WHITNEY TILSON: Here are 4 reasons why I'm now even more convinced that Lumber Liquidators is going to $0

Hedge fund manger Whitney Tilson, the founder of Kase Capital, saw red flags in Lumber Liquidators' numbers, and he sent to the story to "6o Minutes" and Anderson Cooper.

The "60 Minutes" report found that America's largest speciality retailer of hardwood flooring appeared to be selling Chinese-made laminate flooring with levels of formaldehyde higher than what's permitted under California law.

After the program, Tilson circulated an email listing off four reason why he thinks the company is going to go bust.

1. What customer is going to want to buy any product from LL?

2. Every customer is going to demand that LL pay to have their floor tested - and not just laminated flooring.

3. If any formaldehyde is detected (even below CARB2 standards), customers will demand that LL pay to remove and replace their floor.

4. If anyone in a household with LL flooring (again, not limited only to laminate) suffers any illness associated with formaldehyde (chronic respiratory irritation, change in a person's lung function, increased risk of asthma; myeloid leukemia and nasopharyngeal cancer at high levels and respiratory issues as well as eye, nose and throat irritation at even low levels), they will surely demand that LL not only pay their medical bills, but also compensate them for pain and suffering, job loss, etc.

Tilson's points are part of a much longer email, which we've included below.

Since the "60 Minutes" report, Lumber Liquidators' stock has gotten absolutely hammered.

In a statement, the company said that they believed "60 Minutes" used "and improper test method." The company also that that these were inaccurate allegations coming from short-sellers.

"...these attacks are driven by a small group of short-selling investors who are working together for the purpose of making money by lowering our stock price. Their motives and methods are wrong and we will fight these false attacks on all fronts."

Lumber Liquidators is Tilson's largest short position, but it's only 3% of his portfolio. He only stands to make $3 million for his investors if the company goes bankrupt.

Tilson told Anderson Cooper that he first started shorting the stock in 2013 after he noticed a red flag regarding the company's profit margins. It wasn't until six months later that someone tipped him off that the company might be purchasing tainted wood in China.

He also said in the email that he's even more certain the stock is going to zero.

Here's more of Tilson's email:

1) I love the old "conspiracy-of-short-sellers" trope. In fact, sometimes short sellers DO communicate with each other, share information and analysis, etc. There's nothing wrong with this - investors talk to one another every day. But in this case, I've never had any communication whatsoever with the lawyer and environmentalist that appeared in this segment, nor with the short sellers who are apparently backing them. I'm almost embarrassed to admit that 60 Minutes found them, as I was only vaguely aware of their existence.

In fact, this is a case study of how hedge funds, however self-interested their motivations may be, can be a force for good, by doing the difficult and expensive work it can take to uncover companies doing nefarious things (such as poisoning their own customers) - and then bringing this to the attention of regulators, prosecutors and the media.

2) As for who has motivation to do nefarious things to manipulate the stock price, let's look at the players. For me, this is around a 3% short position. So, if I'm right that the stock is a zero, I make three percentage points of return -- so, for example, instead of having a 12% year, I'd have a 15% year. It would be nice to have an extra 3% of course, but it's not going to make or break me - and certainly not cause me to make false accusations against a good company.

In contrast, the senior executives at LL have massive incentives to get their share price up. Guess what the top two executives (Founder and Chairman Tom Sullivan and CEO Robert Lynch) did after the stock skyrocketed from ~$13 to as high as ~$119? Of course they dumped a ton of stock and pocketed a small fortune. Specifically, Sullivan, in May and August 2013, sold 300,000 shares (~1/3 of his total holdings) at an average price of $89, pocketing $26.7 million.

Meanwhile, Lynch, in May and July 2013, sold 154,500 shares at an average price of $68.61, for a total of $10.6 million (contrast this with his total cash comp in 2012 of $1.2 million). (He appears to have sold every share he could at that time, as his remaining holdings hadn't vested yet.)

So, in summary, I stand to make for my investors less than $3 million if I'm right and the stock goes to zero, whereas just the top two guys at LL have already cashed out to the tune of $37.3 million!

3) As for LL challenging the test results, I can't figure out if they are evil liars, trying to cover up the fact that they're knowingly poisoning their own customers to save a few bucks on sourcing costs, or whether they're just incompetent - but it's one or the other. Based on my research and analysis, I believe that LL's testing regimen is largely a sham because it's disconnected from rigorous, credible tests that others (regulators, Home Depot, Lowe's, etc.) use and rely on. Evidence for this are the results from five independent sets of tests, including one I commissioned, which show that LL is buying and selling to its customers highly toxic laminated wood (virtually all of it from China).

4) Once it becomes clear that LL is, in fact, doing this, they will undoubtedly go on an apology tour, saying how sorry they are and positioning themselves as the victims who were defrauded by unscrupulous Chinese mills. This is complete nonsense. Laminated wood is a low-end, global commodity product in which 1% or 2% differences in pricing are meaningful. For a savvy player like LL, which has been buying in China for roughly two decades, they would instantly know that if they were buying 10% below the standard price for a particular piece of laminated wood that something was wrong: perhaps it was stolen, used illegal or incorrect wood, was of exceptionally low quality, or was filled with toxic chemicals.

Maybe this example will resonate. Let's say you're in Shanghai and looking to buy the DVD of the latest Hollywood movie - let's say, Academy Award winner Birdman, which is still in theaters, so it's of course not yet out on DVD. Ah, but lo and behold, as you walk down the street, you see that a street vendor has a copy and sells it to you for $2. Moments later, the police apprehend you and accuse you of buying illegal /forged merchandise. You would of course claim that you had no idea - but OF COURSE you knew, based on where you were (China) and the price you paid.

Similarly, LL had to have known there was something seriously wrong with the laminated wood it was buying, given the absurdly low price and the fact that it was coming from China, which is the wild west when it comes to environmental standards and rule of law. Even if the Chinese mills said they were CARB 2 compliant and even if they were supposedly inspected, this cannot be relied on. Heck, this is a country that sold us defective wallboard that soon because filled with toxic mold, and which pumped pigs full of clenbuterol (see: www.rsc.org/chemistryworld/News/2011/April/19041102.asp). In short, many Chinese companies, especially those in highly competitive, commoditized industries, scoff at most regulations, especially if the product is being shipped to the US. Many friends have told me that China is for the Chinese; if they can screw Americans, they will - and they did with LL, which might take down company.

But LL's pleas that they are the victim here ring hollow once you realize that the two biggest buyers of wood flooring in the US, Home Depot and Lowe's, also buy laminated wood in China, yet don't have a formaldehyde problem (to the best of my knowledge). The reason is simple: they have serious, rigorous compliance programs and understand that you can't hit the low bid in China and expect to get high-quality, compliant product. So they pay more and get good flooring - but earn lower margins, something LL wasn't willing to do in its pell mell pursuit (regardless of the consequences) of a higher and higher stock price so insiders could cash out.

It worked for a couple of years - but now I believe the company is going to have to pay a price that I believe will bankrupt it, for a number of reasons:

1. What customer is going to want to buy any product from LL?

2. Every customer is going to demand that LL pay to have their floor tested - and not just laminated flooring.

3. If any formaldehyde is detected (even below CARB2 standards), customers will demand that LL pay to remove and replace their floor.

4. If anyone in a household with LL flooring (again, not limited only to laminate) suffers any illness associated with formaldehyde (chronic respiratory irritation, change in a person's lung function, increased risk of asthma; myeloid leukemia and nasopharyngeal cancer at high levels and respiratory issues as well as eye, nose and throat irritation at even low levels), they will surely demand that LL not only pay their medical bills, but also compensate them for pain and suffering, job loss, etc.

I believe the combination of a dramatic decline in sales plus the massive contingent liabilities will quickly overwhelm the company's ability to stay in business. While it has no debt, it only has $20M in cash and earned a mere $17M in net income in 2014 (while operating cash flow was $57M, cap ex was $71M, resulting in free cash flow of -$14M).