Herbalife: A Goose Well-Cooked, Part 1

Famous activist investor Bill Ackman is pushing the envelope yet again, this time going as far as to launch a beautiful website dedicated to educating people on the wrongdoings of weight management multi-level marketing company Herbalife (NYSE: HLF  ) . Now, Herbalife is no stranger to big-shot investors claiming that the company is a few steps short of a hoax -- not even a year ago David Einhorn asked a few simple questions about the company and sent the stock reeling. With Ackman and his newfound love for the Internet, though, this may be the company's biggest whistleblower yet. Are you still invested in Herbalife? Why?

Bulls going extinct
I was surprised to see a major sell-off in Herbalife stock this week, as I was unaware that anyone still owned shares of the company. Sure enough, there are still some believers out there. As late as Friday afternoon, after a rough week in the markets, Herbalife traded down nearly 20%, bursting through the floor of its 52-week low of $33.05. Investors can thank Bill Ackman and a talented team of programmers for putting together quite an elegant and professional website explaining to us all why Herbalife is the worst.

The site, Facts About Herbalife, is riddled with reports, videos, presentations, and SEC correspondence. It's really quite a fun site to peruse regardless if you care about Herbalife.

One of the first videos I came across was one with Herbalife founder Mark Hughes talking at a conference. In it, Hughes tells the story of a young Herbalife that had hit $2 million in sales. During that time, Hughes was telling everyone that the company was headed for $100 million in sales. He confides to the audience that he did not believe the company would ever hit $100 million, but he believed in the mantra "Fake it 'till you make it." Certainly not the best thing to hear from a public company.

There are plenty of cultish videos from Hughes, team members (Herbalife individual business owners), and board members that are downright creepy. All investment advice aside, this stuff is just weird.

But let's talk about the more substantial issues outlined by Ackman's team.

Slamdown
Ackman was recently a keynote speaker at the Sohn Conference, where he presented his short case against Herbalife.

One of the first scores for the investor was rebutting Herbalife CEO Michael Johnson's claim on Thursday that Ackman was a market manipulator trying to take advantage of a put expiration date. The fund, Pershing Square, didn't have any options in Herbalife; it is only short shares.

Ackman wastes no time, pointing out that Herbalife values its "Formula 1" brand at $1.8 billion, more than Palmolive and right under Gerber baby food and close to Crest toothpaste. But is Herbalife's protein powder anywhere near as well known, in your mind, as these other brands? No way.

According to the presentation, Herbalife sells six times more nutritional powder than GNC, Unilever, and Abbott Labs' products combined. The company compares its brand to that of Nike and Disney, yet it spends essentially nothing (in a report to the SEC, the company spends "de minimus") on advertising.

In trying to justify the price premium that consumers pay for Herbalife products, Ackman looks at R&D spending, since the company's products don't seem to have any blatant advantage over competitors' in the commodity health and weight management goods business.

R&D is done by outside consultants and costs around $2 million per year.

How can a company that basically doesn't advertise and spends virtually nothing on product development have such an incredible line of goods that warrants industry-leading prices and constitutes one of the fastest-growing companies in history? I think the insinuation is that it doesn't.

Ackman spends the first 17 minutes of the video completely destroying the Herbalife business model. The video is three hours long.

Pyramid
It takes 25 minutes for Ackman to get to the big kahuna -- that he thinks Herbalife is a pyramid scheme.

If an entity is paid primarily (> 50%) by recruitment versus sale of products or services, according to the SEC, that's a pyramid scheme. The people at the top of the pyramid -- who recruited people who have then recruited many more -- make enormous amounts of money, while those at the bottom are usually left with nothing. This is the reason that one of the "biggest brands in the world" is a product very few of us have ever seen or used.

To explain Herbalife's high pricing compared to competitors, Ackman believes they inflate the suggested retail price of the goods to cover the fact that the bulk of company earnings are from recruitment, which would violate SEC rules. There is simply no other way to explain Herbalife's pricing and massive revenues.

Stay tuned for part two of this article, which will further outline the allegations made by Pershing Square. In the meantime, if you are an Herbalife shareholder, please tell me why in the comment section.

Coming soon...
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Read/Post Comments (11) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 24, 2012, at 12:26 PM, dhuddle wrote:

    @ Michael Lewis - I am amazed that Motley Fool would publish this article. This article is unworthy of having the Motley Fool name associated with it. I am honestly amazed - you have tarnished the Motley Fool brand - I have never seen anything like this come out under their name. I don't know if you are a shill or just woefully ignorant. There is nothing kind I can say, it is just shockingly weak and without substance. Your entire article is nothing more than "You are dumb to own HLF" and "Bill Ackman is trying to save us from a bad investment." You appear to have not done any research except reading Ackman's attack. Honestly, you have embarrassed yourself and Motley Fool. I have never written a post like this before - usually I enjoy the articles and find them insightful.

    You say:

    "With Ackman and his newfound love for the Internet, though, this may be the company's biggest whistleblower yet. Are you still invested in Herbalife? Why?" and "I was surprised to see a major sell-off in Herbalife stock this week, as I was unaware that anyone still owned shares of the company. Sure enough, there are still some believers out there. As late as Friday afternoon, after a rough week in the markets, Herbalife traded down nearly 20%, bursting through the floor of its 52-week low of $33.05. Investors can thank Bill Ackman and a talented team of programmers for putting together quite an elegant and professional website explaining to us all why Herbalife is the worst."

    Do you really think Ackman is a Do Gooder "activist" and "whistleblower" who is trying to help us be better investors? Did you read the long disclaimer you have to agree to before getting access to the website where they admit that they are doing this to drive down the price of the stock so they can make money?

    The best indication that nothing is wrong with HLF is the fact that the COO (who was the CFO prior to that) bought $3 million in November at $44 a share - he would know if there was anything wrong with HLF and obviously thought it was a great buy at $44. Ackman's claims are the same as Einhorn's - lots of smoke - it is amazing that the market can be manipulated this way. Ackman has been wrong many times, but his shills keep saying "He does his homework - he was right about MBIA". .Ackman has made some big mistakes in the past and reportedly lost 85% of $2 billion when he bought Target options in 2007: On July 16, 2007, Ackman announced that he had accumulated a 9.8% position in Target, proclaiming it a great company whose stock would rise from $70 to more than $100. It currently sells for $60. I am long HLF as of this morning at $26 which is a 4.6% yield and a 6 PE. I expect to sell within 6 months at $44.

  • Report this Comment On December 24, 2012, at 1:12 PM, SkepticalDude wrote:

    Sorry, but the fact that Herbalife executives bought Herbalife stock does not mean there isn't a serious problem with the company. Enron's executives also owned a ton of Enron stock before the company crashed and burned.

    Herbalife has been operating as an illegal pyramid scheme per the FTC's definition for 32 years, the executives probably thought it could continue to do so, not an unreasonable assumption since the FTC has done nothing to protect consumers from their predatory business model (and very well may continue to do nothing, which is the real bet you are taking with your long position).

    Ackman is donating all the proceeds of his short position to charity, and it's perfectly legal to take a short position and explain why, even if doing so results in the stock going down. If you explain why you think a company is great and the stock goes up, no one complains, do they?

  • Report this Comment On December 24, 2012, at 1:27 PM, dhuddle wrote:

    Is Pershing also donating their proceeds? Why are they taking out Google ads?

  • Report this Comment On December 24, 2012, at 2:05 PM, dhuddle wrote:

    @ SkepticalDude - I haven't studied Enron, but there is a big difference between owning stock that the company gave you and that you were restricted from selling and using your own money to buy $3 million. And it also makes a big difference that the person who invested the $3 million is probably the most person with the most knowledge about the company's operations and finances. Also, I simply don't believe your statement that "Herbalife has been operating as an illegal pyramid scheme per the FTC's definition for 32 years," That defies logic and has been refuted many times. Has the FTC filed a lawsuit against HLF in the past 5 years? Yes or no - a simple answer please. I Googled "FTC lawsuit Herbalife" and don't see anything about FTC lawsuits against HLF. In fact, nothing relevant came up except a complaint in 2001. For a comparison, at random I Googled "FTC lawsuit Walgreen" and "FTC lawsuit Procter & Gamble" and LOTS of stuff came up. If you are reading this, do it yourself and judge for yourself. By comparison, HLF looks clean. I suspect that all large consumer products companies have complaints filed against them with the FTC. The SEC has investigated HLF twice and found no cause for action. It is impossible to run a true "pyramid scheme" for 32 years - and don't bring up Madoff, his was a financial Ponzi scheme, not a pyramid based on selling products. I have personally bought the products and know of others who have and I am not a distributor - they simply have some good products. Are you affiliated with Ackman or Pershing, or short, or do you own puts?Do you have any facts and proof, or just your opinions? I have disclosed my position - disclose yours. Look up "Barry Minkow" who made similar claims in 2008 and is now in prison. (Read Wikipedia for more info about Herbalife and its history)

  • Report this Comment On December 24, 2012, at 2:22 PM, dhuddle wrote:

    On Thursday, Ackman told Bloomberg TV that he has a short position in Herbalife of 20 million shares.

  • Report this Comment On December 24, 2012, at 3:59 PM, mazlat10 wrote:

    You have to be a fool to believe that Ackman discovered that they are operating "32 years as a phony". yes Ackman is raking it in by shorting it and the market sells first and asks questions later.

    p.s. i do not own as of now any shares of H.L.F. but hope to buy soon at $20 or better

  • Report this Comment On December 24, 2012, at 6:26 PM, SkepticalDude wrote:

    @Dhuddle: I wouldn't make the mistake of assuming the lack of regulatory action against Herbalife by the FTC is evidence it's not a pyramid scheme. There are many reasons a government agency may not pursue legal action such as lack of funds, lack of political will, bigger fish to fry, etc.

    I am not associated with Ackman, nor have any position on Herbalife. I am however, interested in financial puzzles and am only interested in what the data say. Ackman's presentation--and I've watched it all--was very compelling. If Herbalife comes out Jan 10th (they have moved it from the 7th) and provide the data that supports the CEO's assertation that 90% of Herbalife's sales come from outside their distributor force, then I'd change my mind on that score. I think that very, very unlikely--since they say they don't even collect data on retail sales, but we'll see.

  • Report this Comment On December 24, 2012, at 8:15 PM, dhuddle wrote:

    @ SkepticalDude - So you admit there hasn't been any regulatory action (even though there is plenty of evidence that the FTC will take action if it is justified) and once again you try to create fear by throwing out that you think it is a Pyramid Scheme. I will make a strong statement too - It is NOT a Pyramid Scheme and you either don't know what you are talking about or are intentionally trying to mislead people. HLF sells its products thru a sales system that basically consists of entrepreneurs who can recruit other people to work under them. In my business I also have Distributors who I sell too. There are many companies that give exclusive relationships to retailers. You throw out the words "Pyramid Scheme" because it scares people.

    You made a very damaging statement - "Herbalife has been operating as an illegal pyramid scheme per the FTC's definition for 32 years". I think that is a lie. DO you have any proof that you are correct? The FTC doesn't agree with you or they would have taken action long ago. Before you dig a deeper hole keep in mind that an investigation and litigation is likely on its way. Fortunately, I didn't lose any money on HLF and I bought in today at $25.65, so at this point I have some skin in the game.

    So, like Ackman you are a "Do Gooder" who is looking out for the public interest? I notice how you carefully frame your answer. Do you have any connection with or are you being compensated by anyone who is shorting the stock? Ackman has said that Pershing has a short position in Herbalife of 20 million shares. For every dollar they can drop the price they make $20 million, so they have a lot at stake and they have even gone so far to influence public opinion as to buy Google ads (google HLF and you will see their ad at the top of the page). I believe they (meaning Ackman and others who are shorting HLF or have bought puts) have shills monitoring posts and replying. are you one?

    I think it is telling that you make a point of defending Ackman by saying "Ackman is donating all the proceeds of his short position to charity, and it's perfectly legal to take a short position and explain why, even if doing so results in the stock going down. If you explain why you think a company is great and the stock goes up, no one complains, do they?" That sounds like a legal disclaimer. I hope HLF sues or that a class action is brought by the stock holders who have lost $2 Billion. And Ackman may be donating his personal proceeds but is Pershing donating theirs? I'm guessing Pershing has made at least $300 million and tat doesn't count others who are reportedly in on it too.

  • Report this Comment On December 24, 2012, at 9:21 PM, TMFBiggles wrote:

    @ dhuddle -

    Based on the government's track record before, during, and after the financial crisis of 2008, it seems a bit naive to say that no wrongdoing has taken place simply because the government hasn't done anything about it.

    Ackman's presentation was incredibly detailed and incredibly damaging. The negative publicity it's caused will only be effectively refuted by an equally strong, detailed presentation from Herbalife's leadership that explains why Ackman's assumptions on metrics it does not detail are wrong.

    Your comments remind me of the initial reaction of a Forbes blogger, which were written before he actually saw the presentation:

    http://www.forbes.com/sites/igorgreenwald/2012/12/19/why-bil...

    Note that, on the right side, the most popular post is by this same blogger, reversing his stance after having seen the presentation. If you have this much time to argue about it, you have the time to go see what Ackman's put together.

    - Alex

  • Report this Comment On December 24, 2012, at 10:04 PM, SkepticalDude wrote:

    @dhuddle: I think you have a point, I should modify my statement regarding Herbalife operating as an illegal pyramid scheme for 32 years for clarity. It should read "I believe, based on the evidence provided in Bill Ackman's Herbalife short thesis that Herbalife is currently operating as an illegal pyramid scheme as defined by the Federal Trade Commission." I have not in truth analyzed how Herbalife's compensation structure has changed over the last 31 years--it's common for MLMs to change those frequently, although they retain the same general structure (a pyramid), but I'm not 100% sure about that in Herbalife's case, although I think it likely.

    Now Herbalife can most certainly change my opinion should it provide suitable data to refute Ackman's evidence, especially providing data that more than 50% of their sales are true retail sales to people who are outside the distributor force. According to the CEO, 90% of their sales are real retail sales. Fine-O dude, but sorry if I don't trust your word--provide the data please.

    My statement about the legality of explaining a short position as compared to a long one was not a legal disclaimer, it was logic.

  • Report this Comment On December 24, 2012, at 11:21 PM, SkepticalDude wrote:

    As to me being a Ackman shill, no I'm not. MLM companies do hire people to do exactly what you are accusing me of--they hire people for "online reputation management", and they encourage their distributors to praise them online, even providing template text for pro MLM websites. To see proof of the latter, Google the name of any MLM plus the word "scam" and you will see pages and pages of "unbiased" reviews using those keywords, but when you read these they invariably say how the MLM is totally not a scam and you should sign up right now! You will also notice how similar the text is on many of these sites.

    MLM distributors have an inherent interest in putting a positive light on their MLM company because they only really make money by recruiting.

    My only skin in the game so to speak is having relatives who have lost a lot of money after working their asses off in a MLM business. When they tried to recruit me, I became interested in the industry and researched it. Of course, MLMers would just say my relatives were lazy losers who didn't work hard enough instead of victims of an inherently unfair compensation plan and deceptive marketing.

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