Bill Ackman seems extremely confident in his bet against Herbalife Ltd. (NYSE:HLF). Ackman has called the short his highest conviction pick, and he is staking his entire reputation on the future on Herbalife Ltd. However, Herbalife has many defenders on the sell-side. Unsurprisingly, out of nine firms covering the company, not one has a sell. According to Reuters data, six firms have a strong buy, two have a buy, and one has a neutral rating.  Most analysts are already on vacation, but two firms with some very dedicated employees are not leaving the office early this holiday season. On December 19th, the day of Mr. Ackman’s announcement, BAML came out with a report on Herbalife Ltd. (NYSE:HLF) defending the company. BAML, which is one of the firms with a buy (or strong buy stated):

Multi-level marketers (MLMs) have proven targets for short sellers in the past, with certain market participants seemingly able to drive big share price moves with a mere disclosure of a position, or a question on a conference call. So while there’s no tangible evidence to validate the “pyramid scheme” allegations and HLF has been operating in plain sight since the early ‘80s, in the near-term, it may prove difficult for the market to take a bullish stance, and shares are likely to remain under pressure..

Scott Van Winkle, CFA of Canaccord Genuity is out with a new report defending HLF. Canaccord Genuity has a buy (or strong buy) like BAML. We summarize the points below followed by the most exciting aspect of this article.

Scott believes that Herbalife’s ‘efficient business model along with deployment of its daily consumption models across its major markets’ will continue to drive double digit revenue and earnings growth.

Van Winkle states that Herbalife Ltd. (NYSE:HLF) is facing an investor confidence/sentiment challenge that is driven by repeated efforts to paint network marketing as a pyramid scheme. It would be easy to say that Herbalife is the target, but the reality is that the targets are Herbalife’s stock and the entire multi-level marketing industry’s business model.

Additionally, Herbalife deploys ‘one of the most common compensation systems in the network or multi-level marketing industry’, and sells a class of products (weight loss) that is one of the largest segments of the selling channel.

Furthermore,  Canaccord Genuity believes that Herbalife has arguably (and tough to even argue against) the strongest management team in the sector, measurable efficacy of its product offering that is evident on the weight loss boards in nutrition clubs, and a consistent and  broad history of growth in a range of developed and developing markets.

Defending the network marketing model appears to be a challenge only on Wall Street, and in response to public critics rather than to financial or business performance. The public allegations are the challenge to investor sentiment rather than a realization of an argument that the business model isn’t sustainable.

Scott mentions an interesting story in the report, we summarized the story below:

The last aggressive short-seller of Herbalife, Barry Minkow, argued five years ago, with just as great a level of detail and equal vigor, that this business model was unsustainable. Five years later, Minkow is in prison for securities fraud and Herbalife sales are nearly double the prior level. Scott states ‘that clearly the business was sustainable and will prove to continue to be.’ In that famous for-profit attack on network marketing, the SEC investigated and closed its inquiry of a couple of publicly traded network marketers (including Herbalife) without any action.

Furthermore, he states that ‘we don’t see anything different today, other than that the selling channel is even healthier. We assumed, incorrectly apparently, that investors recognized that the anti-MLM arguments are common yet not reflective of long-term fundamentals. We see no question as to whether HLF offers significant value at current levels. The question is when the catalyst will materialize to change the sentiment. We unfortunately don’t know as prior bear markets had identifiable catalysts. We reiterate our BUY rating and recommend any patient investor take a hard look at HLF’s cash flow and growth profile.’

Scott then goes on to discuss valuation. However, the example about Minkow is disingenuous at best. Many frauds have operated for years and the SEC (as well as other agencies did nothing). In fact  this story sounds quite similar to another story with Mr. Ackman, when he started shorting MBIA Inc. (NYSE:MBI) in 2002. As of 2007 (five years later as well) the stock was trading even higher than it had in 02, but it fell approximately 90% in 2008. However,  before the big collapse in price, Ackman was called a fraud by the New York Times and Wall Street Journal, and investigated by the SEC. The story with Minkow and Ackman have many parallels , the one big difference is that in Ackman’s case the company was proven to be wrong. We have no idea how this will play out, but if history is any guide as Canaccord believes, Ackman should be quite confident in his bet.

Disclosure: The author of this article has no position in Herbalife. However, we thought it would be interesting to mention the disclosure which appears on Canaccord’s report (which is standard for any research report on any company) and the readers can get the picture as to why Herbalife (and almost all public companies) have far more buy ratings than sells. BAML listed nine potential conflicts of interested related to its coverage of Herbalife, Canaccord slightly edges them out with 14. We use small print for the disclosure in an attempt to provide readers an almost real life experience, as if the report was sitting right in front of them.

Company Disclosure
Herbalife 5, 7
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