From an email which Whitney Tilson sent to investors on his largest short, which he has now disclosed – Wayfair
STOP THE PRESSES! The New York Times has just broken a story that I’m involved with that major U.S. public companies, including Wayfair (and via Wayfair, Wal-Mart, I’m sure they will be horrified to learn) were, until the NYT reporter called, likely selling toxic, formaldehyde-drenched Chinese-made laminate flooring seven months after the 60 Minutes story aired that has destroyed Lumber Liquidators. Wayfair is currently my largest short position by far.
Here are some excerpts from the article below (I’m mentioned a couple of times):
The hedge fund manager who publicly accused Lumber Liquidators of selling wood with dangerous levels of formaldehyde is leveling the same claims against Ark Floors, a California importer of Chinese wood products that are sold all over the United States.
…Test results from five types of Ark laminate show levels of formaldehyde “well above” the emission standards set by the California Air Resources Board, according to Josh Hosen, senior manager of certification programs at HPVA Laboratories, a testing company in Reston, Va. Whitney Tilson, the hedge fund manager who runs Kase Capital Management, hired HPVA to run the same tests on Ark’s products as the lab had done on Lumber Liquidators’ products.
…It is difficult to know exactly where Ark’s laminate was sold and whether the products are still on store shelves in the United States. Mr. Tilson has bet against the stock of the online retailer, Wayfair, which sold the products on its website and through Walmart.com.
While Wayfair listed some Ark products among its best-selling laminate, Jane Carpenter, a spokeswoman for the website, said it had sold just 10 orders since December 2014, including one order through Walmart.com. Jaeme Laczkowski, a spokeswoman for Walmart.com, confirmed that the site had sold one order of laminate through Wayfair before the product was removed.
…Lumber Liquidators’ stock has dropped more than 70 percent since Mr. Tilson appeared in a March 1 episode of the CBS program “60 Minutes,” which accused the company of selling Chinese-made laminate flooring that contained unsafe amounts of formaldehyde.
The Consumer Product Safety Commission opened an investigation in March, and in May, Lumber Liquidators announced that it would suspend sales of laminate products from China.
But other companies, including Home Depot and Ark, appear to have sold laminate from some of the same Chinese mills that supplied Lumber Liquidators, raising questions about other products for sale in the United States.
“We all believe it’s a pervasive problem. It’s not just a Lumber Liquidators problem,” said Denny Larson, an environmental consultant who works with plaintiffs’ lawyers.
…Shortly after “60 Minutes” broadcast its report on Lumber Liquidators, employees at Ark were told that the company no longer sold laminate to California customers unless it had a CARB-compliant label, three former employees said. Another former employee, Tim Wang, who said he had worked in the sample department of Ark’s California warehouse until July, confirmed that the company sold noncompliant flooring outside of the state.
You may have never have heard of Wayfair (W), but it aims to be the Diapers.com or Zappos of everything for the home – here’s the description of the company from Yahoo Finance:
Wayfair Inc. engages in the e-commerce business in the United States. It offers approximately seven million home products under various brands. The company’s brands include Wayfair.com that focuses on offering home furnishings and décor from low-to high-end and across various styles; Joss & Main, an online flash sales site; AllModern, an online destination for original design for modern home enthusiasts; DwellStudio, an online design studio for modern, fashion-forward home furnishings; and Birch Lane, a destination for classic style home designs. Wayfair Inc. also sells its products through retail partners. Wayfair Inc. was founded in 2002 and is headquartered in Boston, Massachusetts.
It has grown like wildfire – that’s what willingness to lose a ton of money plus buying a lot of Google keywords will do! – and has run-rate revenues of around $2 billion. It went public a year ago and now has a nearly $4 billion market cap. It reports earnings tomorrow morning and has a conference call at 8am.
Wayfair is my largest short position because, 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 $4 billion market cap are close to zero. (Operating income over the last four quarters (through Q2) is -$142 million vs. -$59 million in the four quarters before that. The company as of Q4 had $288M of cash, $79 million of long-term investments, and no debt.) Plus this business is so poorly managed and/or spread so thin that they were selling Chinese-made laminate long after everyone in the flooring industry knew (thanks to 60 Minutes) that there were big issues – and potential liabilities – associated with this product so extreme caution was called for.
To be clear, this is not Lumber Liquidators Part 2. LL was selling ~$140 million annually of Chinese-made laminate flooring before the scandal, whereas Wayfair claims to have “sold just 10 orders since December 2014, including one order through Walmart.com.” Also, Wayfair was smart enough to immediately pull the product once the NYT reporter called and made them aware of the potential problem. So the possible liabilities here are much lower – and, I suspect, there was no intent to harm. Unlike Lumber Liquidators, I don’t think Wayfair was deliberately poisoning its own customers to save a few bucks on sourcing costs.
Rather, to me it is compelling evidence of Wayfair’s gross incompetence and/or a business that’s completely out of control. They are selling “seven million home products” – talk about growth run amok! I’ve seen this story so many times by companies trying to justify their insane share prices. It’s a curse because it almost always ends in tears…
Take a look at zulily (ZU) for one good example (which I was short successfully). The company IPO’d in late 2013, with the stock trading in the mid-$30s. It then briefly soared to over $70 before reality set in and the stock crashed to under $12 before investors got bailed out (sort of) when Liberty Interactive bought ZU for $17.40.
I think Wayfair’s stock will be below $10 within a year (it closed today at $45.84).
PS—One reader just sent me another analogy: “I think Wayfair is Overstock.com 2.0. It seems like the exact same business model.”
I replied: “I agree – and that has very sobering implications for Wayfair’s stock, as OSTK, which I think is roughly fairly valued, trades at an EV/Sales multiple of 0.20 whereas Wayfair’s is 2.05, implying 90% downside for Wayfair’s stock…
PPS—If you want to read more on the short case for Wayfair, see the following:
- Wayfair is the Most Mispriced Stock Citron Research has seen in Years — Fair Value Under $10, by Andrew Left, Citron Research, 8/31/15
- Sell Wayfair When Negligent Wall Street Analysts Are Too Lazy To Google, Xuhua Zhou, 9/9/15 [Xuhua is the analyst who first wrote about Lumber Liquidators’ formaldehyde problems in June 2013 – see here and here]
- Don’t Get Zulily’d By Wayfair’s Overstocked Valuation, The Friendly Bear, 8/17/15
- This Stock is Another Sign We’re in a Tech Bubble, by Andre Rouillard, 3/30/15
- The Wayfair Battleground, IPO Candy, 9/10/15
That’s all the commentary for now, but will have lots more to say when I present this idea at the Robin Hood Investors Conference on Monday afternoon, starting at 3:55pm. If you’d like to attend, there are still tickets available – see: http://investors.robinhood.org. I hope to see you there!