Poor Overstock.com! The firm created an interesting business model that has attracted analyst criticism for years. Given all the attention, we just couldn’t resist taking a look ourselves, and the current vitals do not look good. Actually, as we shall soon see, that is an understatement!
Sam Antar has long asserted that the company has been involved in some accounting hanky-panky and insider trading. For example, Antar claimed that the CEO dumped some stock before a bad earnings report and misled investors as well. Antar currently thinks the firm is in a death spiral and appears ready to write its obituary.
And Sam is not alone. Writing for Seeking Alpha, Gary Weiss wrote about the apparent unreliability of Overstock’s accounting. Greg Greenberg at TheStreet.com thought it dumb for the Company’s CEO to say “it was an ugly end to an ugly year.”
So, we decided to take a look and see what the fuss is all about. We opened the Overstock 2011 10-K and indeed, it isn’t pretty. As our readers know, we’re traditionalists, so the first thing we did was to compute the Altman Z-score. After all, if you can’t find a pulse, there isn’t much use in testing for other signs of financial health. We applied Altman’s modified model for non-manufacturers as discussed in his 2002 paper, “Corporate Distress Prediction Models in a Turbulent Economic and BASEL II Environment”:
Z = 6.56 * WC/TA + 3.26 * RE/TA + 6.72 * EBIT/TA + 1.05 * BVE/TD
where WC = working capital, TA=total assets, RE=retained earnings, EBIT=earnings before interest and taxes, BVE=book value of equity, and TD=total debt.
The Z-score interpretation is straight-forward. If Z is greater than 2.60, then the firm has little financial distress and is healthy. The model predicts this firm will not fail. A Z-score between 1.10 and 2.60 is in the grey zone; it is indeterminate whether the firm will fail or not fail. The analyst should garner additional evidence to make this assessment. But, if the Z-score falls below 1.10, the model predicts corporate failure. And the lower the Z-score, the greater the amount of financial distress.
For Overstock, the metric has these values:
Driving these results are the negative earnings before interest and taxes, as well as negative retained earnings. Some improvement occurs in 2009 and 2010, but a significant worsening takes place by the end of 2011. Additionally, and not surprisingly, the negative values also are driven by the erosion of shareholders’ equity. The debt/equity ratio rests at a staggering 12.56!
Sam, Gary, and Greg: if there’s room on the bandwagon, we are on board!
What more can we say? In pace requiescat.
This essay reflects the opinion of the authors and not necessarily the opinions of The Pennsylvania State University, The American College, or Villanova University.