Nu Skin China Probe Derails CEO’s Sevenfold Share Gain

Nu Skin Enterprises Inc. (NUS) Chief Executive Officer M. Truman Hunt, who oversaw a sevenfold gain in the direct-seller’s shares in the past seven years, is facing the biggest test of his tenure after a state-run newspaper in China said his company runs a pyramid scheme.

The report in the People’s Daily earlier this week and the government’s subsequently announced probe of Nu Skin’s Chinese operations sank the shares 38 percent in two days. While the Provo, Utah-based company has denied the accusations, the situation threatens to disrupt Nu Skin’s business in the nation that is providing the bulk of its growth.

“We are absolutely not a pyramid scheme,” Hunt said in a telephone interview on Jan. 16. “Our business in China and elsewhere is a consumer, product-based business. Nobody gets rich in our world by recruiting others and selling them on nothing but the income opportunity.”

Hunt took over as CEO in 2003 and, after three years of sales stagnating at around $1 billion annually, decided to reorganize its hodge podge of business units around a simple “anti-aging” theme.

Capitalizing on graying populations and consumers’ growing desire for youth and beauty, the plan helped break the sales rut. Hunt expects revenue this year to surpass $3 billion, and he wants to reach $10 billion by 2020, a goal he calls “aspirational” yet “reachable.” Investors liked the transformation and boosted Nu Skin’s shares as high as $140.50 this week, from $17.58 at the end of 2005.

China Growth

Nu Skin’s growth in its Greater China unit, which includes Hong Kong and Taiwan, has been particularly rapid. Sales there more than tripled in the three-month period ending Sept. 30, accounting for the bulk of the company’s total 76 percent revenue gain for the quarter. Mainland China alone accounted for 30 percent of Nu Skin’s $2.16 billion in revenue during the first nine months of 2013, Hunt said.

The country’s market is particularly ripe for Nu Skin’s anti-aging products. The United Nations has forecast the population of people aged 65 and older there will increase by about 66 million from 2015 to 2025.

In China, Nu Skin’s more than 40,000-person salesforce pushes weight-loss kits and skin cleansers in at least 19 of the 32 provinces and municipalities.

So it was a big blow to shareholders’ confidence when the state-run Chinese newspaper said Nu Skin brainwashes trainees and sells more products than allowed. The State Administration for Industry and Commerce said it will probe the company’s operations. The company has said the People’s Daily allegations and government inquiry are likely to hurt revenue.

China Obstacles

Other foreign firms have been contending with new obstacles in China in recent months, too. Last year, the government-controlled media accused Starbucks Corp. of charging too much and said Samsung Electronics Co.’s smartphones don’t work properly. International Business Machines Corp.’s China revenue fell after state-owned companies delayed orders of servers and mainframes. Qualcomm Inc. technology is largely absent from devices on China Mobile Ltd.’s network because the state-owned carrier deployed a related system it said was developed locally.

Nu Skin may be less well known in the U.S. than competitor Herbalife Ltd. (HLF), in part thanks to hedge fund manager Bill Ackman. He accused Herbalife of being a pyramid scheme in the U.S. and placed a bet against the company’s shares, bringing the entire sector to investors’ attention. China accounted for about 6.8 percent of Herbalife’s 2012 sales.

LifePak Supplements

Nu Skin’s global sales are split almost evenly between nutrition and personal-care products, Hunt said. The biggest seller is the LifePak dietary supplement, a collection of vitamins, minerals, antioxidants and other ingredients packaged in pouches. The product generated about 15 percent of sales.

In personal care, the star is the AgeLOC Body Spa. The device uses “pulsating micro-current technology” to help reduce signs of aging,’’ the company said. AgeLOC TR90, a collection of shakes, bars and supplements for weight management, may have generated $550 million in sales last year, the company’s largest product introduction ever, Nu Skin says.

In 2011, Nu Skin paid $11.7 million for Genetic researcher LifeGen Technologies LLC to bolster its product research and development. The deal included a proprietary tissue bank and gene-expression database, patents and other intellectual property related to anti-aging research.

Sales Networks

Nu Skin sells more than 200 products by way of its consumer and sales networks that include almost 1 million people. The representatives earn commissions from the products they and others in their network sell to friends, family and strangers. The model is different in mainland China, which heavily regulates direct sellers. There, products are sold in large part by an employed salesforce through its own stores. Some independent direct sellers are licensed in specific areas to sell away from the stores, as well.

Pyramid-scheme operators typically seek to make money by recruiting new members who pay fees to existing members rather than relying entirely on selling goods and services. The U.S. Federal Trade Commission has said modern pyramid schemes can use products to hide their true intent.

While the allegations that Nu Skin operates such a scheme are “preposterous,” the probe may prompt the company to make some changes to its practices, Timothy Ramey, a Lake Oswego, Oregon-based analyst at D.A. Davidson & Co., said in a telephone interview yesterday. He recommends buying the shares.

Affecting Growth

“Will it have an impact on their growth rate in China? Probably,” he said. “Will it derail growth, will the company shrink? I doubt it.”

Nu Skin reaches a more affluent customer than Herbalife, and its product quality is “quite high,” he said.

Nu Skin’s roots date back to 1984 in Utah, where Brigham Young University graduate Blake Roney and his sister created a line of beauty products without all the fillers they disliked, according to Hoover’s Inc. The siblings got seed money from friend Sandra Tillotson. Rather than taking on debt, they decided to use multilevel marketing to distribute the products.

Utah is home to other multilevel marketers, including supplement maker Usana Health Sciences Inc. (USNA) and closely held MonaVie.

Hunt, a former practicing attorney, started with Nu Skin in 1994 as counsel after selling a houseware-products company whose investors included Nu Skin’s founders. He would take over as CEO almost a decade later. The 54-year-old received $7.78 million in total compensation including stock awards in 2012, according to data compiled by Bloomberg.

‘Nightline’ Report

Nu Skin has been accused of wrongdoing before. In 1991, the television show “Nightline” characterized the seven-year-old company as a pyramid scheme. The following year, Nu Skin settled charges with five states that alleged deceptive advertising and recruiting claims.

There also were federal investigations. In 1994, Nu Skin and related entities were ordered to pay about $1.23 million to resolve allegations by the Federal Trade Commission. The FTC said Nu Skin misled consumers and sellers, ordering the company to back up product claims with “reliable scientific evidence.” Three years later, Nu Skin was ordered to pay a $1.5 million fine to the FTC after allegations that it made unsubstantiated product claims.

“The company was able to resolve these inquiries to the satisfaction of all regulators,” Nu Skin said in an e-mail.

Nu Skin said in a statement that the Chinese newspaper’s allegations were exaggerated, and Hunt said he stands by the company’s selling methods there. However, some “confused” Nu Skin sales reps may have used marketing materials from neighboring countries that aren’t allowed in China, he said.

Government Inquiry

Hunt, who has so far let his China managers deal with the government’s inquiry, said the company will work to make sure officials are satisfied with its operations. Still, Hunt said the episode has made him question the merits of doing business in China.

“As we look at the global marketplace,” Hunt said, “you can’t not do business in China.”

To contact the reporters on this story: Duane D. Stanford in Atlanta at dstanford2@bloomberg.net; Lauren Coleman-Lochner in New York at llochner@bloomberg.net

To contact the editor responsible for this story: Kevin Orland at korland@bloomberg.net

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