What: Shares of beleaguered flooring retailer Lumber Liquidators Holdings Inc (NYSE:LL) are up nearly 22% on Dec. 15 (before noon EST) on news that hedge fund manager Whitney Tilson has covered his short position in the company's stock, and is backing off of his allegations that the company was willfully and knowingly selling flooring to customers that put them at potential health risk.
So what: In a blog post, Tilson wrote that he had "received information" (though, of course, he couldn't identify the source of said information) that the company's management wasn't aware that it was selling product with high levels of formaldehyde. He went on to say that the company was "sloppy and naive, but not evil," and that he no longer saw it as a good short candidate at current stock prices.
This runs directly counter to the headlines of previous blog posts where Tilson did indeed accuse the company of being evil, and prior claims that management was aware that its products had illegal and potentially harmful formaldehyde levels.
Frankly, it sounds a lot like Tilson was just ready to move on to his next target, as the tenor of his latest blog post -- especially those unidentifiable sources -- is just a good backstory and excuse to move on.
While I've been critical of Tilson's role in the whole Lumber Liquidators saga from the beginning, that's not the same thing as thinking that the company is "off the hook" now, or that there's no longer any risk to the company. That's simply not true.
Lumber Liquidators is still working with California's Air Resources Board -- the only government agency in the U.S. with any current formaldehyde emissions rules -- as it investigates the potential risk of some of the company's Chinese-made laminates.
The U.S. Consumer Product Safety Commission is also still investigating the company, announcing back in March that it would conduct what it described as "real-world" tests, to determine the real risk to consumers from the products alleged to be hazardous.
Between the two, the biggest risk is probably from the California ARB, simply because of the existing laws in California, whereas the CPSC would probably have to find, categorically, that the company's flooring was:
- Producing hazardous levels of emissions in normal use (versus ARB's much-questioned test procedures which destroy the product).
- Measurably more hazardous than other products available.
The second part of this is important, because even if the company's products do turn out to be releasing relatively high levels of formaldehyde, the industry standard will be a factor, to at least some degree. Agree with it or not, the "everybody's doing it" angle could come into play.
Now what: Tilson has moved on, but there remains very real risk to the company. If Lumber Liquidators is found to have sold product -- knowingly or unknowingly -- that is potentially harmful, there will be serious financial repercussions. But to Tilson's point, management's knowledge or ignorance will play some role in the burden placed on the company.
This is doubly true when it comes to consumer litigation against the company.
Any thesis on Lumber Liquidators has to be at least partly based on an expectation that consumer confidence will return ... eventually ... and that the company has a strong enough balance sheet and will generate enough sales to make it through even the worst-case scenario. Tilson's departure from the story doesn't eliminate all of the risk, but it's an indication that the true risk may never have been as big as he and others alleged.
It's a good day for Lumber Liquidators shareholders, but the company's not out of the woods just yet.
Jason Hall owns shares of Lumber Liquidators. Jason Hall has the following options: long January 2016 $24 calls on Lumber Liquidators. The Motley Fool recommends Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.