June 11 (Bloomberg) -- Herbalife Ltd. has an image problem on Wall Street.
Ever since Greenlight Capital Inc.’s David Einhorn dialed into a May 1 earnings conference call asking for more disclosure, investors have shunned shares of the nutritional and weight-loss supplement maker. The influential hedge-fund manager’s query hit right at Herbalife’s marketing Achilles heel: how to keep track of inventory when much of it is sold from thousands of distributors’ homes and car trunks. Einhorn had dredged up skepticism that has long plagued direct sellers from Avon Products Inc. to Tupperware Brands Corp.
Herbalife executives say they thought they’d put such concerns behind them, especially since their products increasingly are sold in so-called nutrition clubs -- shopfronts where customers can drop by to sample products and exchange weight-loss tips. These operate more like traditional retail stores, which are easier for investors to understand.
“There is enough insecurity in the direct-selling model that the stock reacted significantly with the questions Einhorn raised,” Chief Financial Officer John DeSimone said in a telephone interview. “It’s an indication we need to do a better job of educating Wall Street as to how the model works.”
On the call, Einhorn asked why Herbalife stopped giving a breakdown of three groups of distributors it had previously provided. He also asked for an explanation of financial incentives given to supervisors who sign up new distributors. DeSimone, who told Einhorn he stopped providing the data because it didn’t seem valuable to investors, agreed on the call to resume the disclosures.
Investors weren’t assuaged. Herbalife plummeted 20 percent the day of the call, on the way to its largest three-day decline since the shares began trading in December 2004. Before Einhorn’s query, Herbalife’s share price had hit an all-time high on April 23, spurred on by a 26 percent sales surge in 2011. The shares, down 36 percent from April 30 through June 8, rose 0.1 percent to $45.10 at 1:41 p.m. in New York.
Einhorn declined to comment.
Herbalife executives will try to reassure investors by demonstrating the benefits of nutrition clubs, DeSimone said.
That should help because “you can go into these nutrition clubs and see the sales channel and measure it,” said Scott Van Winkle, a Boston-based analyst with Canaccord Genuity Inc.
The first nutrition clubs popped up in Mexico in 2003 in the homes of independent distributors, much like Tupperware parties. Soon, distributors were opening small shops to mix protein shakes and sell them one at a time. Latino migrants took the method to the U.S. in 2006. It soon spread to Taiwan, Korea and Brazil. The most popular nutrition club products are a “Formula 1” protein shake, tea and an aloe drink.
The clubs boost sales two ways, according to DeSimone. Distributors interact with their customers on a daily basis, instead of every few weeks or months. And the clubs offer weight-loss support groups and a social outlet, providing an emotional connection to the products and distributors.
Why doesn’t Herbalife open its own stores? Building and maintaining them is expensive. Herbalife’s return on capital last year was 59 percent compared with GNC Holdings Inc.’s 9.5 percent. That’s partly why Herbalife traded at a premium to GNC before Einhorn got involved. Since then, investors have bought Herbalife at a 41 percent discount to GNC.
The direct selling model -- where customers proselytize on behalf of the products -- is also well suited to nutritional supplements, according to Van Winkle.
“In the case of weight-loss products, articulating the benefit is incredibly challenging in a retail storefront when there’s 150 products on the shelves,” he said. “It’s about being face-to-face, telling a story about the product.”
Maria Avila, an Herbalife distributor who runs a nutrition club at a strip mall in suburban Atlanta, entices customers with a snapshot of herself 30 pounds heavier.
Last week, Avila scooped powder for an Herbalife shake into a Styrofoam cup and mixed it with water in a blender. Pop music accompanied the din of whirring blenders and conversation as more than a half-dozen customers at a bar sipped lemon tea and aloe-infused water.
Avila charges as many as 20 clients a day $4 for a serving of each of Herbalife’s three top-selling drinks. Some come by seven days a week. Avila holds weight-loss challenges, shows Herbalife sales videos and sells drink mixes by the multi-pack. She and the distributors in her organization operate the club together and share the rent. Herbalife provides guidelines on how to manage a center.
If it weren’t for a small illuminated “open sign” showing through windows obscured by green curtains, the center could be easily missed. Avila and her partners aren’t allowed to use Herbalife logos outside. The company doesn’t want clubs to have an unfair advantage over distributors who work out of their homes. Avila hands out coupons and talks to potential recruits, just like every other distributor.
“This is where it all starts,” said the 30-year-old mother of two. “We tell them to just come by and try the products. It’s like going to Starbucks, but not being alone.”
Nutrition clubs and similar operations generated as much as 41 percent of Herbalife’s $3.45 billion in revenue last year, the company says. Lost in the dust-up between Einhorn and Herbalife is the fact that the growth of clubs like Avila’s has made the company more transparent than ever, Van Winkle said.
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