Herbalife Ltd/ (NYSE:HLF) short case from Quoth the Raven @QTRResearch
- Quoth the Raven Research continues to believe Herbalife is a strong sell with downside of more than 46.3% before the end of 2017 and further downside in following quarters
- The potential impact of a coming nation-wide documentary has been significantly underestimated and may cause an unprecedented public relations nightmare for the company that it may permanently have trouble recovering from
- For comparison, Blackfish, a similar style of critical documentary, drove SeaWorld’s stock price down 60% leading up to its release. A critical nationwide 60 Minutes expose on Lumber Liquidators helped drive its stock price down more than 80% in the months following the report
- Carl Icahn has a history of selling his stake in companies into buybacks.
- In 2016 he sold $500m in shares into Nuance’s buyback. In 2012, he sold $1.17 billion in stock back to Motorola Solutions. I believe Mr. Icahn may consider exiting his Herbalife position before the documentary’s March 17, 2017 release or before the FTC’s sanctions on Herbalife’s business model take effect in May 2017
- The company’s largest growth market, China, appears to be stalling and a newly disclosed SEC Foreign Corrupt Practices Act investigation and a new joint venture with a China-based company raises questions about whether the company is still on solid footing in its largest market
- I believe the company’s true fundamentals continue to deteriorate much more than the company’s Non-GAAP numbers and accompanying constructed narrative lead on
- I believe the only publicized sell side analyst for the company (who is also an Herbalife distributor) continues to lead shareholders to the slaughter with an absurd $90 price target
I am short Herbalife through owning put options.
I stand to make money if the price of Herbalife stock moves lower.
I am not a stockbroker or financial adviser. I hold no licenses and am not registered with FINRA or any other financial body. I am a casual investor making casual observations for the purpose of discussion and open communication and analysis of companies and stocks. Often, I am wrong. I have been wrong in the past and will be wrong in the future.
Again, all articles are my opinion only and are not suggestions to buy or sell any equity, bond, option or other financial instrument. QTR may have long or short positions in any tickers mentioned at any time and reserves the right to open, close, or modify positions at all time without notice. My conclusions are the result of my personal due diligence and have been wrong in the past. Alright, now you kids go have fun out there.
When I asked [outgoing Herbalife CEO Michael] Johnson how he felt about all the people who had lost money trying to get rich through Herbalife, he hesitated. “I’m sorry that it happened,” he said. “I’m sorry people lost money at a racetrack and at the lottery. Today’s Herbalife is about hard work and energy. I can’t go and fix anything in the past. — The New Yorker, 3/5/2017
$30 Per Share and Under: To Me, It’s Only a Question of “When” and Not “If”
In what will be my only report on Herbalife issued for the rest of this year, and possibly for good, I want to give the public my firmly held belief on why the stock could easily be $30 or under by the end of 2017.
Obviously, this differs with the “analyst consensus” targeting $90 per share, but I believe my track record of accuracy and attention to detail thus far with Herbalife should cause readers to carefully examine what I am going to present in today’s article.
I believe coming effects of the Betting on Zero documentary have been vastly understated and underestimated by the market and I am in a unique position to comment on it, having been one of the few who has had a chance to view the film prior to its release. I also believe that the company’s latest financing and corresponding buyback could possibly be used to take Carl Icahn out of his position in the company. The new and growing debt burden that the company now has to deal with and service in an environment where rates are going up could wind up being devastating, as I predict the core of the business will continue to deteriorate, eventually giving way only to a balance sheet with a book value of $2.11 per share.
Also to blame for what I believe will be Herbalife’s continued deterioration this year is a reduction in growth for the company’s largest market, China. In a small informal blog post I put up a week ago, I pointed out that I thought there was something weird about the company’s new joint venture with China-based company Tasly. While I believe that the deterioration of growth and this joint venture are likely tied together one way or another, I have yet to fill in the missing link between the two. What is for certain is that, across the board, the company’s core business is deteriorating. Analyst estimates continue to come down, the company’s guidance continues to get lower, and the GAAP numbers tell a starkly different tale than the company’s “adjusted” Non-GAAP guidance. It is using these numbers that has helped me arrive at the belief that Herbalife could very easily be worth a fraction of what it is worth today in just a few short months.
We have already seen significant selling over the past few trading days, as the stock has moved from around $60, where it was after earnings, to about $53, where it trades today. I believe this to be the
Under $30 beginning of a much larger downtrend that could once and for all wrap up the Herbalife story for the most part.
Betting on Zero Could Be PR Armageddon
The first thing that needs to be addressed is what I believe to be a vast under-estimation and flippant attitude towards a coming documentary that will be available nationally, as well as on subscription services that have millions of international subscribers. Everyone knows that Betting on Zero is going to be released on March 17 of this year. What everybody doesn’t know is exactly how devastating the film could be for the company.
It has been asserted over the last few years by me that much of Herbalife’s organic internal growth comes from the confidence of its distributors and the confidence that those distributors have in their ability to earn from potential new recruits. This film will be the first effective instance of taking what is otherwise a Wall Street story and boiling it down to a gut wrenching and stomach churning experience that any average movie watcher can experience. It could wreck the confidence of millions of potential recruits, as well as potential existing distributors.
I went into the world premiere of Betting on Zero at Tribeca having seen everything that has to do with Herbalife. Because the company declined to participate in the documentary, much of the story was produced using financial news clips and publicly available documentation on the company. These interviews and details I have memorized and seen many times over. The story is nothing new to me, nor are what I believe to be the harsh and negative effects of the company’s business model on a good majority of its participants.
However, even after my extensive background, I wound up leaving the film in tears because of the portrayal of several personal accounts that director Ted Braun profiles in the film. The point is that if it is enough to incite emotion from somebody that knows this situation cold, it is going to be more than enough to incite real emotion from viewers who are only first familiarizing themselves with the Herbalife saga. For those that want a little bit more of an in-depth look at the film itself, you can watch the trailer and then read a review I wrote after the Tribeca Film Festival last year.
The good news for critics and bad news for the company is that the film has since been amended to include the results of the FTC’s recent findings, content that will only serve to make the film that much more devastating for the company.
Let’s look at a couple of quick examples as to what mainstream media can do to the public’s perception of a company. First, there is the obvious comparison in Blackfish, the documentary that critically portrayed SeaWorld for its business practices. It sent the company’s stock down 60%:
In January 2013, the documentary Blackfish premiered at the Sundance Film Festival, telling the story “about Tilikum, a performing killer whale that killed several people while in captivity,” according to the official film synopsis. A little more than three years later – a period marked by sustained activism, multi-platform distribution, and media coverage – SeaWorld officially announced on March 17, 2016, that it will officially end its orca breeding program and end orca shows at all of its theme parks.
The decision didn’t happen overnight, and neither did the full extent of the film’s social impact.
The path to change was paved over three years of ongoing pressure sparked by an emotional story told in an intimate, authentic way unique to documentary storytelling. And the signs appeared quickly. In December 2014, about a year and a half after the film’s July 2013 theatrical premiere, the stock price of SeaWorld had already declined by 60 percent.
SeaWorld stock has yet to recover from mid-2013, when the film first debuted:
We also have the situation with Lumber Liquidators for comparison. Lumber Liquidators was featured during one 15 or 20 minute critical segment on 60 Minutes and it subsequently resulted in an immediate 25% drop, followed by a catastrophic loss for shareholders when the stock moved down more than 80% over the course of the year after the report:
Those that have not seen Betting on Zero or those who are writing it off as a nonevent do not understand director Ted Braun’s knack for grabbing the gut and the heart of the viewers who are watching. Braun tries to take an objective look at both the company and the entire situation, but Herbalife comes out looking horrible. I said in my review of the film in April of 2016:
While Betting on Zero is not a decidedly anti-Herbalife movie from the onset, its ability to profile real victims, the Wall Street story and the simple truth about the company’s business practices could be absolutely devastating to Herbalife if the film is picked up and distributed on a national scale.
And unlike anything that we have seen throughout the media coverage of the Wall Street story,
Betting on Zero tells us the story of 10 to 15 undocumented Latino immigrants who have lost hundreds of thousands of dollars as Herbalife distributors. The film follows them in a quest for justice and reparations, led by LULAC activist Julie Contreras. The film profiles Contreras just as much as Ackman, explaining her ferocious activist nature as the product of proud Mexican parents and a gunshot wound that almost left her dead in the early 2000’s. A notable scene in the film is Contreras’ reaction to a cease and desist letter sent to her from Herbalife. Contreras, in tears, swears to never apologize for sticking up for victims of Herbalife.
$30 The movie has some surprisingly touching and deeply emotional moments. I always knew that what the company was doing to people who did not understand how the business plan worked was disingenuous, but seeing on film a group of victims literally praying to God for justice after many of them severed relationships and spent hundreds of thousands of dollars tugged at the heartstrings of Ms. QTR and I, who both teared up.
There’s no real better way to sum it up than to say that if you hold shares heading into the national release of this film, I believe you are playing Russian Roulette with your capital.
Could Carl Icahn Decide to Exit into the New Buyback at Any Time?
This brings us to one of the film’s antagonists, Carl Icahn. Without even bringing up the fact that Mr. Icahn has petitioned publicly to buy up to 50% of the company and has yet to act on much more than half of that – and without bringing up the fact that Mr. Icahn may have put out an inaccurate press release after the FTC settlement announcement, let’s talk some basic common sense about why Mr. Icahn could want to exit his position in the company as soon as this month.
Think about this. You are Mr. Icahn. You hold a $1.3 billion position in Herbalife as of February of this year and have seen the fundamentals of the business implode before your eyes. The CEO you originally bet on is stepping down soon, after selling tens of millions of dollars in stock, some of which as recent as just a couple of days ago. A documentary by an award-winning director is about to hit the national stage that is going to make you look like a mix between Lex Luther and Gordon Gekko – and, in the process, will make Herbalife look like it is of extremely questionable moral and ethical standards.
Your good friend, Bill Stiritz, who you possibly got to buy into the stock, has just sold a significant portion of his stake in the company after reassuring the media and the public just months prior that he had full confidence you and the in the company. His stake in 2015 was 7.5 million shares, or about $350 million. His stake now is 4.8 million shares, which Matt Stewart writes may even be “closer to 4 million shares as many of his call options may expire worthless or out of the money”.
If you’re Carl, do you wait around to see what the results of this film ultimately are? If you do, what about the FTC order that kicks into effect in May of this year? Do you wait for those sanctions to kick in?
I sure wouldn’t, but again, maybe the guy who has consistently displayed a lack of knowledge as to the fundamentals of the business has some type of inside track lined up that I don’t know about. It could happen – as my disclaimer says, I’m often wrong.
After all, there has been all of this talk about Icahn wanting to make a bid for the company and take it private. So far, he has done no such thing and we have already gotten one credible report that he was looking to sell his shares in the company. I’m not the world’s greatest financial analyst, but that seems like the complete opposite of taking a company private.
A case for a leveraged buyout gets significantly more difficult when you consider that the company just completely obliterated its balance sheet with this last $1.45 billion credit facility it has taken on.
If he still wants to sell, isn’t it more likely that Carl Icahn would sell into the company’s newly authorized buyback in order to take himself out of his position instead of trying to make a strategic move for the company that is levered significantly more than it was just a quarter ago?
If you answered yes, we are on the same page. This option looks to be more and more of a reality as investors look into Icahn’s track record of selling into buybacks. For instance, in 2016 he sold back $500 million in Nuance shares to the company.
And in 2012, he sold into Motorola Solutions’ buyback:
“The filing speaks for itself,” Stiritz said when reached by phone. He declined to comment further. — Matt Townsend, Bloomberg, February 2017
Article by Quoth the Raven Research
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