Herbalife’s Rock And A Hard Place: Dumb Investment Of The Week

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Herbalife’s Rock And A Hard Place: Dumb Investment Of The Week by Ben Strubel of Strubel Investment Management

4/21/14

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During a 1998 playoff game between the New York Knicks and Miami Heat, Larry Johnson of the Knicks and Alonzo Mourning of the Heat started a bench clearing brawl. For reasons unknown, the 5’9” 150-pound coach of the Knicks, Jeff Van Gundy, waded into the fight, fell on the floor, and clung to the 6’10” 240-pound Mourning’s leg, producing one of the most memorable (and painful) NBA playoff moments of all time.

We view the situation with Herbalife as similar to that memorable 1998 playoff game with Bill Ackman and Carl Icahn playing the role of Johnson and Mourning and individual investors taking on the role of the hapless Van Gundy. While Icahn and Ackman battle it out, individual investors are just clinging to Alonzo Mournings’s proverbial legs and being painfully drug across the floor.

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There are plenty of articles on SeekingAlpha and elsewhere around the Web that argue for short case and the long case, so there is no need to for me to publish my opinion on the stock. Instead, I want to examine the set of risks long and short investors are taking due to the feuding billionaires.

What if Icahn is correct?

Some investor might find Carl Icahn’s arguments for Herbalife Ltd. (NYSE:HLF) convincing and decide to go long the stock. (I found John Hempton of Bronte Capital’s series of posts on Herbalife the most compelling long thesis that I’ve read.)

Let’s assume for a minute that they are 100% correct, that Herbalife Ltd. (NYSE:HLF) is not a pyramid scheme. This would, on the surface, seem to be a riskless investment, except for one problem: Bill Ackman and Pershing Square.

In 2013, Bill Ackman spent $264,000 on lobbyists to press his case that Herbalife Ltd. (NYSE:HLF) is a pyramid scheme. Also, since 2010, Bill Ackman has contributed $30,000 to New York AG Schneiderman’s political campaign. This spending has given Ackman and Pershing Square representatives unprecedented access to lawmakers that regular investors don’t enjoy.

Pershing Square representatives met with Securities and Exchange Commission officials in early 2013. Also, in early 2013, Ackman and the lobbyists he hired arranged meetings with congressional Representatives Linda Sanchez (D-CA), Loretta Sanchez (D-CA), and Peter King (R-NY) as well as Senator Ed Markey (D-MA). After these meetings, Linda Sanchez wrote to the FTC requesting that they investigate Herbalife. In January of this year, Ed Markey sent several letters to the SEC and FTC asking them to investigate the company.

Herbalife Ltd. (NYSE:HLF) is currently being investigated by the FTC, SEC, The Department of Justice and the FBI, Illinois Attorney General’s Office and the NY Attorney General’s office. No one knows how many of the investigations were spurred on by the lobbying efforts of Ackman and Pershing Square, but I believe it would be naïve to assume that Ackman’s efforts had no effect.

The point of all of this is not to pass judgment on whether or not what Mr. Ackman is doing is correct or ethical. (The amount of time and money Ackman and Pershing Square have spent on lobbying pales in comparison to what Herbalife Ltd. (NYSE:HLF) and other MLM companies spend.) The point is that Mr. Ackman has far more resources than individual investors to attempt to bring his thesis to fruition. In fact, it wouldn’t be farfetched to see a scenario where the lobbying efforts of Ackman and Pershing Square could bring down Herbalife despite no major wrongdoing by the company. The government and regulators in the United States are awash in legal bribery, referred to as “campaign contributions.”

What if Ackman is correct?

On the flipside, some investor may find Bill Ackman’s series of voluminous presentations convincing and decide to short the stock.

Again, let’s assume that Bill Ackman is 100% correct, that Herbalife Ltd. (NYSE:HLF) is a pyramid. With all the investigations underway, this would seem again be a riskless investment. The problem is Carl Icahn and others.

What if Icahn led a leveraged buyout of Herbalife?

The company generates tremendous cash flow. Over the past three fiscal years, the company generated $626M, $446M, and $420M in free cash flow, respectively. The company also has just $850M in long-term debt versus $973M in cash and equivalents. Already, Carl Icahn has floated the idea of a LBO; and Bill Stiritz, Herbalife’s fourth largest shareholder, has expressed interest in participating. Together, they own almost 23% of the company. In addition to having two representatives on the board of directors, Icahn was recently granted permission by Herbalife Ltd. (NYSE:HLF) to add three more representatives. While there are certainly plenty of difficulties in lining up financing to take private a company under investigation by multiple judicial and regulatory agencies, stranger things have happened.

It’s certainly possible for shorts to be correct and have the company taken private out from under them.

Summary

We continue to maintain that it is foolish for small investors to get into the middle of this bench clearing brawl between Wall Street titans.

You could research the company thoroughly and be 100% certain in your conviction, long or short, and still lose a significant amount of money

There are thousands and thousands of other potential investments out there with much lower levels of risk. There is no reason Herbalife Ltd. (NYSE:HLF), long or short, needs to appear in your portfolio and no reason you need to end up as collateral damage in this battle of billionaires.

Disclosure: No positions

Updated on

Ben Strubel earned a Master’s in Business Administration in Investment Management from Drexel University’s LeBow College of Business in Philadelphia, PA. He was inducted into the Beta Gamma Sigma honor society, the highest academic honor society for master’s degree students. While at Drexel, Mr. Strubel founded the LeBow Graduate Investment Management Club and the DragonFund Large-Cap Fund, which was responsible for investing $250,000 of Drexel University’s endowment. He also holds a Graduate Certificate in Financial Planning from Florida State University. He earned a B.S. in Information Technology from Rochester Institute of Technology in Rochester, NY. He teaches classes on finance and investing at Harrisburg Area Community College and for Manheim Township. Mr. Strubel also writes for several investing websites including Valuewalk.com and SeekingAlpha.com. He resides in Lancaster, PA.
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4 COMMENTS

  1. The main lawsuit issue was related to some distributors accusing P&G of being a satanic cult. Amway showed it wasn’t the company that was at fault, but some distributors. The distributors ended up paying P&G millions of dollars, just google “Procter & Gamble wins $19 million lawsuit over Satanism rumors,” so the RICO charge was NEVER put in front of a jury. Amway knows they would be found to be running an illegal pyramid (lack of retail sales, just like Herbalife) and RICO fraud (just like Herbalife’s “lead generation” programs), so it’d be nice if you informed your brain of the facts. If you have PROOF of P&G paying Amway’s legal fees and costs, show the link. Or, you can continue with lies, half-truths, misinformation, etc.

    Correction: You’re a LIAR, Rene. Nothing more, nothing less. LIAR!!!!!!!!!!!!!!

  2. tex2,
    “in 1998, Procter and Gamble was suing Amway in Texas, including for violations of RICO, alleging it was a sophisticated Pyramid scheme, and they hired a RICO expert to make their case.”
    It’d be nice if you informed the readers that P&G’s RICO case against
    Amway based on pyramid scheme allegations was dismissed and P&G was
    ordered to pay Amway’s legal fees and costs. The dismissal also was
    affirmed by the 5th Circuit court of appeals. Or, you can continue with
    half-truths, misinformation, etc.

  3. In this case, all of the regulators are akin to the referees in your analogy, and they’re not going to be nearly as concerned about one side talking about the other’s mama, they will enforce the illegal pyramid and RICO fraud rules. For information how Herbalife works, it is very similar to Amway, the world’s largest MLM scam – click on my name and go to the listed blog.

  4. Why do you think Ackman could win the legal bribery game when Herbalife alone has outspent him by a factor of about 10, let alone all the other MLMs have given over the years?

Comments are closed.