Free-Reprint Article Written by: Geoff Gannon 
See Terms of Reprint Below.

* This email is being delivered directly to members of the group:

We have moved our TERMS OF REPRINT to the end of the article.
Be certain to read our TERMS OF REPRINT and honor our TERMS 
OF REPRINT when you use this article. Thank you.

This article has been distributed by:

Helpful Link: 
  The Digital Millennium Copyright Act - Overview


Article Title:
An Analysis of (OSTK)

Article Description:
Why is a value investor writing about an unprofitable internet 
company? Because value investing is about finding dollars that 
trade for fifty cents; with a market cap of less than 75% of 
sales, (OSTK) looks like it may be exactly that.

Additional Article Information:
1034 Words; formatted to 65 Characters per Line
Distribution Date and Time: Fri Feb 17 01:47:38 EST 2006

Written By:     Geoff Gannon
Copyright:      2006
Contact Email:  mailto:[EMAIL PROTECTED]

Article URL:

For more free-reprint articles by this Author, please visit:


An Analysis of (OSTK)
Copyright © 2006 Geoff Gannon
Gannon On Investing

Why is a value investor writing about an unprofitable internet 
company? Because value investing is about finding dollars that 
trade for fifty cents; with a market cap of less than 75% of 
sales, (OSTK) looks like it may be exactly that.

But isn't it too risky?

The greatest risk in any investment is the risk of overpaying. 
So, the real question is: what is Overstock worth? I think 
it's worth at least $1.5 billion. With Overstock's market cap 
currently sitting around $500 million, my valuation certainly 
looks far fetched. But, there's only one way to know for sure. 
Let's take apart my argument piece by piece, and see if any of 
my assumptions are unreasonable.

First Assumption: Over the next five years, Overstock will 
neither generate truly free cash flow nor consume cash. In other 
words, its free cash flow margin will average 0%. Cash generation 
in some years will exactly offset cash consumption in other 
years. Obviously, this assumption is unreasonable, because there 
is almost no chance the cash flows will exactly offset.

That's not a problem if it turns out Overstock does generate 
some free cash flow over the next five years. In that case, my 
assumption simply errs on the side of caution. If, however, it 
turns out Overstock actually consumes cash over the next five 
years, there is a problem – possibly a very big problem. So, 
which scenario is more likely?

Overstock's revenues are growing quickly. Gross margins look 
solid at 13.3% in 2004 and 14.9% over the last twelve months. 
Overstock's unprofitability is the result of its selling, 
general, and administrative expenses (SG&A) which have been 
growing exponentially. Will these expenses continue to grow? 
Yes, but not as fast as revenues. Over the last twelve months, 
Overstock's spending on cap ex has been 5.6% of sales. That 
number is an aberration. In the long run, spending on cap ex 
should not exceed 3% of sales. Considering the business Overstock 
is in and the expected sales growth, the company will, more 
likely than not, generate some free cash flow over the next five 
years. Therefore, the assumption that Overstock will be cash flow 
neutral over the next five years is not overly optimistic.

Second Assumption: Over the next five years, Overstock's sales 
will grow by 15% annually. Is this an unreasonable assumption? 
Again, I don't think it is. Very few industries are expected to 
grow as fast as eCommerce. Overstock's revenue growth in 2003 and 
2004 was over 100%. In the past year, that growth has slowed. 
However, it is still closer to 50% than it is to 15%. Overstock 
isn't in a cyclical business. So, there is no reason to believe 
current sales are abnormally high.

Also, all that spending on advertising is increasing consumers' 
awareness of Overstock. A review of Overstock's traffic data 
shows it has not only been gaining more visitors; it has also 
been climbing the ranks of the most popular web sites. While it 
is a long, long way from the Amazons, Yahoos, and eBays of the 
world (and will never reach those heights) Overstock is becoming 
a well known internet destination. This fact was most clearly 
evident in the weeks leading up to Christmas. Shoppers who 
visited Overstock during the holiday season obviously know it 
exists, and may very well return at some other point in the year. 
Analysts are predicting very high growth rates for Overstock; 
however, they are also recommending you sell the stock. I don't 
put any weight in their estimates. But, for the other reasons 
given, I believe the assumption that Overstock will grow sales 
at 15% a year for the next five years is not unreasonable.

Third Assumption: Six to ten years from today, Overstock will 
have a free cash flow margin of 3%. Ten years from today, 
Overstock's free cash flow margin will rise to 4% and remain at 
that level. Now, of all the assumptions I've made, this one is 
the most questionable. Sure, Amazon has that kind of free cash 
flow margin, but Overstock isn't Amazon, and it never will be 
Amazon. Overstock's gross margins are less than Amazon's. In 
fact, Overstock's gross margins are less than Wal – Mart's. 
However, Overstock's fixed costs will eat up a much smaller 
portion of its sales than is the case over at Wal - Mart.

If you compare Overstock to other online retailers, you will see 
that if Overstock does experience strong sales growth, a 3% free 
cash flow margin six years from now is not unreasonable. I 
assumed Overstock's sustainable free cash flow margin will be 4%. 
There's a case to be made that 4% is too high. I won't make that 
case, because I don't believe in it. Remember, that 4% number 
comes ten years out. That gives Overstock plenty of time to grow 
sales and thus reduce SG&A as a percentage of sales.

Fourth Assumption: Six to ten years from today, Overstock will 
be growing sales by 12% a year; eleven to fifteen years from 
today, Overstock will be growing sales by 8% a year; thereafter, 
Overstock will grow sales by 4% a year. Let's see what this 
really means. According to these assumptions, Overstock's sales 
will be as follows:

Today: $707 million

2011: $1.59 billion

2016: $2.71 billion

2021: $3.83 billion

2026: $4.66 billion

2031: $5.67 billion

2036: $6.90 billion

Seven billion dollars is not an unreasonable target – if you have 
thirty years to achieve it. To put that figure in perspective, currently has sales of about $8 billion. So, even 
after thirty years, these assumptions don't lead to Overstock 
reaching the same size as today's Amazon. Don't forget these 
numbers assume some inflation. For instance, if inflation 
averages 3% a year over the next thirty years, Overstock's 
projected $6.90 billion in sales only translates to $2.84 billion 
in today's dollars. So, these assumptions only lead to a fourfold 
increase in Overstock's real sales over a period of thirty years. 
I think that's pretty reasonable.

If you take these four assumptions together, you get a value of 
$1.5 billion for Overstock. Today, Mr. Market is offering it for 
$500 million – that's why I'm writing about an unprofitable 
internet company. 

Geoff Gannon is a full time investment writer. He writes 
a (print) quarterly investment newsletter and a daily value 
investing blog. He also produces a twice weekly (half hour) 
value investing podcast at:



TERMS OF REPRINT - Publication Rules 
(Last Updated:  April 7, 2005)

Our TERMS OF REPRINT are fully enforcable under the terms of:

  The Digital Millennium Copyright Act


*** Digital Reprint Rights ***

* If you publish this article in a website/forum/blog, 
  You Must Set All URL's or Mailto Addresses in the body 
  of the article AND in the Author's Resource Box as
  Hyperlinks (clickable links).

* Links must remain in the form that we published them.
  Clean links should point to the Author's links without
  redirects having been inserted into the copy.

* You are not allowed to Change or Delete any Words or 
  Links in the Article or Resource Box. Paragraph breaks 
  must be retained with articles. You can change where
  the paragraph breaks fall, but you cannot eliminate all
  paragraph breaks as some have chosen to do.

* Email Distribution of this article Must be done through
  Opt-in Email Only. No Unsolicited Commercial Email.

* You Are Allowed to format the layout of the article for 
  proper display of the article in your website or in your 
  ezine, so long as you can maintain the author's interests 
  within the article.

*** Author Notification ***

  We ask that you notify the author of publication of his
  or her work. Geoff Gannon can be reached at:

*** Print Publication Reprint Rights ***

  If you desire to publish this article in a PRINT 
  publication, you must contact the author directly 
  for Print Permission at:  


If you need help converting this text article for proper 
hyperlinked placement in your webpage, please use this 
free tool:


ABOUT THIS ARTICLE SUBMISSION is a paid article distribution 
service. and 
are owned and operated by Bill Platt of Enid, Oklahoma USA.

The content of this article is solely the property 
and opinion of its author, Geoff Gannon



1. Print the article in its entirety. Don't make any changes in the article . 
2. Print the resource box with all articles in their entirety.
3. Send the Author a copy of the reprinted article or the URL 
  where the articles was posted.

Anything short of following these three rules is a violation 
of the Authors Copyright. 
Yahoo! Groups Links

<*> To visit your group on the web, go to:

<*> To unsubscribe from this group, send an email to:

<*> Your use of Yahoo! Groups is subject to:

Reply via email to