Tilson: Why I’m More Confident of My Herbalife Ltd. (HLF) Short

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Its been a big Herbalife Ltd. (NYSE:HLF) news day, but its apparently not over yet. As we first reported, Whitney Tilson had made the MLM company one of his largest short positions before Ackman’s presentation today. Now with the stock up over 25% he says that he is even more confident in his short. The following is from an email which Whitney Tilson sent to investors.

Whitney Tilson – Why I’m More Confident of My Herbalife Short Position Today


The Herbalife bears won the day yesterday and the bulls won the day (and then some) today. Yawn. This is why I run a diversified short book.


Over the past year and a half since his initial presentation, Bill Ackman and his team at Pershing Square uncovered a lot of great new information about the company and how it operates that neither I nor anyone else (nor even Ackman himself) knew, but much of this didn’t come through clearly in his presentation today (which you can watch here) for various reasons – just read any of the harsh media coverage. But I don’t care about the messaging – that can be fixed. I care about the substance.


To be short this stock (as I am), you have to believe two things:


1) That the majority (not all) of this company’s operations are based on a pyramid scheme, false and deceptive marketing, etc.; and


2) That regulators will act to shut the company down or at least seriously rein it in.


On these two measures, I have more confidence in this investment now than I did before his presentation. To put rough numbers on it, before today I thought there was a 90% chance #1 was true and a 70% #2 would happen, so that’s a 63% chance of this investment working out. Now I think the odds are 95% and 80%, meaning I think my odds have improved to 76% — so I’m perfectly happy to have a 25% larger short position (which the market took care of today – I didn’t have to do a thing!).


The main reason for my increased confidence is that I think Ackman showed convincingly that nutrition clubs (which he estimates account for as much as 50% of Herbalife’s U.S. business and nearly all of its incremental profits) are fundamentally not about genuine consumption of Herbalife products by people pursuing healthy lifestyles and weight loss (as the company would have you believe) but almost entirely by: a) Those pursuing the business opportunity (i.e., building a downline rather than real sales as, for example, Amway, Tupperware and Pampered Chef); and b) Their friends and family who are trying to support them.


And, critically, the business opportunity is being sold in a false and deceptive way in which mostly vulnerable, unsophisticated people are promised that if they just work hard and invest their time and money they are likely to become President’s Club members and earn $500,000 annually forever. There is, of course, no disclosure whatsoever about how much time and money the average person invests, the real financial characteristics of the average nutrition club (almost all lose money), and the likelihood of anyone ever earning $1 in revenue, much less breaking even, much less earning enough money to make it worth one’s time, and much less becoming a President’s Club member (approaching 1 in 100,000).


In short, Ackman present voluminous evidence that Herbalife is aggressively selling millions of people a promise of the American Dream but is instead giving them the American Nightmare – bleeding them dry and discarding them. This is the very definition of fraud.


The best analogy I can think of is a slimeball going around targeting people dying of a terrible illness and promising them that he has the cure – all they have to do is pay him $3,000, do what he says (or take the “medicine” or “treatment” he gives them), and they’ll be cured. In fact, scams like this are all too common – see this 60 Minutes expose, for example, of stem cell fraud. However, these frauds are mostly located overseas because, of course, they’re illegal here!


To be clear, this is not like Amway, in which a relative of mine, years ago, peddled Amway products to her friends and family (which we reluctantly bought to support her). She wasn’t pursuing the business opportunity, but rather, like the vast majority of Amway reps, was just selling products and making a commission. That’s the difference between legitimate multi-level marketers and pyramid schemes: are most of the people in it to sell products or for the business opportunity? The key thing Ackman showed today is that these nutrition clubs, which the company, analysts, and bulls point to as evidence of legitimate end demand, are really just fronts for people pursuing the business opportunity and few of the people coming to them are what any sensible person would view as real customers.


Nor is it like buying a lottery ticket (where people knowingly waste their money in pursuit of a big payday) because everyone who buys a lottery ticket knows what their odds are (close to zero). Could you imagine the outcry if the lottery ran ads of lottery winners saying, “Just pick numbers like I did and you’re certain to strike it rich! (And if you don’t, you’re a loser.)”


A final point: I think Ackman today rebutted the primary bull argument (which was the only lingering doubt I had): that if Herbalife were a pyramid scheme, there would be a ton of excess inventory in the system and one would see large volumes being sold at distressed prices on eBay and elsewhere. But now we know why: the majority of the product is actually being consumed – but not by real consumers, but rather millions of people (and their unfortunate friends and family) caught up in a vast scam that’s like a cult, with vast promises, huge rallies, etc.

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