An Interview With Overstock.com CEO Patrick Byrne

On June 16, The Wall Street Transcript interviewed Patrick Michael Byrne, Chairman and CEO of Overstock.com (OSTK). Key excerpts follow:

TWST: We'd like to begin with a brief historical sketch of the company and a picture of the things you are doing at the present time.

Mr. Byrne: The historical sketch of the company: it grew out of one idea, and that is, at the corner of retail there is a group of people called "jobbers" who clean up the mistakes of retail. They clean up excess orders, bankruptcies, etc. Our goal was to become an online jobber, where we would buy stuff, bring it into Salt Lake and sell it on the Internet. We wouldn't have everything, but what we would have would be cheaper than anyone else. That was the idea. It let us get going on comparatively little money, very little invested capital compared to the other big guys, and it worked very well for about five years. I'd say that we grew the company on a shoestring. Up to the end of 2005, the business plan was just to grow. We found that we should grow 60% to 100% a year at basically breakeven. We call "breakeven" plus or minus 1% as breaking even. So that was our motto, let's keep that up as long as we can on an annual basis, and then some day the world won't let us grow at a 100% rate, and at that point we slow down and see what we have. That whole theory worked very well until, let's say, the end of 2005.

At the end of 2005, we had built the company on a shoestring; we built an $800 million business on a shoestring. I think we had lost about $70 million GAAP at that point. In 2005, we started switching to enterprise class systems, big, expensive, powerful systems that could support us well into the multi-billion dollar range, maybe even $5 to $10 billion. Through a combination of just growing so fast on the systems we had and switching over to these new systems very abruptly, the shoestring broke.

We also realize that there were some things going on in the Internet marketing world. We realize now it had changed dramatically and we hadn't kept up with it. We had originally been, I think, the guys who figured out a lot of Internet marketing techniques before other people. But for a few years, I think we got kind of stale on figuring out the new techniques. As that happened, for one reason or other, growth came to a screeching halt. We got the technology figured out, the shoestring fixed and replaced with a cable in early 2006.

But 2006 was a horrendous year economically; we lost $100 million. We always had our scale chasing our actual size in the past. Then starting in 2005 and 2006, we built this big engine, and it was way over-built, given that our growth had stalled. So we had to spend 2006 and 2007 — 2007 especially — really cutting expenses, cutting out some of this extra scale we had built, and we got through it, had some bad losses but we got through it, and in the first quarter reported growing 27%. We have a nice trailing 12 month operating cash flow in the $20 million range at this point, and so we feel like we're through the woods. Now we're just starting to leverage this operating system that we've built.

TWST: Your stock rose as high as $77 at one point?

Mr. Byrne: Briefly, yes.

TWST: And now it's back down to $26. You've had sort of a campaign against naked short selling. Did that affect what you were doing?

Mr. Byrne: I've tried to do everything I could to separate Overstock.com from the naked short selling campaign. Here's the issue. There has been a myth for over a decade in the markets that there is a way that hedge funds have been serial killers of small companies for profit. I always ignored this myth until somebody got in touch with me and started telling me about it, and then made some predictions that came true. I eventually said I would look into it, and I eventually become convinced this is true.

There are hundreds, maybe 1,000 or more companies that have been destroyed by hedge funds using an illegal technique. It's a perfect crime because nobody even sees there is a crime. A typical citizen just sees that her stock portfolio goes down, and she doesn't understand that behind the scenes the game has been rigged. So I got involved.

To me there's been a cover-up. The cover-up has been people saying "this guy is just mad that the stock price went down." But I have been talking about this issue when our stock was going up, when it was going down, when it was going sideways, and now it has tripled in the last month or two, and I am still talking about it. It's because the issue really isn't about Overstock, the issue is that we have this enormous problem in our capital markets which somebody needs to address, and, yes, it has affected Overstock, but to me, the way that people have been adamant about trying to spin this off as an Overstock issue — "oh, this guy should just focus on Overstock" — they are missing the point quite deliberately, it seems to me.

TWST: You said that you have done very well, that your stock price has tripled. What were the initiatives that you took to correct the problems?

Mr. Byrne: There are two different issues. The initiatives we took to correct the problems were taken in 2006 and 2007. I think what's happened is the laws have changed or rather, the regulators have started to enforce the law. It may be rather gently, but they've started to enforce the law of late. I think that has meant that the people who have been manipulating the stock are having a tougher time of it as of late.

TWST: What's on your agenda for the next few years?

Mr. Byrne: We have launched a car tab, we have launched an auction tab. Both of them are making money, small amounts of money, but they are covering all their expenses and doing well. We have one more tab launching: real estate. And it's really to make Overstock the central place for somebody who wants to squeeze a penny.

I think our economy is in for a very rough future. Typically value shoppers are poor people and rich people. The middle class pays full retail. But what happens is when you go into a recession the middle class starts trying to maintain its standard of living and to do that they have to figure out better ways to spend their money, and I think that's where we pick up a lot of new customers.

TWST: What about future challenges and problems. What are you going to be worrying about?

Mr. Byrne: I think we still have several more months of getting this model fleshed out. It's been many years. We tripped and broke our ankle, but I think we are back. I would say that this year feels like it is going to be a fine year. We're going to have a nice positive operating cash flow. I think that if this year goes well, it will really convince ourselves that we're out of the woods and we can be a little bit more forward thinking, not just fixing problems. But I see an opportunity for our growth maybe to spin up. I don't think things are going to spin back up to 100% growth, but I think it's quite possible that you could see us spinning up to a growth rate substantially above where we are now, by the end of this year. And then the goal is just going to be to keep the nose of the rocket above the horizon like that and see what kind of trajectory we can get ourselves into.

TWST: What yearly milestones should investors watch for over the next couple of years?

Mr. Byrne: What they should watch for is our G&A and Tech. The economics of our business are very simple to model now. They've become much simpler than they have ever been. Our G&A and Tech is basically running at about $100 million a year, and I think it can stay there for several years, because within that G&A and Tech is $25 million of non-cash charge and that's dropping to $15 million next year, and it keeps on dropping and I think it goes flat at $10 to $15 million. But what that means is we should be able to keep our G&A and Tech fixed at $100 million for a couple years.

So then the question is, what can we do with our contribution margin? Well, our contribution margin, that is, our gross profit minus our marketing, I would like to see that a notch above $100 million this year. What people should look at is not the growth in the top line, it's the growth in the contribution margin, which is, once again, the gross profit minus your marketing costs. In the first quarter, that grew 41%. If we can keep that number growing anything like 41%, which is a tall order, but even if your model is growing  at 25%, I think we will have a great business. And those are the two numbers people should really fix on, the G&A and Tech staying at about $100 million GAAP, and the contribution margin (the gross profit minus marketing cost), how fast is that growing. Those two numbers really will end up determining the whole economics of the business.

TWST: What would be the two or three best reasons for the long-term investor to look very closely at Overstock?

Mr. Byrne: I can't make a recommendation. I can't suggest that people look. I can't suggest that people buy and in fact, sometimes I have gone out publicly and said, this is a pretty dangerous stock to own, because it's being manipulated by very powerful people, and I am unpopular. A couple of years ago I was told by a well-known hedge fund manager that I had become the most hated man on Wall Street. He says that I could kill people and I wouldn't be hated like people on Wall Street hate me. So I don't go out there and try to convince people to buy our stock. They have to figure it out themselves, but how can they do that reasonably? Let's just assume $100 million of G&A, I can say we're going to have about $100 million of G&A for a few years. And the question becomes, how quickly do you think we can grow that contribution margin, and so it's a pretty easy business to model at this point.

Comments

[John Pseudonym:]

I like overstock.

I've recently started shopping there more often and will continue to look there first for the items I want.

I am done shopping at eBay! That place is a disaster! I won't run through the list, but I dread buying there.

2008 Jun 16 03:35 PM

[Berkstock3:]

A very good interview by Dr. Byrne.
he has made it very easy for everyone to understand although I wish that Sam Antar or another Seeking Alpha contributor could please explain what "positive operating cash flow" means?

I also found the mention of the stock being at $26 a share interesting. for people that follow the direction of this stock they probably uunderstand and realize the interesting point that it is imo.

Long Overstock.com and proud of the leadership that this company shows its shareholders.

Berkstock3.com

2008 Jun 16 06:07 PM

[Indaknow:]

Mr. Byrne seems to have an excellent grasp on his numbers. I credit him for that.

His grasp on reality may be somewhat more tenuous. What he seems to omit above is the amount of company resources that he devotes to his 'crusades' (multiple Overstock employees working on his personal anti-naked short selling 'deep capture blog', slimy stalker Judd Bagley on the payroll for the entirety of 2007, etc), the unqualified and spineless personnel that he surrounds himself with simply because they are bullied into agreeing with his every word (anyone who does agree with him is promptly shown the door), and most importantly the contradiction between his diversification of the business (Auctions, Cars, Real Estate) and the results of that diversification.

He neglects to mention that Auctions has been around since 2004 and that model had never made any noise until ebay started to make mistakes. Auctions nearly closed auctions in 2006, but instead fired 80% of the staff to avoid showing any sort of cracks in the armor. Overstock lost tens of millions of dollars on 'O-travel' between buying it in 2005 and selling it in 2007. The cars site brings in about $.00002 per visit, and the real estate site is simply a platform for allowing other companies to use their engines on a larger site. I doubt Overstock does much to monetize foreclosed real-estate that it sells on-site after all the middle men have been paid. I certainly does help Byrne do what he does best... put on an elaborate dog and pony show that attempts to demonstrate success and hide fundamental problems with his business (i.e. never having turned a profit).

2008 Jun 16 06:16 PM

[truthinvesting:]

this stock should be shorted over 30

2008 Jun 16 06:19 PM