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Why Herbalife Surged 18.5% in February (Hint: Bill Ackman Isn't Happy About It)

By Jamal Carnette, CFA - Mar 5, 2016 at 8:46AM

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Favorable commentary regarding an FTC investigation helped the company power higher.

Source: Herbalife

What: Shares of multi-level marketing and direct-selling company Herbalife (HLF -2.20%) soared 18.5% in February as the company reported stellar earnings, according to S&P Capital IQ data. The combination of better-than-expected earnings and positive commentary regarding the Federal Trade Commission's probe into its business operations placated investors' concerns. Shares of the company rose 27% on Friday alone in response to a filing outlining a potential resolution with the FTC.

So what: For the fourth quarter, Herbalife reported adjusted earnings per share of $1.19 on revenue of $1.1 billion. Thompson Reuters analysts' consensus expectations had been for earnings of $0.94 per share on revenue of $1.06 billion. However, the biggest boost to the stock was Herbalife's disclosure it has started discussions with the FTC about resolving the nearly two-year long probe regarding its business model, and whether it should be considered an illegal pyramid scheme or a legitimate business.

The inspiration behind the FTC's probe of Herbalife was Pershing Square Capital founder Bill Ackman. After revealing a $1 billion short position in the company, Ackman publicly and repeated called its business model a "fraud." After more than a year of increasing stridency, he even upheld Godwin's Law by comparing the company to the Nazis. Unfortunately, Wall Street hasn't agreed with Ackman's Herbalife thesis, and that has cost Pershing Square Capital dearly.

The combination of the fund's short position in Herbalife and a long position in struggling drugmaker Valeant Pharmaceuticals have combined to drive down returns in Pershing 20% in 2016, further adding to the 20% loss Pershing investors endured in 2015. For comparison, shares of the S&P 500 finished down 1% and 3% during that period, respectively.

What now: While investors were ebullient about a potential favorable ruling (as they should be), there appear to be headwinds on the horizon. The company lowered its full-year EPS guidance from $4.35 to $4.75 per share to $4.05 to $4.50 per share during the conference call, a drop of 6% at the midpoint. The company blames unfavorable foreign exchange rates for the decreased guidance, and predicts the strengthening dollar will reduce its net sales by 3% to 6%.

That said, the company's biggest risk appears to be operational and not legal at this point -- a big difference from the risks it faced at the beginning of the month. Last year, the saga took an odd turn when The Wall Street Journal (subscription required) reported FBI officials had investigated Ackman and Pershing for possibly making false and misleading statements to spur investigations into the firm. It seems as if the FTC is signaling Pershing's concerns are baseless.

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