Herbalife Ltd. (NYSE:HLF) was down today after Bill Ackman released a 52 page paper to the auditors of the company. Additionally, the President of a large latino organization complained about the firm to the FTC, scaring some investors. However, D.A. Davidson analyst, Tim Ramey, CFA, thinks that Bill Ackman misses the point (in short). The Herbalife bull has issued a rebuttal to Ackman, and despite his seeming dislike of Ackman he seems to be okay with ValueWalk (despite reason to think to the contrary, which is confidential), as he linked to the letter we posted. Below is the full note which came out today.
Pershing Square Letter to PWC (RE Herbalife Ltd. (NYSE:HLF)
We have read the Pershing Square letter linked here and do not expect the impact of this letter to either slow the PWC audit or change its outcome. We would make the following observations after discussing the letter with CFO John DeSimone. The letter was sent on August 29th so the company has had 13 days to review the contents before it came to light today. Discussions with CFO DeSimone indicate that there is nothing material here, in his opinion.
- The opening point in the PWC letter is that Herbalife is a pyramid scheme, and PWC will have risk if it audits the Herbalife books and does not disclose that fact. The remainder of the 52 pages does absolutely nothing to prove or allege the pyramid scheme hypothesis. Remarkable.
- The letter is an eleven-point discussion of various accounting treatments that Herbalife and its previous auditors have taken. We did not see a single “smoking gun” or anything that would cause us meaningful concern. There are audit-type questions, something that two accountants might have a spirited discussion about at a cocktail party, but nothing that seems material. If this is all Ackman has after millions spent on forensic accounting, Ackman has been cheated. On some of the points Pershing Square is just wrong, in our opinion; a risk you take when your securities analysis does not ever engage in a dialog with the company.
Point I is a recitation of the idea that ‘wholesale commissions” should be a P&L cost rather than a contra-revenue account. Frankly we are indifferent as to which accounting treatment Herbalife uses, but the treatment it uses seems more conservative than what Pershing Square proposes.
Point II – Ackman seems to assume that the borrowings and repayments are linear rather than random. The company uses it’s LOC as a checking account so it may be a borrower on day one, repay on day two, and a borrower again on day three. There is not a quarterly build of borrowings followed by a quarterly squeeze.
Point III – Pershing Square questions the tax treatment for unremitted earnings. We suggest that this is a question for U.S. tax policy more broadly. Virtually all multi-national companies do this.
Point IV – Every company has some small non-controlling interests – Herbalife operates in 88 countries, and some require that there be a local partner. From an economic perspective, these interests are not material and thus are not disclosed.
Point V – Herbalife would love to write down its Venezuelan assets and the Street would embrace it; doing so would be positive to future GAAP EPS. It can’t do this, however, until its accountants tell it to.
Point VI – Herbalife follows the law in every jurisdiction it operates in regarding unclaimed foreign royalties.
Point VII – This one gave us a chuckle. We see some pretty outlandish items classified as “non-recurring for non-GAAP EPS” in many companies’ 10Ks. Herbalife uses this very sparingly. And GAAP is GAAP; investors can choose what they wish to adjust for.
Point VIII – Pershing Square misses the fact that Herbalife has a global organization and pays globally, so a U.S. Sales Leader may well have downline members in another country. The $369.8 million figure for gross payments then reflects both U.S. and non-U.S. sales.
Points IX through XI are truly minutia. We didn’t see anything that should move the needle. Bottom line – We reiterate our BUY rating and $92 price target.