Why Does Whitney Tilson Hate Wayfair Inc. So Much?

The online furniture marketplace Wayfair (W -1.08%) continues to grow each quarter. While it isn't technically profitable, the retailer is making great strides in major areas of its business, and third quarter numbers seem to confirm the progress.

That has not stopped Whitney Tilson, Managing Partner of Kase Capital Management, from being very negative on the stock.

Join Chris Hill, Aaron Bush, and David Kretzmann, as they try to make sense out of the love/hate relationship between Wayfair and investors.

A full transcript follows the video.

Chris Hill: Wayfair's third quarter revenue rose 77%. They're not profitable, but the loss is getting smaller. Third straight quarter of a narrower loss. And yet the stock's down about 10%. Is this just because ... I don't know. Why is this?

Aaron Bush: So, pre-market, the stock was actually up more like 10% and so being down 10% is something else. I'll get to that in a minute. Let me just explain the quarter a little bit. As you said, revenue is up 77%. Active customers up 60%. Revenue per customer, average order value --  those are each up about 10%. It was a very impressive quarter. It was a very good quarter.

And when it looks like they are not profitable, they are actually free cash flow positive. So they actually are generating a decent amount of cash. There is one metric that I saw, that I wish were a little better. And that is the percentage of repeat customers out of the total customers. And so this clocked in at 55% up from 50% a year ago. It's down a couple percent from last quarter. And this is important to Wayfair because it creates economic value in these repeat purchases.

So, it spends a pretty good chunk of money on customer acquisition and so when people first buy they don't really make much money. So, it's really when people come back a second or third time where cash flow starts piling up. And I wish that were a little better. But the real reason the stock is down 10% is because Whitney Tilson went and published --

David Kretzmann: Our good friend.

Bush: Our very good friend, published that Wayfair is the worst business model in the world, and it's his largest short position. Which I personally don't agree with. If the company's free cash flow positive and it's growing that at a pretty decent rate, it's not the worst business model in the world. But --

Kretzmann: I think you could find a worse business model. Going out on a limb there.

Hill: So for those unfamiliar, Whitney Tilson, probably best known recently for being the person shorting Lumber Liquidators (LL -2.47%). He helped to push the story on 60 Minutes. Certainly that didn't work well for Lumber Liquidators for a number of reasons. And tip of the cap to Whitney for that one.

Bush: A lot more people now know what formaldehyde is than Whitney Tilson.

Hill: But, like most investors, his track record is not home run after home run. But I think he's kind of the got the hot hand right now. So I could see where that would ... and he's not the only one shorting Wayfair. Let's be clear.

This is an online home furnishings business that is at the moment not profitable. And so there are gonna be people betting against that no matter what. But as you said and as I indicated at the top, all of the numbers appear to be going in the right direction.

I get that the repeat purchase customers is higher year over year but slightly lower quarter over quarter. But, I don't know. I feel like Whitney might be taking a bath on this one a year from now.

Bush: We'll see, and in his long article ... to me, when I read it, it seemed like half of the article was about Lumber Liquidators. So there is a lot of...

Hill: At the top of a paragraph where there's a pull out or something, was it just him repeatedly saying, "By the way, I'm the guy who called Lumber Liquidators!"

Bush: It was a lot of support for saying what it was terrible and trying to pull it back to why Wayfair is terrible. Which, kind of like, after the first part, "By the way just to be clear, Wayfair is not Lumber Liquidators." It's like, "Oh, well thanks for letting us know now."

Hill: They don't have formaldehyde furnishings.

Bush: They have sold some that did, but they've kind of moved past that.

Hill: Wait, really?

Kretzmann: Yeah, there is. Because Wayfair has over 7,000 vendors and one of their vendors had some products that had formaldehyde. And a New York Times reporter had reached out to the company and said, "Hey, I think that vendor might have formaldehyde."

The first thing management did is just pull those products. But what Whitney Tilson is saying is that, they had a vendor that had some potentially sketchy products in terms of formaldehyde. He's said that Wayfair's management is incompetent. I think they did the competent thing. They pulled the products as soon as they found out about it. The business model, cash flow positive, free cash flow positive now. So, I don't know. I feel like Whitney might be stretching a little bit here.

Hill: I feel like, that's something that happens from time to time. And just to remove and pull it away from Wayfair for a second. I feel like there are occasions where people are quick to blame management. And what they're really blaming them for is failure to be clairvoyant.

There is a difference between being completely asleep at the wheel and you delegate some authority to some of your lieutenants. Something slips through the cracks. We saw this last week with Chipotle. They have a food safety issue in the Pacific North West and as soon as they find about it they act the way you would want a company to act. They basically shut everything down in that region. So it's not Wayfair. Barring clairvoyance they did the right thing. Which is, "Ok. Let's get rid of this stuff immediately."

Bush: Yeah, and he compares them to Overstock.com too. I think that's part of his thesis as well. But if you just look at the two businesses they are similar but they still are different. And Wayfair has much better economics.

Kretzmann: Did Overstock actually carry inventory? Because I feel like that's a key with Wayfair. I feel like if you're gonna sell couches and big honkin' furniture over the Internet, Wayfair's business model makes the most sense. They're not actually carrying much of any inventory. They're the middleman between all these independent vendors and suppliers. They're connecting them to people who are shopping online. If you're gonna sell stuff that's 1,000 lbs or 500 lbs it seems like that's the way to do it. Rather than having massive warehouse facilities where you're holding all that inventory.

Hill: Last question on Wayfair and then we'll wrap up. Has management given any guidance on when they believe they will be sustainably profitable? I feel like this is the type of business that could surprise people with a profitable quarter. In the way that Twitter did last year. When Twitter was, over the summer of 2014, or just in the wake of the summer they had a profitable quarter and the stock went nuts. Because nobody was expecting it. But I'm just curious if management has given any guidance on that.

Bush: I don't remember specifically. I'm sure that they've said something at one point. But to me, to reiterate again, they are free cash flow positive. Which to me is pretty much being profitable. And so they aren't profitable from a Gap perspective. I mean if they continue to scale this way it probably will happen. Probably in the next year or two.