Whitney Tilson Out With Another Attack On Lumber Liquidators (LL)

Whitney Tilson Out With Another Attack On Lumber Liquidators (LL)
Whitney Tilson

Why Lumber Liquidators’ Wood Testing Doesn’t Comply With CARB by Whitney Tilson, Seeking Alpha


  • Lumber Liquidators released a statement following the 60 Minutes report on Sunday.
  • In fact, I, 60 Minutes and others used the correct CARB testing protocols.
  • I am now even more convinced that this stock is a zero, for reasons I outline below.

Anderson Cooper: Do you have any idea how much of this wood is in people’s homes right now?

Richard Drury: We believe there are probably tens of thousands of households in California that have installed Lumber Liquidators Chinese laminates that may exceed formaldehyde standards

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Anderson Cooper: Nationwide?

Richard Drury: Nationwide, its probably hundreds of thousands.

Drury and Larson bought more than 150 boxes of laminate flooring at stores around California and sent them to three certified labs for a series of tests. The results? While laminate flooring from Home Depot and Lowes had acceptable levels of formaldehyde, as did Lumber Liquidators American-made laminates, every single sample of Chinese-made laminate flooring from Lumber Liquidators failed to meet California formaldehyde emissions standards. Many by a large margin.

Richard Drury: The average level in Lumber Liquidators products that we found was over six to seven times above the state standard for formaldehyde. And we found some that were close to 20 times above the level that’s allowed to be sold. “60 Minutes” March 1, 2015

Following the 60 Minutes segment quoted above, Lumber Liquidators released a statement that says, in part: “We believe that 60 Minutes used an improper test method in its reporting that is not included in CARB’s regulations and does not measure a product according to how it is actually used.”

This is nonsense.

In fact, I, 60 Minutes and others used the correct CARB testing protocols, and it’s Lumber Liquidators that’s using its own made-up tests. It’s a complex story, but briefly, the generally accepted and used test is to sand off the outer layer of the laminate and then test it. This allows for an accurate reading of the formaldehyde that’s embedded in the product. LL, in contrast, tests the laminate without sanding it, which is, in fact, how the product “is actually used.” But:

  • a) CARB, scientists, etc. all do it the other way; they could do it LL’s way, but then they’d set a much lower exposure/detection threshold – pick your poison (pun intended) but it’s incumbent upon LL to do the tests the way the regulators do or the results are meaningless (as are the claims Lumber Liquidators makes that their products are all CARB 2 compliant, blah, blah, blah; in short, you can’t do the tests a different way than CARB – which minimizes the amount of formaldehyde detected – and then proclaim that your flooring complies with CARB standards); and
  • b) just because the formaldehyde is somewhat “sealed” into the laminated wood by the outer layer doesn’t mean LL’s customers aren’t being poisoned – it just means that the formaldehyde leaks out slowly over a long time, along the edges, as the floor wears, etc.

Finally, here are some spot-on insights from friend who manufactured and imported luggage from China for many decades:

Sent: Monday, March 02, 2015 2:43 AM

To: Whitney Tilson

Subject: You on TV


I watched the 60 minutes piece. Congrats.

Having done business in China for literally decades, what I found most amazing in the piece is the LL CEO’s statement that they trust their manufacturers. If that is true, then the company is guilty of incredible naivete or incompetence.

I have negotiated with factories in China. What happens is that the American buyers drive a hard bargain…..and with multiple factories, as LL has, the factories know that they are in competition with one another. A negotiation always comes down to pennies. It is pretty common for the Chinese factory to do what they have to do to keep the business…..ie, agree to the best price they can get from the buyer, but agree nevertheless. And then, once they have the business, they try to figure out how to make money on it.

But a reasonably savvy buyer knows that, and has approved samples against which actual production is compared. If the actual production does not match the approved sample, then the production is rejected. We did that with just about every production run. If LL didn’t do that, then they deserve whatever flak they catch….not because they are deceitful necessarily, but just because they are incompetent.

Of course, if they knew about it, and were complicit either by looking the other way or somehow condoning it, then that is a different story. Either way, however, the company is guilty. And the State of California goes after the seller, not the supplier. So a company like Home Depot, for example, will have a standard clause in their contracts whereby the vendor indemnifies Home Depot against any action that may arise from a product that they sell, made by the vendor.

But a vertically integrated operation like Lumber Liquidators, where they are both the retailer and the supplier, has no place to hide if the California DOJ comes a’callin’.

Even with our best inspections, our best efforts to compare product against the approved samples, from time to time, there would be quality problems. We had our standard purchase agreement which we executed with each factory that supplied us, which allowed us to deduct from future payments to them, whatever quality charge-backs we received from our customers. That is unbelievably punative. Here’s why:

Suppose a product was sold to us FOB China for $10. By the time it landed in the US, freight and duty etc included, it cost us $13.20. We would then sell it to the retailer for $20 (which would net us about $18 after advertising deductions etc.) And they would sell it for $40. If the consumer returned the product, the store refunded the consumer the $40 she paid. And charged that $40 back to us. We in turn charged the factory $40 for one defective product they had originally sold to us for $10.

The point is that, knowing they stood to risk a 4:1 expense if the quality was poor, was the best quality control tool we had. The factories ultimately found it was much less expensive to give us the correct quality and make a smaller profit, than to cut corners and risk a 4:1 expense. In other words, they way you get quality control out of China is to make it in their economic interest to do what you want them to do.

Now I didn’t learn this in business school. It is common sense. If Lumber Liquidators doesn’t have common sense, then they deserve to lose. As simple as that.

Anyway, I enjoyed watching you on TV.

I am in awe of the investigative journalism 60 Minutes did, which validated my decision to bring the story to them. They uncovered many things I didn’t know and I am now even more convinced that this stock is a zero, for reasons I outline below.

As for LL challenging the test results, I can’t figure out if they are evil liars, trying to cover up the fact that they’re knowingly poisoning their own customers to save a few bucks on sourcing costs, or whether they’re just incompetent – but it’s one or the other. Based on my research and analysis, I believe that LL’s testing regimen is largely a sham because it’s disconnected from rigorous, credible tests that others (regulators, Home Depot, Lowe’s, etc.) use and rely on. Evidence for this are the results from five independent sets of tests, including one I commissioned, which show that Lumber Liquidators is buying and selling to its customers highly toxic laminated wood (virtually all of it from China).

Once it becomes clear that LL is, in fact, doing this, they will undoubtedly go on an apology tour, saying how sorry they are and positioning themselves as the victims who were defrauded by unscrupulous Chinese mills. This is complete nonsense. Laminated wood is a low-end, global commodity product in which 1% or 2% differences in pricing are meaningful. For a savvy player like LL, which has been buying in China for roughly two decades, they would instantly know that if they were buying 10% below the standard price for a particular piece of laminated wood that something was wrong: perhaps it was stolen, used illegal or incorrect wood, was of exceptionally low quality, or was filled with toxic chemicals.

Maybe this example will resonate. Let’s say you’re in Shanghai and looking to buy the DVD of the latest Hollywood movie – let’s say, Academy Award winner Birdman, which is still in theaters, so it’s of course not yet out on DVD. Ah, but lo and behold, as you walk down the street, you see that a street vendor has a copy and sells it to you for $2. Moments later, the police apprehend you and accuse you of buying illegal /forged merchandise. You would of course claim that you had no idea – but OF COURSE you knew, based on where you were (China) and the price you paid.

Similarly, LL had to have known there was something seriously wrong with the laminated wood it was buying, given the absurdly low price and the fact that it was coming from China, which is the wild west when it comes to environmental standards and rule of law. Even if the Chinese mills said they were CARB 2 compliant and even if they were supposedly inspected, this cannot be relied on. Heck, this is a country that sold us defective wallboard that soon because filled with toxic mold, and which pumped pigs full of clenbuterol (see: www.rsc.org/chemistryworld/News/2011/April/19041102.asp). In short, many Chinese companies, especially those in highly competitive, commoditized industries, scoff at most regulations, especially if the product is being shipped to the US. Many friends have told me that China is for the Chinese; if they can screw Americans, they will – and they did with Lumber Liquidators, which might take down company.

But LL’s pleas that they are the victim here ring hollow once you realize that the two biggest buyers of wood flooring in the US, Home Depot and Lowe’s, also buy laminated wood in China, yet don’t have a formaldehyde problem (to the best of my knowledge). The reason is simple: they have serious, rigorous compliance programs and understand that you can’t hit the low bid in China and expect to get high-quality, compliant product. So they pay more and get good flooring – but earn lower margins, something Lumber Liquidators wasn’t willing to do in its pell mell pursuit (regardless of the consequences) of a higher and higher stock price so insiders could cash out.

The three funds I manage are currently short 44,676 shares of LL (a $2.3 million position based on Friday’s closing price), making it a 2.6% position (it was well over 3% before the stock got whacked last week).

I first shorted it on 10/9/13 at $102.69. My last trade was shorting more on 10/6/14 at $56.06.

I have never bought or sold options on Lumber Liquidators – I have only shorted the common stock.

If you’re wondering why I didn’t short a lot more recently, when I knew the 60 Minutes story was going to air and would likely be very negative, the answers are:

  1. It might have been illegal for me to do so (the laws around insider trading are very vague, so it’s best not to be anywhere in the gray area);
  2. Even if I’d gotten a clean legal opinion, I wouldn’t be comfortable with the optics/ethics (I try to live my life keeping in mind the front-page-of-the-NYT/WSJ test); and
  3. I promised 60 Minutes, once I brought the story to them, that I wouldn’t trade the stock until after the story aired (or they told me they decided not to do it).

Although the risks are less than they once were, I know from long, hard experience that if you’re a short seller and go after a company publicly, as I’ve done in this case, you should expect to be sued by the company and/or investigated by the SEC or other regulators, so I wanted to make sure there were no questions about my trading. Thus, once I got the results from the tests I commissioned on three samples of Lumber Liquidators’s laminated wood (and the formaldehyde levels were very high), which confirmed to me that I had the story right (that LL was poisoning its own customers and knew – or should have known – this fact), I established my full (~3%) short position, gave all the information I had to 60 Minutes, and let them run with it.

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