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

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.


Read/Post Comments (1) | Recommend This Article (0)

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.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3075364, ~/Articles/ArticleHandler.aspx, 11/28/2014 12:25:02 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement