Bill Ackman's New Target? Herbalife

By Tim Parker | January 03, 2013 AAA

If you are a boxing fan, you know about the pre-showdown hype. One side accuses the other of something, the other side is outraged and accuses the other of something worse, and each side makes claims of what will happen when the showdown happens. Although not quite the same, the showdown between hedge fund manager Bill Ackman and Herbalife (NYSE:HLF) has turned into something of a media hyped event you would see before a high profile boxing match.

Moreover, the media loves it! In a recent three-hour presentation, Bill Ackman called Herbalife a pyramid scheme. Herbalife CEO Michael Johnson stated the world would be better off without Bill Ackman. Game on! Wall Street is known for its - let's say - heated debates, but this has been enough to make even the most hardened Wall Street insiders gawk. Want to know the story? Here it is.

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Herbalife
You may have heard of Herbalife. According to its website, Herbalife is "a global nutrition company that has helped people pursue a healthy, active life since 1980." It also claims to "change people's lives by providing the best business opportunity in direct selling and the best nutrition and weight-management products in the world."

According to the Herbalife site, it not only earns revenue from the sale of products, it also empowers independent distributors to share in the company's success.

CEO Michael Johnson points out that Herbalife has been in business for 32 years and has millions of customers worldwide. The day before Ackman's presentation, Johnson gave a CNBC interview in which he accused Ackman of attempting to manipulate the market as put options were preparing to expire. He also noted that Herbalife requested to be a part of Ackman's event but Ackman turned them down.

Pershing Square Capital Management
On one side of this high profile battle, is Bill Ackman's hedge fund, Pershing Square Capital Management. Ackman is known as an activist investor. Much like Carl Icahn, Ackman usually establishes long positions in companies and attempts to enact change that will drive the stock price up. One of his best-known positions is JC Penney, (NYSE:JCP). Ackman owns an 18% stake in JCP and was instrumental in replacing the company's former president with now CEO, Ron Johnson.

In the three-hour Herbalife presentation, Ackman laid out the reasons he believes that Herbalife is a pyramid scheme. In the early part of his presentation, Ackman showed a Herbalife promotional video complete with fancy cars and highlighted a distributor who made millions selling Herbalife products. Then Pershing Square analyst Shane Dinneen pointed out that only 0.04% of distributors earn $300,000, which equates to one in 2,500. 93% of Herbalife distributors earn zero gross compensation. That means that most distributors are actually losing money.

Ackman argues that Herbalife generates most of its revenue from its network of distributors who purchase products, don't sell them, and in most cases, cannot return them. Distributors' best way of making money is through the commissions they receive from signing up other distributors.

After 300 slides, Ackman concluded by announcing that any forthcoming profits from Herbalife would be donated to charity. Asked later why he isn't keeping the profits, he said that making money from such a company would be "blood money."

Analysts to the Rescue
Since Ackman's presentation, Herbalife has only provided a short press release saying that the accusations were so "without merit" that it would take too long to respond. It has scheduled an analyst day for January 7 at which it will, "Respond in detail to the distorted, outdated, and inaccurate information contained in Pershing Square's presentation."

Analysts have come out in defense of Herbalife. Analyst Scott Van Winkle said that not only are the arguments nothing new, but regulators have already scrutinized the multi-level marketing firm and found it to be lawful.

Net cash rose to $509 million from $271 million four years prior. Sales are expected to rise another 17% this year after a rise of 26% in 2011. Even if Herbalife's business practices were found to be unethical, as long as they aren't illegal, Wall Street has proved that it is happy to invest in just about any profitable business.

The Bottom Line
Ackman has indicated that he plans to present his research to government regulating industries and publish a website in an attempt to save people from the predatory practices of Herbalife. He believes that its stock will go to zero, and says he will donate any profits he may make to cancer research and his own personal foundation.

Herbalife vows to answer to the charges of Ackman, but if we are to pick a winner of round one of this fight, it's Bill Ackman. Herbalife's stock is down 33% since the announcement of Ackman's involvement. Who ultimately wins remains to be seen. What we do know for sure is that this is going to be a big financial media event.

At the time of writing, Tim Parker did not own any shares in any company mentioned in this article.

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