Friday, May 20, 2005

Of Hunter S. Thompson, Giant Deformed Hedgehogs, and Doctor Patrick Michael Byrne



Overstock.com CEO and CBMG (Chief Binomial Marketing Guru), Patrick Byrne, was at the J.P. Morgan technology conference this week, answering questions about all things Overstock.

Actually, he only answered questions about a few things Overstock, because the questioners did not really get to all aspects of what Inspector Clouseau might have called “The rich tapestry of Overstock.com.”

Therefore, we will have to do it ourselves.

But before we get into the Top 10 List of Questions We Would Like Somebody To Ask Patrick Byrne, let me point out here that another mystery in the casebook of Overstock has been cleared up.

Specifically, the Case of the Reappearing Merchandise, in which we noted that furniture highlighted as “Almost Sold Out—Act Fast” in pop-up ads, mysteriously reappeared weeks after first being identified as “Almost Sold Out.”

This despite the fact that Overstock is supposedly a closeout buyer of overstocked merchandise—not a private label manufacturer.

Recall that we noted the product in question was sourced from Sitcom Furniture, a direct-import outfit offering product to U.S. retailers, and that the appearance of this kind of private label merchandise appeared to coincide with the dramatic rise in gross margins at Overstock, about which Patrick Byrne boasted on conference calls throughout 2004, crediting it almost entirely to better “logistics.”

Well, one of the questions Byrne got at the J.P. Morgan conference earlier this week concerned the $50 million Asian currency hedge Overstock put on the first quarter.

“Why hedge?” Byrne was asked.

“We do some buying in Asia,” he answered. “Not a tremendous amount, but we do…and we hedged what we felt was an adequate amount of currency.”

Since we have learned that it is better to watch what Patrick Byrne does rather than what he says, let’s ignore his protest that Overstock doesn’t buy “a tremendous amount,” and do the math ourselves:

Overstock did about $215 million of direct sales last year, with a $185 million cost of goods. Assume the cost of goods grows 50% in 2005, to roughly $270 million. By hedging $50 million worth of currency, Byrne is hedging almost a quarter of his
company’s entire direct cost of goods.

Therefore, based on the math—not on Patrick Byrne’s spin—Overstock is in reality sourcing almost a quarter of its so-called over-stocked, closed-out merchandise from Asian manufacturers.

No wonder that stupid Newport Coffee Table, list price $434, “our price $179.99”—which began popping up back in March as “Almost Sold Out—Act Fast!” is still popping up on my Overstock.com web page.

Thus The Case of the Reappearing Merchandise and its sister mystery, The Wonder of the Rising Gross Margins, have been solved: Overstock.com sources product from Asia.

Moving on to the “Steal of a Lifetime” diamond purchase, not much new ground was broken at the J.P. Morgan conference.

Bizarrely enough—at least during the ten minutes or so of the question and answer session I listened to—Byrne never fully explained the profit-sharing scheme outlined in the Overstock.com 10Q, whereby the company splits profits on the diamonds with an unnamed special purpose entity (SPE).

Recall that according to the 10Q, the company cut a deal with an SPE for the purpose of buying diamonds in August, 2004—months before the sudden arrival on Byrne’s doorstep of two partners having a “nasty split” who, the way Byrne described it on April’s conference call, wanted to dump their diamonds at almost any price.

Those two fellows must be real players in the diamond business, don’t you think?

Instead of the logical, easy, and more profitable move, which is to simply get on a plane to either New York City or Tel Aviv and—as one of my diamond contacts who scoffed at Byrne’s story said—“just open up the briefcase and sell them,” this pair decided it would be better to give Overstock.com and its CEO, Patrick Byrne, the “Steal of a Lifetime.”

Can’t you just see these two guys, dirty and unshaven, driving across the Utah desert on Route 80 in a drug-addled, Hunter Thomspon-esque haze of Maui Wowie and 22 caliber gunsmoke, veering south on 215 to avoid the Giant Deformed Hedge Hog suddenly rising up before them blocking the entire mountain pass to the East and leading cops on a wrong-way chase down the entrance ramp at Route 190, bouncing off cars and fire hydrants before screeching to a halt in front of 6322 South 3000 and stumbling into the lobby of Overstock.com, banging the door shut behind them—loose diamonds and Peruvian flake spilling out of their pockets, pupils dilated and eyelids twitching, one firing at the blinking electric bats swooping down from the light fixtures while the other screams at the receptionist to “get Patrick out here right now!”…

And suddenly Byrne appears, a vision to behold, serene in his Buddhist-like detachment, sizing up the situation in a second and offering the cowering dogs $7.2 million on the spot—just like that.

Deal done, he scornfully whips the pair with his belt and drives them from the lobby into the strong arms of the waiting, grateful Utah troopers—the “steal of a lifetime” safely done, the loot on its way to a vault on 47th Street in the heart of New York’s diamond district.

After all, who in their right minds would dump diamonds for $1.3 million less than their actual current value?

For that is what Byrne claimed on the conference call about the diamonds for which he paid $7.2 million, and he repeated that claim this week: “We…could turn around and flip them for $8.5 million and they probably have a good retail value of $10-$12 million.”

While not exactly the Hunter S. Thompsonish scenario envisioned above, Byrne also repeated his statement that it was a deal quickly done: “It was just an exceptional deal that happened sort of in an afternoon.”

And so, with no further ado, the Top 10 List of Things We’d Like To Hear Somebody Ask Patrick Byrne (the presumption being, of course, we would get a straight answer):


1. Who bought the diamonds? You said “we did do a very large diamond buy” on your call, but the 10Q says it was a special purpose entity (SPE). Did you buy them, or did friends of yours buy them?

2. If you in fact bought the diamonds, and considering the fact that you yourself have admitted blowing substantial deals in the past (an electronics deal last quarter, the Franck Muller watches, FarenHYPE 9/11 etc.), why would the board let you buy $7.2 million worth of diamonds anyway?

3. How much money did Overstock actually commit to the diamonds? You said “we paid” $7.2 million, but the 10Q says Overstock loaned the diamond-buying entity $8.4 million. What happened to the extra $1.2 million?

4. You made it sound like you had scoped it out yourself and it was such a great deal…why split the profits? Why not keep all the profits for the benefit of Overstock.com and its shareholders?

5. Why did you say that Overstock could “flip” the diamonds for a $1.3 million profit, when it appears that Overstock would receive only half of any profits from the SPE? Furthermore, 50% of $1.3 million is $650,000, and a $650,000 profit on a $7.2 million diamond purchase is about an 8% gross profit, which is almost half the current 15% gross margin at Overstock.com. How does a deal that is only half as profitable as Overstock’s existing business qualify as the “steal of a lifetime”?

6. Do you or anyone related to you or anyone in management or on the board of Overstock have an interest in this SPE? Who actually owns the equity of the SPE? What equity did they contribute?

7. How did you set the $3 million strike price for the 10-year 50% option…and who were the counterparties to the negotiation?

8. Why did the SPE buy $264,000 worth of PP&E? That’s a lot of furniture for an entity whose sole apparent purpose is “buying inventory,” as per the 10Q. What else did the SPE buy besides the diamonds?

9. If the SPE is not owned by Overstock.com, but supplies the diamonds for the “Build Your Own Jewelry” site on Overstock’s web site, who gets the profits from the diamond sales on the web site? Does the SPE sell the diamonds to Overstock.com at a mark-up?

10. Stepping back and looking at the entire “steal of a lifetime,” the 10Q says your company loaned the SPE $8.4 million to buy inventory. The SPE bought diamonds which, supposedly, you could “flip” for $8.5 million. What’s so great about generating $8.5 million on a capital investment of $8.4 million?


Those are the questions.

Expect no straight answers.

Await the spin on the next conference call.

And beware the Giant Deformed Hedgehogs on Route 80.



Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

21 comments:

Forensic Doc said...

Mr Matthews,

We have never met, although no doubt the conspiracy theorists will allege that we've at least met once in a grocery store and that we conspire together frequently by phone. But I digress...

I am glad to see that you have chosen to focus on the now infamous footnote to the OSTK Q and K. This is not the sort of thing that should go unnoticed.

P.S. Maybe one day you and I will actually meet; I think we'd have a great talk over a few beers. Keep up the good work.

bsilly said...

Mr. Mathews,

Could you provide a link or info to listen to the jp morgan conference you cited.

Thanks
bsilly

Jeff Matthews said...

"ForensicDoc"--I would enjoy getting together. The Conspiracy always needs new recruits, plus I can teach you The Secret Handshake. Meetings are held in Aisle 7, next to the canned fruit.

As for the JP Morgan Q&A, I'm sorry but that is something I can't make available here.

martindressler said...

bsilly, you can access the JP Morgan webcast with free registration here:

http://www.mapdigital.com/jpmorgan/technology05/welcome.html

mfairview said...

Mr. Matthews,

I'm curious.. Did you partake in the witty reparte of your JP companions and assault Dr. Byrnes with questions of the same voracity of your postings? Or did you opt to take the lower road and keep silent at the gathering choosing instead to launch grenades from behind your keyboard? I'll be listening anxiously at the next OSTK CC in hopes of hearing your insightful questions to Dr. Byrnes.

k9thunder said...

Jeff,

Thanks for another excellent detective work. Byrne and his trail of lies... Heck he can't recall what he said since he is mouthing off whatever comes into his pea sized brain.

Sounds like another BIG con at work here. So much cloudy and suspicious dealing surrounded by asnine characters like O'Brien and all these "interesting" entities... All I can say is show us the profit...

Its_strange said...

And where is CNBC ? The "leader in business news " ......

Its_strange said...

Didn't OSTK say they were "opportunistic" buyers and that we can expect more deals like the diamond deal ?

Think JP Morgan people are reading Jeff ?

BelowTheCrowd said...

The use of SPEs should have always been a warning call to investors. Since Enron, their use should be more than just a warning. A "red flag," to use the nomenclature of our favorite pit-bull (hardly a lapdog).

This is not to say that there's never a valid reason for using one, but such reasons, as well as the full background of the SPE needs to be disclosed. Legitimate users won't hesistate to make such disclosure. Companies that fail to do so are highly suspect, IMO.

This observation is true regardless of the apparent nature or profitablity of the transaction in which such SPEs engage, which in this case are highly questionable as well.

And incidentally, there are NO hedgehogs on I-80. But drive up the hill from Overstock to Snowbird, and you can always meet my buddy Larry, who usually dines on leftovers outside the Steak Pit. http://www.belowthecrowd.com/photos/larry1.jpg

BelowTheCrowd said...

"The Leader in Business News" doesn't employ many people who can read a balance sheet. Patrick is a funny guy. Maria likes him. What else do you need to know?

tom said...

I enjoy your posts so keep it up.

I understand your attempt to point out that overstock is overvalued, I don't disagree with the general assertion. What I would say however, is that in comparision to other internet retailers, perhaps Amazon, I don't believe they are.

I have no idea of the real details of the jewelry outlet, however my guess is that someone came to overstock and said look we can help you get in to the online jewelry business, similar to blue nile and we want to this with either you or amazon, walmart, smartbargains..... We have the background and product knowledge you have the traffic we will help you, In return we get to a cut of the profits.

For Patrick he probably realized the cost and time of entering the market quickly exceeded the cost of building the industry knowlegde and finding the buyers on his own.

Should he have been more forthright with this yes, but he was probably scared of letting his competitors know what was going on ahead of time.

As to his misleading comments on the conference call, that wasn't right.

Vitaliy N. Katsenelson, CFA said...

Jeff, great job! Aside from being educational your analysis is also very entertaining.

Its_strange said...

Maria .....She also thought Hank Greenberg was the greatest. She went off on Spitzer thinking it was all politics. But she is a "leader" in business news.

BelowTheCrowd said...

I was going to point out all the various guys who Maria has swooned over, but decided to just leave it alone.

That said, I seem to remember her being endlessly complimenary to The Koz too. And obviously everybody on CNBC is enamoured with Trump, whose primary financial skill seems to be making himself rich while his investors are wiped out.

We've seen those guys worship so many false idols over the years, it's impossible to take them seriously. Finally decided to shell out the extra dough (turned out to be five bucks a month) to have Bloomberg on my desk.

As another commentator on another website pointed out recently, you can't gain financial literacy from a Lightning Round...

-btc

Its_strange said...

Herb Greenberg's stuff on TTWO prompted me look at its founder and his pals in the Hamptons . I had to laugh at the number of times a read something about the place with Maria in the story. ...What a seriouly phony place.

bpl1000 said...

Mr. Matthews,

Thank you for this forum and sharing your insights. This blog has been "educational" for me.

Thanks again.

Jeff Matthews said...

Wait a minute, "Tom." You got it 100% wrong.

I have NEVER made "an attempt to point out that Overstock is overvalued" on this blog.

Ever.

While I appreciate your reasoned response to my post on the Overstock diamond issue, I want to make clear this blog is not about valuations.

I urge you to re-read every post on this blog and you will never ever once read a comment on the valuation of Overstock.com.

Not once.

I have, certainly, pointed out that Patrick Byrne's many grand pronouncements--such as his auction venture--have in fact had the affect of "supersizing" the valuation of Overstock.com shares in the marketplace.

But I have never made a comment about the valuation itself, and whether it was proper or not.

And that is for one simple reason: stock market valuation is entirely subjective, and this blog is about facts.

After all, one investor's "cheap" is what another investor might consider "expensive." Second, valuations fluctuate with interest rates, crowd psychology, tsunamis and terrorist attacks. Third, valuations change every minute of every day--facts do not.

And this blog is about facts, plain and simple--about "not making it up." When I have been wrong on the facts, I get corrected.

Indeed, I appreciated your response because, unlike others who have taken issue with our previous work on Overstock and the very wide gulf between certain visions and certain realities promulgated by Overstock's CEO, Patrick Byrne, it was measured and constructive.

That's what this blog is all about--to get behind the true picture behind the mask, as it were, of a public image.

And speaking of faces behind the mask, I note the very handsome mug of Vitaly Katsenelson, a compatriot from my Street Insight days--who is well worth following on his own blog.

Finally, it is only right to acknowledge the debt owed to Hunter S. Thompson in my last (and final) post on Overstock.com.

I urge all readers to pick up his "Fear and Loathing in Las Vegas" and read it in one sitting.

And watch out for the bats...

newvikes03 said...

I have to admit this travel site has some great offers. No cars, hotels or air but WOW how about those cruises and vacation packages. I think this stock will go through the roof and to the moon now. Or maybe it won't let's see. Let's start with cruises they must have some great relationships with the cruise lines for those rates. Then again I just checked Yahoo cruises and it says powered by NLG and I checked the prices between Overstock and Yahoo and they were the same. Grandma don't kick the cat it seems that NLG is actually the cruise program on Overstock. So I thought at least they have awesome vacation packages. That is a great addition. Then I noticed that Overstock vacations had WWTE on the legal disclaimer. So being so savvy on the Internet and not knowing what it meant. I searched under Yahoo and low and behold heaven have mercy WWTE is actually owned by Expedia. So I searched other websites and sure enough the offers on Overstock were the same. I was furious and my grandma was ready to have a heart attack. Lucky for her I had her nitro nearby. Then I gave her some soothing news. I said grandma don't worry about your investment in Overstock, Expedia is going to be spun off. Since they will be getting most of the profit from the travel bookings on Overstock you can just buy Expedia and sit back in your rocking chair and relax. After my grandma realized her good fortune she called her niece, the stock broker, and sold Overstock and bought Expedia and never worried again. She then put her finger to her chin and asked me do you think NLG will ever go public?
The End

Jeff Matthews said...

"newvikes03" has some good stuff here. Precisely where in the legal disclaimer on Overstock's travel site does "WWTE" appear? I could not find it at first glance.

newvikes03 said...

SELLER OF TRAVEL

Overstock.com Vacations is a registered seller of travel in California, Florida, Iowa, Nevada, Ohio, and Washington under each state's seller of travel regulations.

California registration number: 2058111-50

Florida registration number: ST-31531

Iowa registration number: 677

Nevada registration number: 2002-0759

Ohio registration number: 29546904

Washington registration number: 601975108

Registration as a seller of travel in California does not constitute the state's approval.

SELLER OF TRAVEL

WWTE is a registered seller of travel in California, Florida, Iowa, Nevada, Ohio, and Washington under each state's seller of travel regulations.

California registration number: 2058111-50

Florida registration number: ST-31531

Iowa registration number: 677

Nevada registration number: 2002-0759

Ohio registration number: 29546904

Washington registration number: 601975108

Registration as a seller of travel in California does not constitute the state's approval.

©2004 WWTE. All rights reserved.

leewhee said...

Prickly CEO aside, I'm wondering just what the point of OSTK is?

I've never actually purchased anything from OSTK.

But for fun, I ran a spotcheck of 10 different products that I might purchase---sports equipment, electronics, etc.

Within two or three clicks, I found the same products on competing sites at the same price or cheaper.

So what is the point of OSTK?

Example: I'm an avid tennis player. I often purchase at tenniswarehouse.com and other tennis sites. They have terrific customer service, good pricing, fast shipping and know tennis inside and out.

Since I can buy tennis equipment at tenniswarehouse.com for the same price or lower than OSTK, why would I purchase it at OSTK---which i assume has little knowledge of the tennis equipment it sells.

Since OSTK can't compete on service and knowledge with more narrowly-drawn online retailers, it can only compete on price. And when price is the same, what's the point of OSTK?

Is there any product category that OSTK has an edge? Or is this company some sort of marketing pipedream?