Have you ever heard of a firm downgrading a company, then upgrading it three days later? Additionally, have you ever heard of a firm downgrading a company from a price target of $78 to $38 only to boost the price target back to $78 (again only three days later)? Have you ever heard of a firm stating a company could be delisted and then three days later state the concerns are unwarranted? Well we have not either! This could very well be a first. D.A. Davidson downgraded Herbalife Ltd. (NYSE:HLF) on Tuesday and is now upgrading the stock. D.A. Davidson explains their reasoning below, which we present without comment.
We are upgrading Herbalife Ltd. (NYSE:HLF) to BUY from Neutral and increasing our target back to $78, previously $38 – which is 16x our unchanged 2013 EPS estimate. With our recent concerns alleviated, the risk/reward ratio remains overwhelmingly positive.
Earlier this week we downgraded shares of Herbalife to Neutral from Buy, concerned that the withdrawal of KPMG’s audit opinions for the past three years could have material negative impacts on the shares. After our action, the company made assurances that they did not see the risk of a delisting notice from the NYSE, nor do they believe they are, or expect they may be, in violation of their loan covenants. We are relieved to have these assurances. It’s unfortunate they could not have provided such assurances to us earlier in the day when we asked these questions. Chalk it up to the heat of battle. These are unique circumstances. The other concerns we had on the downgrade have been addressed and are discussed more fully on page three, herein.
We read with morbid interest the criminal complaint against Scott London, Herbalife Ltd. (NYSE:HLF)’s former Audit Partner at KPMG, LLP. We would make two conclusions given the wire-tapped conversations Mr. London had with his tipee, Bryan Shaw.
1) The two discussed public rumors regarding Herbalife going private and Mr. London was anxious to believe that this could happen and wanted to profit from such an event. He clearly did not view Herbalife going private as unlikely;
2) Mr. London advised long positions in Herbalife Ltd. (NYSE:HLF) despite the threat of “hedge fund manager Bill Ackman driving down the price of the stock.” Clearly Mr. London did not place significant weight in Ackman’s characterization of Herbalife as a pyramid scheme – he was happy to recommend long positions.
Three weeks ago a heavily-redacted copy of a Freedom of Information Act request was floating around the internet and posted on Twitter. At the time, we could not determine either the veracity, or the exact meaning, of the SEC response, which concerned “investment/trading activity regarding Pershing Square Capital Management, L.P, Herbalife, and/or William Ackman, from December 1, 2012 through February 15th, 2013.” Having made our own FOIA request, we can now verify the authenticity of the document and will leave the interpretation of the document to the reader.
Another concern: would HLF be able to report Q1 earnings on April 29th
Our experience with Diamond Foods, Inc. (NASDAQ:DMND) (DMND*-NEUTRAL-$15.48) and American Italian Pasta suggested there would be either no (in the case of DMND), or highly abridged reports (in the case of AIPC). We understand these “analogous situations” are not clean comparisons given that AIPC had executives that went to jail and DMND was judged to have a material weakness in financial controls. But again, the company has assured us that “It is business as usual for the finance teams, with everyone still working to the April 29 release date.”
Annual General Meeting
The company has told us “We are 100% having our annual meeting as scheduled on the 25th.” We had concerns over this, given that in our previous experience with companies that were not current in their financial statements, they did not have their Annual General Meeting, an NYSE Requirement. With full confidence in management’s statement, that concern seems well addressed.
We are not persuaded that it will be difficult for Herbalife Ltd. (NYSE:HLF) to enlist a big four accountant
PricewaterhouseCoopers, LLP handles the audit duties for Nu Skin (NUS*-BUY-$49.21), USANA Health Sciences (USNA*-BUY-$48.17), Tupperware (TUP – $82.01) and Avon Products (AVP-$21.26). PwC clearly understands the MLM model. Herbalife Ltd. (NYSE:HLF) may be better served by PwC given their depth of experience. This would be the ultimate and hopefully final vetting; putting nails in the “pyramid scheme” charges.