Over the past two years, shares of multi-level marketing giant Herbalife (NYSE: HLF ) have been immensely volatile, largely due to the activities of activist hedge fund manager Bill Ackman, who has been waging an aggressive campaign against Herbalife's management, accusing the company of fraud.
At times, his accusations have prompted sharp sell-offs, but more recently, the focus seems to have shifted to Herbalife's earnings. Last month, shares of Herbalife tumbled after its earnings report came in short of analysts' expectations.
Management remains confident in its business, and in a subsequent earnings call, pointed out a number of factors investors should be aware of. Below are five of the most important quotes from Herbalife's most recent earnings call, courtesy of S&P Capital IQ.
The market for its products is growing
Herbalife's products are, broadly speaking, aimed at helping to facilitate weight loss. A meal replacement shake, Formula 1, is the cornerstone of its portfolio, while it also offers supplements such as metabolism-boosting tea and multivitamins.
So long as global obesity rates remain elevated, Herbalife's management believes the market for its products is large. Citing a recent study, the company's CEO Michael Johnson quantified the opportunity for Herbalife.
The Harvard School of Public Health estimates that the worldwide rate of obesity has nearly doubled since 1980, with over 200 million adult men and just under 300 million adult women being obese.
It's not a pyramid scheme
Of course, obesity rates are not relevant if -- as Herbalife's critics claim -- the company is a pyramid scheme. Herbalife's management insists that it isn't, and offers up the results of a recent study commissioned by Herbalife as evidence. As CEO Johnson notes:
Dr. Vandaele found that approximately 97% of Herbalife's U.S. products are purchased by consumers for end-use consumption. In addition, he found that the vast majority of Herbalife's product line, 80% is consumed by members who joined Herbalife to receive product discounts for themselves and their families or is consumed by [non members].
Dr. Vandaele, an economist, was once employed by the Federal Trade Commission, one of the regulatory agencies currently investigating Herbalife. The FTC itself may eventually come to a wildly different conclusion, but Vandaele's findings may lend some credence to the argument that Herbalife is not a pyramid scheme.
Still, Vandaele's analysis was limited to the United States -- Herbalife operates in many foreign countries -- and fails to dismiss Ackman's most-recent accusations against the firm. Last month (in a lengthy presentation that I've summarized here) Ackman pointed out how nutrition clubs could allow Herbalife to disguise recruitment-related purchases as legitimate consumption.
Management is committed to share repurchases
Herbalife shares have fallen more than 34% this year, but might've been down even further if it hadn't been for an aggressive stock repurchase program. Per Mr. Johnson:
We recently completed the successful repurchase of $581 million of our common shares during the second quarter. Since 2007, we've returned approximately $3.1 billion to our shareholders in total share repurchases and we will continue to try to use our capital effectively to create value for all our stakeholders.
In February, Herbalife raised $1 billion in a convertible note offering and in April, announced that it was suspending its dividend. Both moves were designed to facilitate an aggressive share repurchase program.
Any company engaged in an aggressive share repurchase program is likely to see the value of its shares rise over time. In Herbalife's case, however, it may be doubly true, as so many of its shares have been sold short. More than one-third of Herbalife's public float has been bet against, a ratio that could rise as Herbalife continues to repurchase its shares. With high short interest, the company's stock could be prone to an aggressive short squeeze.
Direct sales help facilitate weight loss
Herbalife's multi-level marketing model (in contrast to traditional retail sales) may be unusual for investors looking at the company. But Herbalife's management insists that it's an integral part of the company's success. As CEO Johnson notes:
Our direct sales model is more effective in creating sustainable behavior changes for weight management in promoting a healthy, active lifestyle. The reality is that people are more likely to lose weight in a group setting or an environment than going at it alone.
Rather than sell its product in stores, Herbalife relies on its members (and the members they recruit) to sell its products individually. Though this may appear strange, Herbalife believes it adds value by facilitating greater community involvement, which may lead to better outcomes for customers.
Ignore the short seller
Lastly, and perhaps most significantly, Herbalife urges its investors to ignore Ackman's crusade against the company, and focus instead on its improving earnings profile. Once again, per CEO Johnson:
Our EPS is 40% higher this quarter than it was before all this other stuff started, the short-seller noise started.
Referring to Ackman's extensive campaign as mere "noise" suggests that the company is not too concerned about his activities. Herbalife's management is spending millions to respond to short-seller attacks ($5.6 million last quarter) but has still seen its earnings rise meaningfully over the last two years.
If Ackman's accusations prove true, its earnings won't matter, but if the government finds little fault with Herbalife's business, investors could be attracted to a company trading at a P/E ratio near 11.
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