Whitney Tilson On Zhang Lei, Lumber Liquidators & Short Sellers

Whitney Tilson talks about China’s richest investor Zhang Lei, provides an update on Lumber Liquidators, sheds a light on why the market is healthy for short sellers.

Whitney Tilson on Zhang Lei

1) A nice article about one of the most successful investors in China, Zhang Lei:

With an $18 billion war chest, he is one of China’s richest investors. Yet on a recent trip to San Francisco, Zhang Lei and his entourage crammed into a three-bedroom house in the Mission District, rented through Airbnb.

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He also ordered water from Instacart, the on-demand grocery delivery service. A few days later in New York, he bought food through Google Express.

Of course, it is not as if he could not afford luxury hotels and restaurants. Instead, it was research. Mr. Zhang just wanted to get to know some of the businesses he might one day invest in.

Starting 10 years ago with $20 million from Yale University’s endowment, Mr. Zhang was an early backer of companies like Tencent and JD.com, businesses that have shaken up traditional industries across China. Now he thinks these companies could stir things up globally.

He spoke at the Value Investing Congress in May 2010 and attached is the presentation he gave. The idea he pitched was the B shares of Yantai Changyu Pioneer Wine Co., a Chinese wine maker, which were then trading at 32.06 HKD. As you can see from this chart, the shares more than doubled in less than two years, but have since fallen and, at 28.13, currently trade slightly below where he recommended them:

Whitney Tilson on Lumber Liquidators

2) Below is my latest article on LL, published on SA this morning:

  • Lumber Liquidators reported that same store sales were down 17.8% in March.
  • Even worse, gross margin plunged from an estimated 38.5% to 31%.
  • The company’s margins soared in 2012 and 2013 in large part, I believe, because it was cheating by sourcing tainted products.
  • Now that it can no longer do so, margins will likely return, at best, to historical ranges, which will significantly reduce earnings going forward.
  • Using even generous assumptions, the stock is significantly overvalued.

PS–All nine articles I’ve published on LL in the last month are posted here: www.tilsonfunds.com/LLTilsonarticles.pdf

3) Here’s a question I received about LL and my reply:

Sales will obviously decline and cost will rise, but that will be because of your activities. My question to you is if the CPSC/EPA and/or CARB come out and determine that LL was not in violation of the laws you suggested, will you voluntarily seek to compensate LL and its employees for the loss of business, increased cost and hassle of having to deal with the allegations put forward by you?

To put a finer point on it, store level managers are compensated on a commissions based on certain sales targets. These managers were woefully under-compensated this last month because of the 60 Minutes piece. If those allegations prove untrue, will you pay back wages to such individual employees?

Thanks, Max

My reply:

I genuinely believe that all of the research and conclusions that I’ve published are correct. The idea that I’m knowingly doing the opposite to benefit my short position is beyond ludicrous — which should be clear to anyone who does even a perfunctory check of me and my background. My reputation for integrity is well deserved and something I cherish, so rest assured that I wouldn’t throw it away (not to mention risk going to jail) by engaging in short-and-distort scheme.

My financial interest in LL may be causing subconscious bias — by definition, I wouldn’t know, but I will say that I’m actively seeking disconfirming information (and not finding any).

If I am proven wrong — that LL’s Chinese-made laminate is in fact safe and CARB-compliant — then it will be a major embarrassment to me and I will publicly apologize to the company and anyone else who’s been harmed. (I’m not worried, as I think odds of this are less than 1%.)

But, to answer your question, if I am proven wrong I will not be paying damages to anyone. Think of it this way: if I saw and smelled smoke in a theater, I would surely yell “FIRE!” If it turned out that there wasn’t a fire — but I genuinely believed there was one, had good reason for this belief, and yelled “FIRE!” with good intentions of saving people from harm — nobody would think I should pay the medical bills of someone who sprained their ankle running out of the theater.

Whitney Tilson on short sellers

4) Here are two articles on why it’s healthy for our markets for short sellers to share their research and conclusions publicly. Here’s the first, by Julia La Roche of Business Insider:

The bottom line here is that funds have the ability and the resources to shed light on issues that the public would want to know about. And it’s OK if they make money for their investors in the process.

“In fact, this is a case study of how hedge funds, however self-interested their motivations may be, can be a force for good, by doing the difficult and expensive work it can take to uncover companies doing nefarious things (such as poisoning their own customers) – and then bringing this to the attention of regulators, prosecutors and the media,” Tilson wrote in the group email after the segment aired.

5) Here’s the second by Quoth the Raven:

  • Short sellers are an integral part of the markets.
  • They raise questions about frauds, help the market recognize overvalued and risk-laden companies, and create sales for buyers.
  • The market is Darwinist; only the foolish will ignore the methods used to profit from when their due diligence tells them an equity or the macro markets will decline.

Whitney Tilson