3 Reason's Herbalife Ltd.'s Stock Could Rise

Herbalife shares could be poised for a rally if any of these three things occur.

Aug 19, 2014 at 9:35AM

Under siege from activist hedge fund manager Bill Ackman, multi-level marketing giant Herbalife (NYSE:HLF) has been an immensely volatile stock over the last two years. Ackman's periodic accusations of fraud have, from time to time, sent Herbalife cratering, while strong earnings reports and analyst notes have occasionally buoyed shares.

Although Ackman insists that the company is destined to collapse, other investors are more bullish. Below I offer three reasons as to why Herbalife shares could rally. Of course, it's important to note that even if all possibilities break Herbalife's way, there's no guarantee that the stock will rise. A more general stock market downturn, other threats to the business, or just plain random chance could keep things from turning out well for Herbalife investors. With that in mind, let's get started.

Herbalife is hit with only modest infractions -- or even none
Ackman's ongoing crusade against Herbalife has drawn the attention of several government regulators, most notably the Federal Trade Commission. The FTC has a track record of bringing down pyramid schemes masquerading as legitimate multi-level marketing firms, including Fortune Hi-Tech Marketing and BurnLounge.

Herbalife could be the next firm to fall victim to the FTC's wrath, or at least, that's what Herbalife bears are betting on. If the FTC does charge Herbalife's management with operating an illegal pyramid scheme, the resulting impact on shares is likely to be catastrophic.

However, the inverse is equally true. That is to say, if the FTC were to conclude its formal inquiry with only modest action -- perhaps a small fine or slap on the wrist -- or even none, Herbalife shares could surge to the upside, as the likelihood of a government seizure or shutdown evaporates. Herbalife could continue to operate its business, and though its results could be dampened by any FTC action, the threat of a looming binary event would effectively vanish.

More bullish would be the FTC ending its formal inquiry and taking no action whatsoever. Although other government agencies (including the SEC, several state attorneys general, and perhaps the FBI) are also looking into Herbalife, the FTC has a history of leading the charge when it comes to prosecuting pyramid schemes.

If the FTC found Herbalife to be operating within the limits of the law, the bear case would effectively vanish. The ongoing regulatory threat would dissipate, and Herbalife shares would likely be revalued, gaining a multiple commensurate with the broader market.

A short squeeze is triggered in Herbalife shares
That surge to the upside could be prompted, partly, by a wave of investors rushing to purchase shares of an extraordinarily cheap stock (currently trading with a price-to-earnings ratio near 11). But more significant could be the buying by those investors who had been short shares of Herbalife.

As of this writing, about one-third of Herbalife's outstanding shares have been bet against -- making it one of the most heavily shorted stocks in the market. To stop potentially unlimited losses, short sellers could turn into buyers if Herbalife shares begin to move to the upside.

Even if the FTC's ongoing investigation is not resolved, a short squeeze could still occur. Herbalife's management has undertaken a strategy that has seen it aggressively repurchase its own shares this year. In February, it issued $1 billion in convertible senior notes to expand its buyback program, and in April, it stopped paying a dividend in order to finance more share repurchases. As my Foolish colleague Jim Royal points out, borrowing additional money to buy back even more stock could raise the short interest to untenable levels, prompting a major short squeeze on the slightest positive headline.

Herbalife's rapid growth could resume
The possibility of regulatory action (or inaction) is likely to dominate the Herbalife trade in the near-term. Yet, operational improvements could have a modestly positive affect on Herbalife shares.

Last month, Herbalife disappointed shareholders when it delivered an earnings report that came in short of analysts' expectations. Although Herbalife's adjusted EPS increased 10% from the same period last year, analysts had been expecting better results. Not surprisingly, Herbalife shares declined on the report.

A reversal in fortune, and a string of strong earnings reports could produce the opposite effect. Assuming that Herbalife is, as it says, not a fraudulent company, the market for its weight-loss shakes appears to be expanding. Earlier this year, researchers found that worldwide obesity rates had risen sharply over the last three decades: In the U.S., as many as a third of the population is now obese, and Australia and the U.K. are not far behind.

A special situation
Still, unlike other stocks, which may move on the basis of the underlying company's ability to bring desired products to market, Herbalife is truly a special situation.

At least in the near term, the return on Herbalife shares is likely to be related more to the outcome of ongoing investigations than the business itself. For Herbalife shares to head higher, investors should look for the FTC to end its inquiry with only modest penalties (or no penalties whatsoever). That, in turn, could prompt a short squeeze, and send shares trading significantly higher.

Leaked: This coming blockbuster will make every biotech jealous
The best biotech investors consistently reap gigantic profits by recognizing true potential earlier and more accurately than anyone else. Let me cut right to the chase. There is a product in development that will revolutionize not just how we treat a common chronic illness, but potentially the entire health industry. Analysts are already licking their chops at the sales potential. In order to outsmart Wall Street and realize multi-bagger returns you will need The Motley Fool's new free report on the dream-team responsible for this game-changing blockbuster. CLICK HERE NOW.

Sam Mattera owns put options on Herbalife. The Motley Fool has the following options: long January 2016 $57 calls on Herbalife. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information