Tuesday, April 12, 2005

The Mystery of the 38 Diamonds, Part I

Like a series of old-fashioned Hardy Boys adventures, the Overstock.com story, as told through the words and writings of CEO Patrick Byrne, contains mysteries aplenty—each with its own twists and turns—that leave outside observers guessing each outcome until a final conclusion is revealed.

In the Hardy Boys' cases, the ending was always the same: Hardy brothers Frank and Joe, sometimes with the help of their good chums Chet and Biff, would unravel the mystery, catch the true perpetrator, and receive hearty thanks from dear old Dad, Detective Fenton Hardy, along with mild but affectionate admonishments from Mother.

Overstock.com’s adventures, however, do not always tie together so neatly. Some are easily resolved, others not. Why, a new mystery appeared just last week.

But to begin with, I offer a two-part recap of the adventures thus far.

One of the first Overstock mysteries was The Riddle of the Disadvantaged Artisans, arising from a 2001 Overstock venture known as “Worldstock.”

“Worldstock is the brainchild of Overstock.com’s CEO, Patrick Byrne,” the company trumpeted in a 2002 release, “who holds a doctorate from Stanford University centered upon issues related to poverty and social justice.” (The doctorate is important to Byrne: he made certain Charlie Rose’s viewers knew about it during a recent interview.)

Byrne “conceived of Worldstock as a global network of disadvantaged artisans plugging into the modern advantages of a 21st century business.” The concept was a genuinely noble effort to nurture third-world artisans by offering their hand-crafted wares on the Overstock site—“our own little United Nations Development Program.”

Setting a pattern for subsequent Overstock mysteries, the company (in the same 2002 press release) boasted that the “overwhelming popularity of Worldstock among Overstock’s customers” had led to its swift expansion among the disadvantaged artisans—then stopped mentioning Worldstock until the CEO’s 1/28/04 letter to investors, where Byrne gave it “Overstock’s 2003 ‘Most Improved Player’ award” for a “remarkable turn-around.”

“Turn-around” from what was not entirely clear, but Worldstock has since disappeared from discussions, save in a brief, feel-good mention during the Charlie Rose interview.

The odd thing about such a radical enterprise is that each item under the “Worldstock” tab gets listed just like any other Overstock item—with a “List Price” and a substantially lower “Our Price.” The difference being a huge theoretical savings for the Overstock buyers—and by definition, lost profit to the “disadvantaged artisans.”

For example, a “Turkoman Hand-Knotted Rug (Afghanistan)” comes with a $1,400 “List Price” and a $449.99 “Our Price.” Now, take at face value the company’s noble statement that “Overstock adheres to an audited net-5% profit ceiling for their [the disadvantaged artisans] goods, stimulating sales at prices that maximize the artisans’ return.”

At a $449.99 “Our Price,” it would appear that the disadvantaged Turkoman rug artisan is receiving something like $425 for a rug that would “List” for $1,400. Hardly seems like the way to end poverty and social injustice.

In The Case of the Vanishing Milestones, the company introduced a membership loyalty program called “Club O.”

Byrne promised shareholders, “I will announce it if and when we reach the following levels: 10,000; 25,000; 50,000; 100,000; 250,000; 500,000; 1 million,” noting “I do not anticipate that we ever will reach 1 million members, or anything close to that, but if we do, I will let you know.”

For a while there it looked like Byrne might have an easy time announcing those milestones. After a company visit just two months later, Legg Mason analyst Thomas Underwood wrote “Given the success that Overstock has already seen in its ‘Club O’ campaign, the company will introduce ‘Club O Gold’”

Shortly thereafter, Byrne announced his first “Club O” milestone—it had breached 10,000 members. But he also pulled the plug on the milestone pronouncements:

“I previously promised to inform shareholders when certain thresholds had been reached…I now withdraw that commitment because I have trouble sleeping with open-ended commitments.” (7/22/04)

Apparently Byrne knows how to sleep, because “Club O” numbers—while not forthcoming from the company—were placed at something above 40,000 in a late-2004 analyst report estimate, a good bit closer to the low end of the 10,000 to 1 million range than to even the middle of that range.

The Mystery of the Pristine Inventory began in early 2004, when Byrne told investors:

“In the closing weeks of 2003 your chairman seized an opportunity to buy over $5 million of Franck Muller watches…they represent a sizable fraction of our inventory. Pick one, write me…and I’ll make you a deal.”

One year later, Byrne announced a large inventory clean-out, which cost the company $1.5 million.

“The dead inventory that I had accumulated over the years, both from my own bad buys and those that I let buyers ‘put’ to me, has been almost entirely flushed (including the Franck Muller watches).”

However, on the investor call the next day, he led investors to believe there was nothing left in the way of “dead inventory”:

"I decided in early December, let's just flush everything that has been around more than a few months. Our inventory has never been this clean. We just marked down, promoted, did whatever we had to do to blow out the older inventory. I lost $1.5 million on that inventory to move it all. But our inventory has never been this pristine."

It is not clear whether the inventory is “pristine,” as stated to the analyst community, or whether some “dead inventory” remains, as implied in his shareholder letter.

The answer may partly be found in the brief Case of the Forgotten Movie. Here, another big Byrne bet—a film called “FarenHYPE 9/11”—went from “a unique business opportunity” (10/21/04) to $700,000 worth of losses in just a couple of months (1/28/05).

The Enigma of the Sputtering Rocket was the first involving several “skunkworks” projects at the company. Byrne delights in tantalizing shareholders and Wall Street alike with Hardy Boy-esque code names for projects from the so-called “skunkworks.” This one was named “Rocket,” and it began some time in early 2003, when something called “mCommerce,” which stands for “mobile commerce” (commerce conducted via cell phones), became a short-lived faddish buzzword:

“We decided that there would be an opportunity to lead the field with a push-based mCommerce application that delivered special bargains to subscribers.”

After some delays, Byrne announced a break-through in April of 2004:

“We have applied for a patent on push-based mCommerce and a certain kind of transaction through mCommerce. I think you're going to hear a lot more about mCommerce. It's like the Internet of five or six years ago. And I think people ought to look hard at different companies that are emerging in there.”

Never lacking in ability to jump on a trend that might, to use a favorite Byrne phrase, “super-size” the P/E in shares of Overstock.com stock, he wrote:

“To give an idea of the size of this market; there are 150 million cell phones in the U.S….”

Shortly thereafter—three short months later, in fact—Byrne admitted the obvious:

“I am not giving up, but this has been a dud… mCommerce just has not yet caught on in the United States. If and when it comes, Overstock.com has staked out some high ground without a huge investment.”

Next up in this three-part series will be The Mystery of the Shallow Ocean—a rather involved tale involving yet another “skunkworks” project...

Until tomorrow.

Jeff Matthews
I Am Not Making This Up


mfairview said...

Hey Jeffy, I think I missed it, but could you repost how many shares you and/or your firm are currently short on OSTK (puts inclusive please)? I would think it was the Jeffy Matthews way of fair disclosure while you're not making things up. It's 9pm EST 4/12/2005.


Frxzogg said...

I started reading this with much anticipation, drooling to hear just how big a jerk Byrne is... and then the whole story just fell flat.

So the guy takes risks. He sees opportunities no one else sees, and he takes a shot. Then he publically admits when some risks don't work out. Isn't that what we want in a CEO?

And isn't $425 in Afghanistan about, like, 67 years' income or something? Starving artisans is not a convincing argument.

In fact, you could call the whole story about the "O" an anti-climax, if you get my drift.

mfairview said...

Yes, but it could be worth 180 years if OSTK were selling it for at retail prices (I think that's his point). Wait till Jeffy writes his next article bashing Byrnes for winning his fight on cancer. That will be a real eye openner.

mfairview said...

btw- OSTK sits at approximately 50% short at this point, increasing about 8% since last month. If you don't think Jeffy and his buddies are nervous at this point, then you're in denial. Given his last postings on OSTK here regarding "Dumb auction listings" and then this "OSTK is ripping off artisans with Worldstock", he's sounding a bit desperate. Keep it coming Jeffy, you're really showing your us your true colors.

bubbles said...

First off I have no skin in the OSTK game, but am watching it closely.

mfairview, why don't you disclose some facts other than complaining about short sellers. Jeff has at least come up with some very interesting facts and questions about OSTK to which I still have not heard any good explanations too.

Secondly you should be happy that people are short selling OSTK, this gives you a chance to add to your position when the sellers are more aggressive driving down the price. Your long position will benefit when the shorts cover their position, causing the shares to rally. Remember this is a stock market and there is always two sides to a trade, a buyer and a seller, that is what makes a market.

If you really think OSTK is a great company you will prove Jeff and other shorts wrong in due time. But I would suggest that you do some real homework and try to intelligently answer the questions posed by Jeff over the past few months. Maybe you can enlighten the readers and even Jeff why OSTK is such a great company rather than just blaming short sellers which just makes you look stupid!

mfairview said...


Honestly, is it worth commenting on dumb auction listings or why OSTK isn't charging 1400 retail price for world stock items because 475 dollars is not enough? c'mon. My comments have been more towards the overt skewed views Jeff holds on this company. I don't believe my comments here have been in complaint of general short sellers per se, just that Jeffy may carry alterior motives on his barrage of OSTK.

Here's a good post from yahoo worth a repost on the company:

There is no question that the stock has been falling since December, when it peaked at $77.18. As of this writing the stock is at $41.81.

By way of history, the company sold 1 million shares at $57.53 in November and followed that with another 180,000 shares about 10 days later.

Also in November the company issued $100 million of convertible notes and followed that soon after by issuing another $20 million.

In both cases, the additional issuance appears to be because of demand.

The buyers of the stock and the notes are unlikely to be small investors like those who post on this board. Instead, they are most likely sophisticated institutional investors. That doesn't mean that they couldn't make a mistake, but the only information that has come out since then has been the company's fourth quarter earnings on January 27, which exceeded everyone's expectations.

Nevertheless, it is undeniable that the stock has been sinking.

I understand the debate over whether Byrne should have said anything about naked shorting. I've never thought that a CEO ought to take a position on that other than to point to his company's performance and let it speak for itself. But, I'm also willing to allow a man to speak his piece.

As for Byrne's performance, I find the numbers themselves hard to criticize. He's managed a company that has nearly doubled in revenues on a year-over-year basis. Meanwhile, the company appears to be keeping on the cutting edge technologically. At the same time, the company's operating costs as a percent of revenues have been dropping consistently. This last point appears to be a combination of economies of scale combined with truly more efficient operations. That's hard to ignore in a company that's growing as fast as this one appears to be.

The results speak for themselves. Sales are growing at breakneck speed but losses have been shrinking. That's pretty good for an on-line dot-com company. Not only that, but the company has a war chest that will allow it to last for a very long time at last year's loss rates.

I think it will be interesting to see the company's results for the first quarter. They will be released on April 22.

Unless someone can make a good case to the effect that the company is cooking the books, I am inclined to accept the numbers they post. If things are going poorly, there should be plenty of telltale signs. The economy has been strengthening, so the company should have no excuses for a worse performance than a year ago. I don't expect as good a quarter as the fourth quarter, however, simply because the Christmas season can be expected to be a seasonal peak.

I've now bought things on OSTK and have been pleased with the experience. I'm not sure what to make of the resellerrating report except that 94 reports in the last six months is not statistically significant given the number of transactions the company has. As a customer, it never occurred to me to go online and report that I'd had a successful experience. I would only look for a site like that if I'd had a bad experience.

All in all, I think the naysayers are in overkill mode. However, I don't think the company has yet proven itself, so the naysayers are entitled to their opinions and the market price of the stock has certainly not been encouraging.

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