Business

Why Tilson Is Again… Short Lumber Liquidators In A Word: Cancer

Whitney Tilson is short Lumber Liquidators again. The stock is down on the news. We heard from reliable sources earlier today that he would be announcing an LL short, but since the Harbor Conference is off the record and it was not confirmed we did not report it. Now that at least with this the embargo has been broken we are posting his slides below.

Enjoy!

Published on Mar 9, 2016
Whitney Tilson of Kase Capital presents 48 slides in which he explains why he has again shorted Lumber Liquidators, Boys & Girls Harbor Investment Conference, 3/8/16

Whitney Tilson – Why I’m Again Short Lumber Liquidators In a Word: Cancer

Lumber Liquidators’ Stock Is Down Nearly 90% Since I First Presented It

Lumber Liquidators

Why I Covered

I published an article in December explaining why I was exiting my short position in Lumber Liquidators. Here’s the summary:

  • I 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 naive, but not evil
  • If there are no “smoking gun” documents/emails, then the doomsday scenario for the company (and the stock) is less likely

At the time, LL also had a net cash position and I thought that:

  • Formaldehyde off-gassed to normal levels within 3-10 months
  • There was little/no cancer risk
  • The operating performance of the business might improve, if not in Q4 then certainly would once the company started to lap the March 1, 2015 first airing of the 60 Minutes story

Based on the information I had at the time, it was a good decision to cover.

Summary of Why I Put the Short Back On

I continue to believe that LL’s senior management was unaware of the toxic laminate and thus no longer believe this company is evil, plus the stock is now a bit lower, so why have I reestablished a meaningful short position (my largest at 4+%)?

Very simply, I have new information that leads me to believe that the odds of very bad outcomes for Lumber Liquidators and its stock have risen materially based on new information in six areas:

  1. Widespread media coverage of the CDC’s error and increased cancer risk appears to be having a severe impact on the business
  2. The cancer risk is likely significantly greater than even the CDC’s revised estimate, which could result in further damaging publicity and increased liabilities
  3. A “Prop 65” trial has just begun that LL is likely to lose, resulting in further adverse publicity
  4. Likelihood of even larger legal and regulatory liabilities
  5. Operating performance of the business in Q4 was much worse than I expected – and I think meaningful improvement is unlikely for quite some time (if ever)
  6. Lack of confidence in company leadership

I Now Believe There Is at Least a 50-50 Chance That Lumber Liquidators Eventually Goes Bankrupt

I now believe that there is at least a 50-50 chance that LL eventually goes bankrupt (despite the fact that the company had $6.7 million of net cash and $67.2 million available on its line of credit at the end of Q4, and, under normal circumstances, a nicely profitable business), for the following reasons:

  • I think operating losses and cash burn will remain severely negative (in the range of Q4’s -$20-$30 million per quarter) for the foreseeable future – and could even get worse
  • It will likely be very difficult and expensive to settle the regulatory issues (Consumer Product Safety Commission, CA Air Resources Board, etc.) as well as class action (multi-district litigation), securities fraud, and Prop 65 cases, especially in light of the CDC recently tripling its exposure and cancer risk estimate, as well as the fact that more than one million Americans may have been exposed to LL’s Chinese-made laminate since 2010
  • LL’s liability insurers have all denied coverage for the formaldehyde claims under the pollution exclusion in the insurance policies, forcing LL to pay its enormous legal fees out of pocket

More Than 1 Million Americans May Have Been Exposed to LL’s Chinese-Made Laminate Between 2010 and May 7, 2015

Lumber Liquidators

Assumptions/estimates:

  • LL finally suspended sales of Chinese-made laminate on May 7, 2015
  • For 2012 and 2013, laminate sales and percent from China are estimates
  • Average Ticket (Laminate) is an estimate based on 80% of the total ticket (laminate is cheaper than engineered and solid hardwoods)
  • People exposed is customers x 2.54 residents per household (US Census)
  • January – May 7, 2015 assumes that sales continued at 2014 levels in January and February and then fell by half after the 60 Minutes story aired on March 1, 2015

See full slides below.