Business

Whitney Tilson: Why Wayfair (W) Is My Largest Short Position

Whitney Tilson in his email discusses why Wayfair is my largest short position – as we first reported yesterday; Platform Specialty Products could rebound; updated Berkshire Hathaway slides and maybe financial markets have been wrong all along.

1) I just published the article below on Why Wayfair Is My Largest Short Position. Here’s a summary:

  • In an article on its web site yesterday, the New York Times revealed that Wayfair was, until very recently, likely selling toxic, formaldehyde-drenched Chinese-made laminate flooring to at least a handful of customers.
  • The formaldehyde problem, by itself, isn’t a major issue; rather, it’s compelling evidence to me of Wayfair’s gross incompetence and/or a business that’s completely out of control.
  • I am also short Wayfair because it has one of the worst business models I’ve ever seen. Competing head-to-head vs. Amazon, Home Depot, Target, Williams-Sonoma, etc., 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.
  • I predict that Wayfair’s stock will be below $10 within a year.

I will have lots more to say when I present this idea at the Robin Hood Investors Conference this coming Monday afternoon, starting at 3:55pm. If you’d like to attend, there are still tickets available (see: http://investors.robinhood.org) – and it’s for a wonderful charity. I hope to see you there!

Despite crushing revenue estimates when it reported Q3 earnings this morning, the stock is down ~10.5% so far today.

2) A nice article in this weekend’s Barron’s about Platform Specialty Products, one of my largest positions, whose stock has gotten whacked in recent months. I’ve been buying more.

The shares, which began trading in New York at about $15 hit a high of $28 in June, but have since fallen 60% to a recent $11.70, as investors have grown uneasy with leveraged operations. Lost in the selloff, however, is Franklin’s enviable track record of making roll-ups work. The stock could stage a rebound in the next 12 months.

Difficult conditions in agriculture, Platform’s largest market, and a strong dollar have hurt business. Investors also were dismayed by the Oct. 23 announcement that CEO Dan Leever would retire. Ackman’s involvement, given his travails with Valeant Pharmaceuticals (VRX), might have contributed to the free-fall.

Still, concerns over West Palm Beach, Fla.–based Platform appear overblown. The departure of Leever could be a plus, as he admitted that he wasn’t the right leader to bring the businesses together.

3) Berkshire reported decent Q3 earnings last Friday and I’ve updated my slide presentation and posted it at www.tilsonfunds.com/BRK.pdf. I peg intrinsic value at $267,000/A share, 33% above the current of $200,682. The most interesting bit of analysis, courtesy of my friend Glenn Tongue of Deerhaven Capital, is on page 14:

Berkshire’s Financials Don’t Currently Reflect $7.7 Billion ($4,700/A share) of Value in Kraft Heinz

  • On June 7, 2013, Berkshire invested $8 billion in preferred stock and $4.25 billion in equity in the buyout of Heinz, alongside 3G.
  • On July 6, 2015, Heinz merged with Kraft. In connection with this transaction, Berkshire invested an additional $5.26B in the new company.
  • Upon the merger, Berkshire’s two equity investments totaling $9.51 billion were converted into 325 million shares of the new Kraft Heinz Company, worth $23.2 billion at the current share price of $71.43.
  • Thus, the total investment, including the $8 billion of preferred stock, is currently worth $31.2 billion, yet it is only carried on Berkshire’s balance sheet (under the line item “Investments in The Kraft Heinz Company“) at $23.5 billion, or $7.7 billion ($4,700/A share) less.
  • This amount should be added to the calculation of intrinsic value.

I will be speaking about the company tomorrow at the Berkshire Hathaway 50th Anniversary Symposium in NYC (which is sold out, sorry).

4) A provocative article:

Is the value premium disappearing? The answer to that question could shake the foundations of the asset-management industry.

…There are signs that this is happening. Although value stocks did well in the early 2000s, they have dramatically underperformed since the crisis, even though the market has boomed. Of course, that might simply be a particularly long period of underperformance — we might expect to see value bounce back soon enough. But in fact, the decline has been going on for quite a bit longer than that — the value premium has been falling since the mid-1990s. Coincidentally, that is exactly when the Internet and computerized trading systems made it possible to invest in stocks much more cheaply, and to gather information much more easily.

That would mean that markets are getting more efficient — at least, in this one particular way. But it would also mean that market efficiency takes a very long time to establish itself. If big, systematic mispricings such as the value premium can survive for decades before they are finally traded away, it means that other flaws in the market might be equally long-lived. For example, the momentum factor — another mainstay of standard finance theory — might also be a market flaw that will eventually be shown the exits.

If the market is that inefficient, it also means that stock prices are, in some deep sense, “wrong” — that they are not the best available estimate of a company’s value. That would suggest we should be relying on markets less than we do for things like executive compensation. So watch to see if the value premium comes back. If it doesn’t, it means it might never have been about risk in the first place.

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Whitney Tilson: Why Wayfair Is My Largest Short Position

Whitney Tilson

Nov. 10, 2015 8:49 AM ET  |  About: Wayfair (W)

Disclosure: I am/we are short WAYFAIR. (More…)

http://seekingalpha.com/article/3670336-why-wayfair-is-my-largest-short-position

Summary

  • In an article on its web site yesterday, the New York Times revealed that Wayfair was, until very recently, likely selling toxic, formaldehyde-drenched Chinese-made laminate flooring to at least a handful of customers.
  • The formaldehyde problem, by itself, isn’t a major issue; rather, it’s compelling evidence to me of Wayfair’s gross incompetence and/or a business that’s completely out of control.
  • I am also short Wayfair because it has one of the worst business models I’ve ever seen. Competing head-to-head vs. Amazon, Home Depot, Target, Williams-Sonoma, etc., 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.
  • I predict that Wayfair’s stock will be below $10 within a year.

The New York Times has broken a story 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 Times 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 my largest short position by far.

Here are some excerpts  from the article below (I’m mentioned a couple of times):

As Lumber Liquidators continues to struggle in the aftermath of a safety crisis over its Chinese-made laminate flooring, a much smaller flooring company has been drawn into the spotlight.

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 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 TTM revenues of nearly $2 billion. It went public a year ago and now, thanks to investors and Wall Street analysts falling in love with the growth story, it has a nearly $4 billion market cap. It just reported Q3 earnings this morning and had a conference call at 8am.

This isn’t my largest short position because I thought Wayfair would miss Q3 numbers (in fact, it reported YOY revenue growth of 77%, smashing estimates). Rather, it’s primarily because 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 nearly $4 billion market cap are close to zero. (Operating income over the last four quarters was -$137 million, 71% higher than the -$80 million in the four quarters before that. The company has $399 million of cash and long-term investments and no debt.)

In addition, 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.
Just as I did with Lumber Liquidators, I hired a testing company to purchase and test five samples of Ark laminate flooring from Wayfair’s web site. All five failed the California Air Resources Board (CARB2) limit in spectacular fashion (by a factor of 2-5x). In fact, the test results were very similar to those for the three samples of Lumber Liquidators Chinese-made laminate that I had tested more than a year ago.

To be clear, however, I am not claiming that Wayfair is Lumber Liquidators Part 2. Lumber Liquidators 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 Times 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.  While the company was founded in 2002, it was only rebranded and started pursuing extreme growth in 2011. They are now selling “seven million home products” sourced from over 7,000 suppliers, and grew revenues 77% last quarter – 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 for one good example that I shorted 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 zulily for $17.40.

One of my readers wrote to me with 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 Overstock, which I think is roughly fairly valued, trades at an EV/Sales multiple of 0.20x whereas Wayfair’s is 2.05x, implying 90% downside for Wayfair’s stock…

I predict that Wayfair’s stock will be below $10 within a year (it closed yesterday at $45.84).

I will have lots more to say when I present this idea at the Robin Hood Investors Conference this coming Monday afternoon, starting at 3:55pm. If you’d like to attend, there are still tickets available (see: http://investors.robinhood.org) – and it’s for a wonderful charity. I hope to see you there!

PS—If you want to read more on the short case for Wayfair, see the following:

Wayfair

Backed by Bill Ackman, Platform Specialty Products Could Rebound

Free cash flow could rise sharply at Platform, a chemicals company rollup.

By David Englander

Barron’s, November 7, 2015

Martin Franklin of Platform

A few years ago, Martin Franklin, a noted deal maker who built the consumer-products company Jarden into a juggernaut with $8 billion in annual sales, decided to get into the chemicals business.

With the backing of investors Nicolas Berggruen, Bill Ackman, and others, Franklin made his first deal in October 2013, acquiring chemicals maker MacDermid. Not long after, in January 2014, his Platform Specialty Products (ticker: PAH) was listed on the New York Stock Exchange.

Platform has since closed four acquisitions, and announced two additional deals in the summer, giving it a portfolio of chemicals firms specializing in agriculture, electronics, and coatings. Ackman’s Pershing Square is the largest shareholder, with a 20% stake.

The shares, which began trading in New York at about $15 hit a high of $28 in June, but have since fallen 60% to a recent $11.70, as investors have grown uneasy with leveraged operations. Lost in the selloff, however, is Franklin’s enviable track record of making roll-ups work. The stock could stage a rebound in the next 12 months.

See full article here.

Maybe Financial Markets Have Been Wrong All Along

33 Nov 5, 2015 8:00 AM EST

By Noah Smith

Is the value premium disappearing? The answer to that question could shake the foundations of the asset-management industry.

First, for the uninitiated, a little background. In the late 1970s and 1980s, a lot of investors and researchers confirmed what market analysts had claimed for a long time — that certain stocks seemed cheap relative to their value on paper. These stocks tended to perform better, on average, than the stock market as a whole. That was a bit of a puzzle, since basic finance theory says that it shouldn’t be that easy to beat the market. If you can just buy stocks that are cheap relative to their book value, and wait for them to go up, the market isn’t very efficient, is it?

To beat the market that easily and that consistently, the strategy should incur some kind of systematic risk — risk that you can’t get rid of with diversification. In the early 1990s, future Nobel-winning finance researcher Eugene Fama and his longtime co-author Kenneth French came up with a partial answer to the puzzle. Some stocks, they said, were so-called value stocks that tended to trade at prices below their book values. During certain periods, these stocks all tend to rise in value, but other times they tend to all fall together. Over a long period of time, the rises outweigh the falls, so that these value stocks earn a premium. But if you invest in value stocks and you get caught in one of the bad periods, you’re in trouble. Hence the value premium persists, because trading against it — by simply loading up on all the value stocks you can grab — incurs some risk.

That answer wasn’t completely satisfying. Why do value stocks all tend to rise in certain periods and fall in others? One possibility, described here by asset-management mogul Cliff Asness, is that value stocks are “crappy companies.” Shaky companies might find themselves suddenly squeezed for credit under certain conditions, while other companies are still able to borrow. That might explain the value premium. But it turns out that the times when value underperforms and outperforms are not clearly tied to the business cycle. The mystery remains.

Fama and French’s model of a risk-based value premium has become standard throughout the asset-management industry. But there’s another, more disquieting possibility. It may be that the value premium is caused not by risk, but by systematic inefficiencies in the financial market.

See full article here.