Whitney Tilson – Why I Covered My Short Position In Lumber Liquidators
In the past week, I’ve received information that leads me to believe that senior management of Lumber Liquidators wasn’t aware that the company was selling Chinese-made laminate that had high levels of formaldehyde.
If this information is correct, then the company was sloppy and naïve, but not evil.
Coho Capital 2Q20 Commentary: Podcasts, The New Talk Radio
Coho Capital commentary for the second quarter ended June 30, 2020. Q2 2020 hedge fund letters, conferences and more Dear Partners, Coho Capital returned 46.6% during the first half of the year compared to a loss of 3.1% in the S&P 500. Many of our holdings, such as Netflix, Amazon, and Spotify, were perceived beneficiaries Read More
If there are no “smoking gun” documents/emails, then the doomsday scenario for the company (and the stock) is less likely, so I covered my short position today.
In the past week, I’ve received information (I can’t reveal the details at this point) which leads me to believe that it’s likely that senior management of Lumber Liquidators (NYSE:LL): 1) Wasn’t aware that the company was selling Chinese-made laminate that had high (non-CARB2-compliant) levels of formaldehyde; and 2) Made the decision to continue selling the product even after the 60 Minutes story aired in large part because they genuinely believed that the product was safe and compliant.
If true, this new information doesn’t change certain key things – there’s no doubt in my mind that the company was, in fact, selling dangerous, formaldehyde-drenched laminate and that it completely bungled damage-control efforts after the 60 Minutes story aired (most damningly by continuing to sell the product for 67 more days) – but it does change the narrative from a company that was knowingly endangering its customers to save on its sourcing costs to one that was duped by Chinese suppliers and/or middlemen into believing that it was receiving CARB2-compliant laminate. If so, Lumber Liquidators was sloppy and naïve, but not evil. Many companies, alas, have unwittingly bought low-quality, toxic and/or illegal products from Chinese suppliers.
Prior to today, even with the precipitous decline in the stock, which has plunged ~80% this year, I maintained (and even added to) my short position in Lumber Liquidators because of three factors:
1) The adverse publicity has tainted the brand and caused large numbers of customers to avoid the company, which has led to a substantial drop in sales, margins and profits;
2) Numerous regulators are investigating the company and, if they found evidence that the company knew it was selling non-compliant laminate, would likely impose crippling penalties; and
3) There are numerous lawsuits against the company that could (similar to the regulatory risk) result in enormous damages if evidence emerged that the company knowingly endangered its customers.
The combination of these three factors led me to believe there was a material chance that the company could, ultimately, be forced into bankruptcy and the stock could be a zero. If, however, there are no “smoking gun” documents/emails, then this doomsday scenario is much less likely (though the company, to be sure, still faces extremely serious issues).
In the court of public opinion and among regulators, judges and juries, intent matters. If the senior management of Lumber Liquidators didn’t have evil intent, then the downside scenarios for the company (and the stock) are less likely and the upside (recovery) scenarios are more likely. This shift in the risk/reward equation has led me to cover my short position (for tax reasons, I have done so by buying in-the-money ($10 strike) call options expiring next month; I expect to close out these offsetting positions in the new year).
To be clear: I no longer believe that Lumber Liquidators’ stock, at today’s price, is an attractive short.