Silvergate Bank is well positioned to be one of the dominant banks within the digital currency space with its strong network of industry connections and unique product offering. The company has been able to exhibit strong balance sheet growth despite nearly a year-long crypto bear market while achieving one of the lowest cost of deposits in the banking industry. Given the success of the digital asset industry, the upside potential for Silvergate can be extremely high. However, the company’s aggressive growth strategy coupled with the added complexities of monitoring customers’ cryptocurrency movements could open it up for possible fines/sanctions if any of its customers are found engaging in illegal activities. Additionally, management’s track record is an area of concern given its past cease-and-desist order from the FDIC.

Competitive Landscape

Within the current environment, digital currency related businesses have struggled to find reliable banking partners. The world of banking is highly regulated, and the vast majority of these institutions have been reluctant to work with the crypto industry due to the elevated levels of risk these clients present. Anti-money laundering regulations require banks to identify customers and to monitor the customer’s flow of funds, something that becomes tricky with the pseudonymous nature of cryptocurrencies. However, there are a handful of banks in the US that do accept digital currency related clients including Silvergate (SI), Metropolitan Commercial Bank (MCB), Signature Bank (SBNY) and Cross River Bank (private).

Although this first-mover advantage presents a great opportunity for these few banks that can stomach the added regulatory risks, the crypto industry has been facing a grueling bear market with the entire cryptocurrency market plummeting over 80% since its all-time high. The two largest types of customers in this industry include digital currency exchanges and crypto funds, both of which have been hurting as a result of the market downturn. Trading volumes have decreased significantly across all exchanges. Many crypto funds have shut down while others face subpoenas from US regulators.

Despite current headwinds caused by market volatility, however, Silvergate believes that the addressable market for fiat currency to digital currencies is somewhere between $30B to $40B.

History of Silvergate

Silvergate Capital Corporation is a $2.2B asset bank holding company for its wholly-owned subsidiary, Silvergate Bank. The La Jolla, CA-based bank was founded in 1988 and has 3 branches in San Diego County. The company began pursuing digital currency customers in 2013 through an initiative started by its CEO, Alan Lane.

After 5 years of developing its expertise in the space, SIlvergate has refined its core strategy around serving digital currency customers and has become a leader within crypto banking in the US. The company has been able to build a competitive moat with its unique products/services such as its Silvergate Exchange Network (a network that allows its customers to efficiently exchange USD amongst each other 24/7) and its proprietary approach to regulatory compliance. Silvergate has also created a wide network of powerful organizations in the digital currency space through its clients (such as Coinbase, Circle, Bittrex, Gemini, Paxos, bitFlyer, and Kraken to name a few) and its investors (most notably Digital Currency Group).

Business Strategy & Financials

Growing Customer Base

Through its digital currency initiative, the company has leveraged its unique product offering expand its crypto related client base. As of September 30, 2018, the company had 483 digital currency customers (up from 114 the year prior) with a strong pipeline of 145 prospective customers. The company splits its client base into three separate categories: Exchanges, Institutional Investors, and Other (developers, miners, custodians, etc.)

Strong Deposit Growth in 2017; 2018 Not so Much (But Still Better than MCB)

Thanks to a dramatic crypto bull run that took place late last year, Silvergate saw extremely robust deposit growth during 4Q17, increasing $790M sequentially to $1.8B. Since then, deposit growth has been much more modest, increasing by only $160M to $1.9B despite continued strength in customer growth. As of September 30, 2018, $1.6B of the banks $1.9B deposits belonged to its digital currency clients.

Management noted that deposits in existing digital currency related customer accounts had declined between December 31, 2017 and September 30, 2018 (presumably ~$550M when accounting for an influx of $831M in deposits from new customers during that same time period). Given the current state of the industry, declining deposit balances is not too surprising and I suspect the trend will continue in 4Q18 given the persistent market selloff we have seen thus far. Still, Silvergate’s digital currency related deposit growth for 2018 is impressive when compared to fellow crypto-friendly bank, Metropilitan Commercial Bank (MCB), one of the only banks besides Silvergate that publicly gives their digital currency related deposit figures.

Among the Lowest Cost of Deposits in the Industry

Cost of deposits for banks have been steadily increasing as a result of rising interest rates. However, Silvergate Bank has been able to achieve one of the lowest cost of deposit ratios in the industry (11bp vs. an industry average of 76bp) by catering to a community that has struggled to find banking partners. Noninterest bearing deposits made up 88.2% of total deposits as of September 30, 2018 (up from 12.4% in 2013) with its digital currency customers contributing the large majority of that. Management expects its cost of deposits to rise with potential increases in short term interest rates, but not to the same extent as the rest of the banking industry.

Interest Income Generation Limited Due to High Volatility in the Crypto Industry

In response to the extremely volatile nature of the crypto industry, Silvergate is forced to invest into mostly lower yielding assets to maintain high levels of liquidity. Most of the funding from incoming deposits has been deployed into deposits in other banks and investment securities, while loan growth has been relatively flat since last year. The net interest margin has come down as a result (3.45% vs. 3.77% in 3Q17), but still sits at moderate levels in part due to a high concentration of commercial real estate loans within its loan portfolio (nearly 50% of total loans). Moving forward, management plans to continue this shift in asset composition into more liquid assets which should push its NIM even lower.

Future Earnings Growth Reliant on Increasing Low-Cost Deposits

Diluted EPS grew to $0.86 for the nine months ending September 30, 2018, compared to the $0.59 for the same period last year. This came as a result of the huge interest-earning asset growth partially offset by a declining NIM and rising noninterest expenses. Since upside on interest income is limited due to the company’s asset allocation strategy, future earnings growth is heavily reliant on the bank’s ability to increase noninterest bearing deposits. Expanding the bank’s customer base will be extremely pivotal moving forward; especially if customer deposits continue to decline.

Fee income is currently only 10.2% of net revenues, but has the opportunity to scale as the Silvergate Exchange Network gains traction and the company adds new services; thus leading to additional upside.

Competitive Advantages

Wide Network of Industry Connections

One of the main aspects that separates Silvergate Bank from its competitors is its long list of connections from prominent organizations within the crypto community. The bank serves 483 digital currency related clients which includes some of the most well-known crypto exchanges such as Coinbase, Kraken, Circle, Bittrex, and Bitstamp. It also has many digital currency related investors (most notably Digital Currency Group) who accumulatively own approximately 13.1% of the company’s outstanding common stock. Moving forward, Silvergate will be able to leverage its contacts to be able to identify new customers and opportunities for growth.

Silvergate Exchange Network (SEN)

The Silvergate Exchange Network is a product the bank offers to its commercial clients that enables them to efficiently transfer US dollars from their SEN account to other SEN participants. As opposed to traditional wire transfers and ACH transactions which can take several hours to several days to complete, SEN transfers occur virtually instantly and can be done at any time (24/7 capabilities). The network launched in early 2018, and the bank has already had about 61% of its eligible digital currency customers participate in the program. Management expects the platform will one day grow to a “critical mass of adoption and utilization across the digital currency industry.”

Outside the traditional banking system, competitors to SEN include RippleNet and the Stellar Network. Like SEN, these global payment systems are fast, available 24/7, and benefit from a network effect as more participants enter the ecosystem. According to each of their websites, RippleNet had 100+ customers while the Stellar Network had ~25 companies that were either integrated with, working with, or supporting the platform at the time of publishing.

Proprietary Compliance Capabilities

Over the course of five years of working in the digital currency industry, the company claims that it has developed “proprietary compliance capabilities” which give the bank a distinct advantage from its competitors. These capabilities include:

· Prudently and efficiently establishing deposit accounts

· Ongoing monitoring of customer activities

· Evaluating a market participant’s ability to actively monitor the flow of funds of their own customers

In regards to how it establishes deposit accounts, the bank will categorize each customer based on its level of risk. At a minimum, the company will produce detailed reviews of each customer’s ownership, management team, business activities and the geographies in which they operate. Depending on the needs of each customer, the bank will investigate further with exchanges being the most complex/demanding. The on boarding process for each applicant can take between a few days to 6–8 weeks.

Although the bank did not give many details on the latter two capabilities within its S-1 filing, CEO Alan Lane did mention at a recent blockchain conference that Silvergate uses blockchain data to see transactions line up with customers’ deposits and claims.

Possible Growth Opportunities

Stablecoin Transaction Flows & Collateral

Stablecoins have been a hot topic within the crypto space as it’s seen as a more optimal medium of exchange compared to fiat currency. In theory, it shares many of the benefits of other cryptocurrencies with its ability to be traded quickly, cheaply, and securely, but without the price volatility. There are several types of stable coins, but the most widely used ones are backed by fiat currency. The aggregate market cap of the 8 most popular stable coins is just under $2.5B

Silvergate believes that further adoption of stable coins can benefit the bank in 3 ways:

· Transactions flows from fiat currency exchanged for stablecoins

· Moving of fiat currencies onto exchanges in order to buy stablecoins using the Silvergate Exchange Network

· Holding fiat currency in a deposit account as collateral

Management stated that they are “working closely with several leading stablecoin developers to hold their deposit collateral.” Currently, Silvergate has connections with Coinbase, Paxos, and Gemini but the extent of their relationship is relatively unknown. Each of those connections has their own USD-backed stablecoin called USD Coin, Paxos, and Gemini Dollar with market caps of about $170M, $135M, and $30M respectively.

Custodian Services for Digital Currencies

Silvergate estimates that there are “custodial services currently being sought with respect to several billions of dollars worth of digital currency related assets” and believes its well-positioned to capture market share given its existing relationships. The company hopes to establish a New York state licensed limited liability trust company subsidiary to provide these custodial services with a full application submitted to the state by 4Q18.

The bank will face competition in this area from several large institutions. Coinbase, one of Silvergate’s customers, opened its own custody business in July of this year. Fidelity announced the launch of its own crypto custody company called Fidelity Digital Asset Services in October. JPMorgan Chase, Northern Trust, and Goldman Sachs are developing their own products to hold cryptocurrencies in custody as well.

Risks

Several Large Depositor Relationships Make Up a Substantial Portion of Total Deposits

As of September 30, 2018, Silvergate has $1.1B in deposits, or 56.2% of its total deposits, from its 10 largest accounts (9 of which are digital currency related customers). It’s likely that these digital currency related customers have deposit accounts with Silvergate that are almost entirely noninterest bearing. Not only is Silvergate’s financial stability highly dependent on these few customers, but that reliance also gives these customers leverage to negotiate for higher-yielding deposit accounts that are more in line with traditional banks.

Management stated that withdrawals from any of these accounts could force the bank to rely more heavily on higher costing sources of funding like borrowings, which would have adverse effects on net interest margin and overall profitability.

Regulatory Risks Associated with Digital Currency Customers

Strict anti-money-laundering (AML) regulations require banks to identify their customers, know who they do business with, and monitor their flow of funds. Most banks have refused to work with crypto related companies in large part due to the added complexities of monitoring the flow of funds of digital currencies. Both Signature Bank (SBNY) and Metropolitan Bank (MCB), two of the only banks in the US that have accepted deposits from crypto clients, have mentioned being extremely selective with prospective clients from the industry. Joseph DePaolo, CEO of Signature Bank, even said that his bank has “turned down billions of deposits” from crypto businesses they deemed as bad actors. With Silvergate bringing on so many new clients, it could be possible that they are not being prudent enough with their selection process, opening them up for possible fines or sanctions.

Concerns

Top Executives Still Remain Following Cease-and-Desist Order in 2006

On December 18, 2006, the FDIC hit Silvergate Bank with a cease-and-desist order that detailed several unsafe banking practices and violations of the law/regulations which included:

· Polices and practices of management which were detrimental to the bank and jeopardized the safety of its deposits

· Inadequate supervision over management of the bank from its Board of Directors

· Inadequate loss reserves

· Inadequate internal routine and controls policies

· Operating in violation of the Bank Secrecy Act

· Operating in violation of the Federal Reserve’s restrictions on transactions with affiliates

Although the cease-and-desist order from the FDIC was later dropped after the bank made several improvements, a few of the executives that were responsible for the bank’s problems still remain in prominent positions on the Board and management team. Those include the following:

*It’s not clear what role Robert Campbell held at the bank in 2006. At a minimum, he was a Director on the Board at that time.

Chief Credit Officer’s Past Association with Steve Sugarman and Banc of California Allegations

Under the helm of former CEO, Steve Sugarman, Banc of California (BANC) was surrounded by controversy. Stemming from several detailed posts from an anonymous short seller that came out late 2016/early 2017 (Post #1, Post #2, Post #3), Sugarman and his team were accused of several nefarious activities. Some of these allegations included:

· Former-CEO Steve Sugarman and former Lead Independent Director Chad Brownstein’s strong ties to fraudster, Jason Galanis

· Several related party transactions that benefitted insiders

· Mortgage fraud hidden by a complex scheme which involved:

The bank hired law firm WilmerHale to do an independent investigation of these claims in late 2016. On February 9, 2017, Banc of California put out a press release stating that WilmerHale did not find any violation of the law or “evidence establishing that any loan, related party transaction, or any other circumstance impaired the independence of any director.” Strangely enough, the bank has since sold its mortgage lending business and has almost entirely replaced its management team. The bank is currently facing an ongoing SEC investigation and several lawsuits related to the situation.

Paul Simmons, Silvergate’s EVP & Chief Credit Officer, was there for a lot of the ordeal. According to Silvergate’s S-1 filing, it says that Simmons most recently worked as Banc of California’s Chief Credit Officer between 2016 and 2018. However, a press release put out on November 3, 2017 states that Simmons had started a lending company called The Capital Corps, LLC with Sugarman and fellow ex-BANC employees, which implies that he was no longer with BANC at that time. It’s uncertain how long Simmons worked at The Capital Corps, but according to his LinkedIn, he joined Silvergate in April 2018.

Simmons’ repeated affiliations with Steve Sugarman and his association with the controversy at Banc of California are concerning and add to the bank’s risk profile.

Conclusion

Although Silvergate has been able to increase its profitability in the midst of a nearly year-long crypto bear market, future earnings growth will heavily rely on the bank’s ability to draw in new digital currency clients. Assuming the long-term success of the crypto industry, Silvergate is well positioned to be a leading banking provider in the space with its unique product offering and deep industry connections. However, as more banks start entering the market, it will become increasingly more important for Silvergate to maintain the competitive moat it has established. The complexities of digital currencies and the digital currency industry currently present large downside risk if the bank is unable to monitor for illicit activity. The performance of its management team is also an area of concern given a previous cease-and-desist order from the FDIC.

Disclaimer: I am not a financial advisor. Investing based on this report is done at your own risk. All information was derived from publicly available information. I have no financial interest in Silvergate’s S-1.

This is a follow-up from my OSTK 3Q18 Preview

Overview

Overstock (OSTK) reported earnings after the close on Thursday, November 8, 2018. Although financial results were mixed, management seemed optimistic on the call as it described a more efficient retail business and progression towards closing the deal with GSR. The next day, however, the stock tanked 15.5% to $17.21 a share. What caused the major sell-off following the call despite management’s upbeat outlook?

A few red flags listed in the 10-Q:

· $94.6M of common stock sold through the companies ATM offering during the quarter (an 8.2% dilution)

· GSR likely buying tZero equity at a lower valuation than the previously announced $1.5B

· Overstock’s fallout with StockCross, likely causing the delay in the token trading platform launch

· Questionable business practices with company acquisitions

ATM Offering

Last quarter, Overstock quietly announced in its 10-Q a sales agreement it had with JonesTrading to conduct an ATM offering of up to $150M in common stock. Once investors got wind of it, the stock quickly dipped. In the 3Q18 10-Q released last friday, the company revealed that it had sold almost 2.9M shares of its common stock (an 8.2% dilution) for proceeds of $94.6M through its ATM offering. The average price it sold at was $33.71 (a price that OSTK held for less than a week after it announced GSR’s $1.5B valuation of tZero on August 9, 2018).

The company went on to say:

“Although we believe that our cash and cash equivalents currently on hand and expected cash flows from future operations will be sufficient to continue operations for at least the next twelve months, we also believe that we may need to raise additional capital and/or obtain significant additional debt financing to be able to fully pursue some or all of our plans discussed below, including plans for our retail business while also funding our Medici initiatives, beyond the next twelve months.”

It also follows it up by saying:

“Any projections of future cash needs and cash flows are subject to substantial uncertainty.”

Right now, the $55.4M available in the ATM offering is one of the very few options Overstock has at the moment to raise additional capital. Despite management stating that it doesn’t need the capital, the company currently faces a multitude of reasons in which it would need a boost:

· Receiving less capital from GSR than originally anticipated

· Lower than expected sales growth due to a reduction in ad spend

· Funding needed for a new broker for its security tokens after the fallout with StockCross

· Additional exposure to claims under Delaware’s Abandoned Property Law

With each of these reasons having a decent likelihood of happening, I would not be surprised if Overstock took advantage of the rest of its ATM offering sometime in the near future leading to further stock dilution.

GSR likely to buy-in at lower tZero valuation

On the earnings call, management noted that the deal with GSR was progressing nicely as GSR recently completed its extensive due diligence process. CEO, Patrick Byrne, noted that “we have until December 15, but I think [the completion of the deal is] going to be significantly sooner than that.”

However, the company skipped over a few crucial details that were mentioned in the 10-Q.

1. GSR is likely to purchase fewer shares of OSTK stock at a lower price per share.

2. GSR might be able to buy tZero equity at a lower valuation than the $1.5B that was originally agreed upon.

Neither of these details are surprising given the drop in OSTK’s share price as well as Overstock’s desperate need for a capital injection. Although it is reassuring knowing that the deal with GSR is more likely to happen after management’s comments, I am curious to see how low Overstock would be willing to drop its tZero valuation and how the stock would react if it was announced to go through at something like a $800M valuation instead.

Overstock’s fallout with StockCross

After a previously-expected 4Q18 launch date, the company stated this quarter that the opening of its token trading platform would be delayed till 1Q19. The details on why the launch got delayed were glossed over, but the 10-Q gave some insight.

Back in February, tZero announced that it had purchased a 24% stake in StockCross Financial Services for $12M to add a partner with the custodial and clearing functionality of a U.S. DTCC member. In the 3Q18 10-Q, the company also stated that tZero had plans on using StockCross as an Introducing Broker and Clearing Broker for security token trading, but recently chose not to go through with that idea.

The 10-Q goes on to say that:

“During the third quarter of 2018, tZERO began evaluating alternative strategic relationships that may replace one or more roles tZERO expected StockCross to fulfill. tZERO believes it has identified suitable candidates to perform these roles but has not yet entered into definitive agreements with those parties. Management of tZERO will continue to devote time and resources to identify the necessary components for tZERO’s trading ecosystem and enter into appropriate licensing and/or other contractual arrangements with one or more entities. Doing so will likely require capital and may cause delays to the development and launch of tZERO’s planned trading platform.”

Although the reason as to why it chose not to use StockCross as its broker for security tokens was not disclosed, I suspect it had something to do with the departure of Todd Tabacco, Overstock’s prior SVP Business Development and brother of John Tabacco, tZero co-founder who also departed from the company earlier this year. According to his LinkedIn, it says that Todd left the company in August 2018. Todd was also the Head of Securities Lending at StockCross. The fact that Overstock backed out of an agreement with US registered broker-dealer, Weeden Prime Services, to acquire 81% of Weeden’s outstanding membership interests for $18M further supports this claim. Todd had previously served as Vice President for Weeden back in 2014.

Like I said in my preview, I believe it to be extremely crucial for tZero to stick to its timeline for its token trading platform with competitors like OpenFinance Network vying to beat it to the punchline. The delayed launch date coupled with the possible time/capital needed to find a replacement broker-dealer is extremely concerning.

Questionable business practices with company acquisitions

After following Overstock for some time, I have noticed that the company has a habit of investing into its executives’ pet projects. With these executives being in positions with major influence on company acquisitions, it’s hard to imagine that these individuals would remain partial to OSTK’s shareholders when negotiating an acquisition price for their own side projects. Seeing this pattern makes me question whether Overstock is deploying its capital meaningfully or if management is trying to cash out at the expense of its shareholders.

Chainstone Labs

In September 2018, Medici Ventures entered into a stock purchase agreement with Chainstone Labs to acquire a 29% equity interest in the company for $3.6M. Very little is known about the company besides the fact that it is 71% owned by Medici Ventures and tZero Board member, Bruce Fenton. The company appears to have been created a year ago and it focuses on the tokenization of securities and digital assets according to its website.

Bitsy, Inc.

In July 2018, Medici Ventures entered into a stock purchase agreement with Bitsy, Inc. to acquire an additional 25% equity (beyond its current 33% interest) for $3.0M and $1.5M worth of OSTK common stock. This would put Bitsy at a valuation of $18.0M. The digital wallet company was founded about a year ago by Medici Venture Chief Operating Officer and general counsel, Steve Hopkins, and is managed by presumably Steve’s wife, Ann-Marie Hopkins, who serves as CEO. According to LinkedIn, the company has around 7 employees, one of which is presumably Steve’s daughter, Grace Hopkins.

SiteHelix

In June 2018, Overstock acquired SiteHelix for $500K plus 100,000 shares of OSTK common stock for an aggregate purchase price of $3.4M. tZero CEO, Saum Noursalehi, co-founded the company and owned 62% of SiteHelix prior to the acquisition. SiteHelix’s website had minimal details, but according to LinkedIn, the company was founded in 2015 and provided SaaS solutions to automate the optimization of content on mobile and web pages.

Medici Land Governance

This company was not acquired by Medici Ventures, but rather was formed by Medici Ventures alongside Overstock CEO, Patrick Byrne. The reason I bring this company up is due to its origins as DeSoto, Inc. DeSoto, Inc was first announced on December 13, 2017 where Patrick partnered with economist Hernando De Soto to form a company in which individuals could claim ownership of property using blockchain technology.

According to this MOU, Patrick was to invest $14M into the company by the extended deadline of July 31, 2018 (the original deadline was March 31, 2018). By looking at the work dates provided by Medici Land Governance President, Rob Huges, on his LinkedIn, it appears that DeSoto Inc. was abandoned after the MOU expired and Medici Land Governance (MLG) took its place. It was not until September 21, 2018 where Patrick invested $6.7M into MLG for 43% ownership.

From my perspective, it appears that Patrick failed on his obligation to provide the needed capital for DeSoto Inc. leading to Hernando De Soto’s departure. This just goes to show how fickle the company and its management team can be with its agreements.

Conclusion

Despite management’s rosy depiction of the quarter on the earnings call, several red flags were left buried in the 10-Q. The stock reacted negatively with a 15.5% downturn the following day. Despite this, however, I think the selloff has further to run as people discover the full extent of the problems presented during the quarter. An announcement of a completed deal with GSR capital could easily send the stock soaring depending on the stipulations, but in the long term I think the outlook of the company looks bleak due to the constant missteps of its management team.

Disclaimer: I am not a financial advisor. Investing based on this report is done at your own risk. All information was derived from publicly available information. I am neither long nor short shares of OSTK.

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.

Disclaimer: I am not a financial advisor. Investing based on this report is done at your own risk. All information was derived from publicly available information. I am neither long nor short shares of OSTK.