The MLM sector is not a place I'd usually be looking for long ideas. In fact, I'd know nothing about most of the listed names in the sector if I hadn't started scouting the space for short ideas after David Einhorn's Herbalife (HLF) conference call cameo. But there is no denying that the MLM bunch is an appealing sector for a short-seller because you are pretty much banking on generating returns by taking down some fast talking hustlers. As far as shorting goes, this is even more satisfying than catching a fraud, because for the most part, the people in this space have found a legitimate way to make money that they know is about nothing more than selling hope to the masses.
So, when Ackman showed up in Herbalife with the kind of confidence that makes onlookers want to see someone fall flat on their face; I was tempted to suspend all rationale and join him in his crusade against the 'Evil Herbalife Empire.' The key word here is tempted because unlike Mr. Ackman, I have had enough bad experiences going after not so kosher industries to know crusading short sellers usually end up crucified. I had a not so memorable experience going after the for-profit education sector long before Steve Eisman was testifying to Congress about their predatory practices. And to a lesser degree, I can say the same thing about shorting some subprime scamsters in 2005, and pay day lenders back in 2006. Sure these sectors eventually deflated, but rarely do they truly die in the way you expected. This is why I am a bit surprised by Ackman's 'I will hold Herbalife till it's a zero' declaration. The only way Herbalife is getting to zero, barring a major management blunder, is if the MLM space dies. And despite its impressive thoroughness, Ackman's report does nothing more than reminding us that some really profitable businesses are nothing more than legal pyramid schemes.
There may not be much honor in investing in such a business, but then again you can say the same thing about the tobacco or alcohol industries. What is clear to me, which I think is not so clear to Ackman, is that most of the 'poor suckers' who become distributors of Herbalife products would do so even if you explained to them that only a tiny fraction of people get rich in this business and that the rest are almost guaranteed to fail. The MLM dream is no different than playing the lotto for most people, and no, the state lottery doesn't market itself as the place where 99.999% lose a little money every week. So, as long as some people are getting rich in the MLM space, these companies are not going anywhere, in fact in this economy and with social networking, odds are they will only become more prevalent.
Operating under that assumption, I started to take a look at the MLM sector from the standpoint of a value buyer, albeit one with much more reasonable expectations for where valuations in this sector should be over the long haul as the more pure pyramid MLMs are bound to experience major dead periods after growth spurts. The stock that came back out of all of this was Blyth (BTH). I got to the name by narrowing my universe of MLMs down to the pure pyramid-focused plays which generally left me with nothing but nutritional/health-wellness MLMs. With a universe of Herbalife, Nu Skin (NUS), Blyth, and USANA Health Sciences (USNA), I started looking at comps and quickly discovered that Blyth appeared to be the cheapest name in the group. (USNA and NUS have China-related question marks, courtesy of Citron Research that made them easier to rule out too).
Blyth The Candle King
Once you start delving into it, the Blyth story makes for quite interesting reading. The company was founded in 1977 by DLJ's LBO Group head Robert Goergen Sr. after a $100k investment into a Brooklyn-based candle company with a little less than $3 million in annual sales. Two years after making his investment, Goergen left investment banking to sell candles full time, and over the span of three decades built what would eventually become a billion dollar a year business. The bread and butter of Blyth throughout its history as a public company has been a direct sales company called Partylite. For those not familiar with this business, Partylite is the Tupperware (TUP) of candles and potpourri. Consultants host Partylite parties at their homes to sell the product. It has been a very solid and reliable business, and at its peak around 2005, was generating $700 million a year in sales for Blyth. Pretty impressive considering I'd never heard of the company, but then again it's always the seemingly simplest little businesses that sneak up on you like this.
Blyth also has an Internet catalog business with brands like Easy Comfort and Miles Kimball, a wholesale business, and some other small non-core businesses that up until recently included the likes of Sterno fuel, but despite Goergen's willingness to dabble with other businesses, the Blyth story has pretty much been all about Partylite. And for the better part of two decades that has been a good story; however, just like the candles they sell, Partylite's business eventually started to melt away.
Though sales growth ended in 2005, the Partylite business managed to remain relatively stable through 2008 with revenues declining no more than a percent or two in a given year. It was not until 2009 that things took a turn for the worse with Partylite's U.S. sales declining by 14% and overall Partylite sales falling 4%. This was followed by a 20% overall decline in 2010, a 10% decline in 2011, and 14% decline in 2012 (ytd). That means over the past four years, Partylite has seen 42% of its sales disappear, and yet there are still few convincing signs that this is going to level off. Basically, if you just looked at Partylite's recent operating results, you'd conclude this company is fast approaching its death, and you'd be running from Blyth shares. And that's probably how this story would have ended were it not for a very lucky investment Mr. Goergen made in small MLM company called Visalus.
The Vi Saves Blyth
In August of 2008, Blyth entered into a purchase agreement to progressively acquire all the membership interests of little known Visalus Sciences from its three founders and Ropart Asset Management. At the time, this acquisition didn't seem like anything special. Visalus looked like a nice little punt in the health & wellness direct selling space for a company with strong expertise in building and expanding such businesses, and for the sellers the initial $15 million cash consideration for just under half the company probably felt like a windfall profit as Visalus had de minimus sales. But then something unexpected happened; Visalus started to grow like a weed.
Visalus Quarterly Revenue ($ millions)
When Blyth upped their Visalus stake to 57.5% in April of 2011, the company was doing $20 million in revenue a quarter. Not too shabby of an investment, considering it only cost $17 million, and things just kept getting better from there. By the time Blyth upped their stake to 72.7% in January of 2012, Visalus was at a $100 million a quarter run rate. So for $52.6 million, Blyth had acquired nearly 3/4 of a company that had generated $36 million in EBITDA over the previous 12 months. Not too shabby had now morphed into incredible, and with the deterioration at Partylite, the timing couldn't have been better. Now this is the point where things get complicated because despite all this growth, Blyth shareholders have not been rewarded. But before I get into that let's backtrack a bit and take a look at the Visalus phenomena.
An MLM On Steroids
It's very hard for someone like me to look at a company like Visalus and not just shake my head. I mean, if Ackman wasn't busy trying to wreck the seemingly wreckable Herbalife, he probably could have put together a very nice report ripping into this model as Visalus really is one impressive legal pyramid business. How else do you go from $3 million in sales to $190 million in 8 quarters? What the founders of this business have done well is build the MLM of the Facebook generation complete with a Youtube reality TV show 'The Pyramid Thing,' a mobile app, a challenge, good-looking people, a bimmer club, and plenty of social media marketing. Like Herbalife, Visalus primarily derives its revenue by selling a shake supplement product (just as 'overpriced' as Herbalife) through a network of 'promoters' (yes, they don't try and hide it by calling them something else). There really is nothing special about the product and the company doesn't deny this in its s-1 as the risk of losing their licensing rights is disclosed as being non-material.
Furthermore, current R&D spend consists solely of the licensing fee paid to a Dr. Michael Seidman, an otolaryngologist who is Visalus' resident nutritional expert and Vi-Pak creator. Now how an ear, nose and throat specialist turned into a vitamin guru is beyond me, but this seems to be par for the course in this space (I mean, for example what does Madeleine Albright have to do with Herbalife...'good products made by good people'...pretty ridiculous to watch a stateswomen play MLM paid promoter).
The bottom line is just as Visalus' filing alludes; the product is nothing special. What is special here is how well they have managed to get people motivated to buy the shake mix and lose weight via the 'challenge,' and more importantly to get friends in their social network to do the same. Look good and get rich at the same time is basically their pitch, and that pitch is working very well. In just under three years, Visalus went from a few thousand promoters to over 110k, and this is just in North America. You can imagine what is going to happen once this network starts expanding internationally. But like all MLMs, if you want to pick at this, you can find plenty of holes. For example, while they don't disclose churn, you can guesstimate that Visalus has to have a churn rate that is at least double or triple Herbalife's. Add in the rapid growth, outsourced 'game changing' weight loss product, a BMW club, a somewhat dubious M.D., and an industry-leading aggressive payout structure and you have enough red flags for a MLM short. But that is not what I am thinking here, and before I explain why, let me circle back to Blyth's miserably performing share price.
The Vi Nearly Kills Blyth
One would think owning a controlling stake in a super fast growing MLM is a good problem to have, but for Blyth that has not been the case of late. This is because the original purchase agreement required that Blyth acquire the remaining outstanding interest of Visalus at what would now be considered a generous multiple of 2012 EBITDA for most MLM businesses. With Visalus' rapid growth continuing the final payment that was supposed to be made in early 2013 would equate to something in the neighborhood of $250 million in cash. This sum, for the 27.3% Blyth didn't already own, meant Visalus was now being valued at just under $1 billion dollars. Yet go look at Blyth shares and you will see the whole company is not worth much more than $250 million. Now how is that possible? Well it's possible because the way Blyth planned on completing this transaction was via a Visalus IPO, but with all the negative press in MLM land these days and the market for new issues still suffering post Facebook trauma, that plan hasn't panned out.
This left Blyth with a large cash payment due in the same year its $100 million in outstanding notes need to be redeemed. Now Blyth was sitting on roughly $200 million in cash at the time this became apparent, so that left a $150 million hole that needed to be filled in less than a year and at a point when the core business is still in free fall. Meanwhile, the one most valuable asset can't be liquified, and to make matters worse, Blyth shareholders were now bearing the risk that after this payment; Visalus' rapid growth starts to reverse course. Which then raises the potential conflict of interests issues with this transaction as Mr. Goergen and his family also sit on the other side of the transaction via Ropart Asset Management's remaining 8% stake in Visalus. Yep, pretty much the stuff short sellers dream of, and it's no surprise that over this period, Blyth shares fell from nearly $45 to $15. But last week, Blyth and the remaining shareholders reached an agreement that remedied most of this problem. For $57 million in cash, Blyth raised their stake in Visalus to 80.4%. For the remaining 19.6%, the stakeholder receive convertible preferred stock in Visalus that are required to be redeemed on December 31, 2017. If Visalus IPOes before, then the stock converts automatically into common shares on a one-for-one basis. If it doesn't, Blyth is still on the hook for a $147 million convertible or they can just basically forfeit their stake in Visalus by allowing the pref shares to convert on a 100 to 1 basis. So after this final payment, Blyth will have about a $130 million in cash against roughly $85 million in notes due next year. This should remove some pressure from the shares, but it is not why I want to be long.
Why Buy Blyth Here?
Look, Visalus is one of the more aggressive MLM pyramid plays I have come across, and I have no doubt that at some point down the road, this business will hit a wall. However, as I discussed at the start of this article, I can't see any reason for governments to kill off this industry (weight loss in an obese planet and hope for unemployed/unhappy vs. moral/ethical obligation... you don't need to be a rocket scientist to figure who wins out), which means going long at times can be very lucrative. While I'd probably be lining up to short BTH at $50-$60, at $15 it looks like a steal that is too good to pass on. At this stage, I think international growth prospects and value are enough to warrant taking a long position.
International Growth Is Coming
MLMs clearly do even better outside of North America these days, and this one should be no different. I think if you look closely at Partylite's history, Mr. Goergen has proven he knows how to milk the expansion game, which means Visalus should have no problem moving into Europe in early 2013. And when it comes to MLMs, you are better off getting them when they start expanding instead of when they are already regionally diversified. With that in mind, I can handle a slowdown in North America at this point if that ends up being the case.
Valuation Margin For Error Is Huge
As of this writing, Blyth has a market cap of $250 million. Trailing twelve month EBITDA for the company is $106 million. The company exited last quarter with $181 million in cash and $92 million in debt. Run those numbers and you'd come back with an EV/EBITDA of 1.5x. Now there have been some notable changes since the end of the quarter that sent this multiple up. Blyth is paying $57 million to boost their stake in Visalus to 80.4%. They also have committed to fund the redemption of all outstanding interests of the Visalus equity incentive plan for $25 million. These commitments are partially offset by $16 million in dividend disbursements from Visalus and $23.5 in cash for the sale of Sterno. Add it all up and you get to a rough estimate of an enterprise value that is 1.9x trailing 12-month EBITDA. Now compare this against Herbalife which has an enterprise value of $3.66 billion and trailing twelve-month EBITDA of $708 million. That works out to a 5.2x EV/EBITDA multiple.
So, Blyth, whose story these days is basically Visalus, a direct competitor of Herbalife, is trading at 63% discount to the multiple of 'distressed Herbalife,' and at similar steep discounts to the comparably short targeted peers of USNA (4x) and Nu Skin (5.7x). However, the controversy-free MLMs like Tupperware and Avon (AVP) trade at 9-10x, and while I am not saying these stocks deserve that multiple, that should put things in perspective. And if you take a look at EV/Operating Cash Flow, you get a similar result. Blyth's operating cash flow for 2012 is expected to be about $70 million on an adjusted basis (net Visalus' IPO-related fees) versus $500+ million for Herbalife. So Herbalife is in the 7x-8x range versus slightly below 3x for Blyth.
Now there is a reason for all of this, and depending on how you view things, you can get to a price target for Blyth that makes sense to you.
The notable difference that jumps out between Blyth and Herbalife is that Blyth's Partylite business has been in free fall. The other notable difference is that because its Visalus division is in turbo growth mode, working capital requirements and capex have been more significant cash eaters versus the cash cow that is the globally diversified and more mature Herbalife.
But that is one side of the coin. On the other side, you can argue that Visalus' EBITDA has gone from $36 million to about $100 ($97 million is what was used for 2012 EBITDA in the Visalus closing according to disclosure) million in the last twelve months. That is growth which usually warrants expanding multiples, and Visalus has yet to enter international markets. And what is even more interesting is that the one company Visalus is going toe to toe with is Herbalife. The global market for weight loss shakes is huge, but you have to believe that if Visalus is anywhere near remotely as successful with its MLM 3.0 approach as it has been in the US in international markets that their progress will start weighing on Herbalife results. Last quarter Herbalife did $208 million in revenue in the US/Canada versus $170 million for Visalus, which is not saying much until you look back and see that the previous year Visalus only generated $73 million in that quarter. Put simply, Visalus is now a serious competitor in a market that accounts for 20% of Herbalife business, and it is putting the infrastructure in place to do the same in every other market that Herbalife is in. And when I say infrastructure, I am also referring to human capital which these days seems to consist of hiring all the key people that helped grow Herbalife's business.(a little time on Linkedin or Google is all you need to fully understand this) So, you clearly have a bit of a zero sum game here which I think will favor Visalus for now, but eventually may turn into a problem for both.
As you can tell, a valuation exercise here requires making some assumptions that, well, are not exactly clear cut. Still the beauty of Blyth is right now you really don't have to worry too much about that because, well, the stock is priced like Partylite is simply going to run it into the ground. I mean let's assume you think Visalus is worth 5x trailing EBITDA because the rapid growth rate just freaks you out and you are not willing to pay anymore than that for a weight loss themed MLM. That's still $500 million. Assuming this non-aspirational market cap is something the Visalus founders have to live with, you are talking of a $147 million liability at the end of 2017. Let's say you decide to liquidate the rest of Blyth's business and just cease all non-Visalus related operations, you still should come out with at least $80 million in tangible value even if all the other divisions are worth zero. That means $580 million less the full $147 and you get to a company that should be worth 73% (58% after adjusting for pref shares) more than its current price. Come down to 4x and you still have roughly 30- 35% upside from here.
You could get a little more rosy by assuming the market gives Visalus the 8x EBITDA multiple Blyth applied, and that Partylite stabilizes. In this scenario, you are looking at a company that should be worth closer to $900 million which is 210% return from here.
Clearly, getting to an upside of major significance in this stock does not require a wonderful imagination, and if Ackman's HLF trade really blows up and the heat comes off MLMs that is precisely what is going to happen. You also have to consider that Goergen has the ability (LBO Specialist) and incentive (family controls nearly 40% of Blyth) to protect the parent and ensure he unlocks his value in it. This could mean putting a group together to take Blyth private or an outright sale.
I don't really have a bearish scenario for the stock because that is what I think it is currently reflecting, thanks to the IPO being pulled, problems at Partylite, uncertainty around Visalus-related closing obligations, the first sequential revenue decline out of Visalus in Q3, and MLM-related short-selling heat. So, I have chosen to replace bearish with Disaster just to remind people that this is a risk you take getting into this space. In this scenario, Visalus flames out quick and never manages to expand internationally and Partylite continues to struggle, regulators tighten the screws on MLMs, and this all happens before a Visalus IPO. What's the stock worth then? The answer is not complicated, the company will eventually go bankrupt and you will gradually be bled to death along the stock, but then again you could contemplate this scenario for many MLM models and plenty of non-MLM businesses, and that is just a risk you have to accept and manage (i.e. have a reasonable stop loss) with this type of trade.
Some Thoughts on Ackman and Herbalife
Before I wrap up on Blyth, I wanted to share some more detailed thoughts on the Herbalife situation as I don't think this piece would be complete without them. I have not written a dedicated Herbalife piece, but I have shared some views on it via my personal distribution list and some Seeking Alpha comments I made back in May of last year. My Herbalife trade, despite an initial strong short inclination when the Einhorn cameo crisis started, was to buy calls and some deep out-of-the-money puts in case there was some fraud/smoking gun. I went this route because I frankly didn't see MLMs as something that regulators would go after in the same way as for profit education. I got to that conclusion because unlike the for-profit education sector, MLMs are not a burden on federal resources.
When the heat came down on for-profit space, there was data that showed the group accounted for nearly a quarter of all Federal Pell Grants despite enrolling less than a tenth of all college students. Combine this with the fact that this small group was responsible for nearly half of all student loan defaults and you can understand why when the economy crashed, policymakers finally woke up and paid attention to their shenanigans. MLMs don't fit into that category. If anything they are more akin to dollar stores, pay-day lenders, pawn shops and casinos as far as their relationship to a weaker economic environment goes. They provide the opportunity for the underemployed and unemployed to make extra cash and chase long shot dreams of great wealth. And the ones that focus on weight loss also are indirectly alleviating some of the fiscally burdening government healthcare obligations. So, why would elected officials put the screws on them? That leaves massive fraud which I never rule out but which I also have a hard time with here because the space is such a 'shameful' money maker. It would be like a casino rigging it, so everybody loses when they know that their whole model thrives because once in a blue moon somebody wins. The bottom line is you don't need to cheat.
Anyway, this logic didn't work out for me as Herbalife went nowhere and I lost on both ends. But when Ackman showed up I hopped on the short-trade immediately simply because I figured going from rumored potential respected short target to official respected investor short target would leave the stock extremely vulnerable for a few days, and after just about 20%, I was happy to say goodbye. But I didn't turn around and go long because I am worried that Herbalife's undoing will be that it has already milked this nutritional club/ international expansion growth phase. I mean at the end of the day, this business will run out of new markets and have to reinvent its pitch (what comes after nutritional clubs?) as the vast majority of people not making money throw in the towel. I also think Visalus is running a smarter more aggressive version of their model and will benefit at their expense over the next year or two. Still this is not enough to build a short thesis on, and the stock is way too cheap down here for me even to consider that even if I had conviction. Now what would make things interesting for me would be another giant buyback just to burn Ackman. Really gearing up the balance sheet here and goosing the stock could actually create the ideal long-term short entry point in Herbalife. This of course would be the ultimate irony as Ackman's short attack will have triggered a chain of events which ultimately make Herbalife shortable, but they end up coming at his expense. Though I am pretty certain this is not in the long-term interests of the company, and that proceeding with caution or looking at being the space's main consolidator makes more sense.
Anyway despite my respect for Ackman, I wouldn't want to be in his shoes right now. He clearly hired lawyers, consultants, and private investigators to put this report together. Basically, he went fishing for dirt in a space where you can expect to find dirt. Problem is if you go after an industry that is comfortable with shades of grey, you better be prepared for them to come back at you in the same way. Lawyers, investigators, and anything else you can think of should not be ruled out; my guess is these folks are probably much more familiar operating in this space than Ackman. If there are any skeletons in the closet, I have no doubt they know how to find them. I also think Ackman's declaration that he does not intend to cover, leaves him in a very inflexible position from a disclosure standpoint. Herbalife was clearly vulnerable thanks to the Einhorn cloud, and Ackman's end of the year presentation could be viewed as an opportunistic way to leverage that vulnerability for a big hit and run trade. And if he covered at all that is exactly what he will have been accused of doing which from a legal standpoint could turn into an interesting defamation/libel suit. So, my guess is, even if he doesn't believe it's a zero and the greatest short ever, and that was all just 'deceptive marketing,' his hands are now kind of tied. And when it comes to shorting, that is the last place you want to find yourself. Think about it....
What hedge fund manager that values self-preservation would want to have his hands tied when he is 75% of the short interest in a stock with a position that equates to 25-35% of the market cap depending on his cost basis?
It's like you are almost inviting everyone else with a hedge fund to squeeze you regardless of what they think about the company. And based on recent news, it appears more than a few hedgies are doing just that. Will I just get 'Ackmaned' become trader lingo for being squeezed out of a short? Only time will tell.
Putting this altogether and adding the obvious catalyst of the IPO being re-filed (though I am not banking on that anytime soon) and of the aforementioned possibility of Ackman's HLF short blowing up and turning this whole group into a short squeeze trade for a couple of months (much more likely), I want to be long Blyth shares.
Personally, I think this stock gets to $25 which is where, assuming no new material developments (yes, no absolutes from me on this one), I plan on re-evaluating my position. (but factoring in the front page nature of the space and the high short interest... a wilder move wouldn't shock me) The only real fundamental concern you have at this point is that Visalus' sales start to fall off pretty quick before international expansion gets going which is a real possibility with something like this, but also one that is pretty thoroughly mitigated by the current depressed share price. Keep in mind, this is not a long-term investment but rather a trade, and it's a trade that is more on the risky side of things. So, if you don't have the stomach for this, I suggest you find less stressful things to invest in.