Herbalife Bulls Take On Short Ackman After Pyramid Claim: Retail

Activist Investor Bill Ackman
Activist investor Bill Ackman pauses while speaking in front a screen displaying "Herbalife is a Pyramid Scheme" during a presentation in New York. Photographer: Scott Eells/Bloomberg

Were this a movie script, the working title could be “The Short Versus the Herbalife Bulls.”

Yesterday, in a blistering 210-minute presentation in New York, activist investor Bill Ackman called the maker of nutritional and weight-loss supplements a pyramid scheme and said he had shorted the stock. Ackman’s comments riled the company’s chief executive officer and ran into a wall of opposition from the nine Wall Street analysts who cover the company. All but one today still listed the shares as the equivalent of a buy, according to data compiled by Bloomberg.

“Ackman gets an ‘A’ for effort and style points,” Tim Ramey, an analyst for D.A. Davidson & Co. in Lake Oswego, Oregon, said in a note. “Not much substance in our view.”

If the rout in the stock was any guide, investors are listening to Ackman, who runs New York hedge fund Pershing Square Capital Management LP. The shares fell 19 percent to $27.27 at the close in New York, after sliding 9.8 percent yesterday and 12 percent the previous day, when Ackman first said he was shorting the stock.

“This is the highest conviction I have ever had about any investment I have ever made, full stop,” Ackman said in an interview with Bloomberg Television. “This is all-hands-on, and I have everyone in the entire organization working on this project, including two of the top law firms in the country.”

Independent Distributors

Herbalife Ltd. sells vitamins, shake mixes and skin gels through a marketing network of independent distributors in at least 81 countries. Those independent contractors earn revenue by selling products directly to customers and recruiting new distributors, for which they earn a share of those sales and incentives from the company.

A classic pyramid scheme attempts to make money solely by recruiting new participants into the program, according to the U.S. Securities and Exchange Commission. Ackman said Herbalife has structured itself to hide that intent.

“Today’s presentation was a malicious attack on our business model based largely on outdated, distorted and inaccurate information,” the company said in an e-mailed statement after the presentation. “We operate at the highest ethical and quality standards.”

Herbalife said today in a statement it will hold a meeting with analysts sometime the week of Jan. 7 to address Ackman’s claims.

The company also said Ackman declined to allow company executives to participate in the conference. Ackman responded later in an e-mail, saying two Herbalife employees registered and possibly attended the conference and that he declined only to let the chief financial officer be part of the presentation. Ackman offered to go on air with Herbalife Chief Executive Officer Michael O. Johnson for a “point/counterpoint” anytime, he also said.

Short Sellers

This is the second time this year that Herbalife executives have watched their stock tumble after a short seller questioned the company’s business model. On May 1, Greenlight Capital Inc.’s David Einhorn dialed into an earnings conference call asking for more disclosure. He wanted to know why Herbalife stopped giving a breakdown of three groups of distributors it had previously provided. The shares have since lost more than half their value.

Einhorn’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.

At the time, Herbalife executives said they thought they had put such concerns behind them, especially since their products increasingly are sold in so-called nutrition clubs -- shop fronts 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.

SEC Letter

After Einhorn’s comments May 1, the SEC questioned Herbalife, asking why executives viewed certain disclosures related to its distributors as immaterial to investors, according to a letter dated June 5 that was released Aug. 8 in a filing. On July 11, the SEC said it had completed its review following an explanation from Herbalife, an additional correspondence shows. Greenlight Capital declined to comment on Ackman’s presentation.

Yesterday, Ackman panned Herbalife’s nutrition clubs, saying they exist to recruit more distributors rather than sell product at retail.

Ackman misses the fact that Herbalife sells a premium product to a growing number of individual users in the midst of a global trend toward healthier foods and weight loss, Ramey said in his note.

“We will gladly take the other side of that bet,” he added. “In our view, Herbalife has really never been more exciting than today.”

‘Light’ Presentation

Linda Bolton Weiser, an analyst with B. Riley & Co. in New York, said Ackman’s presentation was “light.”

“The product is sold to people, people do use it,” said Bolton Weiser, who is also a Herbalife distributor. “He included very little of that aspect.”

Bolton Weiser said she buys for herself only and that being a distributor helps with access to company information. She also is an Avon sales representative, she said.

“His claim is that nobody is buying it at all,” Bolton Weiser said, disputing Ackman’s assertion. “He literally said at one point there’s almost no retail sales going on. That’s a very odd statement to make.”

Ackman brought an associate and his firm’s chief attorney to give parts of the presentation, which included more than 340 slides and a question-and-answer session.

Charity Pledge

Pershing Square is short more than 20 million shares, Ackman disclosed in an interview, which is about 97 percent of the 20.7 million short interest shares outstanding today, according to data compiled by Bloomberg. He pledged to donate his proceeds from the bet to charity.

Short-selling refers to the practice of borrowing shares and selling them, with the goal of profiting by repurchasing them later at a lower price.

Ackman said he chose his timing carefully to get maximum attention before Herbalife distributors are required to purchase new product in January to qualify for certain commissions. Pershing Square turned over research to the U.S. Federal Trade Commission and will be available to investigators, Ackman said in the interview.

“A lot of people have been harmed here,” he said.

Herbalife has urged the U.S. Securities and Exchange Commission to investigate Ackman’s announcement because certain Herbalife put options expire today, the company said.

Pershing Square doesn’t own options in Herbalife, Ackman said at the conference.

In another e-mailed statement, Johnson said “the allegation that Herbalife is a pyramid scheme is bogus.” Earlier, Johnson had told CNBC that the U.S. would be better off with Ackman gone.

Ackman’s riposte: that he feared for his safety.

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