Friday, March 11, 2005

Diamonds Are Forever, But Where Did Overstock Get Them?

“The steal of a lifetime,” crowed Patrick Byrne on the Overstock.com earnings call. “We did a $7 million deal on diamonds," Byrne told his admirers, for a 'Build Your Own Ring' feature the web site had opened--one of the “skunk works projects” Byrne likes to tease his fans with on the calls. “We intend to dominate in the $1,000 to $5,000 range” of diamond engagement rings, he bragged.

Big talk, even for the voluble Doctor Byrne.

According to Byrne—and this is important—Overstock will sell engagement rings at price-points above the low-end, which is “controlled by Zales and Wal-Mart,” and below the high-end where, among others, fast-growing online jewelry retailer Blue Nile lives.

Byrne defined the low-end as "up to $1,000"; the high-end at $5,000 and up. Blue Nile, for example, operates with an "average order size [of] about $5,500,” according to Bryne. This price gap between the Wal-Marts of the world at the sub-$1,000 low end, and the Blue Niles of the world at the $5,500 high-end, offer the potential for “fantastic pricing” for Overstock, Byrne exulted.

Unfortunately for Overstock.com, for Patrick Byrne and for Overstock.com shareholders and the analysts who recommend the stock, there is no such gap that I could find in the actual web sites of the companies he mentions; only, apparently, in the fertile imagination of Doctor Byrne.

Go to “Walmart.com”. Type in “Diamonds.” Sort them by “Top Seller.” You will find the Top 5 sellers to be priced, in order: $697, $5,488, $1,399, $3,288, $898. I wasn’t a math major, but that’s an average price of $2,354 per ring. Smack in the middle of the price range Overstock.com fancies itself "dominating."

Now, Wal-Mart certainly sells a great many more pieces below $1,000, and its average ticket is undoubtedly below the $2,354 average of its five best-selling rings. But Wal-Mart's best sellers are right there in Bryne's price "gap," and I find it hard to see how Overstock.com will source and sell better than Wal-Mart.

What about the high end of the diamond ring market—the $5,500 “average order size” that Blue Nile operates on, according to Byrne? Another sketchy data point from the erudite Doctor Byrne.

“A key metric is our average order size,” Blue Nile’s CFO states on that company's recent earnings call, “which was $1,283 in the fourth quarter.” While engagement rings did indeed average $5,500 in 2004, as Doctor Byrne noted, Blue Nile sells far more units of lower-priced merchandise. Tour the Blue Nile site and you will find pre-set engagement rings starting at $325.

Tour the Overstock.com site, on the other hand, and out of the Top 20 sellers, only 5 of the rings sell for over $1,000. The other 15 range from $199 to $999. Hardly the $1,000-$5,000 pricing strata staked out by Byrne.

So much for the hype behind the Byrne spin. But here's where the whole "steal of a lifetime" gets interesting.

Blue Nile ended its year with $9.9 million worth of inventory. Inventory for Blue Nile consisted of “settings for our customized diamond products, customized jewelry…and finished jewelry such as pearls and sterling silver products.”

Notably absent in Blue Nile’s inventory is the mention of a large slug of diamonds. This is because Blue Nile operates with hardly any actual loose diamonds. As of last October Blue Nile carried a mere $120,000 of loose diamonds on its balance sheet.

Patrick Byrne, on the other hand, positively gloats about “a $7 million deal on diamonds that was the steal of a lifetime.”

Why a fledgling Blue Nile-type web site knockoff requires $7 million worth of diamonds, when the actual Blue Nile operates with 98% less is a question worth asking.

Furthermore, even assuming Overstock.com has—thanks to its “skunk works”—figured out how to convert $7 million of diamonds into a profitable business, it would be worth understanding how exactly one goes about getting a “steal” on $7 million worth of diamonds.

The wholesale diamond market is not exactly inefficient in the manner of, say, Chinese pottery. Diamond sellers know what their inventory cost them, and what it is worth, and the wholesale buyers know it, too. Getting a “steal of a lifetime” on $7 million worth of diamonds is as hard to imagine as an oil trader pulling one over on the boys at Chevron.

I have no answers. But these matters of the price-point "gap" Overstock aims to "dominate" and the $120,000 of loose diamonds on Blue Nile's balance sheet compared to Overstock's $7 million "steal of a lifetime" are all subjects that should be explored more deeply.

Any informed input here is welcome.

Jeff Matthews
I'm Not Making This Up

10 comments:

Its_strange said...

Don't know a thing about diamonds or the diamond business but if Blue Nile carries $120,000 on the books and OSTK starts its diamond business with a purchase of $7,000,000 i gotta figure alot of people in the business are talking...How about some help ?

Its_strange said...

Don't know a thing about diamonds or the diamond business but if Blue Nile carries $120,000 on the books and OSTK starts its diamond business with a purchase of $7,000,000 i gotta figure alot of people in the business are talking...How about some help ?

Its_strange said...

OSTK has had four CFO's in two years ? This that correct ?

Its_strange said...

Byrne in the news again

http://www.investors.com/editorial/tech.asp?v=3/12

BelowTheCrowd said...

I have some knowledge of the diamond business. While $7m is an awful lot for any retailer to keep in inventory, it's really not all that much to have change hands.

The total market for women's diamond Jewlery in the US last year exceeded $20b dollars, as noted in this report: http://www.national-jeweler.com/nationaljeweler/headlines/article_display.jsp?vnu_content_id=1000448777. That number is for finished jewelery and most certainly is much larger than the actual wholesale cost of the stones themselves. Nonetheless, it gives some idea of the size of the total market, and to my mind clearly demonstrates that a $7m acquisition is about as significant as are the activities of a few law-breaking naked shorts.

It also demonstrates something else: The diamond market is very large, and as anybody close to it can attest, very fluid. There is no need to keep inventory except of some unique high end stones. De Beers and others in the pipeline -- like the specialists on the NYSE -- assure that diamonds come to market in an orderly fashion, are always available and are priced consistently. There is really no reason to maintain inventory beyond that which is needed to fulfill short term demand, and many reasons to avoid keeping inventory -- primarily the risk of theft and the high insurance costs associated with keeping large quantities of stuff that cannot be traced if lost or stolen. Long before Wal-Mart came along, diamond dealers understood the costs of keeping inventory and did everything they could to avoid it.

If OSTK are bragging that they have lots of inventory of diamonds, they're merely proving that their inventory control is terrible, which to my mind is a poor reflection on management.

BelowTheCrowd said...

Incidentally, I just ran a search for "Overstock" on the National Jewler site referenced above. Two stories about Overstock entering the auctions market popped up, but nothing about their supposed diamond bonanza.

Clearly, this bit of news is irrelevant to the overall market. It's a drop in the bucket as far as the total market size, and is mostly notable -- as I stated above -- as a demonstration of poor inventory management. Nothing more.

Its_strange said...

i can't help but contrast Jeff's handling of OSTK and that of Jim Cramer's comments on the OSTK conference call of a few months ago.And i can't help but wonder why Jeff started this blog when he could have posted on TSCM . ...

ray dusek said...

Sam's Club carries a better selection of diamonds than WalMart.Check it out if you have not done so.

The Unknown Broker said...

Permit me to add my own "I don't know much about the diamond business comments."

Jeff mentioned something that struck a chord with me. In my experience and observation, the diamond market is pretty darned efficient.

Case in point -- Blue Nile. Since they don't own the diamonds they show on the site (at present there are over 60,000 stones available with prices ranging from $335 to $1.1 million) they are showing someone else's inventory plus their own mark-up, or more accuractly the the inventory of several sources (brokers, wholesalesers, etc.) This gives a fair picture of how "true" the diamond market is -- how efficient and consistent from dealer to dealer, inventory to inventory.

At the Blue Nile site, if you input certain criteria -- size, clarity, color grade, etc. -- and see everything that falls in your chosen range, the pricing is very true. From whatever your starting point is, if you give up a little in color what you then see is all about the same in price. Ask for a little better clarity...all about the same price omparatively. It's $5 here, 10 bucks there.

There is no glaring bargain that pops up -- relative to comparable stones, even when you're looking at onesies and twosies (much less $7 million worth of stones.)

This says to me that a "steal of a lifetime" situation doesn't make sense -- given that there is evidently good efficiency in the market -- and one would assume there would be plenty of buyers if something were offered at even just slightly under market levels (not "steal levels" -- just "flippable."

Now I suppose there could be some extraordinary situation -- a bankruptcy or other distressed sale of a good-sized lot of stones. It does seem unlikely that with all of the experienced buyers out there that OSTK - a relative newcomer -- would be the one to dispaly such incredible savvy as to locate and execute such a deal. But let's say for the sake of argument that they did pull off a great deal. If so, why not just say what the nature of it was? Why the cloak-and-dagger.

It's an unlikely scenario anyway, given the the market is efficient, the fact that $7 mill wouldn't dissuade the serious buyers of stones - they've got plenty of cash to buy inventory for the wholesale biz, and the fact that Overstock -- a newcomer to the diamond biz woudln't be the first to get the opportunity.

Weird deal, weird company.

adamas99 said...

i am the owner of one of englands largest wholesale jewellery companies , the claims made by mr byrne are pure baloney, $7 million is peanuts in this market, an ex director of my company went on to work for a london diamond broker and he personally sells over $100 million of diamonds per MONTH , $7 million is the sort of deal done over a handshake many times a day at the new york diamond bourse , without any form of written contract just trust and faith in the people who operate there, Mr byrne would never be allowed through the doors because he is just an old fashioned salesman promoting his overpriced goods