Month: April 2005

Like Japan retreating across the Pacific Ocean from its 1942 high-water mark—one island at a time—IBM has been selling or spinning off pieces of business as each became untenable for a high-cost, U.S.–based conglomerate.

The first to go was printers, sold off by Lou Gerstner on the cheap to a leveraged buyout group, which turned it around and resurrected it as publicly-traded Lexmark. IBM left quite a few billion on that particular table, although the positive impact on IBM’s P/E multiple from his “hardware-light” model compensated the Gerstner faithful.

Printers were followed, in no particular order, by hard drives, which IBM had pioneered, and the Wintel PC business, which IBM had invented.

IBM continued its transformation from low margin hardware to high margin software and services by acquiring a lot of software cats and dogs (including Informix—remember that one?) plus—for $3.5 billion—the Price Waterhouse consulting business.

Meanwhile, IBM tried to sign every IT outsourcing deal it could, and successfully convinced analysts to focus on IT services bookings as opposed to things like revenue growth, which have never met stated goals in the last five years.

Unfortunately, Jamie Dimon recently decided JP Morgan could handle its in-house IT better and less expensively than IBM, casting a shadow on the face of the new IBM which the Wall Street cheerleaders chose to ignore, until last night.

Last night came IBM’s doubly surprising earnings report—it was four days earlier than expected, and it was lousy. The data reveal starkly the shallowness of the IBM makeover. Earnings, excluding the change to option-expensing, for which I applauded IBM here a few postings ago, were 10% light. And services bookings were down 10% year over year.

I take back the good things I said about IBM for leading the switch to option expensing: the company is back to its old beat-the-number-by-a-penny shell games (which, under Gerstner, included using pension surpluses and the sale of real estate and intellectual property to make numbers), hinting to analysts of impending layoffs and a charge next quarter that will enable the company to, well, beat-the-number-by-a-penny in subsequent quarters.

So, for the “new” software-oriented, services-oriented IBM, the question is “now what?”

Don’t look for answers on the Street. The most un-helpful advice out of a whole batch came today from Goldman Sachs, whose tech research team appears to be trying to out-do its oil research team’s top-ticking “$100 a barrel oil” call of last week (you can look up the exact date of the bullish Goldman call on a chart of crude, and just find the day crude spiked up to its peak—from which it is down more than 10% today). Goldman is telling investors there is no need to buy IBM today, but no need to sell, either.

Thanks, guys!

Jeff Matthews
I Am Not Making This Up

And now, The Mystery of the 38 Diamonds itself.

This case involves yet another Overstock.com “skunk-works project”—that fanciful term given by Overstock CEO Patrick Byrne to initiatives which other, less promotional companies, might simply call “R&D.”

(Google calls them nothing at all—one day, without so much as a press release, a new and usually highly slick function will appear on Google search. You could say Google takes the Warren Buffett approach to new ventures: less talk, more rock.)

Given Overstock’s spotty history with such “skunk-works projects”—including the fizzled “Project Rocket” and the less-than-earthshaking “Project Ocean” —a cynic might refer to them not as “skunk-works projects” so much as “Hail-Mary passes.”

In any event, the “skunk-works” project in this mystery is the company’s “Build Your Own Ring” function within the jewelry site of Overstock.com, announced with fanfare in January:

“We have opened our own Build Your Own Ring site. Something like Blue Nile. But it is where you can think of the diamond industry, up to $1,000 is really controlled by Zales and Wal-Mart and mall jewelers and Blue Nile operates average order size is about $5,500. We intend to dominate in the $1,000 to $5,000 range. Fantastic pricing.”

It sounded good, it sounded exciting—in fact, it sounded like all “skunk-works” projects from Overstock have sounded, at first. (Recall early reports of the “mCommerce” shop-by-mobile phone phenomenon: “We decided that there would be an opportunity to lead the field…”; or the online auction business: “It’s…far faster growth than eBay saw in their first 15 days….”)

The key, of course, is the follow-through, and here the reality—as with “Project Rocket” and “Project Ocean”—does not appear to be cooperating with the ample vision of Dr. Byrne.

For starters, the diamonds offered on the “Build Your Own Ring” site at Overstock do not squarely fit the $1,000 to $5,000 price range Overstock intends “to dominate” with “fantastic pricing.”

Of the approximately 2,800 diamonds available at launch, 582 or so were priced at $5,000 and higher while another 490 or so were priced below $1,000. So roughly a third of the diamonds were offered at price-points outside “the range.”

Some of them way outside the range.

There were 14 diamonds offered at $25,000 a piece and up; 50 at $20,000 a piece and up; and more than 120 at $15,000 and up.

In fact, over $3 million of the total value of diamonds offered on the “Build Your Own Ring” were offered at $10,000 a piece and higher, while the total value of all diamonds offered at $5,000 a piece and higher was more than $5 million.

Granted, this $5 million should be put perspective. After all, if one-third of the diamonds were priced outside the $1,000 to $5,000 price range, then two-thirds were priced within the range. And these numbered approximately 1,750 diamonds.

Stated value of 1,750 diamonds “in the range”? Roughly $2.7 million.

So, having put it in perspective, we discover that the “Build Your Own Ring” site offered over $8 million in stated value of diamonds: $5 million worth at $5,000 a piece and higher; and less than $3 million within the $1,000 to $5,000 range Overstock intends “to dominate” with “fantastic pricing.”

Now, about that $8 million worth of diamonds.

After announcing the new site, and the price range he intends “to dominate,” Byrne went on to speak about what appeared to be the source of the diamonds being offered on “Build Your Own Ring”:

“We did a $7 million deal on diamonds that was the steal of a lifetime. Just fantastic pricing in there.”

(How Overstock came to getting “the steal of a lifetime” on loose diamonds is another mystery, and not the subject of the Mystery of the 38 Diamonds. I take Byrne at his word that he somehow purchased $7 million worth of diamonds at an unusually attractive price, despite the fact that the diamond supply chain is tightly controlled, and not at all an inefficient market.)

Assuming an Overstock-type markup of 15% on those $7 million worth of diamonds, they would appear to be the same diamonds being offered for sale at the time of the launch.

So, how is “Build Your Own Ring” actually doing? Well, once again, it would appear, based on a careful monitoring of daily sales on “Build Your Own Ring” starting in late March, that reality indeed bites.

One diamond was sold March 29—price range $1,000 to $2,5000—and another on April 2, same price range. Then again on April 4, same price range.

Pretty slow.

But on or about April 7, something interesting happened: 38 diamonds vanished from the available inventory. I say “vanished” because it is impossible for an outsider to determine whether the 38 diamonds were sold, or otherwise removed from available stock. Either way, there were 38 fewer diamonds spread across various price points.

Furthermore, if the missing 38 were indeed sold, it is likewise impossible to determine whether they were sold one at a time to 38 different people—unlikely given that the previous single-day sales record tracked since March 24 had been a whopping one—or sold in a batch to a single buyer.

It is, however, possible to identify the price ranges from which the “missing 38” vanished: one was a $25,000+ stone; four were in the $17,500 to $25,000 range; four in the $10,000 to $12,500 range; six in the $5,000 to $7,500 range; and 23 in the $1,000 to $5,000 range.

Total value of the 38 diamonds newly missing: approximately $220,000.

It would be quite a coup for Overstock if the sudden vanishing of those 38 diamonds represented a sudden upsurge in ring-building on its “Build Your Own Ring” site. Going from the occasional one-a-day to 38 is exactly the kind of “tsunami” CEO Byrne once predicted for “Project Ocean.”

But just as suddenly as the 38 diamonds flew out the door one way or another, Overstock customers suddenly resumed building their own rings at a more measured pace—one more on April 8, in the $1,000 to $2,500 range. And none since.

Which makes the Mystery of the 38 Diamonds even more of a mystery than if those 38 were the start of something big.

Like previous Overstock mis-adventures—from The Enigma of the Sputtering Rocket to The Vanishing Naked Shorts and its sister case, The Stranger on the Conference Call—The Mystery of the 38 Diamonds will, no doubt, be followed by other adventures in the casebook of Patrick Byrne and Overstock.com.

It is also likely that certain of these new adventures will begin with a “Project” allowed to ferment in shrouds of mystery, its fanciful code-word hinting of grand aspirations (“Project China,” perhaps, or “Project Google-Killer,” maybe), designed to tantalize Wall Street analysts and perhaps result in the “super-sizing” of the Overstock.com P/E ratio.

And they may even, one day, prove more successful than “Rocket” or “Ocean” or “Build Your Own Ring.”

In the meantime, we watch and wait for an explanation to The Mystery of the 38 Diamonds.

Perhaps you, reader, were the one who bought those 38 diamonds—all $220,000 worth. We’d love to hear about it.

Jeff Matthews
I Am Not Making This Up

Like a series of old-fashioned Hardy Boys adventures, the Overstock.com story, as told through the words and writings of CEO Patrick Byrne, contains mysteries aplenty—each with its own twists and turns—that leave outside observers guessing each outcome until a final conclusion is revealed.

In the Hardy Boys’ cases, the ending was always the same: Hardy brothers Frank and Joe, sometimes with the help of their good chums Chet and Biff, would unravel the mystery, catch the true perpetrator, and receive hearty thanks from dear old Dad, Detective Fenton Hardy, along with mild but affectionate admonishments from Mother.

Overstock.com’s adventures, however, do not always tie together so neatly. Some are easily resolved, others not. Why, a new mystery appeared just last week.

But to begin with, I offer a two-part recap of the adventures thus far.

One of the first Overstock mysteries was The Riddle of the Disadvantaged Artisans, arising from a 2001 Overstock venture known as “Worldstock.”

“Worldstock is the brainchild of Overstock.com’s CEO, Patrick Byrne,” the company trumpeted in a 2002 release, “who holds a doctorate from Stanford University centered upon issues related to poverty and social justice.” (The doctorate is important to Byrne: he made certain Charlie Rose’s viewers knew about it during a recent interview.)

Byrne “conceived of Worldstock as a global network of disadvantaged artisans plugging into the modern advantages of a 21st century business.” The concept was a genuinely noble effort to nurture third-world artisans by offering their hand-crafted wares on the Overstock site—“our own little United Nations Development Program.”

Setting a pattern for subsequent Overstock mysteries, the company (in the same 2002 press release) boasted that the “overwhelming popularity of Worldstock among Overstock’s customers” had led to its swift expansion among the disadvantaged artisans—then stopped mentioning Worldstock until the CEO’s 1/28/04 letter to investors, where Byrne gave it “Overstock’s 2003 ‘Most Improved Player’ award” for a “remarkable turn-around.”

“Turn-around” from what was not entirely clear, but Worldstock has since disappeared from discussions, save in a brief, feel-good mention during the Charlie Rose interview.

The odd thing about such a radical enterprise is that each item under the “Worldstock” tab gets listed just like any other Overstock item—with a “List Price” and a substantially lower “Our Price.” The difference being a huge theoretical savings for the Overstock buyers—and by definition, lost profit to the “disadvantaged artisans.”

For example, a “Turkoman Hand-Knotted Rug (Afghanistan)” comes with a $1,400 “List Price” and a $449.99 “Our Price.” Now, take at face value the company’s noble statement that “Overstock adheres to an audited net-5% profit ceiling for their [the disadvantaged artisans] goods, stimulating sales at prices that maximize the artisans’ return.”

At a $449.99 “Our Price,” it would appear that the disadvantaged Turkoman rug artisan is receiving something like $425 for a rug that would “List” for $1,400. Hardly seems like the way to end poverty and social injustice.

In The Case of the Vanishing Milestones, the company introduced a membership loyalty program called “Club O.”

Byrne promised shareholders, “I will announce it if and when we reach the following levels: 10,000; 25,000; 50,000; 100,000; 250,000; 500,000; 1 million,” noting “I do not anticipate that we ever will reach 1 million members, or anything close to that, but if we do, I will let you know.”

For a while there it looked like Byrne might have an easy time announcing those milestones. After a company visit just two months later, Legg Mason analyst Thomas Underwood wrote “Given the success that Overstock has already seen in its ‘Club O’ campaign, the company will introduce ‘Club O Gold’”

Shortly thereafter, Byrne announced his first “Club O” milestone—it had breached 10,000 members. But he also pulled the plug on the milestone pronouncements:

“I previously promised to inform shareholders when certain thresholds had been reached…I now withdraw that commitment because I have trouble sleeping with open-ended commitments.” (7/22/04)

Apparently Byrne knows how to sleep, because “Club O” numbers—while not forthcoming from the company—were placed at something above 40,000 in a late-2004 analyst report estimate, a good bit closer to the low end of the 10,000 to 1 million range than to even the middle of that range.

The Mystery of the Pristine Inventory began in early 2004, when Byrne told investors:

“In the closing weeks of 2003 your chairman seized an opportunity to buy over $5 million of Franck Muller watches…they represent a sizable fraction of our inventory. Pick one, write me…and I’ll make you a deal.”

One year later, Byrne announced a large inventory clean-out, which cost the company $1.5 million.

“The dead inventory that I had accumulated over the years, both from my own bad buys and those that I let buyers ‘put’ to me, has been almost entirely flushed (including the Franck Muller watches).”

However, on the investor call the next day, he led investors to believe there was nothing left in the way of “dead inventory”:

“I decided in early December, let’s just flush everything that has been around more than a few months. Our inventory has never been this clean. We just marked down, promoted, did whatever we had to do to blow out the older inventory. I lost $1.5 million on that inventory to move it all. But our inventory has never been this pristine.”

It is not clear whether the inventory is “pristine,” as stated to the analyst community, or whether some “dead inventory” remains, as implied in his shareholder letter.

The answer may partly be found in the brief Case of the Forgotten Movie. Here, another big Byrne bet—a film called “FarenHYPE 9/11”—went from “a unique business opportunity” (10/21/04) to $700,000 worth of losses in just a couple of months (1/28/05).

The Enigma of the Sputtering Rocket was the first involving several “skunkworks” projects at the company. Byrne delights in tantalizing shareholders and Wall Street alike with Hardy Boy-esque code names for projects from the so-called “skunkworks.” This one was named “Rocket,” and it began some time in early 2003, when something called “mCommerce,” which stands for “mobile commerce” (commerce conducted via cell phones), became a short-lived faddish buzzword:

“We decided that there would be an opportunity to lead the field with a push-based mCommerce application that delivered special bargains to subscribers.”

After some delays, Byrne announced a break-through in April of 2004:

“We have applied for a patent on push-based mCommerce and a certain kind of transaction through mCommerce. I think you’re going to hear a lot more about mCommerce. It’s like the Internet of five or six years ago. And I think people ought to look hard at different companies that are emerging in there.”

Never lacking in ability to jump on a trend that might, to use a favorite Byrne phrase, “super-size” the P/E in shares of Overstock.com stock, he wrote:

“To give an idea of the size of this market; there are 150 million cell phones in the U.S….”

Shortly thereafter—three short months later, in fact—Byrne admitted the obvious:

“I am not giving up, but this has been a dud… mCommerce just has not yet caught on in the United States. If and when it comes, Overstock.com has staked out some high ground without a huge investment.”

Next up in this three-part series will be The Mystery of the Shallow Ocean—a rather involved tale involving yet another “skunkworks” project…

Until tomorrow.

Jeff Matthews
I Am Not Making This Up

Denial can sometimes be useful. Denying yourself chocolate chip cookies, for example, if you want to lose weight.

But denial in the sense of being in denial…of not admitting the truth, or not being willing to see the what is happening around you—that is usually a dangerous thing. Especially so in human beings as well as in companies, where adaptation to changing circumstances is a key to longevity.

I bring this up after witnessing a stupendous example of denial today at a question and answer session with the CEO of one of the larger owners of radio stations in the U.S., whose stock has been depressed by concerns over satellite radio’s impact on the radio business.

When asked about this matter, the CEO (who otherwise had spoken quite plainly and logically about his business) dismissed satellite radio as a fad. And when I say “dismissed” it, I mean it.

Here’s a few quotes about satellite radio, from the CEO:

“Much ado about nothing.”

Now, I am not suggesting that satellite radio is going to immediately kill off terrestrial radio, or that there will never be the need for local radio once satellite has taken a large share of the market, or that this company is a bad company whose stock should be sold.

But, you would think that the CEO of a business under a threat—real or imagined—would at least acknowledge the threat and spend a little bit of time thinking about how to deal with the threat.

As opposed to dismissing it as “much ado about nothing.”

Jeff Matthews
I Am Not Making This Up

Just 10 weeks ago, Standard Pacific Corp, one of the largest homebuilders in the nation, reported an excellent fourth quarter and full year 2004 to investors.

“We are also positioned for another record year in 2005. Our positive outlook for the year is bolstered by our record backlog of over 6,300 pre-sold homes valued at $2.1 billion, which represents approximately 55% of our projected 2005 revenues. In addition to our strong backlog, the economic and housing fundamentals remain healthy in most of our larger markets.

“To support our 29% increase in projected consolidated deliveries this year, we are planning to open between 130 and 140 new communities, up approximately 40% year-over-year.

Stop the presses!

Or, at least, hold that browser.

There’s an inventor who’s solved the world’s energy problems, and he needs only a minimum of $200,000 to get started.

But don’t take my word for it: click on over to the Overstock.com auction site, go to the Real Estate section, and look at the “Featured Item” as it appeared late yesterday.

If it no longer appears—having been snapped up by some fast-fingered, foresighted mogul-to-be—I apologize for not alerting our readers sooner.

But it’s not as if there’s much to look at on the Overstock auction site—listings have flattened out, bids are low and it looks as if Patrick Byrne’s conference call boast that Overstock’s auction site outperforms eBay in certain areas is hokum. Consequently, the availability of such a unique opportunity (free, renewable energy) took even me by surprise.

I repeat the item as it appeared—capital letters, grammar and all:

Electric Vehicles
I’M LOOKING FOR A INVESTOR OR INVESTORS. I NEED A MINIMUM OF $200,000 TO GET STARTED. I AM TAKING PEOPLES PERSONAL CARS AND CHANGING THEM OVER FROM GAS ENGINES TO ELECTRIC DRIVEN MOTORS. THESE VEHICLES WILL NEVER NEED PLUGGED IN. THEY WILL RECHARGE THEMSELVES AS YOU DRIVE . THIS IS THE PERFECT TIME FOR THIS TO HAPPEN. WITH HIGH GAS PRICES THAT ARE NOT GOING TO COME DOWN, THAT’LL MAKE THIS A VERY HIGH DEMAND TO HAVE DONE NOW. IT WILL SELL ITSELF.

SO IF YOUR LOOKING TO INVEST IN THIS GREAT OPPORTUNITY ,THEN EMAIL ME [address deleted] FOR MORE INFORMATION. LET’S MEET AND TALK OVER A CUP OF COFFEE OR A DRINK. IF YOUR READY TO DO IT NOW THEN GO AHEAD AND PUT YOUR BID IN ON IT. I’M READY TO GO WHEN YOU ARE. WE’LL BE RICH AND FAMOUS.

THANK YOU, [name deleted] CANTON, NORTH CAROLINA

THE PICTURE IS AN ELECTRIC DRIVEN PICKUP TRUCK. I DID NOT BUILD THIS TRUCK.

Renewable energy, for free! Get it while it’s hot, at Overstock.com.

Jeff Matthews
I Am Not Making This Up.

Give IBM credit.

After years of fiercely resisting stock option expensing by most Silicon Valley companies, IBM steps forward and announces plans to do just that.

The magnitude of the deception by which companies—both high-tech and not—handed out stock options to reward employees without reducing “expenses” for purposes of the almighty “Earnings Per Share” calculation has always been easy to calculate from the footnotes of the offending companies.

The offending companies, however, persisted in looking at things the “pro-forma” way, options excluded, and Wall Street mostly obliged, despite the fact that the whole point of reported earnings is to calculate the amount of income left over for…shareholders.

The cleverest ruse of all may have been perpetrated by Dell, which not only grants stock options up the proverbial wazoo, but then boasts to Wall Street about the massive share buybacks it undertakes as a vote of confidence in its own shares.

The fact is, Dell has to buy back massive amounts of stock simply to offset the extra shares created by option exercises: all that money spent to buy back shares in the marketplace simply means Dell is running in place. The cost of “running in place” now approaches a billion dollars a quarter, for Dell. And it is many billions for other companies, Cisco included, that are also hooked up to the option-grant-intravenous-line.

The notion that employee compensation in the form of stock is somehow different from cash and therefore not reportable on the statement of income leftover for shareholders is, and always has been, a scam; and it only took a major bubble, dozens of bankruptcies, and billions of dollars lost by investors to force a change.

But better late than never.

As a result of IBM’s willingness to come forth and expense the cost of option grants properly, we now learn that IBM’s earnings available to shareholders are 10% lower than previously expected. 2005 earnings estimates are going from the $5.60 a share range to the $5.05 range, using the Bear Stearns numbers.

Think of that 10% this way: it is the hidden cost of being an IBM shareholder.

Jeff Matthews
I Am Not Making This Up

Joel Hollander doesn’t have a clue.

Or maybe he’s just saying what Sumner Redstone wants him to say.

Either way, in an interview downplaying the rise of satellite radio in today’s New York Times, Hollander, who is the CEO of Major Mainstream Generic Radio Company Infinity Broadcasting, sounds exactly like Wile E. Coyote looks when he realizes the light at the end of the tunnel—which the Coyote just finished painting on the canyon wall to thwart the Roadrunner—is in fact a train coming straight at him.

“At the end of the day, people want to hear what’s going on in their local markets,” Hollander tells the Times, disputing the importance of satellite radio. “People are emotionally involved with local radio.”

Now, I understand what Hollander means when he says local radio is important: I wake up every morning to the local radio station, first for the weather—especially this past winter when schools in New England were cancelled every three days—and second for news about whatever Connecticut politician got indicted the night before.

But, “emotionally involved” with John LaBarca of WICC Bridgeport?—I don’t think so.

And besides, once people get in their cars, they’re not listening to that local news station anymore: they’re listening to a syndicated national program like Imus in the Morning or Howard Stern, both of which are, incidentally, brought to you by that Major Mainstream Generic Radio Company, Infinity Broadcasting.

Furthermore, the biggest radio draws the rest of the day are, likewise, nationally syndicated shows such as Rush Limbaugh, Delilah, and Casey Kasem. Not local radio.

Me, I don’t drive to work—and when I do drive, it’s either Civil War books on tape or conference calls, so I don’t have satellite radio. But every time I rent a car I get a Ford with Sirius Satellite Radio: it’s indispensable.

As today’s Times article points out, Sirius has six country music channels—that’s almost as many regular Major Mainstream Generic Radio channels you can pick up on a car radio. I’ve never counted but there are at least that many rock channels—hair metal, thrash metal, metal metal—not to mention a 60’s channel, a 70’s channel, an 80’s channel and a 90’s channel, plus reggae, ska, blues, Elvis (literally: an entire channel devoted to The King)…or, talk radio from left wing to right wing and everything in between.

Meanwhile, on my “emotionally involving” Clear Channel Major Mainstream Generic Radio Station, I can, if I get tired of the limitless choice and unheard of variety on satellite radio, hear pretty much any commercial ever made, with a few songs squeezed in between. And sometimes the songs aren’t even the same twelve songs they were playing yesterday!

Which is why satellite radio has grown faster than cell phones, according to the article.

None of which Joel Hollander wants to hear. After noting the competitive response from Infinity, Clear Channel and other radio-killing corporations—including expanded playlists and fewer commercials—the article gives Mr. Hollander the last word. He says, “This book won’t be written for another 10 years.”

On that I agree: the book about the demise of Major Mainstream Generic Radio won’t be written for 10 years.

But the business? It’s already dying. Long live satellite radio.

Jeff Matthews
I Am Not Making This Up

Well now he tells us!

Merrill Lynch insurance ace Jay Cohen today lowers his AIG estimates and also cuts his price target…from $80 to $65.

But he retains his “BUY” rating.

Apparently Jay finally got around to reading Friday’s A+ Wall Street Journal story describing the downfall of AIG Strong Man Hank Greenberg…the most pertinent detail being the description of Greenberg yelling, King Lear-like, at his restive, scared directors as they contemplate his ouster: “You couldn’t even spell the word insurance.”

One wonders, given his low opinion of his own board, why Mr. Greenberg chose them in the first place. On the other hand, it explains how AIG finds itself in its very fine mess.

Today’s installment of the unraveling of yet another Wall Street fave finds that Greenberg’s own closely held company (Starr International) has forced off its board AIG executives not a part of Mr. Greenberg’s palace guards. Starrr International not only owns 12% of AIG stock, it controls AIG’s deferred-pay and investment plans for AIG executives. How’d you like to be an AIG veteran trying to sort out the Greenberg mess, knowing King Lear controls your pension!

The plot thickens, but don’t look to Merrill Lynch for guidance. They’re busy shutting the barn door, not realizing the horse is gone.

Jeff Matthews
I Am Not Making This Up