Overstock.com Feeds on Assets Of Distressed Web 'E-Tailers'

November 14, 2000

By NICK WINGFIELD -- Staff Reporter of THE WALL STREET JOURNAL
SAN BRUNO, Calif. -- Inside an office park on the outskirts of Silicon Valley, not far from the local cemetery, an increasingly common death ritual is under way: A dot-com liquidator is poking through the remains of a start-up. In one room, dozens of computers sit idle in rows of deserted cubicles. Through a back door that leads past a metal detector to a high-security warehouse, two women hunch over a table, tallying up what's left of Miadora Inc., an online jewelry retailer that folded several weeks earlier. Patrick Byrne grins as he watches them pull trays of glittering merchandise from the refrigerator-size safes that line the walls. Another woman plucks a necklace out of one of the safes. It's a strand of champagne Tahitian pearls with 18-karat-gold settings studded with diamonds. Mr. Byrne is buying the piece from Miadora's creditors for for it. "We'll sell it to the customer at $19,000 so we can say, 'You're getting a better deal for it than the jeweler,' " Mr. Byrne says. The vultures of e-commerce have arrived. After burning through one of the most concentrated waves of investment in retailing history, many online merchants are in critical condition. Of the growing number that have gone belly up, little remains except for computer equipment, customer lists and warehouses filled with unsold goods. But that's just what the 37-year-old Mr. Byrne and the small band of businessmen like him are looking for.

Mr. Byrne's company, Overstock.com Inc., employs about 70 people and buys goods from distressed Web start-ups, manufacturers and other sources for anywhere between 30% and 50% of their wholesale cost. Then, it uses -- what else? -- the Internet to sell the very same stock, offering the goods to consumers at less than the original retailer's cost. Overstock might, for example, pay $25 for an item that wholesales for $50 and retails for $100. The closely held Salt Lake City company can then sell the item online for $45 and still pocket a tidy sum on the transaction.

So far, the formula hasn't added up to an overall profit. Overstock, which started out using faxes, rather than the Web, as its primary marketing tool, has incurred losses of $22 million since its inception in 1998. Mr. Byrne, its chief executive officer, expects the company to be profitable by January when the company's sales will be enough to offset the cost of running and marketing the business.

Since he acquired a majority stake in Overstock in May 1999, Mr. Byrne has invested $15 million of his own money in the business, and it has been growing rapidly. Overstock now is the 25th most-visited shopping site among those who surf the Web from work, according to Internet traffic-tracking service Nielsen//Netratings. The company sells about $1 million a week of merchandise ranging from stereo speakers to Fendi handbags. And Mr. Byrne says sales should approach $50 million this year.

A Long Tradition
Liquidators have been around as long as retailers have been going out of business. Bricks-and-mortar stores often turn to specialists such as Gordon Brothers Group LLC, a 97-year-old liquidator based in Boston that manages closeout sales. Manufacturers also depend on liquidators to help them dispose of excess or out-of-season inventory without polluting traditional sales channels with low-priced goods. Distressed dot-coms are a potentially huge new source of goods for the industry. Venture capitalists have invested $4.6 billion in Internet retailers since 1997, according to the PricewaterhouseCoopers MoneyTree Survey. Now the high-profile failures of furniture site Living.com Inc., toy merchant Toysmart.com Inc. and others, as well as a sharp pullback in venture-capital investment in Internet retailers, have created widespread pessimism about the sector's prospects. A May Doonesbury comic strip aptly captured the mood, featuring a character who plans to start a company called MyVulture.com to recycle the inventory of failed Web firms. The MyVulture.com theme made a Doonesbury reappearance Monday. (Mr. Byrne says he taped a copy of the strip on the wall in his company's kitchen.)

Even some old-line liquidators are getting in on the action. In August, Tuesday Morning Corp., a discounter based in Dallas, bought Toysmart.com's $10 million inventory, which included everything from Thomas the Tank Engine train sets to Winnie the Pooh collectibles. Gordon Brothers, meanwhile, is backing a new Internet venture, called SmartBargains.com, in an alliance with America Online Inc., Boston venture-capital firm Highland Capital Partners and others. John Kerney, SmartBargains' president, says the venture is counting on inventory from failed dot-coms and is currently in talks with a home-furnishings Web site, an online toy merchant and two apparel e-tailers, which he declines to identify.

Mr. Byrne is pursuing failed Internet retailers more eagerly than most. In September, his company paid $3.7 million for the inventory of ToyTime.com Inc., a Torrance, Calif., operation that went under earlier this year. He says the goods in its warehouses had an estimated retail value of about $11.5 million. Last month, Overstock bought another Internet liquidator, Gear.com Inc., which specializes in sporting goods. And Mr. Byrne says he recently bid 30 cents on the wholesale dollar for 25,000 Stetsons, baseball caps and other headgear being sold by the creditors of eHats Inc., an Internet retailer that filed for bankruptcy protection earlier this year. That deal is still pending.

Mr. Byrne learned some of his first business lessons as a teenager from value investor Warren Buffett. Mr. Byrne knew the legendary investor through his father, John Byrne, who once ran Geico Corp., an insurer now owned by Mr. Buffett's Berkshire Hathaway Corp. Among the principles Mr. Buffett imparted to the younger Mr. Byrne: The essence of value investing is trying to buy dollar bills for 30 cents. Mr. Byrne took that advice to heart, applying it to a string of deals. In the mid-1990s, he bought an old shoe factory in downtown Manchester, N.H., that had been converted to office space. The building's previous owners had stopped making payments on the mortgage on the property, and Mr. Byrne was able to pick it up for $3.5 million. Earlier this year, he sold it for $10 million. With one of his brothers, Mr. Byrne acquired the ailing Inn at Jackson Hole, in Wyoming, in 1987. He also has acquired distressed strip malls and apartment buildings across the West. Then there's the Grease Monkey oil-change outlet in Florida Mr. Byrne bought from an airline pilot who needed money to settle a divorce. "I realized in the last couple of months that there's a certain theme to my life -- bottom-feeding," Mr. Byrne says.

'Like Buying That Bank'
One of his biggest successes came in the early 1990s, when Mr. Byrne and a group of investors that included his father and two brothers, purchased New Dartmouth Bank, a collection of five failed New Hampshire savings banks. On its investment of $7 million, Mr. Byrne's family reaped a $20 million profit when the banks were later sold to another institution. Buying Internet retailers is "like buying that bank in New Hampshire," says Mr. Byrne. "It's the same principle."

Between his forays into business, Mr. Byrne earned a Ph.D. in philosophy from Stanford University over the course of nine years, two of which he spent battling testicular cancer. He also says he is fluent in Mandarin and holds a black belt in tae kwon do. For a time, he says, he trained to become a professional boxer but quit because chemotherapy had so weakened his lungs. Nonetheless, Mr. Byrne, who is a muscular 6-foot-5, has a pugilist's profile -- his nose was broken during a bout.

Mr. Byrne has little sympathy for failing Internet retailers. "I think a sophomore economics student could have told you why these business models were garbage," he says. As for venture capitalists, they "have no understanding of what will make a good business," he adds, they just "try to pick what's going to be hot in six months."

On a recent day, a substantial amount of venture capital is sitting in Miadora's safes here in San Bruno in the form of diamond-encrusted Cartier chronometers, Rolex Oyster watches and gold earrings. Mr. Byrne is paying Miadora's creditors $2.5 million for the jewelry, which has a retail value of about $11 million, and he says he hopes it will fetch $5.5 million on Overstock.com. Founded in April 1999, Miadora managed to raise a total of $46 million from sources that included Sequoia Capital in Menlo Park, Calif., which backed such high-tech successes as Yahoo! Inc. and Oracle Corp. It sunk much of the money into a costly marketing campaign, including a sweepstakes in which the top prize was a $100,000 diamond necklace. It also embarked on a hiring binge that helped drain its cash. In the end, it couldn't persuade its investors to pony up more capital.

'I Have Cash'
Mr. Byrne found out about Miadora's problems through Joanne Dalebout, Overstock's jewelry buyer. On the day the company closed in September, Mr. Byrne drove to its headquarters in San Mateo, where employees, some in tears, were still boxing up their belongings. He says he scribbled "I have cash" on the back of his business card and asked an employee to deliver it to Miadora's CEO. About 10 days later, Miadora accepted his offer. Mr. Byrne is always on the alert for signs of weakness at other dot-coms. That becomes clear as he and Ms. Dalebout talk shop with Richard Caniglia, Miadora's vice president of operations. Mr. Caniglia mentions that the Web site of Adornis.com, an Irish jewelry retailer with offices in Greenwich, Conn., is no longer accessible. Mr. Byrne and Ms. Dalebout exchange glances. "Interesting," Ms. Dalebout says. "Oh, you gonna get a plane ticket?" Mr. Caniglia asks Mr. Byrne with a chuckle. "This is like the Grim Reaper here." Mr. Byrne says he has since bid less than 40 cents on the dollar for Adornis's inventory. An Adornis executive confirms that a deal to sell its inventory to Overstock is pending.

Mr. Caniglia says he bears no grudge against Mr. Byrne, saying the liquidator is paying a fair price and helping out Miadora's creditors. Still, Mr. Caniglia adds: "No one wants to see his car pulling up in the parking lot." Some of Miadora's suppliers are concerned. Last month, Ms. Dalebout got calls from jewelry designers seeking to buy back pieces they had sold Miadora. They are worried Overstock's discounts will hurt their relationship with full-price retailers, but Mr. Byrne says he isn't going to sell the items back. One of the designers, Jordan Schlanger, who is based in New York, confirms that an employee at his company contacted Overstock about purchasing pieces it had sold to Miadora.

Mr. Byrne routinely scours F----dcompany.com, a Web site that keeps track of dot-com deaths. He recently posted an appeal there for failing companies to contact him. His user name on the site is Hannibal, after both the Carthaginian general and Hannibal Lecter, the infamous cannibal in Thomas Harris's novels.

After hearing that a gourmet foods e-tailer was interested in selling its inventory, Mr. Byrne recently drove to the company's address in Oakland, Calif., to see whether he could make a deal. The address turned out to be a residence; when no one answered, Mr. Byrne stuck his business card on a nail on the front door. And when Mr. Bryne heard last week that Pets.com Inc., an Internet pet-supply retailer, and MotherNature.com Inc., a vitamin and natural-products seller, were shutting down, he quickly sought to contact executives from the companies.

Mr. Byrne says he hopes Overstock's discounts make things harder on rival dot-coms. He thinks the deals he plans to offer on Miadora's jewelry will be especially painful for Ashford.com Inc., one of the best-known Internet jewelry stores. "The people at Ashford are bringing a knife to a gunfight," Mr. Byrne says. "If we can use this to put a big dent in their Christmas, I'll be knocking on their door." Kenny Kurtzman, Ashford's CEO, says he isn't afraid of Overstock, however. "We're very confident that we'll be around next holiday season as a profitable company," he says, adding that Ashford considered buying Miadora's inventory but passed, because it was mostly old merchandise "that won't sell this holiday season." There are few things Overstock won't scavenge. At the company's 175,000-square-foot warehouse near the Salt Lake City airport, conversation is difficult because of the racket made by workers pounding shelves into steel racks that extend several stories high. The shelves belonged to ToyTime. Mr. Byrne bought them along with the company's toy inventory. Digital photos and copy describing the inventory are usually parts of the package. In ToyTime's case, Overstock even bought the maintenance staff's brooms and screwdrivers.

Overstock does much of its bargaining on the spur of the moment, scribbling out offers for packing material, label machines and other items on scraps of paper. At Miadora's headquarters, for instance, Mr. Byrne hears that the company's creditors are entertaining a $4,000 offer for several safes he thinks are probably worth more than $27,000. "Offer $7,500," Mr. Byrne says to Miadora's Mr. Caniglia as a representative of Miadora's creditors drifts out of earshot. Ms. Dalebout, the Overstock jewelry buyer, whispers back: "Why not offer six?" "OK, offer six," Mr. Byrne responds. Miadora's creditors later accept the bid.

The rapid pace of Mr. Byrne's acquisitions has created some recent challenges for Overstock's operations team. On one side of the Overstock warehouse, the company is scrambling to build high-security cages to store the incoming Miadora jewelry. Next to the half-finished shelves, pallets full of Barbie Deluxe Dreamhouses, Intel Computer Microscopes and other ToyTime items occupy a football-field-size section of floor space. "This has been a juggling act," says Scott Stuart, vice president of logistics.

Mr. Byrne thinks most e-tailers will fail eventually, with the exception of standouts such as Amazon.com Inc. Executives within Overstock acknowledge that the supply of wounded dot-coms won't last forever, but Overstock has other sources of inventory, including manufacturers and traditional retailers. While the trend lasts, Overstock plans to exploit it. Ms. Dalebout says she sometimes feels guilty about preying on failing dot-coms. Mr. Byrne says scavenging isn't a moral issue to him. "I say, 'Fella, you're in this position because you're in this position -- I didn't put you there,' " he says. "I'm cleaning up the mess."

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