Is It Time to Buy Herbalife Stock?

Herbalife stocks look like a bargain. Is it time to scoop up shares?

Aug 22, 2014 at 11:49AM

Shares of multi-level marketing giant Herbalife (NYSE:HLF) have fallen more than 34% this year. Despite undertaking an aggressive share repurchase program, Herbalife stock has tumbled in the wake of two bearish presentations by activist hedge fund manager Bill Ackman and, more recently, a disappointing quarter.

With Herbalife trading near a 52-week low, is it time to buy the stock?

An unbelievable bargain
If one considers only the fundamentals, Herbalife shares are clearly a bargain. Presently, the stock is trading with a price-to-earnings ratio near 11 (far below the broader market's), and its forward PE, around 7, is simply incredible.

On average, analysts have price targets on Herbalife near $80, with the most bullish believing Herbalife shares could trade as high as $94 in the coming quarters. At current levels, that's a potential upside of almost 100%, making Herbalife -- from a strictly fundamental perspective -- one of the most attractive stocks in the market.

An unusual situation
However, valuation does not tell the whole story, especially for Herbalife. Herbalife is in a special situation, with its fate likely to be decided by government regulators more so than its ability to successfully execute on its business model.

The FTC and several state attorneys-general are currently investigating Herbalife. For the past 19 months, Ackman and his Pershing Square hedge fund have waged an aggressive war against Herbalife's management, charging the company with operating an illegal pyramid scheme.

Ackman's accusations have clearly caught the attention of regulators. Although the government could ultimately end its investigation by taking no action, it is possible that the government could side with Ackman, seize Herbalife's assets, and then shutter the company -- it's done the same with other multi-level marketing firms in the past.

A complex trade -- and that's putting it lightly
Of course, not everyone agrees with Ackman. Indeed, several other legendary investors -- including Carl Icahn -- have taken the other side of the trade.

But the biggest problem with an investment in Herbalife -- and why I believe most investors should stay away -- comes down to the complexity of the situation. Unlike other stocks, which can be judged on simple concepts like yield, valuation, and business prospects, the outlook for Herbalife is extremely unclear.

Given its high short interest (nearly one-third of the outstanding shares have been bet against), the removal of regulatory risks could send shares sharply to the upside. Yet, in the most bearish of scenarios, shareholders could literally see a total loss of principal.

Judging the relative probability of the outcomes is no simple matter. Government regulators are investigating the firm, but there's no guarantee they'll act. If they do, the level of action could vary significantly, from a minor slap on the wrist and a small fine to a seizure of assets and criminal charges.

Then there's the issue of what a pyramid scheme even is, and if Herbalife meets the criteria. While investors might expect it to be cut and dry, it's anything but, with a long series of legal cases creating a rough framework of how the courts would judge Herbalife's business (assuming it came to that). Even then, it's not clear, as the results of the recent FTC vs BurnLounge case was spun as both good and bad for Herbalife by its defenders and detractors, respectively.

If investors are confident that Herbalife's business model will withstand the pressure of regulatory scrutiny, then they may wish to buy shares, owing to Herbalife's extreme undervaluation. Everyone else should likely stay away.

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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.

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