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Overstock May Be Significantly Undervaluing Its Stake in Crypto Exchange tZERO

Online furniture seller’s stake in tZERO could be worth $1.2 billion or 4X its current carrying value.

February 25, 2022

Overstock (OSTK), an online seller of home furnishings, owns approximately 83% of tZERO, a blockchain based cryptocurrency exchange. Industry reports have valued tZERO at $1.5 billion which, if accurate, suggests Overstock’s stake is worth approximately $1.2 billion. Yet Overstock, in its latest 10-K, valued its stake at just $291.4 million.

The difference between tZERO’s reported valuation and its carrying value as calculated by Overstock can be explained by the assumptions made in the original valuation. As part of a complicated transaction that closed in April 2021, Overstock valued tZERO a variety of ways, including a discounted cash flow (DCF) analysis.

Overstock detailed the assumptions in its model, including a weighted average discount rate of 32.4%. A discount rate of 30% was used to calculate terminal value. Though scaling a cryptocurrency exchange is undeniably risky, the discount rate used to value tZERO appears inflated compared to the 21% discount rate Riot Blockchain uses.

Conversely, an argument might also be made Overstock is using an appropriate discount rate.

In its latest 10-K, Coinbase (COIN) uses a 30% discount rate to calculate the fair value of its shares earmarked for the settlement of certain contingent liabilities— similar to the 32.4% rate Overstock uses. However, one might also argue the Coinbase rate is inflated, not only to reduce its balance sheet liability, but also because Coinbase used a 17.5% discount in 2020.

If you believe 30% is the right discount rate then you also must believe Coinbase’s future cash flows have become 71.4% riskier— as the 2021 discount rate suggests— in just a year. Even though Coinbase’s CEO has been defiant amid legal threats from the SEC, the market is not demanding the same return as the 30% discount rate the company now uses implies.

The incremental borrowing rate for Coinbase is just 3.02%, down from 4.62% in 2020. Likewise, we calculate the company’s weighted average cost of capital (WACC) at approximately 6%.
Even if we split the difference between Coinbases’s 2021 rate and the one Overstock is using to value tZERO— approximately 24.9%— the new rate still accounts for significant risk but also lifts the carrying value of Overstock’s stake in tZERO by several hundred million dollars.

Related: W, AMZN, VIPS

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