Wednesday, April 13, 2005

The Mystery of the 38 Diamonds, Part II

In The Mystery of the 38 Diamonds, Part I we explored five Overstock.com cases in which events failed to bear out the lofty pronouncements of the company’s erudite, professorial CEO, Patrick Byrne.

For the record, there is nothing inherently wrong with a business that tries new things and makes mistakes. It's part of what keeps good companies growing. But jumping on fads, trends and ventures that don't pan out might, after a point, look more like an effort to pump up a stock than a logical plan to rejuvenate a business model.

Today we explore several more Overstock cases, the first up being The Mystery of the Shallow Ocean.

In early 2004 word began to spread on Wall Street of a new Overstock “skunkworks” project, labeled “Ocean” by the label-loving Byrne. As one analyst reported:

“Project Ocean is still being kept tightly under wraps but is expected to be disclosed by the end of the summer. The project requires patents to be filed and will cost roughly $1 million.”

When the wraps were pulled off “Ocean” it turned out to be an auction site. The timing couldn’t have been better: like most of Byrne’s new ventures that have managed to “super-size” the P/E of Overstock.com shares, “Ocean” road the coat-tails of a very hot trend—online auctions—whose poster-child, eBay, had gained mainstream acceptance as a major transactional platform.

Byrne almost immediately began to spread the big news about Ocean's strong start:

9/30/04: just giving an idea of how fast this is taking off...since our launch last Friday: …Sometime around 5 A.M. this morning we passed the mark of 4,000 auctions. 66% of completed auctions are clearing (I think eBay is 44%?)

He followed up this exuberant first report with a certifiable whopper:

10/22/04: It's-- so far, my belief is, it's far faster growth than eBay saw in their first 15 days or 20 days.

It would be hard to imagine how almost any new auction site—with the aid of $2 million in start-up costs (Byrne's number) and the availability of Overstock’s existing customer base to jump-start usage—could fail to beat eBay’s “first 15 days or 20 days.”

After all, it took far more than 15 or 20 days for eBay to become a cultural and business phenomenon. Back then, eBay was merely one man’s online marketplace for collectors of Pez dispensers.

Nevertheless, Byrne continued to compare Overstock to eBay—and claim that in some cases Overstock auction was doing a better job than eBay:

1/28/05: [Our auction conversion rate is back] to the 35 to 40 range…. They [eBay] say that they have a closing rate in the 40s…. But if you remember they count it differently than us. …I wouldn't say we are higher than them but…

The eBay power selling community are very sophisticated people and they are doing all kinds of tests and there are certainly areas on our site where they are getting better results than they do on eBay.

Yet, in fact, after a brief surge following eBay’s February fee increase, Overstock’s auction listings stalled out at the 150,000 level and have more or less steadily declined. Listings recently cruised in at a slight 122,000.

A glance at individual categories—antiques, for example—reveals the problem: of the next 100 Overstock antiques auctions to close, only 8 have multiple bids. Thus, the “Ocean” does not appear to be very deep at all.


The Case of the Reappearing Merchandise might be one of the biggest unresolved Overstock mysteries.

Overstock describes itself as an “online ‘closeout’ retailer offering discount, brand-name merchandise”—in other words, “overstocks.” Pretty straightforward. Byrne himself commented on one of the limitations of being a closeout seller early last year:

“We can't reorder most of the stuff. We just can't reorder most of it. Almost all of the stuff is not reorderable.”

Yet Overstock appears to be doing just that in certain cases.

A “Newport Coffee Table,” for example, was featured in pop-up ads on March 31, thusly:

Almost Sold Out-Act Fast!
Newport Coffee Table
List $434
Our price $179.99
“Limited Inventory! Sell out Risk: High”

Yet that same coffee table re-appeared—in the same “Almost Sold Out” pop-up ad, at the same price—on April 1, 2 and 3. And again a week later.

The strangest thing is that right now—April 13—the very same Newport Coffee Table is still for sale on Overstock, although not identified as a "Sell out Risk."

Either the “Newport Coffee Table” did not have a high sell out risk as advertised, or product has been reordered. Most likely from Sitcom Furniture.

Who or what is “Sitcom Furniture?” Sitcom manufactures in China:

Sitcom's fastest growing division is our direct import/private label program. Customers can select items from our current product line to ship directly from the factory either FOB or on a landed basis. We have also developed a number of exclusive products for customers who can sustain long-running container programs, with annual volumes ranging from 2,000 to 24,000 units per item.

And “Newport” is one of the furniture lines offered on the Sitcom web site.

If indeed Overstock is importing product manufactured for Overstock, as opposed to surplus furniture manufactured for Ethan Allen or Bombay, it might help explain one other thing besides the Mystery of the Reappearing Merchandise: the dramatic increase in Overstock gross margins over the last year, which Byrne credited to “tightening our logistics costs and better merchandise buying.” Margins on direct imports from China, such as the furniture manufactured by Sitcom, could run far higher than Overstock’s targeted 15% gross margin and help explain the "better merchandise buying."


A more recent Overstock mystery, The Vanishing Naked Shorts, and its sister case, The Stranger on the Conference Call, are the last to be reviewed here, before we get to the final Mystery of the 38 Diamonds tomorrow.

Sparing the gory technical details that are at least as boring to write as they are to read, Byrne became fixated on the notion that, because shares of Overstock.com appeared on the “SHO Threshold” list, the company was under attack by a pack of “Naked Shorts”—short sellers who fail to correctly borrow stock prior to selling it short.

Naked shorting is illegal, and, as anyone who has been in the investment business longer than two weeks would know, stupid.

But in his most recent earnings call, Byrne allowed an investor, who goes by the name “Bob O’Brien,” to explain at great length how a supposed “Naked Short” attack was being perpetrated on Overstock.com, along with a number of other, lesser companies.

Byrne pretended not to know “O’Brien”:

Byrne (to the operator):
There was a guy, Bob O'Brien.

O’Brien:
Yes, I'm on the line. Thank you for taking my call, Dr. Byrne. Congratulations on a great quarter.

Byrne:
Thank you very much.

O’Brien:
You…probably, the name is not familiar. Let me start out by introducing myself. I’m a shareholder, and also a retired guy. I think I can explain what is going on with your stock and, basically, why so many people are saying mean things about you.

Byrne:
I would love to know that.


That little one-act play, in which Byrne and O’Brien pretended not to know each other ("the name is not familiar"), continued with a long, fanciful, and—to anybody who has been in the investment business—absurd tale involving German share listings and all manner of regulatory complicity, which Byrne listened to, and prodded along, with rapt fascination, as if he had never heard it before.

But Byrne indeed knew Mr. O’Brien, for they had spoken shortly after Overstock's October 2004 conference call.
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Unfortunately for both actors in that play, the lynchpin of their Conspiracy Theory has gone away. Overstock.com shares no longer appear on the on the SHO Threshold list. The Naked Shorts have vanished.

Which leaves one remaining question: why did the CEO of a company pretend on a conference call with investors that he had never heard of or spoken with a man, of whom he had heard and with whom he had spoken?

Why would the answer to this question matter? Well, in the words of Warren Buffett—whom Byrne frequently quotes:

“We also believe candor benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private.” From the Berkshire Owner’s Manual.

The Mystery of the 38 Diamonds concludes with Part III, here, tomorrow.

Jeff Matthews
I Am Not Making This Up

8 comments:

bob obrien said...

Jeff, do you have a short position in Overstock? Yes or no. Simple question. For the purposes of this discussion, that would include any of the myriad derivative mechanisms that achieve the same thing.

Yes, or no?

I'm trying to understand your motivation here.

First, you take the position that there really isn't any naked short selling. Next, that it really isn't a problem. Next, that anyone that recognizes it as such is a kook.

This, in spite of the SEC's own admission that there are large fail positions out there that could cause significant disturbances to the market if they were bought in. And that they are part of trading strategies for participants and investors (hedge funds.) So is the SEC also kooky? How about the DTCC? They admit that there are almost $6 billion in fails per day. Marked to market. As in yesterday's $30 stock that today trades for $5 is no longer a $30 million fail, but today a $5 million fail, assuming a million shares. Or yesterday's $5 stock that is today .0001 is no longer a $5 million dollar fail, but rather a pack of gum.

Does that sound like a small problem to you? $6 billion in today's value for hte fails, PER DAY? Apparently so, as you have tried to make it sound, in every one of your little touts, like it's no more than a little harmless fun. Noise. A tickle.

As to Dr. Byrne, I had sent him some emails before the CC, and while I am flattered that you believe that I make enough of an impression for the CEO of a billion dollar market cap company to remember my CV, I'm afraid that isn't the case, or at least I presume so based upon his response. Now, I can see where he would be on pins and needles whilst fielding calls from analysts about his business model, margins, scalability, supply chain, etc. etc. and be scouting the message slips for the one and only Bob O'Brien to be calling for him, and further can appreciate that he also would have become fluent in what you term as a conspiracy theory, but I'm not sure that's how the real world works. I get over 200 emails a day just from NCANS related stuff, and I'll bet Dr. Byrne sees more than that, and I can't say as I remember the details of every theory or name that comes across my screen.

You would know best, however, as it sounds as though you have considerable experience starting, growing and operating successful public companies, so you would have a better idea of how they function from the inside than I would.

One interesting point you introduce is the drop off from the SHO list of OSTK's shares, which also took place the same day as 5 or 6 canadian domiciled companies dropped off - all without appreciable increases in their trading volumes or prices.

I've spoken with some experts who tell me that the odds of that being coincidental are astronimical - so what is at play? My hunch is that some large clearing broker figured out a way to move the fails off of the NSCC books and into the ex-clearing area, the non-CNS area where brokers have "agreements" between one another that don't trouble the NSCC with their detail.

In other words, you call them something else, or cover them with slug A of shares which are then ledgered at a different strata of the system, maybe the trading desk level, maybe higher up.

Dunno. But it wasn't a coincidence, and it didn't happen of its own volition. No way of knowing for sure until the DTCC actually opens its books, which they fight tooth and nail, for reasons that remain obscure.

So back to my original question.

Are you short OSTK, via common or options? Yes or no.

And are some of your buddies short OSTK? You know, the lapdog's network of hedge funds at 45 Rockefeller?

I just want to understand.

Help me understand, Jeff. Help us all understand. I think I do, but it's always nice to know.

The Unknown Broker said...

To "Bob O'Brien"

Bob,

You state this (or a variation of it) several times:

Help me understand, Jeff. Help us all understand. I think I do, but it's always nice to know."

Now obviously I can't shed any light on Jeff Matthew's trading position in OSTK, so I can't help you there (although I'm not sure that is the really key point here. If he's negative and chooses to sell short OSTK -- or any other stock -- that's what markets are for. In the same way that your ownership of OSTK doesn't automatically make your positive comments suspect or tainted. Really, if you like a stock you should own it. If you hate it you should short it. Nothing new there.)

Again, I have zero knowledge of Jeff's position in OSTK. I just don't think it matters much as regards the real issues he is raising. (And contrary to what you seem to think, the issue in question is not the naked shorting/no naked shorting one.)

The following is a series of observations I posed to someone who, if not a friend of yours(or "lapdog" to borrow a phrase you seem to enjoy) is at least someone who shares your abiding concerns about naked shorting -- given that he (and you) manage to turn just about any consideration back in that direction.

So in keeping with your "I just want to understand" theme, I am copying my previous missive below. While it was originally directed to "mfairview" you may now consider it to be pointed, aimed, and fired in your direction.

He never responded. Will you?

So, help us Bob. We too just want to understand.

The Unknown Broker

P.S. Jeff has added a lot more information and raised further relevant questions regarding Overstock's operations. As long as you're answering my questions, feel free to take a whack at the additional points he has researched.

_______________

To Mfairview:

I would like to take you seriously and treat your posts with due respect -- just as I hope that any new point of view that I encounter results in some level of education and enlightenment for me.

But dude (Sorry..Mr. Dude) you make it so hard to do so.

When every discussion ends up being diverted to completely unrelated topics, you come across as singularly obsessive and afflicted with tunnel vision.

You're like the guy that tries to veer every conversation back to his favorite subject, whether it's relevant or not. The guy at the office who is hung up on the Knicks, or Pamela Anderson, or Star Trek, or whatever.

Anybody: "So, how should we address this customer service issue?"

MFairview: "Just like Captain Kirk. He's awesome. Let's talk about Star Trek."

Everyone: "Shut up!"

You see, this thread was about real estate valuations and the possibility of a bubble being in progress. And here you show up with a discussion of Star Tre... I mean, short-selling and Reg SHO.

So now it seems that I am also a little guilty -- having chosen to respond to your off-topic post. But since we're on the subject of Overstock, may I request something from you?

Please, pretty please, I beg you, nay implore you, for the love of Pete, as an evident OSTK expert please help us with some answers to certain questions.

Jeff and others have raised questions regarding Overstock's actual business: the "diamond deal of a lifetime," and the progress or lack thereof in their auction business and attempt to take on eBay. Your answers to these have been either silence or a re-rant on short-selling tactics.

Let me explain something relatively basic. There is the company and there is the stock. They are quite different.

If the company is well-run, their service a good one, their business model sound, and the management capable, they will prosper. And in time the short-term fluctuations in the stock (whether short-selling induced or not) will be looked back as just a few wiggles on the chart and as so much forgotten chaff in the history of the company.

On the other hand, if the strategies are flawed, the management poor, the business a bad one, and the services not successful, the stock price will decline as the fundamentals unfold. And it won't be because of short-sellers. It will be because of the failure of the company to execute.

So please, give us some useful information and answers regarding the company, and if you find yourself tempted to veer off into a Round 72 Reg SHO diatribe and discussion of the stock, take a deep breath, count to ten, pinch yourself, have a therapeutic electro-shock adminstered, or whatever. Just say "no" to yourself.

You see, when you repeatedly contend that the one and only thing that is impacting the stock price is the short-sellers and that were it not for them the stock price would be just fine, we must assume that you really know the company well. To make such a confident assertion you must have really done your homework and due diligence and clearly you would have the answers to the relatively straightforward and simple questions regarding diamonds, auction activity, the preponderance of private label merchandise, site traffic, etc. Those aren't phenomenally difficult matters for someone who is a believer in the company.

And yet, in every Overstock discussion (and some that aren't even about Overstock at all) you and Bob O'Brien ignore those basic and legitimate questions and concerns and take the discussion off into your pet subject.

So let's be big boys, and let's try to focus. Some questions have been raised regarding the company (repeat after me: "the company not the stock, the company not the stock") and you should be able to serve as a valuable resource for those of us who don't possess your implied expertise on the company.

So, give us the answers to those questions. Let us respect you. Otherwise we just have to figure you guys are crackpots with obsessive compulsive disorders.

You can answer them can't you?

Can't you?

kevinmr said...

It's my opinion that whether Mr. Matthews is short or long OSTK is not important but whether he is writing the truth. I for one believe him.

bob obrien said...

Unknown:

Have I led you to believe that I have some unique insights into the inner workings of the company?

That I possess some hidden answers to the questions that Jeff has raised in his ten or so missives on OSTK?

I responded to the section of his latest dissertation that was directed at me, unless I am somehow now also a chinese furniture manufacturer.

Did you see that section? The last third of his post? No? It's the bottom third.

As to the first two thirds, in which he raises innumerable "points" about OSTK, bravo, I say, hat's off. Who knows whether he is accurately characterizing the company's operations or not? Dunno. Couldn't tell you. Just plain old drawing a blank on that, old buddy.

But I do know what he is saying about me, and can speak to the portion of the post that he chose to dedicate to my participation on the conference call - that would be the roughly bottom third (in case you missed it) where he brings up: 1) Naked short selling; and 2) Me.

Perhaps if you tire of these forays into topics that Jeff knows little or nothing about, you can propose that he confine himself to areas of presumed expertise. God knows I have other things on my plate than correcting mischaracterizations of my discussions and interactions with Byrne, or of the extent of naked short selling. In fact, while you were cutting and pasting what I'm sure represents a crowing effort from your standpoint, lest anyone miss it the first (I'm assuming we've only been graced with it once before) time, I wrote a comprehensive review of the SEC's latest flight of fancy - their SHO FAQ's. You can read it at www.ncans.net on the news page.

I understand that you wouldn't want to hold Jeff to the same standard that most real journalists are held to, in which they are asked, reasonably, whether they are writing piece after negative piece as a result of attempting to see a financial gain from a price decline, or not. I think it's a reasonable question, as it provides perspective as to young Jeff's motivations - and that speaks to his willingness to omit key facts, or just to make things up.

Hope that addresses your concerns. Wonder if Jeff will answer my question? I'm going to stick with no, he won't.

Final answer.

mfairview said...

No kidding.. All talking heads on TV and the rags mention their position when speaking of stocks. It goes to credibility. Obviously it's a bit less formal on the net. However, for a self proclaimed "straight shooter", I don't think it's too much to ask.

To: Broker, I didn't mean to insult you. I had actually answered the question in a prior blog. To the extent, I'm in the same boat as O'brien, which is to say I have no inside knowledge. Byrne is pretty open about answering questions if posted on his message board at his site (auctions.overstock.com). The prior blogs turned into a big bash clash and I didn't feel like doing DD for anyone just throwing random grenades.

I'm not looking to get ripped off like everyone else here. But I think Jeffy's gone over the deep end with his OSTK attacks. If it's personal, say it's personal so we can all where the appropriate level of sunscreen.

BelowTheCrowd said...

As I've said before, I have no skin in this game, but let me put the following out there, for those of you who don't know how hedge funds like Jeff's work.

He most likely has a contractual agreement with his limited partners to not disclose anything about his positions or trading strategy, and likewise they agree not to disclose what he does on their behalf. This is completely normal in the hedge fund business, and nobody outside the funds group of partners is entitled to know anything about what is going on in the fund.

Second, he most likely trades around his positions, so any statement would most likely be correct only for the moment he posts it.


Yes, CNBC requires disclosure. Which is why you see so few hedge fund managers on CNBC and to the extent that you do see them they generally don't discuss specific stocks, rather they focus on industries or the "big picture." Unlike the mutual fund idiots who take every opportunity to pump their business, hedge fund managers are a quiet lot, and rightly so.

So stop asking. Jeff isn't stupid, and most likely isn't even going to engage in a discussion of what he can and can't disclose. He just won't talk about it.

If you read this site (as I do) you are doing so in order to get the current opinions and observations of a guy whose made a lot of money for himself and his partners, and who continues to attract money, so is probably doing something right. Those opinions, of course, should be filtered through whatever your own beliefs and observations happen to be.

And if that's not sufficient for you, then you shouldn't be here. Sorry to be blunt, but the world includes lots of private things that you are not entitled to know about. Deal with it.

-BTC
(For the record, not involved in OSTK as it fails my criteria for invovement of any type, also not an investor in Jeff's fund or any other fund that is involved in OSTK, but involved in various private investment partnerships_

mfairview said...

What a sweet gig. Say/Do what you want w/no disclosure and nary any obligations to play by the same rules.

btc- Your "if you don't like it don't play" comment is just skirting the issues. I recall reading the same sort of response with the recent war. It's our community (and country) and to quote a politician "My country right or wrong. When right, keep right, when wrong, put right".

---
A bit dated, but salient none-the-less.

July 29, 2004 (AXcess News) New York - How big is the problem with hedge funds? Nobody knows, and that is the crux of the dilemma. Hedge funds have avoided scrutiny by operating below the radar, and outside of registration and reporting requirements currently existing under the federal securities laws. Hedge fund managers make multimillion dollar decisions, often without disclosing to anyone - their investors included - the fund's holdings or financial condition.

But while hedge funds have managed to stay out of sight, they certainly are not out of mind. Observers have expressed concern about the opportunities for abuse that can flow from this lack of disclosure. One recent poster child for such misconduct is the Lancer family of funds, managed by Michael Lauer. In July 2003, the SEC charged Lauer with massively overvaluing fund holdings and manipulating securities. The SEC claimed, among other things, that Lauer and his companies lied to investors about the nature and extent of the funds' holdings.

Hedge fund managers are in a position to make such misleading comments because investors generally do not have access to credible information about fund performance and holdings. Because hedge funds appeal to so-called sophisticated investors, they have been able to remain outside the SEC's more stringent disclosure standards - at least until now.

Earlier this month, the SEC proposed a new set of regulations governing the conduct of hedge fund managers. As the Commission acknowledges, hedge funds have blossomed and flourished outside the regulatory framework. Over 7,000 hedge funds currently manage more

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than $795 billion. As a result, they control significant stock positions and can have a disproportionate effect on the volume and price of some securities - particularly those of small and micro cap companies. The SEC notes that recent enforcement actions have charged hedge funds with overstating fund performance, requiring payment of excessive and undisclosed fees, and using parallel advisory firms to misappropriate client assets.

The expansion of hedge funds coincides with a disquieting drop in hedge fund standards. Many funds have lowered the "minimum investment" level, making them more accessible to small investors. They, in turn, are at the mercy of hedge fund managers who, in the SEC's words, "operate largely in the shadows, with little oversight."

In order to cast greater light on the activities of hedge funds and their managers, the SEC is proposing that hedge fund managers should be required to register under the Investment Advisors Act of 1940. This would allow the SEC to collect basic information and enhance disclosure to investors. The SEC also believes that it would enable regulators to identify compliance problems earl and deter fraudulent practices. Felons, and those with serious disciplinary records, would be prevented from managing hedge funds.

As a practical matter, however, are these proposals likely to deter abuses by hedge funds? How can the SEC be expected to adequately monitor these funds - 7,000 and growing? The agency, which is woefully underfinanced and understaffed, would appear to lack the resources necessary for the task. A glut of filings will have little value unless each registration is carefully reviewed and subsequently monitored. Far too many SEC filings receive only a cursory review from the SEC staff, or no review at all.

Registration of hedge fund managers may serve some useful purpose by deterring a handful of reprobates - but any individuals who are intent on abusing the process will simply find nominees to serve as managers in their stead. In the end, registration alone is not likely to stem serious abuse.

It is somewhat akin to treating the Elephant Man with botox injections.

The Unknown Broker said...

Bob O'Brien says:

"As to the first two thirds, in which he raises innumerable "points" about OSTK, bravo, I say, hat's off. Who knows whether he is accurately characterizing the company's operations or not? Dunno. Couldn't tell you. Just plain old drawing a blank on that, old buddy."

Interesting response Bob, and one that begs a question: If you are as uninformed and uninterested in the fundamentals of Overstock as you claim to be, then why do you own the stock? Do you own it solely because it is supposedly being manipulated and illegally shorted (a claim obviously open to disagreement.)

Is that a good reason to invest in the company -- a reason that supercedes all of the questions and concerns that have been raised about the company's fundamental business operations and management?


On the conference call you congratulated Dr. Byrne on a "great quarter" (your description of the report on the company's business results.) You went on record there as having a fundamental opinion on the quality of this company's operations and business.

What is it that you consider so well-done as to be characterized as in a public call as "great" -- so great that it outweighs the serious concerns that have been raised by Jeff Matthews and others?

On the call you then identify yourself as a shareholder (by definition one who has invested his money in a company in which has confidence) after which you say: "I think I can explain what is going on with your stock and, basically, why so many people are saying mean things."

Now Bob, you said a mouthful there. And you assumed some responsibility as well. In essence you said, "Your stock is going down for reasons other than the fundamentals" and you characterize any of the negative points being raised about the company, its business, and its management as merely "mean things." Implicit in that is a significant amount of knowledge about the company fundamentals, no? To so categorically dismiss negative viewpoints as just "mean things" would certainly lead one to believe that you know the company very well.

You asked me: "Have I led you to believe that I have some unique insights into the inner workings of the company?"

Well, yes. As I note above, I believe you have.

So Bob, why do you believe it is such a "great" company, why do invest your (presumably) hard-earned dollars with the management team, and why are all the naysayers either "mean" or crooked.

Surely you have something else to share other than another discussion of naked shorting?

Oh, and as to my cut-and-pasting my previous post, the one you refer to as what I must consider my "crowing (sic) effort" I plead guilty to the cut-and-paste, although no, I didn't fancy it so crowning an achievement. It's just that unlike you, am not retired. Being rather busy, if I am going to repeat a point, I sometimes find it more efficient to copy it directly rather than write it anew. It's so much faster than writing the same point over...and over...and over...and over again with slightly different wording, in the manner that some people do. Yes, Bob I know. You resemble that remark.

We await with bated breath your insights.