Whitney Tilson (Trades, Portfolio), founder of Kase Capital Management, released a presentation Tuesday regarding his new short position in Lumber Liquidators (LL, Financial), outlining six main reasons that may lead to a 50-50 chance of the company reaching bankruptcy.
Tilson first announced a short position in the flooring company in November 2013 on allegations that Lumber Liquidators was selling Chinese-made flooring tainted with formaldehyde, putting customers at risk for cancer. He then covered the short this past December on a tip that company management was unaware that it was selling toxic flooring. With no “smoking gun,” Tilson wrote in the presentation that “the company was sloppy and naïve, but not evil.”
Tilson, however, announced he reopened a short position on Tuesday, and Lumber Liquidators' stock dropped more than 15% on the news. One of the most damning news items to come out against the company — whose stock has plunged 60% in the past year — is an erroneous report from the CDC that understated the cancer risk from the tainted flooring. Last month, the CDC calculated that the cancer risk was two to nine additional cases per 100,000 people exposed. The investigative TV show “60 Minutes,” however, discovered that the CDC had made a major mathematical error in measuring the formaldehyde concentration in a test room based on a ceiling height of 8 meters instead of 8 feet. Therefore, the predicted formaldehyde levels would be 3.3x higher than initially reported by the CDC.
In 2015, Lumber Liquidators reported losses per share of $2.08, its first year in the red since results from 2003. As Tilson points out in his presentation, some Lumber Liquidators locations have had negative profits due to a large number of returns from customers.
Tilson pointed to several reasons why Lumber Liquidators’ operating performance is unlikely to improve any time soon. SG&A costs have skyrocketed to more than 36% of revenue as of the fourth quarter 2015, likely due to high legal expenses. The operating margin has sunk to -8.5% in fiscal year 2015.
Only two gurus — Paul Tudor Jones (Trades, Portfolio) and John Rogers (Trades, Portfolio) — currently hold shares in Lumber Liquidators. Rogers holds 2.05% of shares outstanding, while Jones purchased a new holding of 31,278 shares in the fourth quarter.
In the fourth quarter press release, CEO John Presley said the company still had much to do to turn around the business.
“Over the past quarter we have taken meaningful steps to re-establish Lumber Liquidators with our customers and our shareholders,” Presley said. “While we have made some progress in key areas such as compliance and core operational efficiency, we still have a long way to go. That said, our business model is intact, we are addressing legacy issues with clarity and candor, and we are rebuilding our brand.”
