Do you believe in the long-term future of initial coin offerings but can’t stomach the lack of regulation, wild-west mentality, and outright scams in the marketplace?
There are just not a lot of good deals out there.
Nano-caps have turned overnight-blockchain with a signed MOUs or JVs that lets them put out a news release with words “blockchain” just to cash in on the hype.
But there have been very few options to bet on a true blockchain based application that is in development and not just written up in whitepaper or PowerPoint presentation.
Except for one: Overstock.com (NASDAQ: OSTK)
Yes the e-commerce company. I know that sounds unlikely. But hear me out.
The Blockchain Visionary: Patrick Byrne
Overstock is run by CEO Patrick Byrne, who has been called the scourge of Wall Street and the most hated man on wall street. Byrne himself has called the SEC a captured regulatory agency and fought a number of protracted battles against it.
He has sued many of the large investment banks including suing Goldman Sachs twice, during his decade-long attack on naked short selling.
But when its come to the potential of the blockchain, Patrick Byrne has had a lot of vision.
His Bitcoin 2014 keynote address was a seminal event. Byrne gave historical and philosophical context for the blockchain revolution and pointed to a number of applications where he expected blockchain to disrupt, all of which are now beginning to occur.
While you might think his emphasis on the historical significance of the blockchain is an exaggeration (he said it had the ability to correct Rousseau’s great philosophical mistake that led to centralization!) there is no doubt Byrne knows blockchain.
The Non-Sexy Part of Overstock: E-commerce
You have probably heard of Overstock.com as an online retailer. The best that can be said is they have managed to survive over 15 years of competition from Amazon. That’s not something many online retailers can say.
On the third-quarter conference call the company admitted that e-commerce is a hard slog with no end in sight. Byrne announced that he was seeking strategic alternatives for the process and had hired Guggenheim partners.
Should Overstock sell its commerce division? Marc Cohodes was one of the first to see the under-valuation of Overstock, and he presented on the company at a recent Grants conference.
Cohodes focused his valuation analysis on the e-commerce business, which he argued was worth $70-$83 alone, if it was valued similarly to other e-commerce platform acquisitions.
However, if Overstock’s keeps its e-commerce division, its hard to see the market giving it a value of more than $20 per share (it’s historical price range).
The Sexy Part of Overstock: Medici and Blockchain
Byrne wants Overstock to more than an e-commerce company.
In 2014 Overstock became the first major retailer to accept bitcoin.
Shortly thereafter, Overstock created a subsidiary called Medici that focuses on investing and developing blockchain technologies.
When Byrne talks about Medici, he describes 5 categories where blockchain will have the most impact:
- creation of money – think digital central banking
- creation of capital – land titling, think Hernando de Soto and his book the Mystery of Capital
- capital markets themselves – the creation of digital exchanges
- identity – think construction of online identities
- voting – take advantage of security and immutability of the blockchain to prevent voter fraud, allow for transfer of voting rights
Within these 5 categories Medici has invested in 7 portfolio companies. The biggest investment is with a company called tZero, of which they own 83%. Medici also owns 11% of Bitt (33% including warrants), 13% of Peer Nova, 2.5% of Factom, 5% of Identity Mind, 30% of Settlemint, 2.5% of Ripio, and 1% of Symbiont. They also have an undisclosed majority holding in a start-up called Spera.
Medici has invested somewhere between $50 – $60 million in these start-ups.
tZero: The One to Watch
.tZero is focused on bringing blockchain solutions to the capital markets. To this end, Overstock/tZero have made 3 announcements:
tZero is launching a stock-lending platform.
Stock lending is an opaque, over-the-counter operation controlled by a few prime brokers that take a large cut of the profits by acting as the third-party intermediary.
Byrne has estimated that pension funds are losing up to 2% to their returns because of the inefficiencies of the existing stock lending structure. The lack of checks and balances make the system relatively easy to game, both by short-changing the borrow and allowing for the lending of naked short positions.
Just a few months ago a number of pension funds filed a lawsuit against some of the largest prime brokers claiming collusion. There is extensive detail of the alleged malfeasance in this lawsuit.
tZero’s platform will eliminate the prime broker. so buyers and sellers can interact directly with all transactions recorded on the blockchain.
Each transfer of stock will be accompanied by a digital locate receipt that will uniquely identify the share on the blockchain. This will remove the capacity for naked short selling (lending out the same share more than once).
Byrne has suggested cost to borrow will be cut by half. The lending institutions will retain 80% of the fee and tZero will take 20%.
tZero’s second announcement is that within a few month, they will deploy the first regulated token exchange.
In 2015 tZero made a very smart move when they acquired a small SEC-approved trading exchange called SpeedRoute.
Speedroute has been blockchained and will provide the backbone for both the stock lending and token exchanges.
On the 25th of the SEC issued a statement describing that any token with attributes of a security could only trade on an SEC-approved exchange.
With Speedroute, tZero has a leg up on competition looking to build token exchanges from scratch that would meet with SEC approval. This is a massive first-mover advantage.
In fact, tZero has the only automated trading system approved by the SEC that can handle blockchain tokens. They are already registered as a broker dealer. I repeat, they have a tremendous head start over anybody else.
While security tokens are likely to be the more common medium going forward, utility tokens have dominated the ICO market up until now.
There is limited SEC commentary on the regulation of utility tokens on an exchange, Overstock is to open up the US based exchange to security tokens only so as to not risk regulatory backlash.
Byrne says that tZero is looking to open a second, utility token exchange elsewhere in the world where the regulatory environment is better defined. They have already been offered residence for a utility token exchange by two separate nation-states.
The last announcement in late October is that tZero is launching its own initial coin offering (ICO). It will have qualities of both a security and utility token.
Holders would participate in the revenue of tZero (likely 10%) and qualify for discounts on platform usage.
Its not clear yet whether the participation and discounts refer to all tZero platforms or just the security exchange. The language I’ve seen suggests it is limited to the security lending exchange.
Byrne has said that he expects $200 million to $500 million from the ICO, but talked down that number to something closer to the low end at the recent conference call.
Many ICO’s in the past 6 months have brought in $100 million or more with little more than an idea. On the other hand many of these ICOs have turned out to be scams, and so the easy days of raising cash so effortlessly may be behind us.
Howard Marks wrote this interesting piece on what he termed ICO 2.0. The two attributes that will characterize this second era of the ICO phenomenon will be regulation and ownership. tZero is well timed to lead us into this new era.
Conclusion
Okay, how we do value Overstock? It’s share price has zoomed in recent weeks to close at $54 yesterday. At beginning of September, the share price was only $20
The run-up in share price can only be attributed to blockchain buzz so the market values the e-commerce business at $20 per share.
Maybe Overstock call sell it off for $60-$70 per share if it is scooped up by the right strategic partner.
Or maybe something in-between because of a lot of a valuation is in the brand which is notoriously difficult to value.
But it’s not zero. There are tangible assets in Overstock, not the least being a management team that has hung in against Amazon for years.
But let’s get to the sexy stuff…
The US stock lending business is a $4 billion market. Using the model described by Byrne that considers a reduction in fees by half and a 20% take for tZero, with 25% market share the stock lending platform could generate $100 million with very high margins.
And that number could easily go higher. If the lending platform is a success in the U.S, then international expansion is on the table, not to mention the much larger bond market.
The incumbents may want to argue the point. Yet Byrne has made a compelling case that the industry is ripe for disruption.
Regarding the ICO exchange there are few details available. It’s almost a black box.
But if (and that’s a big if) ICO’s become the preferred way to raise venture capital, having the first regulated exchange should be of considerable strategic and economic value.
If tZero’s ICO is successful in generating even the low end ($200 million), it means 81% of that cash, or $160 million, is effectively net to Overstock.
tZero should have no trouble investing that money with so many early stage blockchain companies and applications springing up.
Of course, nobody knows what value the market will place on having the first scaled, working use case for blockchain outside of coins.
There are plenty of start-ups with recent ICO’s that are working on a variety of potential applications for blockchain. But none that I know of on the same scale and experience of Byrne and Overstock.
And tZero is the first to come to market. They are already generating revenue from the stock lending platform. They are literally the first to market in the hottest space on the planet.
So what is the value of all of it? With so many moving and early stage parts, nobody knows but it’s worth something.
Right now the market has given Overstock a premium of $34 a share or an extra $856 million in market cap for the blockchain assets.
Is that a fair valuation? In my opinion it’s a binary trade. If tZero takes off, the shares are still cheap. If it flops, then it goes right back to $20.
But I don’t think it will flop.
