Business

Whitney Tilson On Lumber Liquidators; Berkshire; Tech Visionaries

Excerpted from an email which Whitney Tilson sent to investors

Whitney Tilson talks about the 6th annual Take ‘Em to School Poker Tournament, shorting Lumber Liquidators, tech visionaries, Berkshire Hathaway trading cheap and cybercrime.

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Whitney Tilson on the 6th annual Take 'Em to School Poker Tournament

1) The 6th annual Take ‘Em to School Poker Tournament, which I’m co-chairing, is coming up three weeks from today on Wednesday, July 22nd. It benefits Education Reform Now, a non-partisan 501c3 organization committed to ensuring that all children can access a high-quality public education regardless of race, gender, geography or socioeconomic status.

It’s always a great night for players, spectators, and education reformers alike. The poker tournament will feature 260 players battling for prizes that last year included a seat at the WSOP Main Event, a table at Rao's and power lunches with David Einhorn, Seth Klarman and Leon Cooperman. For those attending as cocktail guests, there will be a variety of casino games including blackjack, craps and roulette. This year’s event also features a silent auction and a full swing golf simulator, which will host Long Drive and Closest to the Pin contests.

The evening will be emceed by poker legend Phil Hellmuth, and others participating include poker legends Phil Ivey, Erik Seidel and Layne Flack; sports icons James Blake, Allan Houston, Alex Kovalev, Apolo Ohno and John Starks; and award-winning actors Hank Azaria, Billy Crudup and Seth Gilliam.

The event is almost sold out, so reserve your seat/table today at: www.TakeEmToSchool.org. I hope to see you there!

Whitney Tilson on Lumber Liquidators

2) Below are comments I sent around two days ago to my Lumber Liquidators email list  regarding an article by “The Specialist” about why he covered his Lumber Liquidators short. Here’s an excerpt:

I wonder if this article is why Lumber Liquidators is basically flat today on a big down day? This guy has written some sensible things about Lumber Liquidators in past articles – and, who knows, maybe his trading call here may prove to be right. I never have any opinion on the short-term gyrations of stocks or markets.

But if I had to guess, I think he’s wrong because I totally disagree with his assertion that “Fundamentals may not matter for years to come.” I think the next earnings report, for the quarter ending tomorrow, which the company will report out on or about July 29th, will matter a huge amount. Longs are counting on at least a stabilization, if not recovery, of sales/same-store sales and margins, while shorts foresee more terrible numbers, as customers abandon the company in droves. My best source, someone within the industry, thinks it will be the latter.

In addition, I think there’s likely to be bad news in the not-too-distant future from regulators, relating to both the illegal sourcing of hardwoods from Russia (Lacey Act violations) and the formaldehyde-drenched laminate, so the simple reason that the company is clearly guilty of both and it shouldn’t take regulators too much longer to figure this out.

…it’s possible to make money bottom fishing the stocks of troubled companies – and make a ton of money if the fundamentals actually improve. And, yes, there may be a time to bottom fish Lumber Liquidators (at which point, hopefully I’ll be clever enough to cover most or all of my short; I doubt I’ll ever be long this stock) – but as I’ve been saying over and over again, it is MUCH too early to be trying to bottom fish it here, for two reasons:

3) I’m mentioned briefly in this article in the NYT, The Loneliness of the Short-Seller (what a great contra-indicator!):

The other short-sellers who remain, meanwhile, have also been proved right on occasion. Whitney Tilson reaped a windfall this year when Lumber Liquidators, a flooring company he attacked for more than a year, accusing it of selling an unsafe product, came under pressure after a report by “60 Minutes” in March. Shares of Lumber Liquidators tumbled 25 percent the day after the broadcast, which accused it of selling a type of Chinese laminate flooring that contained dangerous levels of formaldehyde.

Whitney Tilson's books make in Wall Street's Must-Read Books of the Summer list

4) Two of my books made this list: These Are Wall Street's Must-Read Books of the Summer:

As  things slow down a bit on Wall Street during the summer months, many of its best and brightest will find more time in their schedules to read. We asked a few of them what books were on their lists, and here are some of those must-reads. Participants were asked to give one recent book that they enjoyed as well as an all-time favorite, although some of them had so many recommendations that they couldn't narrow it down to just two.

5) A very interesting article about the culture in the tech sector in US – but not in Europe – that leads to tremendous innovation here, not there:

“They’re trying to recreate Silicon Valley in places like Munich, so far with little success,” she said. “The institutional and cultural differences are still too great.”

There are institutional and structural barriers to innovation in Europe, like smaller pools of venture capital and rigid employment laws that restrict growth. But both Mr. Kirkegaard and Professor Moser, while noting that there are always individual exceptions to sweeping generalities about Europeans and Americans, said that the major barriers were cultural.

Often overlooked in the success of American start-ups is the even greater number of failures. “Fail fast, fail often” is a Silicon Valley mantra, and the freedom to innovate is inextricably linked to the freedom to fail. In Europe, failure carries a much greater stigma than it does in the United States. Bankruptcy codes are far more punitive, in contrast to the United States, where bankruptcy is simply a rite of passage for many successful entrepreneurs.

Whitney Tilson on tech visionaries

6) Funny – I had the EXACT same response when I read these three books – it was shocking to read how these three visionaries/geniuses could be so “unnecessarily cruel and demeaning” to their employees:

As I was reading Ashlee Vance’s “Elon Musk: Tesla, Space X and the Quest for a Fantastic Future,” I was alternately awed and disheartened, almost exactly the same ambivalence I felt after reading Walter Isaacson’s “Steve Jobs” and Brad Stone’s “The Everything Store: Jeff Bezos and the Age of Amazon.”

The three leaders are arguably the most extraordinary business visionaries of our times. Each of them has introduced unique products that changed – or in Mr. Musk’s case, have huge potential to change – the way we live.

I was awed by the innovative, courageous, persistent and creative ways all three built their businesses. I also love their products. I own a Mac Pro and an iPhone, and I have been a loyal customer of Apple for 20 years. I buy many books and other products on Amazon, lured by a blend of low prices, ease of purchase and reliably quick delivery. The Tesla Model S is hands down the best car I have ever driven, and it’s all electric, rechargeable in your garage.

Plainly, I have bought in to what these guys are selling.

What disheartens me is how little care and appreciation any of them give (or in Mr. Jobs’s case, gave) to hard-working and loyal employees, and how unnecessarily cruel and demeaning they could be to the people who helped make their dreams come true.

…Why would otherwise brilliant men behave in such destructive ways?

The first answer is that they can. Genius covers a lot of sins. A great product is a great product, and you don’t have to do everything right to be successful. Most customers don’t care how the sausage gets made, as long as it tastes good.

Employees, in turn, are willing to sacrifice a lot to work for a visionary. Much as Mr. Jobs was, Mr. Musk and Mr. Bezos are passionate, inspiring and charismatic leaders.

“Numerous people interviewed for this book decried the work hours, Musk’s blunt style and his sometimes ludicrous expectations,” Mr. Vance wrote. “Yet almost every person – even those who had been fired – still worshiped Musk and talked about him in terms usually reserved for superheroes or deities.

Finally, a certain level of financial success and the resulting power effectively excuse those who achieve it from the ordinary rules of civility and even humanity.

Whitney Tilson on Berkshire Hathaway looking cheap

7) Good to see, as this will likely benefit Berkshire Hathaway over time (BTW, BRK is looking pretty cheap these days, trading more than 21% below my latest estimate of intrinsic value of $261,000/A share – see www.tilsonfunds.com/BRK.pdf for my updated slides):

Warren Buffett has long been a fan of China, admiring its rapid growth and global influence. What is also becoming clear is that China is a big fan of his.

A Chinese online-game developer last week bid $2.35 million in a charity auction for the privilege of dining with Mr. Buffett. Zhu Ye, the chairman of Dalian Zeus Entertainment Co., is expected to bring up to seven guests to the U.S. to have lunch with the billionaire investor.

This year’s bid is one of the highest in 16 years of the auction, through which Mr. Buffett has raised $20 million for a San Francisco charity. It is also the second time someone from China has been named as the top bidder; in 2008, investor Zhao Danyang paid $2.1 million.

“I think there is great interest in the stock market, and they associate me with the stock market,” Mr. Buffett said of Chinese investors in an interview.

The auction was the latest sign of the Berkshire Hathaway Inc. chief’s rising popularity in China. At the company’s annual meeting last month, more than 200 people traveled from China to listen to Mr. Buffett and his partner Charlie Munger answer shareholder questions. The group was large enough that, for the first time, Berkshire set up a special overflow room for Chinese attendees to listen to a simultaneous translation of the question-and-answer session.

Not all of those attendees were Berkshire shareholders, but many in the group were “big hitters” in Chinese business and investing, Mr. Buffett said. A decade ago, barely a handful of people attended from the country.

“They generally regard him as having a Midas touch,” Willy Lam, a China politics expert at the Chinese University of Hong Kong, said of Chinese investors’ view of Mr. Buffett.

8) Very good points re. The High Cost of Investing Like a Daredevil:

Live in the moment: If you’re skiing, surfing or scuba diving, that’s the way to go. But if you’re investing, that approach can lead to disaster.

The numbers show that most people who are lucky enough to have money to invest end up underperforming the markets by staggering margins. A big reason for that is living in the moment — acting in response to ephemeral events. Most of us would be much better off we focused relentlessly on the far horizon, sticking with a simple and cheap plan for getting there.

“When investors think short-term and try to time the market, they haven’t done very well,” Louis S. Harvey, the president of Dalbar, a Boston research firm, said in an interview. “They have been leaving a lot of money on the table.”

His company has been chronicling mutual fund investors’ efforts to beat financial markets for many years, and it has found that as a group, typical investors almost invariably lose.

The numbers are devastating.

For the two decades through December, Dalbar found, the actual annualized return for the average stock mutual fund investor was only 5.19 percent, 4.66 percentage points lower than the 9.85 percent return for the Standard & Poor’s 500-stock index. Bond investors did even worse, trailing the benchmark Barclays Aggregate Bond index by 4.71 percentage points.

Whitney Tilson on cybercrime

9) A fascinating, in-depth cover story, with lots of salacious details, by Peter Elkind of Fortune about “The Hack of the Century”:

A cyber-invasion brought Sony Pictures to its knees and terrified corporate America. The story of what really happened—and why Sony should have seen it coming.

10) A hilarious 2-min South Park segment on how banks incinerate the investments of average folks: https://www.youtube.com/watch?v=-DT7bX-B1Mg

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Whitney Tilson why Lumber Liquidators is basically flat today on a big down day?

I wonder if this article (below) is why Lumber Liquidators is basically flat today on a big down day? This guy has written some sensible things about Lumber Liquidators in past articles – and, who knows, maybe his trading call here may prove to be right. I never have any opinion on the short-term gyrations of stocks or markets.

But if I had to guess, I think he’s wrong because I totally disagree with his assertion that “Fundamentals may not matter for years to come.” I think the next earnings report, for the quarter ending tomorrow, which the company will report out on or about July 29th, will matter a huge amount. Longs are counting on at least a stabilization, if not recovery, of sales/same-store sales and margins, while shorts foresee more terrible numbers, as customers abandon the company in droves. My best source, someone within the industry, thinks it will be the latter.

In addition, I think there’s likely to be bad news in the not-too-distant future from regulators, relating to both the illegal sourcing of hardwoods from Russia (Lacey Act violations) and the formaldehyde-drenched laminate, so the simple reason that the company is clearly guilty of both and it shouldn’t take regulators too much longer to figure this out.

I do agree, however, with The Specialist’s analogy about JCP, but I pick a different time point and thus draw the opposite conclusion, as I think Lumber Liquidators today is where JCP was at the same price in mid-2013. At that time, JCP’s stock had fallen more than 50% to the low $20’s, but as the fundamentals continued to deteriorate, the stock followed and eventually fell ANOTHER 75% to under $6.

At that price, some extremely clever/lucky investors made some good money, as the stock popped back over $11 in a little under a year (in the 10 months since then, it’s now down to $8.59).

So, yes, it’s possible to make money bottom fishing the stocks of troubled companies – and make a ton of money if the fundamentals actually improve. And, yes, there may be a time to bottom fish Lumber Liquidators (at which point, hopefully I’ll be clever enough to cover most or all of my short; I doubt I’ll ever be long this stock) – but as I’ve been saying over and over again, it is MUCH too early to be trying to bottom fish it here, for two reasons:

1) Not nearly enough time has passed. Believe it or not, the 60 Minutes story (on March 1st) aired less than four months ago. Stabilizing a company with significant challenges generally takes at least a year, in my experience/observation – and Lumber Liquidators is in a full-blown crisis, with the departure of four senior execs, investigations by a half dozen federal agencies and two US Senators, etc.

Contrast this with Netflix, which had a PR debacle with its idiotic Quikster idea, which drove its high-flying stock from $303 to well under $100 in less than five months in mid- to late-2011. I was buying it then around $77 – and proceeded to lose a THIRD of my capital, as the stock ultimately bottomed at $53 nearly ONE FULL YEAR later (only then did it start skyrocketing). And this was an easy challenge compared to what Lumber Liquidators faces: NFLX had merely annoyed its customers – it didn’t poison them! – and to fix it, all it had to do was abandon the stupid Quikster idea (which it did within weeks, yet the stock STILL took a year to start moving).

The lesson is clear: busted companies and busted stocks can go down a lot further – and stay down a lot longer – than you think, so BE PATIENT! If there ever is a good time to bottom fish Lumber Liquidators, I suspect it won’t be until March/April 2016, when the company will be lapping easy comps from the 60 Minutes story.

2) When bottom fishing a stock, it’s REALLY important to buy it cheap – not a little cheap, but HUGELY cheap – and Lumber Liquidators just isn’t. In my article on April 3rd, Comments on Lumber Liquidators’ First Quarter Business Update (when the stock was above $33), I wrote:

If we take the midpoint of the historical operating margin, 7%, and assume $1 billion in sales, that means Lumber Liquidators would have $70 million of operating income. Applying a 39% tax rate and dividing by 27.2 million shares results in earnings per share (EPS) of $1.57 – which is almost exactly current consensus analysts’ estimates for 2015 of $1.60.

The difference between us, however, is that I think $1.57 is normalized earnings power in a best-case scenario, excluding many costs that I believe are likely to be substantial and long-lasting, whereas analysts think 2015 will be an unusual trough year and that the company’s EPS will soar 41% to $2.26 in 2016. I would bet my last dollar that Lumber Liquidators doesn’t earn $2.26 in 2016.

Rather, I think it would be extremely generous and optimistic to estimate that the company’s earnings grow 10% in 2016, which would result in EPS of $1.76. If I’m right, what multiple might the stock trade at? It could trade as low as 6x if regulators take strong action and various lawsuits gain traction (which I think is highly likely), and as high as 15x if not, which results in a stock price range of $10.56-$28.16. Either way, it’s a substantial discount to the current price of $33.20, which is why this remains my largest short position.

Since then, analysts have been scrambling to lower their estimates, which now stand at $0.42 for this year and $1.48 for next year. Thus, the stock, at $21.09 today, trades at 50.2x this year’s estimates and 14.3x next year’s estimates. These multiples are much too high for a business of mediocre quality (at best) that is facing enormous uncertainty and contingent liabilities that, in a worst-case scenario, could bankrupt it. Think about it: would anyone care if Lumber Liquidators ceased to exist?

I highly doubt that Lumber Liquidators will earn $1.48 next year, but even if it did, I think a 10x multiple would be generous, so that translates into a stock price of $14.80 – 30% below today’s levels. Thus, while I’m not adding to my short position, I’m very comfortable keeping it as my largest short.

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