Just Avoid These Businesses Completely

The Herbalife (NYSE: HLF  ) drama has brought some long due attention to the multi-level marketing industry. While the company has taken the biggest public bruising of any direct seller, there are quite a few other companies out there doing very similar things. As for stock prices, many of the MLMs have taken a hit on the markets lately, creating the appearance of some value opportunities. But before you go bargain hunting, know that these stocks face the same inherent risks as the heavily scrutinized Herbalife.

Sketchy businesses, good stocks
I believe in the altruistic nature of socially responsible investing in principle, but I have no problem picking up a tobacco or firearm stock if I find it's poised to pop. This won't be a soapbox article about why investing in morally ambiguous companies is wrong, but it will address the risks behind doing so.

Herbalife has boasted incredible growth over its 30+ year lifespan. Even in the past three years through macroeconomic woes, the company has grown revenues from $2.33 billion to $3.45 billion -- or 48%. Employee, advertising, and research and development costs are startling low for a company of its size, yet it commands an army of independent distributors that numbers in the millions. Over the last five years, the stock is up nearly 100%. This compares to the S&P's return of roughly 11% during the same time. As illustrated by most commonly used financial metrics, Herbalife has been and continues to be a wonderful stock to own. Following Bill Ackman's opening salvo against the company last month, the stock continues to perform.

There are other players in the space that have or have previously been just as attractive, if not more so than Herbalife. About 16 months ago, I began to look at Blyth (NYSE: BTH  ) . Blyth isn't a company many have heard of, but it boasts even better growth than the green giant.

The Blyth saga
I first became interested in the company after a colleague pointed out that the company's chairman, Bob Goergen, bought $20 million worth of shares on the open market in early 2012. In early 2010, one of the company's future subsidiaries, Visalus, was doing $600,000 in sales per year. Visalus is essentially identical to Herbalife's business. Over the past couple of years, Blyth has acquired Visalus piece by piece. During that time, the $600,000 in sales grew to $35 million. In other words, Visalus' sales grew 58 times over in two years. This makes even Herbalife look like a dormant machine.

Blyth's stock was tremendous from the end of 2011 through the first six months of 2012. Now, after growth has hit a wall and a delay occurred in the proposed spin-off of Visalus, the stock is back down into value territory -- prompting many value analysts to again look at the company.

While Blyth is again an attractive play based on some fundamentals, it is basically the same business as Herbalife. What happens if Herbalife is determined to be a pyramid scheme by someone other than Ackman -- say, the SEC? Does this spell the end for all multi-level marketers?

Investors need to be extremely cautious before entering into any position involving a multi-level marketing company. I'm not saying any of these companies are fraudulent; but if one topples, it could bring the rest down with it.

A vote of confidence
One element to MLMs that hasn't been mentioned much in the investment community is Warren Buffett's take on the business. Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) owns The Pampered Chef -- a direct seller of kitchenware. I don't need to remind anyone that Buffett invests solely in companies with a high degree of integrity and transparency. So what does this say about MLMs?

The Pampered Chef may not be the typical MLM, but one would imagine it to be an attractive, cash-generating, high-moat business with a great management team. If MLMs are inherently bad companies, why would Buffett bother with one?

I'm confused
I like to look up to my investing idols for guidance, but this time that strategy doesn't seem to work. Bill Ackman believes it is a pyramid scheme. He is so convinced that he has pledged to ride the company to zero and potentially donate the profits to charity. Dan Loeb, a phenomenal investor, believes the complete opposite. Carl Icahn seems to be on Dan Loeb's side as well, but it may personal against Ackman since the two fought it out in a court battle. And then there is Buffett, who of course hasn't said anything explicitly regarding the debacle, but implicitly approves of multi-level marketing firms by owning The Pampered Chef.

At this point, I find MLMs untouchable. I don't know if they are pyramid schemes. It seems by its very definition that a company could be a pyramid scheme one year, or quarter, and not the next. For now, despite the attractive valuations of many MLMs and their seemingly phenomenal profit power, I strongly vote to remain on the sidelines.

When there exists extremely compelling data that a moron could understand for investing in a stock, it's time to take a step back. When some of the brightest minds in investing seem to be at ends over the same businesses, it's time to take another step back. When the president of Herbalife looks like a villain from Harry Potter, it's time to turn around and run away.

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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 January 14, 2013, at 7:52 PM, dhuddle wrote:

    Funny that you are comparing a 2 year old company that could be a pyramid scheme that we have never heard of with a 32 year old company that is in 80 countries that has $3.9 Billion of TTM. Don't you see the difference? Why would you believe Ackman when he admitted that he has a 20 million share short position?

  • Report this Comment On January 14, 2013, at 8:42 PM, XMFMadMardigan wrote:

    dhuddle,

    Visalus was founded in 2005, making it a 8 year old company. It's current parent company is Blyth, was founded in 1976.

    True, it does not have the track record of HLF's 30+ year run, but they are still nearly identical businesses. They take money from independent distributors and instruct them to recruit more underneath them in order to earn royalty payments.

    Up until a recent hiccup, Visalus was on track to hit $1 billion in sales in 2013.

    As for believing Ackman, I don't think he 'admitted' it as much as declared it. There are some valid arguments against Ackman, but to get rich isn't one of them. He has already publicly declared any profits from the short would be donated to charity. He also vowed to hold on the position until the company goes to zero.

    Could he go back on these statements? Sure. But his fund is one of the most respected shops in the hedge fund world and it would be total madness to risk that reputation on a market manipulating short position.

  • Report this Comment On January 14, 2013, at 10:52 PM, SuntanIronMan wrote:

    "I don't need to remind anyone that Buffett invests solely in companies with a high degree of integrity and transparency. So what does this say about MLMs? ... If MLMs are inherently bad companies, why would Buffett bother with one?"

    So argumentum ad verecundiam? Buffett invests in companies with integrity and transparency. Buffett invests in a MLM. Therefore... MLMs have integrity and are transparent?

  • Report this Comment On January 27, 2013, at 1:28 PM, Ricknbp wrote:

    Michael - this analysis and the questions you raise are very insightful and I believe universal out there. How can these companies be so successful over time, operate legitimately in every major country in the world and yet still be so misunderstood? The answer is simple. Everyone believes they can be multi-millionaires. However, we know across the board that requires talent, skill and tenacity most do not have. This is true in any entrepreneurial venture. Direct Selling is highly people intensive. If companies do not have strong consumer and distributor protection rules (1 year refund policy, 10% restock fee), it is possible to lose money. WFDSA (World Federation Direct Selling) companies and USA DSA companies have these rules. And, it requires management to monitor closely their top performers and a willingness to terminate them for practices that cause their team members to lose money (such as the mandatory purchase of leads or other marketing materials). Those unsavory practices are NOT legal in many foreign jurisdictions. Bottom line - ethical companies that proactively and professionally build their companies will continue to succeed and thrive because the person to person approach in Direct Selling works. These are the core issues that separate legitimate Direct Sellers from the rest. Over time, I hope these principles will be better understood here in the US. Keep up the great work!

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