Tilson Covers Short Position In Lumber Liquidators; Hedge Fund Manager Say Company 'Isn't Evil'

• Shares of Lumber Liquidators Holdings Inc LL were surging higher by more than 25 percent early Tuesday morning.
• Investors and traders reacted to a report by short-seller Whitney Tilson who confirmed he covered his position in the company.
• Tilson noted he had received information that suggested the company's senior management was not initially aware of the health risks and danger associated with its Chinese-made products.

Whitney Tilson initiated a short position in Lumber Liquidators earlier this year under the belief that the company's senior management knowingly sold products that may have posed a serious health hazard.

Tilson's May Thesis

Back in May, Tilson offered nine reasons why his short position in Lumber Liquidators remains an attractive investment. As part of his thesis at the time, Tilson suggested there was more than a 90 percent probability that the company's senior managers knew it was sourcing non-CARB-compliant laminate.

Related Link: Whitney Tilson: 9 Reasons Lumber Liquidators Is Still Guilty

Tilson's 'Received Information'

However, Tilson wrote an article on Seeking Alpha on Monday explaining that he has "received information" (which can't be revealed at this time) that led him to believe that the company's senior management "wasn't aware" it was selling Chinese-made laminate that contained high levels of formaldehyde.

"If this information is correct, then the company was sloppy and naïve, but not evil," Tilson wrote. "If there are no ‘smoking gun' documents/emails, then the doomsday scenario for the company (and the stock) is less likely."

With that said, Tilson covered his short position.

Covering His Short

Tilson noted that even if the company's senior management wasn't aware of the high levels of formaldehyde, the company continued to sell the product because "they genuinely believed that the product was safe and compliant."

Tilson continued that the information he received changes 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."

Related Link: Whitney Tilson Publishes Latest Reasons For His Lumber Liquidators Short Position

The hedge fund manager added that his prior short thesis was based on three factors: 1) the adverse publicity resulted in a loss of sales and margins, 2) various investigators were looking into the company's practice and 3) various ongoing lawsuits against the company could result in further damages.

"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," Tilson also wrote.

Tilson's Bottom Line On Lumber Liquidators

Bottom line, Tilson argued that "intent matters" most. If the company didn't have any "evil intent," then the downside scenario is "less likely." As such, a shift in the risk to reward profile led Tilson to cover his short position by buying in-the-money call options at a $10 strike price, which expire next month.

Tilson concluded by saying, "I no longer believe that Lumber Liquidators' stock, at today's price, is an attractive short."

Lemelson Capital: Tilson's Story Didn't Add Up

Rev. Emmanuel Lemelson, CIO of Lemelson Capital Management, told Benzinga back in March that Tilson's short thesis on Lumber Liquidators didn't add up. Lemelson opined at the time that the company may just be guilty of not having the proper policies and procedures in place to verify the quality of its products.

Despite a different opinion, Lemelson did state that Tilson deserves "credit and recognition" for helping to protect the health of a "huge number" of American families.

Lemelson also argued that Tilson's short thesis may have contained a flawed financial analysis. Separately, Lemelson told Benzinga that Lumber Liquidators should have immediately published a financial report that provided evidence that laminate flooring margins could not have led to the "doubling of margins," which Whitney suggested – thus invalidating the alleged profit motive.

Lemelson's hedge fund, Amnova, posted in a blog that Lemelson's statements are now "vindicated" by Tilson's Seeking Alpha post.

Specifically, the blog post highlighted the following statement from Tilson:

"[I]t 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."

Image Credit: By Dwight Burdette (Own work) [CC BY 3.0], via Wikimedia Commons