tZero Token Sale Analysis

Overstock is launching a token sale for its regulated token trading system called tZero. The token sale is targeting a $250MM raise with the option to go to $300MM. Currently, $100MM has already raised from various individual and institutional investors. The token is an ERC-20 token and pays a quarterly dividend of 10% of adjusted gross revenue to token holders. The token is a Regulation D offering in the United States and a Regulation S offering for offshore investors. Overstock is accepting investment in Bitcoin, Ethereum, and USD.

Characteristics of the tZero Token

The tZero token will be sold following security laws of the United States and other jurisdictions in which they are selling but will be exempt from the Securities Act of 1993. The token is sold under Rule 506 of Regulation D. As such; the offering is restricted to accredited investors only. This makes the potential investment pool significantly smaller than traditional ICOs. The investment will also take place in the form of a SAFE (Security Agreements for Future Equity). There is no guarantee that investors will receive the tZero token. Even if they do receive it, there is no guarantee the token will possess any value. The token is solely a fundraising mechanism. It’s unclear what utility benefit the token will provide. The PPM states that Overstock could offer benefits such as complimentary membership on Overstock.com, but no guarantee it will. The only apparent benefit written in the PPM is token holders being eligible to receive dividends of 10% of revenue quarterly. Token holders will receive little to no liquidity in secondary markets. A regulation D offering requires that a transfer of a security only goes to an accredited investor. Additionally, there will be no exchanges (at least in the short term) that offer the tZero token meaning a seller would need to find a buyer and then receive approval from the company. Immediate liquidity is the most prominent benefit of an ICO, but the structure of the sale makes that benefit render moot.

Current Status of Fundraising and Use of Proceeds

tZero plans to raise $250MM for the tZero token with the option to raise up to $300MM if they choose. As of March 1, 2017, tZero has entered into SAFE agreements with 1,100 buyers for tokens worth $114.6MM. ~88% of the tokens have been paid for in advance while the rest are still awaiting payment. There were a variety of discounts for the first $99.99MM worth of tokens sold. tZero lists seven uses of proceeds from the fundraising:

  1. the repayment of amounts payable to Overstock
  2. the Equity Investments
  3. the future development of the Tokens and the Token Trading System
  4. the development of functional utility features that tZERO may offer to holders of the Tokens
  5. general corporate purposes, which may include capital expenditures, acquisitions, debt repayments, cybersecurity upgrades, augmenting technology, infrastructure and personnel, development of products and services, and short-term investments, among other things
  6. lobbying lawmakers and regulatory authorities for the purpose of bringing about changes to laws and regulations related to blockchain technologies, particularly in regards to securities tokens,
  7. offering , legal and accounting expenses.

tZero owes $50MM to Overstock. It’s unclear if this debt will be repaid back in tokens or from proceeds from the token sale. Overstock has agreed to purchase $30MM of tZero tokens, but has not paid for those tokens yet. It’s also unclear if the $114MM worth of tokens sold already includes the Overstock sale. tZero has purchased Weeden Prime Services for $28.2MM. This acquisition will be paid off using proceeds from the token sale. It’s unclear what functional utility features tZero will build for the tZero token. tZero also anticipates that 15% of proceeds from the token sale will go towards legal, accounting and other miscellaneous expenses related to holding a token sale. The fees seem quite high. A traditional IPO has costs that make-up 6-8% of the proceeds of the deal.

Management & Advisory Team

tZero has a solid management team. The CEO, Patrick Byrne, has over 15 years of management experience which includes taking a company public. He was the first CEO of a publically traded company to accept Bitcoin. A wealth of Wall Street experience surrounds him. The President, Joe Camarata, has run multiple electronic trading firms, one of which sold for $1.4B to TD Ameritrade. The COO, CIO, and Controller each have over 20 years of Wall Street experience. The management team has the skillset and networks to turn there in traditional markets to succeed in the cryptocurrency markets. 

I thought it was important to mention the advisory team. While the team is solid, I found it highly unusual that 4 of the advisors listed don’t have formal agreements with tZero while a 5th advisor, Steven Nerayoff, has fraudulently stated that he is a co-founder of Ethereum when in fact he isn’t. If the tZero token trades at the intended purchase price, advisors will receive $23MM in total compensation. (Advisors will collect 2.3M tokens). Managment is irresponsible to be compensating advisors at such an absurd price. An average Fortune 500 Board of Director receives base pay of $245,000.

Technology

Most of tZero’s technology comes from acquisitions. In 2015, tZero acquired Speedroute. Speedroute provides electronic trading services for the equity markets. Overstock would like to leverage that technology for the cryptocurrency space. Another acquisition in 2015 was Pro Securities. Pro Securities is an SEC-registered alternative trading system. Pro Securities would be where security tokens listed on tZero to legally trade. Pro Securities has already handled a small blockchain equity offering on behalf of Overstock.com. In 2017, tZero acquired Blue Ocean. Blue Ocean's technology is focused on electronic trading and provides a marketplace for traders to trade 24/7. tZero has acquired a robo-advisory firm which is being positioned to help new and existing investors purchase cryptocurrency. tZero is also developing a DLR (Digital Locate Receipt) to compete in the stock loan transaction business. tZero's DLR will allow broker-dealers to manage stock inventory in an electronic setting. This will prevent issues such as naked short-selling (a prevalent problem in the equities industry). tZero has announced that Kodak Coin will be using its technology for its ICO and listing, but no official agreement is in place between the companies.

Finances and Valuation

Assuming tZero raises $250MM, it's valuation is 14.7x net sales or 49x gross profit. The company had operating expenses of $8MM, $15MM and $17MM in 2015, 2016, and 2017 respectively. The company lost $6.9MM, $11.5MM and $10.3MM in 2015, 2016, and 2017 respectively. In 2017, 50% of tZero's revenue came from three customers. If tZero transitions purely to cryptocurrency, it becomes questionable if that revenue continues. The majority of their revenue is from their broker-dealer business, Speedroute.

Final Thoughts

tZero is a very ambitious token sale. The management team is one of the strongest we've seen from an ICO in recent months, but that is about the only positive of the sale. tZero has significant debt while continuing to hemorrage money. The token has no clear utility value and seems to exist only as a fundraising mechanism. There is no indication that the techniology it owns will succeed in the cryptocurrency market. It only has one customer (Kodak) which hasn't even signed an official contract with tZero yet. Last, the amount of money raised seems to be excessive. A startup business shouldn't be raising $250MM in it's first round of financiang especially with no clear use of proceeds except to pay off existing debts.