would have to pay a $1.29 for each $1 of revenue at Wayfair compared to $0.39 for each $1 of revenue at Overstock.

Overstock Wayfair 2014
Wayfair versus Overstock at the end of 2014

The difference in multiples doesn’t come as much of a surprise to you. The market is, after all, forward-looking not backwards-looking and Wayfair is simply priced for growth. You discuss this with the board and for one reason or the other, no action is taken. Your attention is diverted elsewhere and time passes.

Fast forward to early 2018 and the topic of omnichannel retail and bolt-on acquisitions comes up again at Bunk, Tub & More. After a board meeting, you decide to take another look at Wayfair and Overstock.

During the three years, Wayfair has emerged as a clear winner. During this time, Wayfair has grown its revenue by 2.5 times, while Overstock only managed a cumulative revenue growth of 16.5%. At the same time, the Overstock’s share count has grown at a faster rate than that of Wayfair, or 14% versus 6% respectively.

Overstock Wayfair Growth
Wayfair versus Overstock: Growth 2014-2017

However, when you start to delve into the numbers, you discover that growth has come at a price at Wayfair. In the three years that have passed, Wayfair has burned through its equity and now records a shareholders deficit of almost $50 million in its 2017 Annual Report. Furthermore, even though the cash level has grown by more than $200 million since the end of 2014, Wayfair issued a convertible bond for proceeds of $413 million in the last quarter of 2017.

At the same time, common shareholders equity at Overstock has actually increased by 35.9%, while the share count grew by 14.4%. You look at revenues generated per outstanding share and as you would have expected, Wayfair has been catching up to Overstock. Wayfair now generates revenues of $53.5 per share, compared to $63.5 in revenue pair share at Overstock.

Overstock Wayfair Rev per share
Wayfair versus Overstock: Burn Rate 2014-2017

Fast forward until today and the board of Bunk, Tub & More takes yet another look at those two companies. According to most recent filings, Wayfair has generated close to $5.7 billion in revenues over the trailing twelve months, while Overstock has sold for roughly $1.8 billion during the same period.

Wayfair’s share price has increased in tandem with its revenue growth, now trading just under $93 per share, compared to the $20 per share price it traded at the end of 2014. Currently, shares of Overstock are trading at roughly $22 or a little less than $2 lower than at the end of 2014.

Since the end of 2017, Wayfair has continued to fuel its growth. As a result, the Shareholders Deficit has now reached $312 million or -$3.46 per common share as per the most recent filing.

To your surprise, the Price-to-Revenue ratio of Overstock is almost exactly the same as it was more than three and a half years ago. Wayfair stock, however, is now trading at an even higher price to revenue ratio before, $1.47 per $1 of revenue.

Overstock Wayfair 2018
Wayfair versus Overstock: 2018

The board is eager to take action and find a target. What recommendations will you give to them? Wayfair is much bigger and also growing faster. However, by taking Wayfair private, there would be no public market to absorb the cash required to feed the growth. The burn rate will have to be absorbed internally by Bunk, Tub & More.

It is also substantially more expensive. A bid will require a premium over the price where the stock currently traded and the stock is already trading at almost $1.5 per $1 of revenue, without considering the effects of the convertible debt, which at current prices has a fair value in excess of $600 million. How much are you willing to pay for growth that you might eventually have to finance yourself?

If the acquirer will have to fund the continued growth anyway, why not take on Overstock at a much lower multiple?

Summarizing the Thesis

We believe that the common stock of Overstock, Inc (OSTK) currently represents a special situation. The company can be segmented into two separate businesses, the legacy online retail operations of Overstock.com and the blockchain related venture capital investments under Medici Ventures.

We foresee that in 2019, Overstock will sell the eCommerce business and the rename the company under the name Medici Ventures. This would make the company one of the first publicly-traded blockchain pure-plays.

The value of the current Medici investments is very unclear and the future potential of blockchain technology is highly uncertain. That is however irrelevant to our Overstock thesis. At the current market capitalization, Overstock is trading at what appears to be a significant discount to the underlying value of the online retail operations alone, with a clear catalyst that could realize the value of those assets within the next 12 months:

  • Patrick Byrne, founder and CEO of Overstock has stated in no uncertain terms, that the online retail operation of Overstock is for sale.
  • With notable M&A activity over the last two years, combining online operation with more conventional physical retail operations:
    • WalMart & Jet.com,
    • WalMart & Bonobos,
    • Amazon & Whole Foods,
    • Samsonite & eBags,
    • Bed, Bath & Beyond & PersonalizationMall.com,
    • Bed, Bath & Beyond & Decorist
  • Overstock currently trades at a Price to Revenue multiple significantly lower than its publicly traded eCommerce peers, most notably its direct competitor, Wayfair.
  • A potential transaction price will ultimately depend on the number of suitors that would compete for the assets.

With regards to the potential transaction value of the online retail business, we believe that Patrick Byrne and other Overstock board members will not settle for a sales price under $1 billion or what would represent an Enterprise-Value-to-Revenue multiple of around 0.6. A transaction at 0.6 time EV/Revenue would represent a value of $37 per share.

Looking at comparable transaction multiples from 2017, the weighted average EV/Revenue multiple was 1. At that multiple Overstock would sell at $1.8 billion, which would be the equivalent of $62 per share.

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