Over the last few years, the market has been gripped by volatility like never before. Many stocks that had never seen extreme moves previously, were soon gripped by huge rises and even steeper declines. This turbulence wasn’t new to Overstock (NASDAQ:OSTK) though, with a beta of 3.7 – giving shareholders exposure to some of the greatest volatility the market has to offer.
My thesis on Overstock is bullish following the fall in stock price this year. I am largely neutral on the e-commerce business at this time with Overstock’s margins getting squeezed as sales decline and this is going to remain the case for the foreseeable future. It’s the overlooked Medici Ventures Fund and in particular, holdings Bitt and tZERO, that make me bullish with the belief they will generate lucrative exit opportunities for Overstock further down the line.
Streamlining the offering
Throughout the second quarter Overstock successfully transitioned the e-commerce business to 100% home assortment. The company did this to streamline its offering. They had always placed emphasis on home, therefore when customers find other items such as jewelry on the site it creates a bit of a ‘mixed bag’ look and people don’t resonate the ‘Overstock’ name with purely home which has been their main focus for a while.
On the back of this transition, Overstock is now rolling out a new marketing campaign to improve that resonation. The main concern for me here is the company is aiming to achieve this during a period of considerable turbulence where growth is slowing down. The question is how this will affect margins, Overstock decreased marketing and sales expense by 32% compared to last year and 8.7% sequentially. This is the main lever (as a variable cost) that they can pull on to reduce expenses. The board will likely look to hold marketing expense at these levels, which may reduce the effectiveness of the campaign.
Operating an asset-light e-commerce business has allowed Overstock to maintain resilient Gross Margins.
However home-goods focus makes the bottom-line margins razor thin. Even when Overstock announced record figures in Q2 of 2021, adjusted EBITDA margin was still just 5.6%. In Q2 of this year, Overstock felt that squeeze when revenues sunk to $528M, Adjusted EBITDA margin moved 280 basis points lower to 3.9% or $21M. Considering the circumstances, reporting Non-GAAP profitability was pleasing. Particularly when key comp Wayfair (NASDAQ:W) turned to a large Non-GAAP loss in the second quarter.
Any further drop on the top line could see Overstock move closer to reporting a loss. This is because nearly half the operating expenses are hard to adjust – both Technology and General and Administrative were practically level year-over-year. Due to this operating income margin was just 2.1% compared to 4.5% in 2021. As mentioned the company did pull in the reigns on sales and marketing expenses but with the roll-out of a new marketing initiative, I’m uncertain how much more they can adjust this without seeing a large slowdown in demand. Management focus is on building long-term growth sustainably, if that comes with controllable near-term low profitability/losses I believe the market and shareholders should be prepared for it, with the pressure then on to achieve a sales recovery thereafter.
An analyst on the conference call did point out this query regarding further deterioration in margins to management, CFO Adrianne Lee said:
Certainly, Jonathan. And Seth, I would just say, of course, as you mentioned in the second quarter with our sales performance, we were able to deliver on our margin targets. And we’ve been able to do this over the last four quarters where we’ve seen revenue declines. To your point, and in Jonathan’s prepared remarks we talked about our goal is to continue to deliver results in that mid-single-digit EBITDA margin and manage our expenses effectively.
And CEO Jonathan Johnson followed up with:
Yes. Seth, we’re always going to look at our expenses carefully. We’ve proven we can manage them. And we have a model that works that way. We are – I should address the other part of, I think your comment and that’s what are we doing to drive sales, because top line growth helps all kinds of things. I’ll say a few things that we’re doing in merchandising and a few things that we’re doing in marketing.
Johnson then went on to talk about the success in adding SKUs and increasing engagement on the marketing side. These responses didn’t really directly answer the question posed and management was more focused on combating sales decline, inferring further sales decline would move the margins lower (as expected).
Medici Ventures Inc. was formerly Overstock’s wholly-owned subsidiary 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 general partner of the fund – giving them full sole authority over investment decisions.
The aim of the fund is to return Overstock’s invested capital first and then split profits thereafter based on the Limited Partnership Agreement.
The Medici Fund seems like the forgotten component of Overstock’s business. This is because it’s given very little air time by management in press releases and conference calls. Overstock management formed the agreement so that they could purely focus on the day-to-day operations of Overstock. Pelion, and their expertise, are entrusted with unlocking value in Overstock’s blockchain division. Medici’s financial results are no longer incorporated into Overstock. This is largely to the benefit of Overstock as the collection of pre-seed businesses would negatively affect the bottom line – In Q2 2021 Medici’s operating loss was $2.18 million. Considering this and Pelion’s expertise – this agreement looks to be a shrewd decision.
Medici owns a number of positions but the most notable and important of those are Bitt and tZERO.
Bitt provides a suite of industry-leading comprehensive financial technology solutions to help customers implement digital currency. Bitt has a digital currency management system that is the technology behind most Criteo Bank Digital Currency (CBDC) deployments across the world.
CDDC has gained increased traction from nations, according to the CBDC tracker from the Atlantic council it has been launched in eleven nations – primarily Caribbean nations along with Nigeria. The growth opportunity is even larger; 14 countries are in the Pilot stage and 26 are in development. Altogether over 90% of the world’s economy is exploring CBDCs.
Bitt’s focus is on Retail CBDCs, which aim to make central bank digital money available to the central public and therefore change the two-tiered system. This diagram from the Bank of International Settlements depicts it well:
tZERO is a blockchain-based asset exchange. tZERO unlike most decentralized blockchain platforms has been designated an alternative trading system and is regulated by the SEC. Overstock management didn’t discuss much about tZERO but did highlight recent director appointments in the CC:
In June tZERO added two new members to its board, 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 should benefit from their combined technology and financial services background. We remain excited about the future of tZERO.
The cryptocurrency space is facing increased regulatory pressure and scrutiny which for some this is a concern, but for regulated tZERO and Bitt this is welcomed. These appointments for tZERO go a step further in legitimizing the platform as both of these new members have previous experience on well-renowned exchanges.
It is going to take a long time before Overstock realizes any value from its Medici venture, this was something Medici Ventures head Matt Mosman was keen to highlight during Medici day. Medici will face difficult downturns like the current one, but the fund is prepared for it – they have strong capital backing and a well-diversified approach. Only one or two of these ventures need to have success for Overstock to realize large value. Right now Medici is in the back of the market’s mind but that will quickly with any sign of a future successful exit.
The Bottom Line
I am very skeptical when it comes to companies that own numerous businesses that are very different and generate little to no synergies between each other. But for Overstock, it’s hard not to be excited about the potential of the Medici Ventures segment. The company has given the fund the appropriate capital backing it needs and management has made the correct decision in passing off the assets to another operator with far greater expertise in the area. This allows management to focus on what they know best – e-commerce.
Overstock.com will see continued near-term sales weakness in relation to macro headwinds, but past that the prospects of the e-commerce 100% home goods business look strong. More importantly, I believe the market is missing a treat with the Medici Ventures business, which appears to be largely overlooked and forgotten by the sell-side.
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