Everybody hit the floor!
OK, not really -- but that's what came to mind when I saw Lumber Liquidators' (LL -2.85%) press release Friday morning, which was ominously titled, "Lumber Liquidators Responds to Action by Federal Authorities."
On Thursday, the release states, federal agents executed sealed search warrants at Lumber Liquidators' corporate offices in Toano and Richmond, Va. Of course, we don't know exactly what they were searching for, thanks to that whole "sealed" part, but Lumber Liquidators was kind enough to tell investors the actions were related "to the importation of certain of the Company's wood flooring products."
We also know the agents hail from the U.S. Department of Homeland Security's Immigration and Customs Enforcement, as well as the U.S. Fish and Wildlife Service. Perhaps unsurprisingly, then, and as if it had much choice, Lumber Liquidators also stated it "takes its sourcing and compliance very seriously, and is cooperating with authorities to provide them with requested information."
So what's the big deal?
As fellow Fool Jeremy Bowman pointed out, federal agents performed a similar raid on Gibson Guitar two years ago, seizing around $1 million of rare Indian ebony, finished guitars, and electronic data, the end result of which was a $300,000 fine to avoid criminal charges for importing exotic woods from Madagascar and India.
Jeremy also noted that Friday's drop at one point shaved as much as $300 million off Lumber Liquidators' total market capitalization, so this could very well serve as a fantastic buying opportunity for steel-nerved investors betting that the company's violations (if any) won't negatively affect the company over the long term.
After all, Lumber Liquidators offers hundreds of wood floor products, and if this particular violation turns out to focus on only a few inappropriately imported varieties of wood, there's no reason the up-and-coming business won't be able to ultimately push through this adversity. Remember, Lumber Liquidators' unique business model involves directly sourcing products internationally from the mills that make them, giving it a key competitive pricing advantage over more traditional distributor models that big-box competitors use, including Home Depot and Lowe's.
What's more, this certainly isn't the first scare Lumber Liquidators' import business has caused. Back in 2011, for example, the U.S. Commerce Department announced an investigation of Chinese dumping in the hardwood flooring market, which some analysts had feared would result in duties on Chinese imports of more than 240%. However, Lumber Liquidators effectively dodged a bullet when the ruling eventually set a much smaller cap on the duties at just above 27%.
Know your risks
But while that issue has long since passed, Lumber Liquidators is also currently facing product safety allegations stemming from a June report claiming that some of its most popular products from China contained illegally high levels of formaldehyde, a known carcinogen, in violation of regulations set by the U.S. Environmental Protection Agency.
CEO Robert Lynch did his best to appease those worries during the second-quarter earnings conference call by highlighting the company's "strict adherence to a set of internal standards set well above regulatory requirements." However, that didn't stop a number of predictable class action lawsuits from cropping up in the ensuing weeks.
I'm certainly no expert in knowing exactly which agencies need to be involved in matters like these, but who knows? Perhaps this week's raid was just related to the most recent yet-to-be-proven formaldehyde transgressions, or maybe it's yet another concern to add to the pile.
That said, if one thing's for sure, the market absolutely loathes uncertainty in any given company's risk factors. In the end, considering the stock has already doubled so far in 2013, that's why I plan on staying on the sidelines until Lumber Liquidators can prove to investors these issues are relatively insignificant over the long term.