Whitney Tilson in his first quarter letter for 2015 discusses his fund’s performance and talks about his short position in Lumber Liquidators.
Dear Partner,
Our fund gained 0.5% in March vs. -1.6% for the S&P 500. Year to date, our fund is off to a good start, up 2.5% vs. 1.0% for the S&P 500.
(Note that I am now reporting our fund’s net returns, reflecting the 20% performance allocation, as most investors, I’m pleased to say, are now above their high-water mark – meaning that we have recouped for you the losses of 2011 and 2012.)
Our fund had gains on both the long and short sides in Q1. Regarding the former, we had double-digit gains in JetBlue (21.4%), Howard Hughes (18.9%), Spark Networks (13.8%), Fannie Mae (12.4%), Platform Specialty Products (10.5%) and Pershing Square Holdings (10.0%). Partially offsetting these gains were declines in Micron (-22.5%), magicJack (-15.8%), Hertz (-13.0%) and Avis (-11.0%).
On the short side, there are only seven positions remaining in the fund (for reasons discussed in my annual letter), but two were big winners with Lumber Liquidators tumbling 53.5% and Exact Sciences declining 19.8%. These gains were partially offset by Unilife, Herbalife and TMF, which rose 19.7%, 13.4% and 10.4%, respectively.
As of the end of March, the fund was 91% long and 14% short. I exited two small positions in Goldman Sachs (long) and Green Dot (short) during the quarter and, despite continuing to look hard, didn’t establish any new positions. This is not unusual, as I seek to keep portfolio turnover to an absolute minimum and invest for the long term.
Whitney Tilson On Lumber Liquidators
I did spend more time on the short side in the first quarter than I expect to going forward, but this was for a good reason: 60 Minutes did an incredibly damning story about our largest short position, Lumber Liquidators, which was the main catalyst for the stock getting cut in half (it was a remarkable piece of investigative journalism; click here to watch it and/or read the transcript).
When I first discovered compelling evidence nearly a year ago that Lumber Liquidators was selling its American customers hundreds of millions of square feet of laminate flooring sourced in China that contained high levels of formaldehyde – a dangerous chemical and known carcinogen – I assumed that once this information became public, the company would follow the standard playbook: apologize, immediately suspend sales of the toxic product, fix the underlying problem, claim (however improbably) that its Chinese suppliers duped them, and make amends to its customers.
Had the company done this, I would have likely covered at least some and perhaps all of this position and moved on, having earned a very substantial gain, as I initially shorted the stock at $102.69 in October 2013 (it closed March at $30.78).
Instead, however, Lumber Liquidators has denied that there’s any problem whatsoever and adopted a no-holds-barred attack on its critics (not only me, which I expected, but also 60 Minutes, one of the most respected news programs in the world, which it accuses of “making up this story”). Most shockingly, the company is continuing to sell its Chinese-made laminate to its customers, assuring them that it’s “100% safe,” despite overwhelming evidence to the contrary.
What could explain this obviously foolish and reckless behavior? I suspect it’s because they weren’t duped by their suppliers at all. Rather, I have good reason to believe that for quite some time they’ve known exactly what they were doing: going to China and buying laminate flooring (and perhaps other types of flooring as well – I’m looking into this) that doesn’t comply with California Air Resource Board (CARB) standards and thus may have dangerous levels of formaldehyde.
Why would they do something so immoral and potentially destructive? The oldest reason in the universe: greed. Non-CARB-compliant laminate is ~10% cheaper, so the company saved a lot of money on sourcing costs (not a few pennies, as the founder claims), which I think was a major contributor to a quick doubling of margins, which in turn helped send the stock price up eight times from $15 to $119 in less than two years. Both the founder, Tom Sullivan, and the CEO, Robert Lynch, recognized a golden opportunity when they saw it, dumping $37 million worth of stock at prices more than double today’s level in early- to mid- 2013.
If I’m right that the company has been knowingly putting untold numbers of American families at risk, they must surely be feeling truly desperate now that they’ve been caught red-handed, as this is the kind of thing that could not only result in an implosion of the company but also big financial penalties and even criminal charges against senior executives. Consequently, from management’s perspective, their current strategy actually might be logical in a twisted sort of way: deny everything, muddy the waters as much as possible by taking advantage of the uncertainty about the testing methods and the harm formaldehyde causes, bully critics and regulators, and hope the storm passes. If their strategy is to claim that all of their flooring is 100% safe, then they can’t stop selling any of it or it would undermine their claim.
For the sake of the health and safety of Lumber Liquidators’ customers, I wish the company would stop selling what I believe is a dangerous product, but as someone who is short the stock, I’m actually delighted that the company has adopted a strategy that I think is truly insane. First of all, management’s credibility is plunging every day they continue to make the preposterous claim that there’s no problem at all. Perhaps the problem is minor, but there’s definitely a problem.
Secondly, more than 70 class action lawsuits have already been filed against Lumber Liquidators and when they start reaching courtrooms, the fact that the company continued to sell tainted wood after the 60 Minutes segment aired will look very bad. Rather than perhaps earning some sympathy by claiming they were deceived by the Chinese mills, they will instead look like rogue actors.
Thus, I more than doubled our short position during the week after the 60 Minutes story aired, making it a 3.5% position currently. I believe this is large enough to warrant additional time and attention, but not so large that it might cause me to lose sleep at night if the stock bounces around a bit (which I fully expect).
If you’re interested in learning more about this story, click here to see two public presentations I made in November 2013 and October 2014, and click here to read the articles I’ve published in the past month.
As always, thank you for your support and please let me know if you have any questions.
Sincerely yours,
Whitney Tilson
The unaudited return for the Kase Fund versus major benchmarks (including reinvested dividends) is:
