Dan Loeb

Herbalife Ltd. (NYSE:HLF)’s potential was one of the main points in Dan Loeb’s fourth quarter letter to investors (embedded below). The founder of the famous hedge fund, Third Point explained why they bought into the company after Pershing Square’s Bill Ackman made some “controversial assertions about it.”

Loeb’s fund bought about 8 percent of Herbalife Ltd.(NYSE:HLF)’s outstanding shares of common stock, mostly in the wake of Ackman’s comments about his short of the stock, which sent it plummeting last month. Loeb called Herbalife “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.”

He goes on to point out that in seven of the last eight years, the company has seen double digit rates of increased revenue. He also said that earnings per share have increased about 20 to 50 percent per year in every year except 2009 since the company’s 2004 IPO. Loeb also said that the company has used its free cash flow to “de-lever its balance sheet and shrink the share count by nearly 25 percent.”

“This type of steady non-cyclical growth is hard to find and puts Herbalife at the head of the compounders’ class,” he wrote.

Then Loeb listed three “smoking guns” in Ackman’s argument. He said Ackman claims that Herbalife Ltd. (NYSE:HLF) has been operating as a pyramid scheme without the FTC being aware of it for more than three decades. Second, he said Ackman claims that the company exploits its customers and distributors even though relatively few complaints have been lodged against it. And third, he said Ackman claimed that the company’s products are “sold at inflated prices not supported by sufficient levels of advertising or R&D.”

Loeb begins debunking Ackman’s claims by pointing out, “No one believes Starbucks is a scam because you can buy a cheaper cup of coffee at your local bodega.” He also said that the FTC receives fewer than 40 complaints about Herbalife each year, which seems to go against what Ackman said about hundreds of thousands of people being scammed. And finally, he said he doesn’t think that the pyramid scheme accusation “has merit.”

“While the short seller’s presentation was lengthy, it presented no evidence to show that Herbalife has crossed a line that would compel regulators to shut it down,” Loeb wrote.

He believes that the company’s stock could return back to the highs it had in April and underlines that the business is performing well in spite of what has been said about it.

Third Point Q4 2012 Investor Letter Herbalife by ValueWalk.com