Yesterday’s announcement that PWC will replace KPMG as Herbalife Ltd. (NYSE:HLF)’s auditor for F2013 and immediately begin working toward the re-certification of financial statements from F2010 through F2012 (in addition to reviewing the Q1/13 financial statements) was clearly a catalyst that removed uncertainty according to a new report from Canaccord Genuity.
The announcement has no impact on their thesis, as thet didn’t expect anything other than the announcement of a new Big 4 auditor on the timeline that Herbalife Ltd. (NYSE:HLF) had articulated. Given word on the late April Q1 conference call that the audit committee’s selection process was drawing to an end, the timing of the announcement isn’t surprising, and ‘was clearly anticipated’ by the Street given a 15%+ rally from last Friday’s close to Tuesday’s open. The implications of the announcement are meaningful on several fronts.
While Herbalife Ltd. (NYSE:HLF) undoubtedly conducted significant due diligence on potential auditor replacements to KPMG, the analysts suspect these potential auditors conducted their own due diligence given the high-profile debate and well-documented public battle that has ensnared Herbalife and the MLM model in general.
Herbalife Ltd. (NYSE:HLF) has already received SEC inquiry and the notion of some future FTC investigation has been thrown around by pundits and investors alike. The risk profile was clearly defined for PWC and its desire to take on Herbalife speaks to a comfort with the integrity of the operating model and broader industry say the analysts. As mentioned, PWC is also the auditor to several other well-known and sizeable multi-national public companies operating within the direct selling industry, some of which operate a MLM model similar to Herbalife.
PWC’s presence across the industry suggests the firm understands the dynamics, operating guidelines and challenges that have emerged within direct selling over the years they believe.
Financially, Canaccord notes that Herbalife Ltd. (NYSE:HLF) enjoys a considerable cash balance ($700M+ of cash/equivalents) and ~$787 million remaining on the current $1 billion share repurchase authorization. On the Q1 call, we learned that the KPMG fiasco clearly interrupted a significant debt-raising effort that would have supported the repurchase of “a meaningful amount of company stock.” Given the strength of the balance sheet, notable FCF generation, and Herbalife’s history of aggressive share buyback activity, Canaccord read “a meaningful amount” of stock to be closer to $1 billion than not.
While the timing of the re-certification of the prior three years’ financial results remains uncertain, yesterday’s announcement puts the process fully in motion. Canaccord wouldn’t be surprised to see Herbalife Ltd. (NYSE:HLF) revisit its debt-raising efforts if the ‘valuation remains depressed’, but a progression of PWC’s recertification efforts might be a pre-requisite, unless Mr. Icahn loans HLF the capital near term. At the very least, the analysts believe balance sheet and FCF provide ample “powder” for repurchases in the interim.
Herbalife Ltd. (HLF) Valuation
Despite the sharp 15% rally since Friday’s close, the shares trade at just 10.5x Canaccord’s F2013 EPS estimate and under 10x next year’s forecast. The valuation continues to reflect the headline volatility rather than the fundamentals showing growth in sales, free cash flow, and favorable financial returns. Canaccord’s $63 price target implies under 12x their current F2014 EPS forecast, with the current valuation reflecting roughly a 25% discount to Herbalife Ltd. (NYSE:HLF)’s historical average of 14x forward earnings and below both its peers and EPS growth rate.