OSTK 3Q18 Earnings Preview

Earnings Call to be held on Thursday November 8, 2018 at 1:30PM PT

Background

Despite mixed financial results for 2Q18, investors seemed revitalized after private equity firm GSR Capital announced its intention to invest into tZero at a generous post-money valuation of $1.5B. The stock quickly shot up to $48 a share. Since then, however, the price has plummeted to around $20 (a 57% decline) as doubts have been accumulating around the deal after three months of no updates.

As we approach the company’s 3Q18 results, there are 3 key items investors should listen for:

· An update on GSR Capital’s investment

· Retail sales growth

· Progress on the STO exchange

Will GSR commit the capital?

By far the biggest question at the moment is whether or not GSR Capital will invest into the company as per the conditions agreed upon in the Token Purchase Agreement and term sheet that was announced on August 9, 2018.

Token Purchase Agreement conditions:

· GSR agrees to purchase $30M of tZero Security Tokens from Overstock.com at $6.67 per token

Term sheet conditions:

· GSR can purchase up to $270M in tZero equity (at a $1.5B post-money valuation) for up to 18% of tZero’s equity

· GSR can purchase up to $104.55M in OSTK common stock at $33.72 a share (a 5% discount to the closing price on August 1, 2018)

No formal updates have been released since then. On October 30, 2018, however, tZero CEO, Saum Noursalehi, sent out a tweet stating that “[GSR Capital’s] due diligence still in progress.” With the earnings release date quickly approaching, it seems extremely unlikely that the situation would change in time for the call.

As a result of a significant decrease in OSTK’s share price since last quarter, I suspect GSR will try to negotiate a buy-in at a lower purchase price. They may also be able to convince Overstock to allow them to purchase tZero equity at a lower valuation by leveraging Overstock’s strong need for a capital injection.

There is also the possibility that the deal completely falls through like it did back in July with Nissan and GSR. Nissan supposedly cancelled a potential $1B sale of its battery business to GSR because the automaker claimed that GSR lacked the funds to make the purchase.

How much will a reduction in ad spend affect sales growth?

Last quarter, Overstock was able to achieve nearly 12% yoy sales growth with revenues coming in at $483M. However, this came at the cost of a 218% increase in ad spend to $94M (nearly 20% of revenues). The company stated during last earnings call that expenses had been elevated due to extensive pricing campaigns/testing but that marketing spend would come down moving forward in order to improve cash flows. This reduction in ad spend also falls in line with the demands of prospective buyers of the retail business who are looking for “a more modest growth company with less cash maintenance cost” as Senior VP of Strategy, Seth Moore, describes. The question is how much will a reduction in ad spend influence sales growth. I expect 3Q18 sales growth of 3% to $436.7M, although negative sales growth could definitely be a possibility.

When will the tZero trading platform launch?

According to the company’s product roadmap that was presented during last earnings call, the company expects the token trading platform to launch late 4Q18. With competitors like Chicago-based OpenFInance Network (which is also expected to launch its trading platform 4Q18) vying for a first-mover advantage, it’s crucial that tZero sticks to its timeline. We will be listening for any updates for the upcoming launch on the call.

Conclusion

With the retail business struggling to find a buyer as well as it continuing to lose market share to Wayfair, investors are putting most of their faith in the blockchain-side of the business. A potential investment into tZero at a lofty $1.5B from GSR Capital seemed to rejuvenate shareholders following a rocky STO. However, tZero CEO, Saum Nouralahi, revealed in a mostly unnoticed tweet last week that the private equity firm is still in the due-diligence stage (which strongly implies that GSR has yet to deploy any capital). I believe any investment from GSR before the earnings call to be extremely unlikely, leading to a slight pull-back in the stock as the many shareholders who missed Saum’s tweet are left disappointed. I also expect 3% sales growth from the retail business, but something <0% could definitely be possible given the decrease in ad spend, which would prompt further sell-off.