It's a clash of Wall Street titans unlike any we've seen. On one side is hedge fund manager William Ackman, who contends that global nutrition company Herbalife (HLF) is "the best-managed pyramid scheme in the history of the world." Last month, he publicly disclosed his views and a $1 billion bet - in the form of a short sale of more than 20 million shares - on the company's impending demise. If he turns out to be right, the gambit could be just what he needs to revive a reputation damaged in recent years by questionable gambles on Target (TGT), J.C. Penney (JCP), and the Hong Kong dollar.
On the other side is his good friend and investing equal Daniel Loeb, who calls Mr. Ackman's allegations "preposterous." He sees promise in Herbalife's "compounding" sales model, and disclosed on Wednesday the acquisition of more than 8 percent of the company. Whether he sees a long-term or quick-hit opportunity remains to be seen. But regardless of his intentions, Mr. Loeb has done a great deal to at least cast aspersions on Mr. Ackman's claims that the company is teetering on the edge of disaster.
In fact, investors were so encouraged by news of Mr. Loeb's position that they drove a 7.54 percent increase in share price before trading was halted by a single stock circuit breaker. Of course, such a pop represents something of a double-edged sword for Herbalife, as it could support rumors that Mr. Loeb is only seeking a short-term investment win. But at the same time, it cannot be ignored that Herbalife shares have been steadily recovering since Mr. Ackman first disclosed his position last month - rising from a low of just over $25 a share to just under $40 when trading closed last week. Mr. Loeb may see that trend continuing in the long term and may be basing his strategy on that assertion. Unfortunately for Herbalife and the investing public, only time will reveal Mr. Loeb's true motives.
And as if all of this wasn't enough to create a Wall Street drama of Shakespearean proportions, the U.S. Securities and Exchange Commission (SEC) is now reportedly entering the fray with an investigation into Herbalife. Exactly what the SEC is looking into also remains shrouded in mystery, as the inquiry is ongoing. We do know that the U.S. Federal Trade Commission (FTC) has examined sales practices similar to those utilized by Herbalife, and that the company has never been found to have engaged in wrongdoing. This may just be a case of a story becoming so substantial that the SEC feels it has to do something. Or, the Commission may feel that there is fire where Mr. Ackman sees smoke - and that it can find fault where other regulators have failed to do so in the past.
With so many questions swirling around the company and the media spotlight firmly affixed on its future, about the only thing certain on Wednesday was the need for Herbalife to take back control of its own narrative - and do so quickly. With a high-powered activist taking aim and SEC's interest piqued, the company could not be content to sit back and simply let Mr. Loeb's investment speak for itself.
Mr. Loeb's disclosure transformed the market into the most captive audience the company will likely ever enjoy. As such, Herbalife needed to aggressively articulate its side of the story in order to capitalize on its best opportunity to ensure that perceptions are not swayed by what it calls the "misinformation" being circulated by Mr. Ackerman.
To the Herbalife's credit, that is precisely what it did Thursday morning during a special meeting with investors in New York City. Just hours after what Herbalife CEO Michael Johnson called an "incredible and unusual" opportunity to address a wide array of analysts, investors, and media, CNN Money issued the headline, "Herbalife comes out swinging" - and swing it did.
In response to Mr. Ackman's claims that the company's nutrition clubs - or networks of distributors in 85 countries who sell products directly to consumers while also recruiting new distributors from whom they get a share of the profits - are nothing more than pyramid schemes, Mr. Johnson opened the meeting with a strong statement on the strength of the connection between the company and the people its business depends on for sales, saying that, "If you really want to know us, find an Herbalife independent distributor."
In response to Mr. Ackman's claims that Herbalife, as a nutrition company, doesn't put enough resources into Research and Development, numerous executives pointed out the company spent $44 million on science and technology last year. Similar rebuttals, rooted in hard numbers wherever possible, were issued to nearly every allegation Mr. Ackman has levied.
And by 10 am Thursday morning, the mantra being echoed across numerous media outlets was Mr. Johnson's assertion that, "We are confident that you will see that we're a legitimate company with legitimate customers." At the meeting's close, Herbalife's share price had climbed higher than it has in a month to $42.99.
As of this writing, Herbalife shares have dipped after Thursday morning's excitement - but that shouldn't be read as an indictment of Herbalife's strategy in this battle of perception. The company rightly recognized an unprecedented opportunity to extol its virtues to an expansive and captive audience - and it seized the day. Rather than let the market draw its own conclusions from Daniel Loeb's capital infusion, it clearly laid out the reasons why Mr. Loeb would see the company as such a strong investment.
Before all is said and done, Thursday morning's performance may very well deserve a great deal of the credit should Mr. Loeb's presumed predictions turn out to be more reliable than Mr. Ackman's. In the meantime, investors should hold their positions, but avoid new investments in Herbalife. The tantalizing possibility of a large short position that has to be covered if Ackman is wrong, along with Loeb's assertions of a much higher value, does not offset the uncertainty of an SEC investigation and the possibility of continued reputational issues as negative information surfaces.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.