Herbalife LTd. HLF


  • Market is 100% completely wrong in driving the price of Herbalife up on Friday, as new disclosures foreshadow FTC alleging company is a pyramid scheme & crippling business changes
  • Market is incorrect in assuming $200M fine and its over; 10-Q states fine would definitely come with “injunctive and other relief” – that’s only if they settle
  • If they litigate, FTC will likely allege the company is operating an illegal pyramid scheme
  • Business changes included in injunctive relief could include a halt of the business as it operates today; guidance yesterday is meaningless and visibility into future operations is non-existent
  • Analyst Tim Ramey, like the rest of the market, is clueless and has no grasp on the potential nature of Herbalife’s latest disclosure; he claimed weeks ago injunction was off the table

If you’ve followed the HLF saga, this might be the most important article you ever read. I don’t say that lightly.

The market has this Herbalife (HLF) news completely wrong, and I am adding to my short with conviction here at $65, and should the stock move higher. The stock should be down meaningfully on yesterday’s 10-Q disclosure, yet it’s running in anticipation of a short squeeze and because retail investors don’t understand exactly what is going on.

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Reading Herbalife’s latest disclosure very closely is extremely important.

It’s so important, the CFO told an optimistic analyst on the call yesterday to “read it carefully” and make sure she “understands it”. He said this after he polished some muck about the company’s made up $200M figure, right before he nearly choked on the notion of ever being able to pay a dividend again. That train wreck looked like this:

John G. DeSimone – Chief Financial Officer

Yeah. Hi, April. This is John, I’ll do my best to answer, and in some cases not answer. With respect to the FTC, I think you need to understand the accounting rules to maybe better describe what’s in our disclosure. We don’t yet have an agreement, what we have is the reasonable possibility of an agreement that’s a threshold, from a contingent liability standpoint that requires us when we file the 10-Q to provide the estimate of the range of a payment we might make, we have provided that, and that range is just the number, it’s still an estimate, but it’s the best estimate we have now, but we do not yet have a deal.

And there is lots of things still outstanding, and there’s nothing more we can say other than what’s in the disclosure, and I would read it carefully if I were you, and make sure I understand it. And then, with respect to dividend, we don’t really have a comment at this point that will be a board decision probably long after, we get through the current days.

Yet again, the market has this Herbalife news completely wrong. The market thinks the company is settling for $200 million, when the reality is that it is now more likely that the FTC will halt the company’s current business practices that it has ever been.

The company’s earnings beat is completely meaningless, as is the company’s future guidance. Any business model changes that the company may have to make, especially elimination of its supervisor program, would likely cripple the company over the coming quarters. Herbalife should be trading down 20% on this news, yet it is up 15% on the manufactured news spewed out by Herbalife’s PR machine.

Herbalife’s PR team appeared to engineer a disingenuous sequence of events yesterday.

They leaked to the press that a $200 million fine would be forthcoming, giving the market the indication that everything would be resolved and all would be said and done for that amount. After the conference call started, ostensibly so analysts didn’t have time to read it, they then filed their 10-Q where they readily admitted that $200 million was an estimate and that other relief is a definite with a fine, if they don’t litigate. That 10-Q language looks like this. I encourage you, like DeSimone, to “read it carefully and understand it”:

The possible range of outcomes include the filing by the FTC of a contested civil complaint and further discussions leading to a settlement which would likely include a monetary payment and injunctive and other relief. The Company is cooperating with the investigation and at this time it is difficult to predict the timing, and the likely outcome, of these matters.  The discussions with the FTC are in the advanced stages, but there are still a number of material open issues that could preclude reaching final agreement.  If discussions with the FTC do not continue to progress, it is likely that litigation would ensue.  Although we are confident in our legal position, litigation outcomes by their very nature are difficult to predict and there can be no assurance of a particular outcome.

The outcome of these matters with the FTC, whether by mutual resolution or through litigation, could have a material adverse impact on the Company’s business operations, its results of operations or its financial condition.  The Company believes it is reasonably possible that it may have incurred a loss. At the present time, the Company’s best estimate of the payment amount that would be made by the Company under a mutual resolution with the FTC is $200 million. The Company has not accrued any amounts with respect to any potential monetary payments relating to this matter. If a resolution is not attained and litigation ensues, the Company is unable to estimate a range of potential loss, if any, relating to these matters.

Used With Permission

Read it again: the company is definitely not just settling with the FTC for just $200 million.

There are only two potential outcomes now – a massive fine with business changes or litigation.

Months ago, bulls on Herbalife were saying the company was going to get off scot-free. Carl Icahn talked about getting “a clean bill of health”. Not only is that now definitely not the case, as denoted by the removal of that option from Herbalife disclosure, but the likely outcome now seems to be litigation.

Litigation, by the way, likely means that the FTC will likely file a lawsuit alleging Herbalife is a pyramid scheme.

How would the business react to that? That’s a serious PR job; I hope Sard Verbinnen’s new 40% equity stake holders are up to the challenge.

A $200 million fine, which is a number that Herbalife arbitrarily disclosed and isn’t definite, will definitely be supplemented by both injunctive relief and other relief, if it happens as part of the settlement.

What this all means is that the FTC wants to make crippling business changes to Herbalife, and the company is resisting. Litigation would be a multiyear costly process, one that has driven Vemma nearly to bankruptcy and a process that will start with the filing of a formal complaint, likely alleging the company is running a pyramid scheme.

How substantial could injunctive and other relief be? Take it from the Federal Trade Commission, who commented on the situation for the first time in years yesterday:

“Injunctive relief can be just as significant as the money obtained for consumers and even more influential on a company’s future operations,” Justin Cole, a spokesman for the FTC, said in a statement. He declined to comment further on the negotiations with Herbalife.

The market has grossly misinterpreted yesterday’s news.

Two important things to remember:

1. An Herbalife settlement would include potentially crippling business changes. This would be in addition to a fine that the company estimates could be $200 million. After the stunt the company pulled yesterday, I wouldn’t be surprised if the FTC suddenly didn’t want to settle. If the FTC forces Herbalife to make the same changes that Vemma made, which from a legal precedent perspective is the obvious decision, the business will cripple on its own and will damn close to a terminal short unless someone in private equity is stupid enough to buy it (see: GMCR).

2. “Litigation” with the FTC is code for “the FTC is going to sue the company for being a pyramid scheme.” In such litigation, the FTC would likely allege that business practices that the company is undertaking are false and misleading, and that the company is running a pyramid scheme. Injunctive relief attached to a complaint, similar to Vemma could ask for the company’s assets to be frozen or put into receivership. Furthermore, the FTC may ask the court for the company to halt business operations until such litigation is settled.

Make no mistakes, these are now the only two options available and they will both be devastating for the company.

For an analyst to come out like Tim Ramey did yesterday and say that this company should be trading at 16 times earnings is an absolutely ridiculous and absurd notion, because absolutely nobody has visibility as to what this company is going to look like in six months let alone in two years or 16 years.

So you can take it from me, or take it from Ramey who in February told CNBC “injunctive relief” was off the table. I debunked him in February in this article, which you should read carefully. I proved him wrong and plan on proving him wrong again. He has been anything but honed in on the specifics of this case.

Herbalife should be trading much lower, the smart money will eventually figure this out, and the rest of the people who do not figure it out will likely get  run over. I am short and I am adding to my short position with conviction.


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