The battle between hedge fund titan Bill Ackman and Herbalife has definitely been one for the record books. Thus far, it has been my version of indulging in celebrity gossip. One could (and should) argue that the implications of this story far outweigh those of a twitter battle between two musicians, but I digress. The thing is, this whole Herbalife debacle has evolved into a whole new monster entirely.
The multilevel marketing model is nothing new. It first emerged in the 1920’s thanks to Nutralite (formerly known as California Vitamin Company) and has grown to the $36 billion behemoth we see today. There are currently over 50 companies in the U.S. that operate under this business model. But Herbalife is something special.
To sum things up, if you aren’t familiar with the story, Bill Ackman of Pershing Square Capital Management announced in 2012, very publically, that he had initiated a $1 billion short position on Herbalife. He was met with immediate opposition by the likes of formidable financiers. These included Carl Icahn (Icahn Enterprises), Dan Loeb (Third Point), John Hempton (Bronte Capital) and Bob Chapman (Chapman Capital). I don’t know about you, but that is one of the most formidable list of opponents I have ever seen in my life. That is nearly $50 billion in enemies.
After Ackman’s short position became public knowledge, the stock fell about 40%. Then, Icahn and friends, along with some choice words about Ackman, announced they were long Herbalife. The stock gained back everything it had lost and went on to reach all-time highs in 2013 of around $80 per share. By my estimates, Ackman got in around $45 per share as the stock traded between $41 and $51 at the time the short interest jumped up (assuming Pershing Square was the main contributor to that).
The stock is up about 24% since the initial short. To hedge his losses and to avoid a short squeeze, Ackman covered 40% of his position (about 9 million shares) and bought long-dated put options. There is no doubt that Pershing Square is hurting right now (never mind their troubles with Valeant and the open insider trading investigation concerning the Allegran takeover). Besides the premiums on the options (which get more expensive with each subsequent extension) and borrowing costs on the shorted shares, Pershing Square has spent $50 million on its own due diligence, attempting to expose Herbalife.
Finally, in 2014, the FTC initiated an investigation into Herbalife’s business practices. Two years late, in July of 2016, Herbalife agreed to pay a $200 million settlement to the FTC and to make “sweeping changes” to its business model. Well that it then, right? Case closed! It’s not that simple, though. A closer look into the FTC’s findings reveals some disturbing information.
An internal survey found that 60% of distributors barely broke even or lost money on their investment. FTC Chairwoman Edith Ramirez said that the promises Herbalife was making to recruit distributors were “an illusion.” She went on to say that Herbalife needs “to start operating LEGITIMATELY” and cease its “UNFAIR and DECEPTIVE” practices (and yes, those are direct quotes). Doesn’t this imply that they were operating illegitimately, unfairly, and deceptively? But wait, the story gets juicier by the minute.
In August of 2016, Ackman called into CNBC and said that he was contacted by the investment bank Jeffries Group to see if he was interested in purchasing a portion of Icahn’s stake in Herbalife. Ackman went on to say that he would gladly pay more than the $30 million proposed deal to get Icahn out of Herbalife all together. As a result, the stock price fell 4.5%. Later that day, Icahn accused Ackman of lying and bought another 2.3 million shares. The price jumped back up 4%.
At some point, we have to take a step back and ask “what in the heck is going on?” Hedgies disagreeing on the direction of a stock isn’t a unique circumstance. In this zero-sum game, there’s always someone on the other side of the bet. However, this bet was garnished with elements of personal disdain and the desire to see Ackman crash and burn. Ackman’s critics have sited his arrogance, pompousness, and iniquitous investment positions as reasons to distrust and dislike him. But this brings up a more broad and serious issue in the finance world.
One party in this whole mess, whether it be Ackman, Icahn, Herbalife, or the FTC, is gaming the system. There is fundamental dishonesty happening right before our very eyes. Is this stock manipulation? Is Herbalife indeed a pyramid scheme? Does Icahn really believe Herbalife is a good long-term investment? So many questions and so few answers.
In finance, we rely on honest reporting as an irreplaceable safety net. Dishonesty, especially when billions of dollars are at stake, has the potential to decimate lives (look at Enron, the Financial Crisis, etc.).
A documentary, “Betting on Zero,” was released earlier this year showing the sometimes dire effects MLM’s can have on peoples’ lives. Obviously, the much publicized battle between Ackman and Herbalife is a big part of this movie. In a rather classy move, Heather Podesta & Partners, a lobbying firm employed by Herbalife, bought 173 tickets to the documentary’s Double Exposure Film Festival screening, leaving the theater essentially empty. Though Herbalife did not comment on this move, it certainly does not look good.
The jury is still out on Herbalife. They were unable to answer a lot of the FTC’s questions regarding employee compensation and sales figures, claiming they did not keep those records. They have to show that 80% of their revenue comes from sales to end users, not distributors buying products. But Ackman isn’t out of the weeds on this one yet. Only 20% of Herbalife’s revenue is generated in North America. An “independent monitor,” who is funded by Herbalife, will oversee its international operations.
So who is the good guy in this story? Your guess is as good as mine.