Loeb takes an 8% Position in Herbalife (HLF)
Now we get to see who is on each side of the trade.
Daniel Loeb Comments on Herbalife
Based on its strong financial performance, Herbalife is a classic “compounder” – a well-managed company that sustains consistent top-line growth, has a leading market position, and steadily increases margins, earnings per share and free cash flow while demonstrating shareholder-friendly behavior. …Led by CEO Michael Johnson, management has also used the company’s ample free cash flow to de-lever its balance sheet and shrink the share count by nearly 25%. This type of steady non-cyclical growth is hard to find and puts Herbalife at the head of the compounders’ class.
With results like these, the case against Herbalife rests on a bold claim that the company is a fraud. The short seller’s lengthy argument against the Company can be boiled down to three principal smoking guns: the first, a claim that Herbalife has been operating an “illegal pyramid scheme” under the nose of the Federal Trade Commission for the past 32 years; the second, that Herbalife’s loyal customer and distributor base has been exploited and harmed despite the low number of consumer complaints and generous company return policies; and the third, a claim that Herbalife’s products are commodities sold at inflated prices not supported by sufficient levels of advertising or R&D.
Taken in reverse order, the third claim misses an essential truth that invalidates the indictment. No one believes Starbucks is a scam because you can buy a cheaper cup of coffee at your local bodega. A key contributor to Herbalife’s growth has been its distributor-led “Nutrition Clubs”, where consumers can purchase single servings of the Company’s signature beverages. The short seller’s assertion ignores the significant value customers place on every consumer brand and its community “experience” – whether at a Herbalife Nutrition Club, a Starbucks, or a corner bar. The markup is merited by community and brand identity, not by the commodity itself.
(Editor: in disclosure, I am long HLF but not as aggressively as Mr. Loeb. Is HLF a franchise because of its brand? But a brand has no meaning unless there is customer captivity. Does HLF have customer captivity?)
The second claim seems similarly dubious. The FTC, by all accounts, receives a very low volume of complaints annually about Herbalife – fewer than forty per year. ….The Company repurchases an average of only 1% of sales volume pursuant to this policy. It is difficult for us to understand why the buyback volume would be so low if there are in fact so many unsatisfied consumers and distributors who presumably would not hesitate to be reunited with their cash.
The pyramid scheme is a serious accusation that we have studied closely with our advisors. We do not believe it has merit. The short thesis rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for over three decades, and will shortly awaken (at the behest of hedge fund short seller) to shut down the Company.
Applying a modest 10-12x earnings multiple suggests Herbalife’s shares are worth $55-$68, offering 40-70% upside from here and making the company a compelling long investment for Third Point.
Herbalife Battle: Great Theater, Terrible Trade By Jeff Macke
In the last 30 days shares of Herbalife (HLF) have gone from the mid-40’s to the 20’s and then back again. It’s a dizzying ride driven by bickering hedge fund managers taking turns in the spotlight to make their cases on the long and short sides. It’s a striking turn for an 11-year-old company with a market cap under $5 billion and, until very recently, almost no mindshare in the investment community.
For those considering getting involved with the stock on either side of the trade, the question is whether or not Herbalife is a “Ponzi Scheme,” as Bill Ackman alleges, or if it’s just another relatively boring company most investors should ignore. Value investor Vitaliy Katsenelson, chief investment officer at Investment Management Associates, says the company is probably best avoided.
“I think you just want to stay away from this fight,” Katsenelson says. He has been to Herbalife’s clubs and came away unimpressed. For one thing, most of the people were there, in his words, “just to sell the product to each other.” For another, the product itself seemed overpriced for what you’re getting. “Most people get into Herbalife not because they want to consume the product but because they want to sell it to their favorite mother-in-law.”
That makes HLF a lousy long, but is it a short? Not really. Katsenelson has done his homework. He’s been to HLF stores and he watched all three hours of Bill Ackman’s argument for shorting the company. After all that legwork Katsenelson just doesn’t see the appeal for either bullish or bearish investors.
Companies don’t just tumble to zero, they need to be pushed. Katsenelson thinks Ackman’s best chance in that regard is to create a self-fulfilling fundamental slide. If Ackman generates enough negative publicity it’s going to be harder for HLF to set up distribution centers. Failing that, the stock could muddle along with the company itself for years before hitting the wall.
“I would just basically stay away,” Katsenelson concludes. That’s probably good advice for the vast majority of individual investors.
Interview with a serial killer
To understand what drives hedge fund managers, I studied this video. Chilling but informative.
Interview with a serial killer: