In what could only be described as one of the greatest flip flops in sell side history, Timothy S. Ramey, CFA, of D.A. Davidson & Company gave a big downgrade to Herbalife Ltd. (NYSE:HLF) after the company’s auditor quit. Three days later they changed their mind and upgraded (with the same price target). Now, after Herbalife released a study (which some found unimpressive) not only does D.A. Davidson like Herbalife stock they also call it ‘Our Single Best Idea for 2013’. Presented without comment.
Herbalife Ltd. (NYSE:HLF): UPDATE: Restating the Case: Our 2013 Single Best Idea
Restating the Case: Herbalife Ltd. (NYSE:HLF) is Our Single Best Idea for 2013 Recall Ackman’s slide #11? “Has anyone ever purchased an Herbalife Product?” Slide 12: “The only $2 billion brand nobody’s ever heard of.” The newly-released Nielsen study affirms what we already knew. Herbalife Ltd. (NYSE:HLF) has millions of enthusiastic consumers, and it is growing every day. Lives are being transformed as the company and its devoted distributors teach and preach the message of a protein-based low-glycemic diet to start your day. Opportunities are being created for hard-working distributors to create their own businesses. These are really positive attributes for a company.
Herbalife Ltd. (NYSE:HLF) went the extra mile to answer criticisms that were generated from the previous Lieberman work. The study was completely blind for the participant – they were asked questions about a number of companies and brands and would have not had the ability to know that the focus of the study was Herbalife. The Lieberman study looked at household behavior, the Nielsen study looked at adults. The studies offer consistent conclusions – Herbalife products are consumed by millions of consumers outside the distributor network.
Herbalife Ltd’s Market Capitalization And Short Position
It never made sense to pick on Herbalife – except Herbalife Ltd. (NYSE:HLF) had the most market capitalization and so a $1 billion short position was possible. Herbalife’s key point of difference is the “retail” nature of its customer base. If 40% of your product gets prepared and served, one shake at a time in thousands of nutrition clubs, it is pretty hard to make the case that the business is not real. No other major MLM is as “retail” as Herbalife, in our opinion.
The bear case is in tatters. From day one, we dismissed Pershing Square’s 300+ page assault as not particularly interesting. And for seven or so slides, we believe Ackman clearly distorted facts that Pershing Square knew, or should have known, were materially false (see our report dated January 4, 2013). We think this was a bald-faced attempt to destroy a company and its stock for profit. Nothing new about that. Why the media and investors continue to give it any credence is a mystery.
The new lead auditor is in place. As we have written before, PriceWaterhouse Coopers is an excellent choice for Herbalife’s lead auditor. It has broad experience auditing four other public MLMs. One can be sure that PWC did their legal due diligence before accepting the assignment and we are relatively sure that the re-audit of the past three years will be speedy. PWC has two teams in place at Herbalife’s Torrance, CA facility. One team is doing the current audit (2013 and forward) one doing the re-audit of 2010-12. They do expect to provide greater clarity on the timing of the re-audit by the Q2 earnings call, expected
between July 29th and August 2nd.
Once the re-audit is complete we expect Herbalife Ltd. (NYSE:HLF) to issue notes to fund a significant share repurchase. At the end of Q1 Herbalife had $979 million of debt and $722.5 million of cash for net debt of $257 million. The company indicated it would like to issue notes to repurchase shares. In our view, it would not be at all excessive to have the company levered at 2.5x debt to EBITDA. That would put the borrowing capacity at about $2 billion, enough to repurchase perhaps a third of the shares outstanding. If the company tendered for 30 million shares at $55 per share and could borrow at 3% to fund that repurchase, it would be accretive to 2014 EPS by over $1.90 per share.
We reiterate our BUY rating and $78 price target. The company is growing at a rapid pace and it has potential catalysts in the capital structure. Once the reaudit is complete we suspect the short position will be gone, one way or another. We are above the Street for Q2 EPS and $0.12 above consensus for the full year. Herbalife Ltd. (NYSE:HLF) remains our Single Best Idea for 2013.