Herbalife's Disclosures Don't Add Up - Again

| About: Herbalife Ltd. (HLF)

Well folks, Herbalife (NYSE:HLF) is at it again. Yesterday it released its 2012 Statement of Average Compensation and in it we find even more inconsistencies and misleading statements.

Recall, Michael Johnson CEO of Herbalife appeared on CNBC in early January and told us that 90% of Herbalife distributors purchase Herbalife product for one reason, "self-consumption". Recall on January 10, Lieberman Research told us that Herbalife had 480,000 Active U.S. distributors servicing 5.2 million retail customers outside the pyramid.

Today, Herbalife offers us some new information. Surprise, surprise - the needle has moved again. In Herbalife's disclosure today, apparently the numbers of distributors who buy for self-consumption has dropped from Mr. Johnson's 90% to 71%. The source of this new information? A survey conducted by Lieberman research (Caveat Emptor).

Aside: Nuskin (NYSE:NUS) actually requires its distributors to disclose whether or not they plan to retail Nuskin products or not when they sign-up as distributors.

Herbalife, rather, relies upon the indirect methodology of a Market Research firm. Hmmm? So, what do we learn from this new disclosure? Here are a number of interesting observations.

Herbalife continues to exclude Inactive Distributors from its Statement of Average Compensation. As for Active Distributors, Herbalife's data tells us that:

  • 493,862 Distributors were included in its Statement of U.S. Compensation.
  • 351,065 had no downline (71%) and buy primarily for personal consumption
  • 30,621 who had no downline were Supervisors (6.2%)
  • 142,797 had a downline (29%)

Of those with a downline,

  • 82,644 were Supervisors (16.7%)
  • 60,333 were not Supervisors (12.2%)
  • 51% of 2011 Sales Leaders requalified ergo 49% churned out

Supervisors both with and without a downline?

  • 82,644 + 30,621 = 22.9%

Herbalife would like us to accept the premise that all Distributors without a downline are just discount purchasers even as it has no categorical proof that this is the case. Nonetheless, if we accept the premise we can deduce the following:

  • 142,797 distributors with a downline serviced 351,065 distributors as customers.
  • This reduces to 2.45 Distributor/Customers Per upline Distributor.

Let me repeat that:

Each Active Distributor with a downline services an average of 2.45 Discount Customers who sign-up as Distributors

Begging the same old question yet again: Where are the 5.2 million outside customers Herbalife has in the USA and who is servicing them?

Herbalife has now stated categorically in its Statement of Compensation that 351,065 Distributors basically don't sell the product. This means, categorically, that 100% of all retail sales must be generated by the remaining 142,797 Active Distributors.

Let's be clear about what Herbalife now wants us to believe. Herbalife wants us to believe it has 5.7 million customers in the USA. It then tells us that 493,862 are Distributors. Which means that 5.2 million are external customers. It then tells us that only 142,797 actually sell the product. This means that 5.2 million/142,797 = 36.4 customers per "real" distributor outside the pyramid.

Meanwhile, inside the pyramid each Active distributor = 2.4 discount customers in their downline. So, the ratio of external customers paying full price to internal customers getting a 25% discount is: 14.9 : 1. Ergo it is 15x easier for a distributor to find a retail customer willing to pay full price than a discount customer willing to pay 25% off. And I am the Wizard of Oz!

Are we really expected to believe that Herbalife has 5.2 million retail customers around the USA? Are we really to believe that for each distributor who actually sells Formula 1, 36.4 customers pay full price but only 2.4 are smart enough to sign-up for the discount? Does this assertion pass the smell test? Would this data map consistently with rational human behavior? Or would reason expect the opposite result?

Herbalife wants to have it both ways in its disclosures because it is feeling the heat.

a) It wants us to believe that all of its distributors who do not have a downline are in it for "personal consumption" (think retail sales)


b) It wants us to believe from its Jan. 10 presentation that it has 5.2 million retail customers outside the pyramid too (more retail sales)

Presumably, it must think investors are delusional - regulators too? It completely defies logic that 300,000 people are smart enough to sign-up for a discount while 5.2 million are stupid enough to pay full price. In a rational world, one would expect this ratio to reverse but in Herbalife's world, nothing seems rational. Rather, the company continues to ask investors and potential recruits to accept the utterly irrational findings of a 3rd party research firm vs. cold, hard data collected directly from distributors on the payroll.

So, here are a few alternative scenarios for you to consider as you digest this most recent data from Herbalife.


a) All these Distributors who have no downline are really discount customers, which makes it extremely unlikely that Herbalife has many outside retail customers paying full SRP at all or,

b) All these Distributors who have no downline are failing at recruiting distributors below them. After all, if those with an upline have an average of 2.45 distributors below them it doesn't seem too far of a stretch to conclude that those at the bottom of the scheme can't find anyone to recruit, or

c) Maybe just maybe Herbalife not only doesn't have 5.2 million outside retail customers but also it has over 300,000 low income people in America failing at the business opportunity?

How do we know?

Maybe the fact that 90% of distributors who have no downline churn out of the business every year and 49% of Supervisors bail is a dead giveaway? Or maybe the idea that it would be impossible for a distributor to make money as a retailer when 71% of direct customers are getting a 25% discount comes to mind?

Or, consider the following too:

The source of the data that asserts that 73% of Distributors buy to self-consume is none other than Lieberman Research. What its actual research from the January 10th presentation states is the following:

Lieberman interviewed 408 former distributors

  • 73% told them that they purchased to consume the product.
  • 27% purchased for full or part-time income

Then on the next slide these same respondents tell us that 56% of this same sample set expected to earn somewhere north of $1 selling product. 44% expected to earn $0.

So, if 73% are buying it not to sell, how come 56% expect to make at least some money? Are these responses not logically inconsistent? Additionally, Herbalife's disclosures would seem to have some further negative implications for HLF longs. Perhaps the market is already saturated?

If Herbalife is now telling us categorically that 73% of U.S. distributors buy to self-consume and from the 10ks we know that most of these "self-consumers" churn out in less than a year:

How does the U.S. business grow in the future? And who is doing the recruiting?

2.45 downline recruits per upline distributor doesn't exactly scream "FRANCHISE BUSINESS" does it? Nor does the fact that 49% of U.S. Sales Leaders failed to requalify in 2012.

To close, Herbalife's management continues to move the goalposts around to ingratiate itself with investors and regulators alike. Herbalife continues to try to argue that it is a legitimate retailer of product to external customers. Or has the strategy changed? Is it now all about the "inside sales"? Who knows?

What we can say, categorically is that its disclosures continue to leave one grasping at straws and/or scratching one's head. Why? Because the circular references simply do not add up to anyone with even a scintilla of common sense. Herbalife still has not demonstrated to anyone anywhere that its pyramid salesforce produces legitimate retail sales to legitimate retail customers outside the pyramid - let alone that they pay full price.

If anything, this most recent disclosure simply confirms the idea that Herbalife is a closed economy and therefore, the economic losses of those churning at the bottom of the pyramid fund the gains of those at the top. Specifically, 11.6% of Herbalife distributors captured 100% of the payments made by the company to distributors in 2012.

More importantly, perhaps, Herbalife has just confirmed to investors once and for all that not only does its business model rely upon recruitment, it depends upon it.

If 71% of distributors are self-consumers and most of these distributors churn out in less than a year then Herbalife's entire business model is dependent upon an endless chain of new recruits for its continuity, irrespective of whether they are discount buyers, distributors or both.

Is that not what one would call a pyramid scheme? As for the 5.2 million outside customers -- your guess is as good as mine as to where they are hiding.

Herbalife. Bad at Math. Weaker at Logic. An endless chain of recruitment and deception. Don't be fooled unless you want to get your capital churned too. No matter how you slice it. No matter whether Herbalife's distributors are distributors, discount customers or astronauts, the entire business model is dependent upon the endless recruitment of newbies to replace the relentless churn of the old and its compensation system is the only thing that keeps the recruiting juggernaut going, i.e. it's a pyramid scheme.

Disclosure: I am short HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.