Latest Herbalife Probe Reinforces Underlying Risk

Whether its marketing practices are legal or not, Herbalife is simply too difficult a business to nail down. Investors are better off seeking growth elsewhere.

Michael Lewis
Michael Lewis
Apr 14, 2014 at 11:40AM
Consumer Goods

Herbalife (NYSE:HLF) remains an enigmatic business. The company can seemingly refute any claims regarding the legality of its multilevel marketing business and has the support of some extremely intelligent, experienced mega-investors. At the same time, the consumer-level evidence against it is hard to refute, and the scarcity of regulatory support suggests there are still many unknowns. Last week, the FBI announced a criminal investigation into the company's practices -- sending the stock down double digits and giving its most outspoken (and anti-investment) opponent, Bill Ackman, new ammunition for his quest to take the company to zero. Where does the retail investor stand?

Mixed messages
With many businesses that attract negative PR -- oil, cigarettes, and firearm businesses come to mind -- there is no debate as to their social, environmental, or geopolitical effects. And when it comes time to show the money that flows through these companies, their investors focus little on what is already known.

Herbalife, while not a slinger of death-inducing, world-melting products, is widely known for its targeting of people on the lower end of the socioeconomic spectrum to benefit a few people higher up the chain of command. Its sales, too, are hard to ignore, as the company continues to post healthy sales and profit growth. Meanwhile, one of the uberinvestors of the world, Bill Ackman, has put $1 billion toward the notion that the company is operating illegally. He's spent hundreds of millions supporting his thesis and keeping the short alive, all while his adversaries (Carl Icahn, among others) pile in on the other side.

Herbalife's new auditor, PWC, completed a multiyear re-audit and found no irregularities in the company's statements. At the same time, the biggest Hispanic rights organizations in the United States came out asking politicians to intervene in what they claim is the "worst player -- bar none -- operating in the Latino communities across the country."

For the average investor trying to determine the legitimacy of Herbalife's business, the evidence seems nearly irrefutable on both sides of the line.

The only hope for some sort of settlement is a decision in Washington, and that may be getting closer. Last month, the Federal Trade Commission announced a civil probe into the company's marketing practices. Now, CNBC reports that the FBI is conducting its own. In true Herbalife style, management claimed they had no knowledge of such an investigation, which seems odd.

Where to stand
What will come of the FBI investigation or the FTC one? Who knows. To Herbalife's advantage, the company operates in a gray area that may allow it to do what it does without threat of regulatory risk, at least in the near term. For investors, the story remains the same: Look elsewhere. There are plenty of companies growing quickly and booking attractive year-over-year gains, and they don't attract near the conflict and drama that this one endlessly does. Let the superstar egos duke this one out. If a final answer comes up, then one can consider the way to play it.