By Damion Rallis, Senior Research Associate
While the bulk of ongoing media scrutiny of multi-level marketing firms focuses squarely on Herbalife and its battle with hedge-fund manager Bill Ackman (see our report "Herbalife: With Vital Signs Flagging, the Company is Fighting Back"), other firms engaged in similar marketing practices should also start working on their rebuttals. In fact, now is exactly the wrong time for Herbalife competitor Blyth, Inc. (NYSE:BTH) to defend its near- and long-term prospects. After its share price peaked above $46 in August amid incredible sales from its primary subsidiary, multi-level marketer ViSalus, the good times at the direct-to-consumer company seem to have come to an end. The question is, does Blyth have what it takes to rebound from its woes or is the company heading into darker waters?
Currently, while Blyth's "C" ESG Rating reflects moderate risk, several red-flagged practices exacerbate investment risk. The company has D-rated board and compensation practices and an ownership structure poorly aligned with shareholder interests. Consequently, GMI Ratings' Litigation Risk model has been showing warning signs for Blyth since the end of September as its score has fallen in three consecutive rating periods, from 48 (or "Negligible Risk") to its current score of 16 ("Moderate Risk"), placing the company in the 16th percentile of all North American companies . This rank indicates higher shareholder class action litigation risk than 84% of all rated companies in this region.
Blyth operates as a multi-channel company focusing on the direct-to-consumer market operating in three segments: Direct Selling, Catalog & Internet, and Wholesale. According to the company's most recent 10-K statement, its Direct Selling segment represented approximately 78% of 2011 total sales. Its principal Direct Selling businesses are PartyLite (representing approximately 67% of total sales of the Direct Selling segment) and ViSalus (representing approximately 33% of total sales of the Direct Selling segment). According to the company's latest 10-Q statement, net sales in the Direct Selling segment for the nine months ended September 30, 2012 increased $322.0 million, or 75%, to $754.1 million from $432.1 million in the comparable prior year period. ViSalus' Net sales increased $363.1 million, or 271% to $496.9 million from $133.8 million last year. On the other hand, PartyLite's net sales for the nine months ended September 30, 2012 decreased $41.2 million, or 14% to $257.2 million from $298.4 million last year. While ViSalus surges, PartyLite appears to be fading; clearly, Blyth's short- and long-term prospects are lining up directly with ViSalus.
ViSalus Holding, acquired by Blyth in October 2008, is a multi-level marketing company that sells weight management products, nutritional supplements and energy drinks through its network of independent promoters. The subsidiary, unfortunately, is very similar to Herbalife. CNBC reported recently that "ViSalus walks what appears to me, based on my read of the company's filing, to be a controversial line between legal direct selling and pyramid scheme." In fact, Blyth states in its annual report that it is "subject to the risk of challenges to the legality of our network marketing program, alleging, for instance, that it is an illegal 'pyramid scheme' in violation of federal and state laws," so clearly there is real concern that ViSalus is dancing on the edge of legitimacy. The problem is that Blyth doesn't appear to have any kind of backup plan. As Blyth's candle and home fragrance sales continue to slump and with no major products waiting to be unveiled, the reality is that the company is relying almost solely on ViSalus and its weight-loss shakes. But really, with sales through the proverbial roof, what exactly could go wrong?
Last August, Blyth and ViSalus announced that they had filed to raise up to $175 million in an initial public offering (IPO) for ViSalus, causing Blyth's share prices to surge from a closing price of $37.09 on August 15 to $43.36 the very next day. Blyth, which held over 70% of ViSalus shares, said that it would use the proceeds to pay a special dividend (more on this later). A month later, Moody's Investors Service downgraded Blyth's rating outlook from stable to negative, citing the company's "constrained liquidity profile in 2013, continued weakness in its core direct selling candle and home fragrance business, as well as uncertainty stemming from the recent announcement that it filed a registration statement for a potential initial public offering of ViSalus." Moody's went on to say that the outlook reflected the company's "growing reliance upon its ViSalus weight management products business and the heightened risk profile associated with its business model and the weight management product category generally in comparison to candles and fragrance products." Not only was ViSalus' extraordinary revenue growth seen as unsustainable, but discretionary spending was also expected to remain subdued.
Six days after Moody's downgrade, Blyth withdrew its planned IPO for ViSalus, citing that it felt that "the valuation we were getting was nowhere near what we believe the value of the company is." Consequently, share prices tumbled to a close of $25.68 to reflect the collective groan of shareholders, a 44% decrease from August highs. IPOdesktop.com told Reuters that "Institutions are not attracted to multi-level marketing companies and that could also be a reason the company did not get a desired valuation." On the heels of Blyth's disastrous week, several law firms began to announce securities class action lawsuits, such as this one by Rigrodsky & Long, another by Bernstein Liebhard, as well as one by Levi & Korsinsky.
Going forward, Blyth must be paying especially close attention to the public spat over competitor Herbalife. While embattled multi-level marketing company Herbalife captured the attention of media after high-profile hedge fund manager Bill Ackman of Pershing Square Capital Management said right before Christmas that he's betting $1 billion Herbalife's stock will fall to zero since it is an "inherently fraudulent company" and is operating essentially as a "pyramid scheme," competitor Blyth, Inc. may not be ready for any amount of increased scrutiny of multi-level marketing companies. One of the key issues raised by Moody's when it downgraded its rating for Blyth was that it expected "the company's financial policies to favor shareholders given the large concentration of ownership by the Goergen family."
Blyth Inc. is a family firm as the Goergen family-including shares held by CEO and Chairman Robert B. Goergen; his wife, director Pamela M. Goergen; and their son, COO Robert B. Goergen-controls approximately 40% of the company's total voting power. When assessing family firms, we consider the extent to which the family makes decisions in the best interests of non-family shareholders. In this case, on top of the hiring of family members, there are also several significant related-party transactions between the company and the Goergen family. For example, a December 2012 agreement that saw Blyth increase its ownership in ViSalus to more than 80% involved a $57.4 million payment in which Blyth paid $5.1 million to Robert Goergen, $1.7 million to Todd Goergen (and trusts affiliated with him) and $0.2 million to Robert Goergen, Jr. Transactions such as these raise serious concerns regarding the effectiveness of the board in representing the interests of minority investors.
To compound matters, the company's board is ill-constructed to provide as an effective counterbalance to management. Of the seven-member board, two directors are the CEO and his wife and a third is former CFO and Corporate Secretary Howard Rose. Moreover, while the CEO is also the company's Chairman, Blyth's independent lead director is none other than the aforementioned Mr. Rose, a company executive for nearly two decades. Using Mr. Rose in the role of lead director is clearly not in the spirit of the position and runs counter to sound governance principles. Can independent directors truly trust a separation between its lead independent director and management? A fourth director, Neil Goldman, cannot be considered truly independent as he has served on the board for more than two decades. Long-tenured directors can often form relationships that may compromise their independence and therefore hinder their ability to provide effective oversight. To illustrate the board's lack of true independence, Mr. Rose and Mr. Goldman constitute two-thirds of the Corporate Governance & Nominating Committee.
Boards of this nature are likely to enrich the pockets of its management through compensation policies that are not in the best interests of minority shareholders. At Blyth, we note that the Goergen executive officers (the CEO and current COO), despite their large equity holdings, participate in the company's annual bonus plan (which gives between 25% to 40% of the total award based on the Compensation Committee's subjective evaluation of the executives' individual performance factor), while the younger Goergen also participates in the company's long-term incentive plan. Furthermore, the CEO received $236,637 in "all other compensation" for the 11-month period ending December 31, 2011, including $147,084 for his personal use of company airplane, $58,067 for driver services, and $18,164 for automobile payments. Because such payments are not tied to performance, they are difficult to justify in terms of shareholder value. Also, the CEO is the only executive to receive pension benefits, including $458,333 in 2011 for a total of over $3.5 million after only eight years of credited service.
Blyth seems to think that its shares are undervalued, as evidenced by an ongoing share repurchase program in which the company announced last week that it had repurchased 2.5% of its 17 million shares outstanding and has 1.6 million shares remaining in its existing authorization. The CEO said that the company will repurchase shares "when we believe it is in the best interest of our long-term shareholders." We fear, however, that too many of Blyth's decisions are in the interest of long-term shareholders named Goergen. It is a company, after all, that actively distributes dividends, including a recent special dividend of $1.50 in November 2011 that netted the Goergens roughly $7 million, a substantial amount considering Blyth's current market cap of about $285 million. In fact, when the company recently announced the appointment of a new COO last November, it came as no great surprise upon reading the company's filing that the new COO's last name was Goergen. With all its eggs in a basket named ViSalus held by someone with the last name of Goergens, we wonder if the company is prepared for the long-term.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.