Formerly sleepy Overstock.com Inc (NASDAQ:OSTK) has become of the more volatile stocks in the market. Backed by blockchain/cryptocurrency enthusiasm, OSTK stock has risen 454% over the past year, with most of those gains coming just since early August.
The surge in optimism is coming from the company’s Medici Ventures subsidiary, including its tZERO ICO platform. Medici (and thus Overstock) owns 81% of tZERO, which is SEC-compliant (a big deal in the cryptocurrency “Wild West”) and undertaking an ICO of its own.
In fact, CEO Patrick Byrne has said he very well may sell the legacy e-commerce business. He told listeners on the Q3 conference call that “there is a non-negligible possibility that this is our last earnings call together.” Earlier this month, rumors swirled that Kroger Co (NYSE:KR) might be interested in buying the business.
Somewhat ironically, that business does seem like it has real potential. Operating margins are ridiculously low, but there is some promise going forward. The blockchain side of Overstock, which has fueled the quintupling of OSTK stock, simply looks overvalued.
That’s not to say that there’s no value there. Overstock has a real model, and the gains of late don’t look as silly as those at Eastman Kodak Company (NYSE:KODK) or Riot Blockchain Inc (NASDAQ:RIOT).
Unlike those companies, Overstock isn’t a Johnny-come-lately to blockchain. Byrne and his company have been building toward this moment for several years.
That makes OSTK stock probably the purest play on whether blockchain is truly a transformative technology. The problem at $75 is that even if Overstock is right, so much of its potential already is priced in. And there are a lot of reasons to believe that Overstock isn’t right.
At the moment, there are two core pieces to Overstock’s blockchain ambitions. The company does have smaller, newer initiatives, including De Soto, which launched last month. But of the nine companies in which Medici owns a stake, only two really matter in the near-term, and in the other seven, Medici’s ownership in some cases is only a minority stake.
The first big project is tZERO – and it’s an intriguing offering. The SEC is starting to pay closer attention to the space, and the core legal question of whether ICOs should be treated as securities from a regulatory standpoint. With fraud and losses unacceptably high, tZERO can position itself as a safe, regulated exchange. Given that Nasdaq Inc (NASDAQ:NDAQ) has an enterprise value of $17 billion, and New York Stock Exchange owner Intercontinental Exchange Inc (NYSE:ICE) is worth close to $50 billion, the potential is obvious.
Of course, the ICO itself needs to be a permanent part of capital markets – far from guaranteed. If ICOs and coin trading volume plummets, tZERO isn’t worth much. If volume reaches even 10% of NASDAQ volume, however, in theory tZERO could support the entire current value of OSTK stock.
One early concern: tZERO’s own ICO appears to be moving slower than planned. Byrne announced last month that $100 million already had been committed. But a Form D filed on Wednesday shows just $38.5 million in sales so far.
Securities Lending and OSTK stock
tZERO is intriguing, even to a cryptocurrency skeptic like myself. But Byrne’s case for a new securities lending business is questionable at best.
Byrne and Overstock spent years suing traders who allegedly were “nakedly” shorting OSTK stock. He claims that discovery in that suit shows that, as he put it on the Q3 conference call, that “75% of American prime brokerage revenue” of Goldman Sachs Group Inc (NYSE:GS) comes from securities lending.
It’s a profitable and opaque business. A dear friend of mine has worked in that business for close to two decades. As he can tell you, it’s been a target for technological disruption the entire time. Yet because of long-standing relationships, and the varying credit profiles of counterparties, it hasn’t changed.
Why will Overstock, with no real experience in the space, succeed where so many have failed?
But there’s a larger concern here. Byrne tends to oversell his case. Multiple times on the call – and elsewhere, as a blogger has pointed out – Byrne dropped the “prime brokerage” qualifier:
“I’m telling you we have an invention – we’re going after 75% of Goldman’s revenue,” he said on the call. Earlier, he said “I suspect [securities lending] may be 100% of the profits at Goldman Sachs.”
Byrne may be misspeaking but investors are incorrectly taking him literally. Prime brokerage is only a part of Goldman’s Securities Services business, which generated just 11% of the company’s total 2016 revenue, per the 10-K.
Meanwhile, the 75% figure dates to 2009, according to a document in the Q3 investor presentation (slides 22-23) – when the equity markets were in upheaval.
Overstock is not trying to displace all of Goldman Sachs. It’s targeting a narrow piece of their business which is much, much smaller than some investors seem to believe, and which has been amazingly resilient to disruption over the years.
What is OSTK Stock Worth?
For the immediate future, OSTK is going to trade on sentiment. For ICO believers, it’s the best play in the equity markets, particularly because non-accredited investors don’t have early access to the tZERO ICO. The opportunity in the securities lending business makes some sense, even if some investors clearly overvalue it.
And OSTK stock only is worth $1.7 billion at the moment. As long as investors can point to the valuation of Goldman Sachs, NASDAQ, and ICE as comparisons, that figure can rise.
With real businesses backing that value, I’d much rather own OSTK stock than KODK, RIOT, or Longfin Corp (NASDAQ:LFIN). And while the legacy business isn’t profitable, Byrne’s argument that money-losing rivals like Wayfair Inc (NYSE:W) are skewing profitability do make some sense.
So shorting OSTK stock looks like something close to financial suicide at the moment, even though the stock has pulled back. But longer-term, I’m questionable there’s a billion-dollars-plus in value here.
Byrne talks a good game, but adding blockchain to efforts industry insiders have made for over a decade doesn’t guarantee success. That talk will keep Overstock up for some time. But unless the company wins big, a letdown is sure to follow.
As of this writing, Vince Martin has no positions in any securities mentioned.