Dec 03, 2018 – Is Blockchain the Right Direction for Ovestock?

As a CEO, what would you do if the core business of your company began to appear in the “Dog” quadrant of the BCG Matrix?

It is time for some tough decision making, and that is exactly what the Overstock (NASDAQ:OSTK) CEO Patrick Byrne has done in the previous week when he announced that the retail business of Overstock is expected to be sold by February 2019. The company, a Utah-based online retailer of furniture, housewares, jewelry, watches and home décor, has over 20 million visitors on its platform each month but has been facing problems with increasing losses and declining growth. The proceeds realized from the sale of its core business are expected to be used for the expansion of the blockchain business that the company had started way back in 2014.

Is divesting the core business for blockchain a sound decision?

Before making any immediate judgments, it makes sense to analyze the current business fundamentals of Overstock in order to determine whether this is a logical decision or not. The fact is that like most e-commerce companies, Overstock is no Amazon (NASDAQ:AMZN) when it comes to growth and margins. The company has been incurring losses for many years and its return on invested capital (ROIC) is as low as -508.88%. The current net margin of Overstock is -14.21% and its return on equity is ridiculously low at -157.76%. It is safe to conclude that the company had been destroying shareholder value over the years.

The only reason the market was optimistic about the company and it commanded a decent valuation in the past was because of one metric, revenue growth. But this metric has been sluggish over the past few years as the three-year revenue growth rate is as low as 4.2%. This leaves little scope for optimism, especially among prudent financial investors.

Yet the news with respect to the divestment of this business coupled with the increased focus on blockchain changes things. This decision has created a ray of hope for long-term investors. Obviously, the company’s exit from its current business and its entry into a new technology imply a high amount of cash losses for the coming years, so there is really not much to be expected in terms of the strengthening of the financial fundamentals. In fact, it is possible that these might worsen significantly for a few years. Also, the risk surrounding the stock is expected to increase and the beta, which is already as high as 2.43, is expected to grow with increasing volatility. But the ray of hope lies in the growth story of blockchain and the expected valuation that Overstock can fetch for its retail business.

Why is the valuation so important?

As far as the divestment, Overstock is in need of a significant amount of cash. The management is expected to invest these proceeds into the blockchain business, which is a practical necessity, given that the new business will burn cash for many quarters. Hence, the valuation of this business is absolutely critical, not just for a good short-term stock performance, but also for the long-term prospects of Overstock’s blockchain business.

Currently, the closest listed peers of Overstock are Bed Bath and Beyond (NASDAQ:BBBY) and Costco (NASDAQ:COST), and both these companies are trading at an EV-revenue ratio below 1, despite being profitable entities. It is possible that Overstock’s retail business realize a value that is well below last year’s revenues, which is probably not the best news for management.

As we can see, the stock has crashed from levels above $85 to below $20 in less than a year. A poor valuation during divestment could result in a further crash. However, the bright side for Overstock is that most blockchain developers are trading at an EV-revenue multiple of over one, which implies a scope for multiple expansion and an eventual increase in stock price once the company is able to monetize the blockchain investments.

What is next in the blockchain business?

The good news for Overstock shareholders is that the company is certainly not new to the world of blockchain. It has invested in the technology for four years through its arm known as Medici Ventures.

One of the key majority investments of Medici is tZero, a potential secure token platform that acts as a trading exchange for equity and cryptocurrencies. While tZero already has a significant amount of competition from the likes of BitDepositary and KickICO, it could prove itself a more unique concept if developed well.

Another key investment by Medici is a minority stake in Bitsy, a cryptocurrency wallet. It is likely that there are many more investments that are expected from Overstock and Medici in the near future so that the company can build a solid, diversified portfolio of crypto products.

Conclusion

To summarize, Overstock has faced stagnation in their its business as a result of the rising competition and price pressures. The margins have always been negative, and the falling growth rate has already reduced the stock to about one-fifth of its 52-week high. The divestment of the retail business in February 2019, as announced by the CEO last week, and having a greater focus on the blockchain business is a strong strategic initiative that could go either way for the management.

While there is a chance for a windfall gain for existing investors, it also increases the uncertainty around the stock. Aggressive investors, particularly those focused on the blockchain technology, could consider an investment in Overstock given the scope for multiples expansion and the management’s four-year traction in the business with key investments like tZero and Bitsy. But for the more prudent and risk-averse investors, it is best to watch how the blockchain story for the company unfolds over the years.

Disclosure: No positions.

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