Bill Ackman's Strategic Retreat From Herbalife

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That's going to leave a mark. Bill Ackman just announced that his Pershing Square Capital  hedge fund was waving the white flag and covering more than 40% of his short position in supplements maker Herbalife (NYSE: HLF  )

Considering the very public and acrimonious dispute he's had with billionaire investor Carl Icahn over this bet, as well as Third Point Capital's Daniel Loeb calling Ackman's take on the company's situation "ludicrous," there's likely a heaping dollop of salt being rubbed into that wound. And coming as it does after his unceremonious exit from a miserable losing stake in J.C. Penney (NYSE: JCP  ) , this quarter's memory is not one he or his investors are likely to fondly remember.

Indeed, from July 1 to Sept. 30, Pershing Square realized a negative 6.3% return (5.4% loss net of all fees), and is barely ahead 2% for the year. Since the S&P 500 is up more than 5% and nearly 20% during those same periods, respectively, there's a lot of wound-licking going on.

Ackman blamed market manipulators and bullish analysts for the run-up in Herbalife's stock from $45 a share at the start of the quarter to $70 at its end, and going from $60 to $70 a share in the month of September alone. In particular he called out an analyst from D.A. Davidson, who said accountants at PriceWaterhouseCoopers would be issuing their restatement of Herbalife's financials for the last three years, very soon after which the company would initiate a $2 billion bond offering to buyback its stock at $75 a stub.

While that bullish call was the catalyst for running up the stock last month, none of that has happened yet and Ackman is doubtful it will play out as the analyst contends since he believes there may be more revelations in the restatements, and the probability of any debt issuance getting a junk rating is high. Moreover, adding $2 billion worth of debt to Herbalife's balance sheet would put the company in even worse financial condition than when Moody's withdrew its ratings on the supplements maker, all while it is undergoing even greater regulatory scrutiny.

Ackman's essentially doubled down on his pyramid scheme charge, but as the old investing adage goes, the market can remain irrational longer than you can stay solvent. He's had to unwind nearly half of his holdings in the investment, which undoubtedly also helped fuel the rise in the stock.

I wonder, though, how much of it is "market manipulators" and "bullish analysts" causing Herbalife's stock to rally and how much is due to market conditions. Nu-Skin Enterprises (NYSE: NUS  ) , another multi-level marketing personal care products maker that could easily fit in the Herbalife mold, has seen its stock jump 58% in the quarter and is up almost 170% year to date. Similarly situated USANA Health Sciences (NYSE: USNA  ) , while up just 20% for the quarter, has surged 164% in 2013.

Ackman has restructured his position a bit, buying long-term derivatives instead, which he maintains reduces the amount of capital Herbalife was consuming from its available funds, but there's no getting around the fact that this has been a damaging time for his hedge fund. There's a word for investors, economists, and hedge fund operators who are early with their predictions: "wrong." 

While there might be a cloud hanging over Herbalife's head, it certainly looks as healthy as ever. A record 80,000 new distributors were signed up in the latest quarter, helping drive revenues 18% higher, to $1.2 billion, and generating 28% more profits at $1.41 per share, up 28% year over year, and recorded $1.22 billion in revenue, up 18% year over year. So far in 2013, the supplement maker's stock has soared 126%, not a situation you want to see when you have a massive short position.

That Ackman still has around 60% of his position out there speaks to some level of belief in his thesis, but also pigheadedness that you can't admit you were wrong and move on. By forcing himself out of his short position before the market manipulators do  -- a torturous bit of logic -- it at least suggests that even if he's not willing to run a white flag up the pole fully yet, he is willing to send trial balloons aloft to see how they fly.

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