In Berkshire Hathaway's (NYSE: BRKA) 1999 annual report, Warren Buffett once said:
Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price... We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated."
Note: Bold print and italics added by me.
So, I ask the question, "Why does a perennial money loser like Overstock.com (NASDAQ: OSTK) buyback its shares?" After a careful analysis provided below, I believe that Overstock.com's "unstated" reason for its share repurchases, like many other companies, is "to pump or support the stock price."
Patrick Byrne's father, former Ovestock.com Director John "Jack" Byrne who resigned and bailed out in 2006 over disputes with his son, is a former business associate and close friend of legendary investor Warren Buffett. Patrick Byrne himself once worked as CEO of Fechheimer Brothers, Inc., a Berkshire Hathaway company. So, why does Overstock.com CEO Patrick Byrne thumb his nose at the very wise advice of Warren Buffett?
Before we begin, let's review certain comments made by Andrew Watts from Oaktree Capital LLC during Overstock.com’s Q2 2008 earnings call:
….I am one of those guys who I think equity repurchases to a large degree are one of those emperor with no clothes kind of situations where a lot of companies have purchased huge amounts of stock at a huge premium to book value, which I see as really destroying shareholder value, except for the guys who happen to sell at that particular point.... I have just seen too many companies that have kind of swallowed the – drink the (inaudible) on the equity buyback and as a result really trash their balance sheets by purchasing stock at just ridiculous premiums to book and the mathematics to me are pretty simple.
Note: Bold print and italics added by me.
In other words, Andrew Watts believes that companies who pay "a huge premium to book value" to repurchase their common shares are “really destroying shareholder value.” However, Overstock.com has not historically practiced what Andrew Watts espoused in his comments above. Rather, the company has historically wasted shareholder capital as it gobbled up millions of shares by paying "a huge premium to book value" or rather "ridiculous premiums to book" and depleting working capital while reporting over $250 million in accumulated deficits to date.
Most recently, during Q1 2008, Overstock.com repurchased 1.1098 million common shares at an average price of $10.81 per share and paid a total of $12 million. In Q4 2007, the previous quarter before Overstock.com’s stock repurchases, the company’s book value was about $1.13 per common share. Therefore, Overstock.com paid "a huge premium to book value" of about ten times book value to repurchase its common stock.
During fiscal year 2005, Overstock.com repurchased 665,000 common shares at an average price of $36.24 per share and paid a total of $24.1 million. During that same fiscal year, Overstock.com acquired an additional 1 million common shares at an average price of $41.10 per share and paid a total of $41.1 million as a result of structured stock repurchase transactions. In Q4 2004, the quarter before Overstock.com’s stock repurchases, the company’s book value was about $8.77 per common share. Therefore, during 2005, Overstock.com paid "a huge premium to book value" of over four times book value to repurchase its common stock.
The "mathematics to me are pretty simple" too
Since 2005, Overstock.com repurchased approximately 2.765 million common shares at an average price of $27.92 per common share and totaling about $77.2 million of shareholder’s capital. As of yesterday, Overstock.com’s shares closed at $17.45 per share. Therefore, the average price per share of each common share repurchased by Overstock.com declined $10.47 per share for a total loss of about $28 million on those shares.
If you agree with Andrew Watts's comments, Overstock.com is "destroying shareholder value" by paying ever larger "ridiculous premiums to book" value. In 2005, Overstock.com paid a "huge" premium in excess of four times book value to repurchase its common shares and in 2008 the company paid an even more "ridiculous" premium of about ten times book value to repurchase its common shares.
In addition, Overstock.com suffered a significant drop in book value per common share from $8.77 per share in 2004 to just $0.54 per share at the end of Q1 2008 when it stopped repurchasing common shares. A major reason for the massive drop in Overstock.com's book value per common share stems from the fact that Overstock.com is a perennial money loser that has never had a profitable year and has reported about $254 million in accumulated deficits to date (Q2 2008). In fact, Overstock.com has reported only two profitable quarters since its inception in 1997 (Q4 2002 and Q4 2004). Those two quarter's reported earnings it turns out were overstated as a result of Overstock.com's intentional revenue accounting errors uncovered by the Securities and Exchange Commission in 2008.
Why did Overstock.com pay "a huge premium to book value" to repurchase it common shares?
Based on Overstock.com's historic pattern of false and misleading disclosures, violations of GAAP accounting, and lies by its management team led by CEO Patrick Byrne, as detailed in this blog, I believe that the company's common stock repurchases are part of its management's plan to hype up its stock price at almost any cost and by just about any means. A high stock price helps Overstock.com to capitalize its perennial money losing operations.
According to Overstock.com's fiscal year 2007 10-K report:
Prior to the second quarter of 2002, we financed our activities primarily through a series of private sales of equity securities, warrants to purchase our common stock and promissory notes. During the second quarter of 2002, we completed our initial public offering pursuant to which we received approximately $26.1 million in cash, net of underwriting discounts, commissions, and other related expenses. Additionally, we completed follow-on offerings in February 2003, May 2004 and November 2004, pursuant to which we received approximately $24.0 million, $37.9 million and $75.2 million, respectively, in cash, net of underwriting discounts, commissions, and other related expenses. In November 2004, we also received $116.2 million in proceeds from the issuance of our convertible senior notes in a transaction event exempt from registration under the Securities Act. During 2006, we received $64.4 million from two stock offerings in May and December. At December 31, 2007, our cash and cash equivalents balance was $101.4 million and we had $46.0 million in marketable securities, for a total of $147.4 million of cash, cash equivalents and marketable securities.
Note: Bold print and italics added by me.
Therefore, Overstock.com has received total cash infusions of about $344 million as a public company and it has yet to show any annual profits. Besides having accumulated deficits to date of about $254 million, Overstock.com has wasted another $77.2 million of capital by buying back its common shares at huge premiums to book value.
Starting from its inititial public offering in 2002, $228 million of Overstock.com's cash infusions came from selling about 10.5 million common shares to investors at an average price of $22.67 per share (based on gross proceeds of approximately $237 million). As I detailed above, since 2005, Overstock.com paid about $77.2 million to repurchase approximately 2.765 million common shares at an average price of $27.92 per common share. Therefore, Overstock.com paid about $5.25 per common share to buyback stock in excess of the average price it sold common shares to investors. Since Overstock.com's common shares closed at $17.45 per share yesterday, the current share price is $10.47 lower than the average price that it paid to repurchased shares from investors and $5.25 lower than the average price that it sold shares to investors. Where is the supposed shareholder value being created?
2004 - 2006: Sell high, buy lower, and then raise more capital at even lower prices per share as losses grow (its insaaaaane!)
Just take a look at Overstock.com's stock sales to investors, later repurchases of its common shares, and then having to go back to investors to sell even more shares as the company's losses mounted from 2004 to 2006.
In 2004, Overstock.com sold 2.68 million common shares to investors at an average price of about $43.90 per share and the company reported a net loss of $4.728 million. In 2005, Overstock.com repurchased 1.665 million common shares at an average price of $39.16 per share or $4.74 less per share compared to shares sold to investors in 2004. In 2005, the company's net loss widened to $25.1 million. In 2006, Overstock.com sold 3.776 million more common shares to investors at an average price of just $17.21 per share or a whopping $21.95 less per share compared to shares repurchased in 2005. In 2006, the company's reported a record net loss of $101.9 million.
Therefore, in 2005, Overstock.com repurchased 1.665 million common shares at a total cost of $65.2 million or $39.16 per share only to go back into the capital markets in the next year (2006) to raise about the same $65 million by selling 3.776 million common shares at an average price of $17.21 per share. The end result is a dilution of about 2.1 million extra common shares.
Could another answer be that Overstock.com wanted to stabilize its stock price after announcing that the SEC uncovered intentional revenue accounting errors dating back to at least fiscal year 2000?
In a previous blog post, I detailed how Overstock.com misled the SEC Division of Corporation Finance about the materiality of its intentional revenue accounting errors dating back to at least fiscal year 2000 in an attempt to justify a one-time cumulative adjustment to correct its revenue accounting errors rather than restate all prior year’s financial reports. In that blog post, I detailed how Overstock.com, in a February 26, 2008 letter to the SEC, failed to make a “full analysis of all relevant considerations” including both "quantitative and qualitative factors" to assess the materiality of its revenue accounting errors as required by SEC Staff Accounting Bulletin No. 99.
For example, in my blog post, one of the many factors that I detailed to determine materiality is whether or not the revenue accounting error resulted in a “significant positive or negative market reaction.” Overstock.com’s response to the SEC on that same question was “no.” The company went on to claim that:
The stock price has not moved significantly since the earnings release date [January 30, 2008]. Therefore, we believe that recording the cumulative adjustment in Q4 2007 would not affect a reasonable investor making an investment decision.
Note: Bold print and italics added by me. Bracketed information added by me for clarity.
However, Overstock.com failed to disclose to the SEC that during the month of February 2008 the company had repurchased a significant amount of common stock that very likely prevented its shares from declining in reaction to its revenue accounting errors. During the entire month of February 2008, Overstock.com repurchased 845,378 common shares at an average price of $11.11 per share or a premium of $0.23 per share or 2.1% over the average selling price during the February 1 to February 28 period. Such share repurchases by Overstock.com during the February period represented 14% of all shares traded or close to 10% of its float as defined by the company in its response to the SEC.
As I detailed in my previous blog post, Overstock.com did not repurchase any shares on January 30 and 31. On February 27 and 28, Overstock.com’s common shares closed at $10.61 and $10.79 per share respectively. Since Overstock.com paid an average of $11.11 per share from February 1 to February 28, it is very safe to assume that a significant majority of its share repurchases occurred during February 1 to February 26, prior to the company's response to the SEC.
Why didn’t Overstock.com tell the SEC about its stock repurchases? If Overstock.com had disclosed to the SEC its significant share repurchases during February 2008, the SEC may have objected to the company’s claim that its reported revenue accounting error resulted in "no" significant positive or negative market reaction.
To be continued....
Sam E. Antar (former Crazy Eddie CFO and a convicted felon)
Disclosure: Not long or short Overstock.com
Additional Note: I deleted my earlier blog post due an error in the Seeking Alpha earnings call transcript that erroneously attributed certain comments to Overstock.com CFO David Chidester. I apologize for the error.