Value Investing

Tilson: Wayfair Doubles Down On Poisoning Its [And Its Partners’] Customers

Wayfair Doubles Down On Poisoning Its (And Its Partners’) Customers by Whitney Tilson

Disclosure: I am/we are short WAYFAIR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Summary

I had three items of furniture sold by Wayfair tested for formaldehyde, and two of them showed toxic levels.

In addition to selling these two items on its own website, the company is selling them on the websites of the partners for which it does fulfillment.

I suspect that these two toxic cabinets are only the tip of the iceberg.

Wayfair continues to sell both and actually slashed the price of the most toxic one in what appears to me to be an attempt to dump it.

The deny-and-attack strategy that Wayfair appears to be adopting is what Lumber Liquidators tried in the 2-3 months after the devastating 60 Minutes story.

Following up on my article last week, Why Wayfair Is My Largest Short Position, on Monday afternoon I gave a 74-slide presentation at the Robin Hood Investors Conference in which I shared additional details of my short thesis on the company (and followed up with an interview on Bloomberg TV).

The most relevant new information I revealed was:

  • I had three items of furniture sold by Wayfair tested for formaldehyde, and two of them showed toxic levels.
  • In addition to selling these two items on its own website, the company is selling them on the websites of the partners for which it does fulfillment (including Wal-Mart, Kohl’s and Staples), so Wayfair is poisoning other companies’ customers, not just its own.
  • Based on what I’ve learned from my two-year involvement with Lumber Liquidators (NYSE:LL), I suspect that a fairly high percentage of furniture and other wood products that Wayfair is selling that are manufactured in China and are constructed of wood composite materials such as medium-density fibreboard (MDF) and particleboard have dangerous levels of formaldehyde.
  • Thousands of products Wayfair is selling are potentially affected, as a search under “MDF” on Wayfair’s website yielded 18,461 items.
  • This problem is likely rooted in the fact that Wayfair appears to do no compliance or quality control of its own; instead, it seems to be relying on little more than assurances from the more than 7,000 suppliers that provide Wayfair with the more than seven million items it sells on its various websites.

What would any sensible, honest, ethical and reputable company do when confronted with evidence that it is selling products that don’t comply with environmental regulations in the largest state, California, and therefore is likely jeopardizing the health and safety of its customers? Wayfair should:

1) Immediately suspend sales not only of the products in question, but also any other products that might be toxic (in this case, at the very least, all furniture and other wood products manufactured in China that are constructed of wood composite materials such as MDF and particleboard);

2) Ask the person who revealed the test results (me) for an official copy of them so that my results can be verified (I’ve posted all three here);

3) Once the results of the tests I commissioned are confirmed, contact all customers who bought these products, inform them of the potential danger, and offer a free return and either a full refund or replacement;

4) Launch its own large-scale testing program to determine how widespread this problem is; and

5) Make a substantial investment in compliance, which would include hiring a senior-level Chief of Compliance, engage firms that specialize in on-the-ground monitoring of suppliers (especially those in Asia), and regularly test products being sold on its site.

Obviously, many of these things will take time, but at the very least I expected Wayfair to immediately stop selling the two toxic products I publicly identified on Monday on this slide in my presentation (page 54):

Wayfair

Indeed, Wayfair had been wise enough to quickly cease selling all laminate flooring from Ark, a Chinese company, right around the time that a New York Times reporter called to ask about high formaldehyde levels in Ark laminate flooring I’d had tested. In light of this, surely Wayfair would be wise enough to suspend sales of the furniture products I’d flagged as toxic, right?

WRONG!

I am truly flabbergasted that Wayfair not only hasn’t suspended sales of the two products in question, but initially slashed the price of the most toxic one (the Shabby 1 cabinet, which is emitting formaldehyde at more than three times the CARB2 limit) from $114.99 to $89.99. Is the overnight 22% price cut an attempt to dump a product that Wayfair now knows is toxic before customers learn that it might be poisonous? Here’s a screenshot from Wayfair’s website yesterday, where one can see the “On Sale” price of $89.99:

Wayfair

Worse yet, Wayfair isn’t content to dump this toxic item on its own customers: it’s also selling it on the websites of the partners for which it does fulfillment. Here are current screenshots showing the same product, “Sold by Wayfair”, on the websites of Wal-Mart, Kohl’s and Staples:

Wayfair

Wayfair

In addition, Wayfair also continues to sell the other toxic product, the TMS Mission cabinet, on both its website as well as Wal-Mart’s, as these screenshots show:

Wayfair

Wayfair

Once Walmart, Kohl’s and Staples realize that Wayfair is, possibly knowingly, selling toxic products to their customers, thereby exposing these companies to significant reputational, legal and regulatory risk, I have to imagine that they will reconsider doing business with Wayfair.

An Update From This Morning

Curiously, when I checked the websites of Wayfair and its three partners this morning, Wayfair had increased the price of the Shabby 1 cabinet to $119.99 on its own website:

Wayfair

Even more curiously, however, Wayfair continues to sell the same product on the websites of Wal-Mart, Kohl’s and Staples at yesterday’s sale price of $89.99. This is the first time I’ve seen Wayfair charging different prices for the same product on its own website vs. its partners’ websites.

What’s going on? Is the price cut yesterday across all sites and the price hike this morning only on Wayfair’s website a computer-driven pricing algorithm, having nothing to do with me publicly identifying this item as toxic on Monday? Or is Wayfair (or Zingz & Thingz) playing a nefarious game, trying to dump a known toxic product on unsuspecting customers?

Deny-and-Attack Strategy

For the health and safety of Wayfair’s customers, I hope the company immediately suspends sales of these two products (and similar ones). As someone who is short the stock, however, I’m delighted that the company has not only continued to sell them, but in fact appears to be rushing to dump the most dangerous item as quickly as possible on unsuspecting customers, while simultaneously attacking its critics (mainly me).

This deny-and-attack strategy is what Lumber Liquidators adopted in the 2-3 months after the devastating 60 Minutes story, and it failed spectacularly as the stock plunged by another two-thirds.

The parallels are striking. Rather than suspend sales of the Chinese-made laminate that 60 Minutes, I and others had tested, which showed formaldehyde levels many times the CARB2 limit, Lumber Liquidators slashed prices and rushed to sell it. Wayfair appears to be doing the same.

And soon after the 60 Minutes story aired, Lumber Liquidators posted this attack on its website:

These attacks are driven by a small group of short-selling investors who are working together for the sole purpose of making money by lowering our stock price. They are using any means to try and scare our customers with inaccurate allegations. Their motives and methods are wrong and we will fight these false attacks on all fronts.

In addition, Lumber Liquidators founder and Chairman Tom Sullivan went on CNBC and accused 60 Minutes, one of the most respected news programs in the world, of “making up this story” and defiantly said the company would continue selling the laminate because “we will sell what customers want.”

Similarly, Wayfair’s co-founder and CEO, Niraj Shah, went on CNBC last week and told Jim Cramer that “These short sellers just look for a stock they can knock around and make a quick buck or two” and slammed the New York Times, one of the most respected newspapers in the world, saying that I “managed to get [the NYT] to write the story for him.”

This Isn’t a Short-and-Distort Campaign

It’s almost not worth responding to the usual trope about we’re-the-victim-of-a-conspiracy-of-nefarious-self-serving-short-sellers, but a few points are in order.

I’ve spent my entire life building a good reputation. Of course I have an interest in making money – that’s my job – but the idea that I would destroy my reputation by inventing a story to smear an innocent company to benefit one position (among three dozen) in my portfolio is beyond absurd. It would also be easy for the company to show that I’m lying – and I’d likely end up banned from the industry (or worse). One might not agree with my analysis or conclusions, but know that my beliefs are genuinely held.

Nor have I done any trading around last week’s New York Times’ article or my own article and presentation. In fact, my last trade in Wayfair’s stock was on Sept. 23rd, when I increased my short position.

Rather than having a conflict of interest, I believe I have a confluence of interest: in speaking out, I am both doing my job and also serving the public interest by warning Wayfair, suppliers, regulators and customers about the likely dangers of certain Wayfair products.

I find it quite ironic that the company is accusing me of distorting the truth for my own financial gain when it is, in fact, the senior executives of the company who have far greater incentives to do so than I. This is one of roughly three dozen positions in my fund (only 11 of which are shorts), so it’s not going to make or break me one way or another. In contrast, the outcome of this battle means everything to Shah and his fellow executives, both reputationally and financially. Shah and the other co-founder, Steven Conine, each own Wayfair stock worth nearly $600 million and the top eight executives at Wayfair have been selling an average of nearly $7 million of stock per month for the past seven months, led by Shah and Conine, at $2.7 million per month each.

So let’s be clear which of us has overwhelming incentives to present a false and misleading picture of Wayfair…

But What About Others Selling Similar Products?

In a note to clients yesterday rebutting my presentation, a Wedbush analyst wrote:

…we do not think W has a compliance problem. We think the company has adequate controls over suppliers and no major online-only competitor, including Amazon, has a Chief Compliance Officer that Tilson believes is necessary.

Tilson points to tests indicating that 2 of 3 MDF-based furniture products (out of 18,337 offered) had excess formaldehyde levels. We note that other large internet companies such as Amazon sell similar products (such as this one) from one of the same manufacturers in question, Zingz and Thingz, suggesting this is not a Wayfair-specific issue if it is one at all.

I agree that other merchants are selling the two toxic items that I identified. For example, here are screenshots of both being sold by other merchants on Amazon’s website right now:

Wayfair

Wayfair

Like Wayfair, Amazon and any other merchant carrying these two products should immediately suspend sales, and then invest in compliance to make sure that no other toxic items poison their customers. In particular, in light of the known potential dangers of composite wood products, especially those made in China, it is irresponsible for any retailer to sell these products without a rigorous compliance program in place. The entire industry, not just Wayfair, needs to wake up and take steps to deal with what I suspect is a widespread problem.

But is the Wedbush analyst seriously defending Wayfair by channeling his inner Richard Nixon and arguing that “If two wrongs don’t make a right, try three”???

I will email Jeff Bezos directly today and make him aware that Amazon appears to have the same problem Wayfair does – but this doesn’t excuse Wayfair poisoning its own (and its partners’) customers (however inadvertently) and, worse yet, failing to fix the problem once made aware of it.

Lastly, I think Wayfair has a much bigger problem than Amazon does for two reasons. First, Amazon is more than 50 times Wayfair’s size, so it can easily suspend sales of any questionable products and invest a few million dollars in compliance with no impact to its business. Second, unlike Wayfair, Amazon isn’t trying to build a trusted brand in the furniture and home goods space, so if this issue becomes widely known, I think customers are far more likely to abandon Wayfair than Amazon, especially in light of the latter’s far better service and long-term customer loyalty.

Conclusion

I am short Wayfair’s stock because I believe it’s significantly overvalued, primarily because (as I wrote in my article last week and presentation on Monday) it has one of the worst business models I’ve ever seen. Competing head-to-head vs. Amazon, Home Depot, Target, Williams-Sonoma, etc. (did I mention AMAZON???), I think the company’s odds of ever reaching breakeven, much less earning a profit, much less earning enough of a profit to justify a $3 billion market cap are close to zero.

This formaldehyde problem is a catalyst for my short position, to be sure, but isn’t likely to be a major issue if – and this is a big if – Wayfair is smart in handling it. It was smart to stop selling Ark laminate flooring, but the company is being very dumb right now in (apparently) adopting a deny-and-attack strategy. It’s just not that expensive to temporarily suspend sales of a small fraction of the seven million products Wayfair sells and implement a proper compliance program to ensure that its customers aren’t being poisoned (unless the problems are more widespread than I believe, which would explain the company’s recent actions – and spell doom for the stock).

As I noted earlier, for the health and safety of Wayfair’s customers, I hope the company immediately suspends sales of the two toxic products I’ve identified (and similar ones) and implements the other obvious steps I’ve outlined. As someone short the stock, however, I hope they channel their inner Lumber Liquidators and turn a manageable situation into a disaster. Stay tuned – this could get interesting…