Home Business Excess Stock: Home E-Commerce Core with Crypto Call Option (NASDAQ:OSTK)

Excess Stock: Home E-Commerce Core with Crypto Call Option (NASDAQ:OSTK)

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Excess Stock: Home E-Commerce Core with Crypto Call Option (NASDAQ:OSTK)

CBDC - central bank digital currency technology

simpson33/iStock via Getty Images

Over the past few years, the market has been plagued by volatility like never before. Many stocks that had never seen extreme moves before were quickly gripped by huge ups and even steeper downs. This turbulence was nothing new for Overstock (NASDAQ:OSTK) however, with a beta version of 3.7 giving shareholders exposure to some of the greatest volatility in the market.

Chart
OSTK given by Y-Charts

My thesis on Overstock is bullish following the fall in the stock price this year. I’m largely neutral on e-commerce right now, with Overstock margins squeezed as sales decline, and this will remain the case for the foreseeable future. It’s the overlooked Medici Ventures Fund and in particular the Bitt and tZERO holdings that make me optimistic that they will generate lucrative exit opportunities for Overstock down the road.

Rationalization of the offer

Throughout the second quarter Overstock has successfully transitioned the e-commerce business to a 100% domestic assortment. The company did this to streamline its offering. They had always focused on home, so when customers find other items such as jewelry on the site, it creates a bit of a “mixed bag” look and people don’t echo the name “Overstock with purely home which has been their main focus for some time.

As a result of this transition, Overstock is now rolling out a new marketing campaign to enhance this resonance. The main concern for me here is that the company is aiming to achieve this goal during a period of considerable turbulence where growth is slowing. The question is how this will affect margins, Overstock cut marketing and sales spend 32% year over year and 8.7% sequentially. This is the main lever (as a variable cost) on which they can rely to reduce their expenses. The board will likely seek to keep marketing expenditures at these levels, which may reduce the effectiveness of the campaign.

Operating (de)leverage

Operating a low-asset e-commerce business has allowed Overstock to maintain resilient gross margins.

Graph of overstock gross margins and gross profit over time

More GM and GP over time (Overstock IR)

However, the focus on household goods makes profit margins extremely thin. Even when Overstock announced record numbers in the second quarter of 2021, the adjusted EBITDA margin was still only 5.6%. In the second quarter of this year, Overstock felt that squeeze when revenue fell to $528 million, adjusted EBITDA margin fell 280 basis points to 3.9% or $21 million. Given the circumstances, the publication of non-GAAP profitability was satisfactory. In particular when the Wayfair comp key (NASDAQ:O) turned into a large non-GAAP loss in the second quarter.

Any further declines from the top line could bring Overstock closer to declaring a loss. This is because almost half of operating expenses are difficult to adjust – both technology and general and administrative expenses were virtually flat year over year. Due to this operating profit margin was only 2.1% compared to 4.5% in 2021. As mentioned, the company has taken control of sales and marketing expenses, but with the deployment of a new marketing initiative, I don’t know how much more they can adjust this without seeing a significant slowdown in demand. Management is focused on building long term growth in a sustainable way, if this is accompanied by low profitability/controllable losses in the short term, I think the market and shareholders need to be prepared for that, with the pressure then to achieve a recovery in sales thereafter.

An analyst on the conference call pointed to this issue regarding further deterioration in management margins, Finance Director Adrianne Lee said:

Of course Jonathan. And Seth, I would just say, of course, as you mentioned in the second quarter with our business performance, we were able to meet our margin targets. And we’ve been able to do that in the last four quarters where we’ve seen revenue decline. On your point, and in the remarks prepared by Jonathan, we talked about our goal being to continue to deliver results within that single-digit EBITDA margin and effectively manage our expenses.

And CEO Jonathan Johnson continued with:

Yes. Seth, we’re always going to watch our spending carefully. We have proven that we can handle them. And we have a model that works that way. We’re – I should get to the other part of, I think your comment and that’s what we’re doing to drive sales, because revenue growth helps all kinds of things. I’m going to say a few things we do in merchandising and a few things we do in marketing.

Johnson then talked about the success of adding SKUs and increasing engagement on the marketing side. These responses didn’t really directly answer the question posed and management focused more on combating declining sales, inferring that a further decline in sales would lower margins (as expected).

Medici Ventures

Medici Ventures Inc. was previously the wholly owned subsidiary of Overstock focused on Blockchain technology. In January 2021, Overstock entered into a Partnership with Pelion Venture Partners. This limited partnership made Medici Ventures a fund and Pelion became the fund’s general partner, giving them full authority over investment decisions.

The objective of the fund is to first return Overstock’s invested capital and then distribute the profits according to the Limited partnership agreement.

The Medici Fund seems to be the forgotten component of Overstock’s business. This is because management gives him very little airtime in press releases and conference calls. Overstock management formed the deal so they could focus solely on the day-to-day operations of Overstock. Pelion and his expertise are responsible for unlocking value in Overstock’s blockchain division. Medici’s financial results are no longer integrated with Overstock. This largely benefits Overstock, as collecting pre-seed businesses would negatively impact bottom line – In the second quarter of 2021, Medici’s operating loss was $2.18 million. Given that and Pelion’s expertise, this deal seems like a smart move.

Medici holds a number of positions, but the most notable and prominent are Bitt and tZERO.

bitt

Bitt provides an industry-leading suite of comprehensive financial technology solutions to help customers implement digital currency. Bitt has a digital currency management system which is the technology behind most Criteo Bank Digital Currency (CBDC) deployments around the world.

The CDDC has gained popularity with countries, according to the Atlantic Council’s CBDC tracker, it has been launched in eleven countries – mostly Caribbean countries with Nigeria. The opportunity for growth is even greater; 14 countries are at the pilot stage and 26 are in development. In total, over 90% of the global economy explores CBDCs.

Map of all the different levels of CBDC adoption around the world

Adoption of CBDCs around the world (The Atlantic Council)

Bitt focuses on retail CBDCs, which aim to make central bank digital currency available to the central public and thus change the two-tier system. This diagram from the Bank for International Settlements describes it well:

Diagram showing benefits of CBDC

The Retail CBDC Explained (BIS)

tZERO

tZERO is a blockchain-based asset exchange. tZERO, unlike most decentralized blockchain platforms, has been designated as an alternative trading system and is regulated by the SEC. Excess inventory management didn’t discuss tZERO much, but did highlight recent director appointments within the CC:

In June, tZERO added two new members to its board of directors, Edwin Marshall, former senior vice president and founding chief technology officer of Intercontinental Exchange and Michael Blaugrund, chief operating officer of the New York Stock Exchange. tZERO stands to benefit from their combined experience in technology and financial services. We remain excited about the future of tZERO.

The cryptocurrency space is facing increased regulatory pressure and scrutiny, which is concerning for some, but for regulated tZERO and Bitt, it’s welcome. These nominations for tZERO go even further in legitimizing the platform as these two new members have previous experience on renowned exchanges.

It will be a long time before Overstock realizes any value from its Medici business, something Medici Ventures chief Matt Mosman was keen to stress on Medici Day. Medici will face tough downturns like the current one, but the fund is prepared for it – they have strong capital support and a well-diversified approach. Only one or two of these companies need to be successful for Overstock to realize great value. Right now, Medici is at the bottom of the market’s mind, but that will happen quickly with any signs of a future successful release.

The essential

I am very skeptical when it comes to companies that have many very different activities and generate little or no synergies between them. But for Overstock, it’s hard not to be excited about the potential of the Medici Ventures segment. The company provided the fund with the capital it needed and management made the right decision by transferring the assets to another operator with much greater expertise in the field. This allows management to focus on what they know best: e-commerce.

Overstock.com will experience continued near-term sales weakness due to macro headwinds, but beyond that, the outlook for the 100% homewares e-commerce business looks solid. More importantly, I think the market is missing a treat with the Medici Ventures business, which seems to be largely overlooked and overlooked by the sell side.

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