Thursday, August 15, 2019

Lumber Liquidators: Get in on the Ground Floor; Markopolos' short report on GE; Enrique Abeyta's take; Ackman bets on idol Warren Buffett's Berkshire Hathaway; My Berkshire slide deck

By Whitney Tilson

1) It's good to see the Wall Street Journal picking up on how crazy cheap Lumber Liquidators (LL) is. I could have written this Heard on the Street column myself! Lumber Liquidators: Get in on the Ground Floor. Excerpt:

Investors with a stomach for volatility might want to wager on the next surprise being a positive one.

Slowing store traffic and tariffs are concerns, but they are known factors. The question, now that big payments for legal claims seem to be done, is how much of a margin of safety is built into the stock. It appears substantial, based on a multiple of enterprise value to forward sales of just 0.4 times, compared with an average of almost 1.9 times for its four closest publicly traded competitors.

While tariffs may hurt, they also will pinch competitors, particularly smaller specialty flooring stores that control about 42% of the U.S. market. Floor & Decor Holdings, which commands a far richer multiple, has nearly doubled revenue and operating income over the past three years as Lumber Liquidators has stumbled.

While Lumber Liquidators can't soon return to the 15% compound annual revenue growth rate it enjoyed leading up to the scandal, it does seem to have stopped the bleeding and it is now opening stores more quickly. Its competitors' success and the intense skepticism surrounding the tarnished retailer make for a potentially lucrative bet that it can at least pick itself up off the floor.

2) Whistleblower Harry Markopolos, who famously figured out that Bernie Madoff was a fraud (the SEC infamously ignored him), is out with a 175-page report on General Electric (GE), alleging that the company is "a bigger fraud than Enron." GE is down about 10% today. Excerpt:

  • The Fraud Investigators have been researching General Electric's financials and accounting practices for more than one year. The result is the discovery of an Enronesque business approach that has left GE on the verge of insolvency.
  • GE has been running a decades long accounting fraud by only providing top line revenue and bottom line profits for its business units and getting away with leaving out cost of goods sold, SG&A, R&D and corporate overhead allocations.
  • My team has spent the past seven months analyzing GE's accounting and we believe the $38 billion in fraud we've come across is merely the tip of the iceberg.

Here's a CNBC article about it: GE shares tank more than 10% after Madoff whistleblower calls it a 'bigger fraud than Enron.'

3) For more insight, I asked my colleague Enrique Abeyta for his thoughts. He replied:

We were involved in both the WorldCom and Enron shorts back in 2001-2002, and one of the first things we learned on the short side is to take notice when companies or management achieve "icon" status but the fundamental math doesn't make any sense to us.

This was the case until recently with Kraft Heinz (KHC), in which its controlling shareholder, Brazilian private equity firm 3G Capital, levered it up and cut costs savagely into massive disruptive competition. (For more on Enrique's thoughts on Kraft Heinz, see this e-mail from last week.)

But GE was always a head scratcher to me and we were short it for quite some time. We call this the "common sense" test of fundamentals.

While we don't think that GE ever intentionally meant to defraud investors, they certainly embraced the concept of "managed earnings," which was quite popular in the 1990s and 2000s. Many non-financial companies (like Enron) figured out how they could use the leverage and opacity of financial-company reporting to produce the appearance of very strong, consistent earnings growth, which resulted in tremendous stock price returns.

We, however, saw GE as a bunch of decent industrial businesses and a lower quality financial services business with way too consistent earnings growth and a premium multiple and didn't believe it.

Obviously the premium at GE has unwound in the last few years as the stock has gone from over $30 in late 2016 to around $8 today. However, we would be very careful with this stock here. With nearly $100 billion in net debt and financial services still a big part of the company, it's ultimately a "confidence" structure. If everyone believes in it, they will continue to lend to it and it is sustainable. But if they don't, it could unwind very quickly.

The big lesson here is: Never let the reputation of a management team blind you to the "common sense" test of a company's fundamentals.

4) I was surprised – but, as I thought about it, not surprised – to see Bill Ackman make a huge (nearly $700 million) investment in Berkshire Hathaway (BRK-B). There's no opportunity for activism, of course, but he's long been a huge fan of Warren Buffett and Charlie Munger – he's the one who first told me about them 25 years ago – and the stock is moderately cheap and super safe, a rare combination in today's market. Ackman bets on idol Warren Buffett's Berkshire Hathaway. Excerpt:

Ackman has publicly credited Buffett with guiding his career. The 53-year old said he has studiously taken pointers from Buffett's investor letters, including the ones he wrote before creating Berkshire Hathaway. Four years ago, Forbes featured Ackman on the cover of its magazine, calling him "Baby Buffett."

At first blush, the investment might seem odd, as Berkshire Hathaway ranks among the world's best known stocks – one that parents often bestow as graduation gifts, designed to hold onto for a lifetime. Two Pershing investors Reuters spoke to grumbled that they would pay hedge fund-like fees for a name everyone knows.

But other investors and analysts called it a smart move and described it as a place for Ackman to put cash while searching for another activist position.

Currently Berkshire stock is considered to be less expensive than it has been for some time, having fallen 9% in the last three months.

5) After I saw the news, I left Bill a voicemail, joking that "20 years too late you finally read my Berkshire slide deck!" (In fairness, while I wrote about Berkshire in my very first investor letter in January 1999 and in many of my earliest published articles dating back to late 1999 (here's a web page with links), the oldest version of the Berkshire slide deck I can find was one Glenn Tongue and I presented at our Value Investing Congress on November 16, 2005, when the stock was at $89,990 – you can read it here.)

The latest version is about a year out of date, but not much has changed, other than further strong growth of both drivers of Berkshire's value: the investment portfolio and the operating businesses.

Best regards,


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Empire Financial Research

Whitney Tilson

Empire Financial Research founder and CEO Whitney Tilson is the editor of the Empire Investment Report, a monthly investment advisory that focuses on cheap, high-quality stock ideas.

Whitney graduated with honors from Harvard University and Harvard Business School, where he earned an MBA and was named a Baker Scholar. Whitney spent nearly 20 years on Wall Street, during which time he founded and ran Kase Capital Management, growing assets under management from $1 million at inception to a peak of $200 million.

Once dubbed "The Prophet" by CNBC, Whitney predicted the dot-com crash, the housing bust, the 2009 stock bottom, and more. Now, he's sharing his secrets and strategies with followers of his latest endeavor, Empire Financial Research.

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