The battle between William Ackman and Carl Icahn over the future stock price of Herbalife (HLF) became a little clearer yesterday when the short interest report for February 15th was released by Nasdaq. As we know, that was an important date because that was the first trading day after Carl Icahn reported that he had amassed a 12.98% stake in the Company. For background on that purchase, and links to filings, see my previous article on the subject. The stock was very heavily traded that day (37.9 million shares), and it was unclear as to whether this heavy volume was due to at least partial covering of the huge short position that existed at the time (34.2 million shares).
Now we have the most current information, and what it shows potentially does not bode well for Herbalife shorts.
According to Nasdaq, the short interest in HLF had only decreased 587,500 shares from the previous report. This represents only a very small percentage decrease (1.72%) from its prior level.
- January 31, 2013: 34,185,820 short interest
- February 15, 2013: 33,598,320 short interest
That small decrease means that the unusually high volume that day was not the product of wholesale short covering.
- During this same time frame between short interest reports (see 13d filing), Carl Icahn purchased the equivalent of 8,725,047 shares. These shares were purchased through the use of OTC call options. As I discussed in my previous article, the counterparties who sold the options were hedged in this position and likely loaned these shares out to short sellers.
- Carl Icahn has expressed his intention to exercise all of the options he bought.
- William Ackman represented approximately 20,000,000 shares of this total short position as of the previous report.
Now that we know the new short interest numbers, this means either 1) that Ackman's short position got bigger, or 2) there are approximately 13,600,000 shorted shares on top of Ackman's short. I concede Ackman could have covered some of his position, but I will not address this as it seems highly unlikely.
The only other assumption I am making is that all of the counterparties on the other side of the Icahn option purchases were covered with the shares and that they loaned them out. If this is true, that means that of the 13,600,000 shares short above Ackman, 8,725,047 of those shares (or 64%) were shorted during the period Feb. 1 - Feb. 15. Obviously, the actual number of non-Ackman shorts could be higher because Icahn in total purchased 11,542,344 shares in option form.
What's useful is that all of this info gives us a good understanding of where that 64% of the non-Ackman short position is priced.
Look at the daily high price of HLF during this time:
The above chart shows that the highest possible price that shares could have been shorted during that period was on 2/14 ($38.28). We know that Icahn purchases were done every day over this period, so it couldn't be that high. Instead, I used the daily high price to illustrate the best possible position for the short and used this "average of daily highs:" $36.76. Using the average, we can get an idea of where we can expect shorts will become underwater in their trade and will need to decide whether to continue the trade or cover.
Icahn has indicated that he intended his position to be in share form. The only thing currently holding him up from exercising these options and getting the actual stock is the FTC. He publicly stated that he applied for approval to accumulate more shares of HLF sometime around January 28. After the 30-day waiting period, I expect that he will start doing this exercising process as soon as practical both because of the dividend payable in March and for the potential increase in share value that would result.
This exercise of options and subsequent stock call-back by itself could cause the price of the stock to rise dramatically as it alone represents a large portion of the non-Ackman short.
But several other factors have now come into play which could exacerbate the upside even further.
If you look at the short interest report, it states the average daily volume is 9,094,087 shares, or 3.69 days to cover. However, a closer look at the numbers reveals that the currently reported number is overstating the effect of some periods with unusually high volume. For example, HLF's average daily volume for all of 2012 was 2,832,438 shares (this would be 11.86 days to cover). And, if we look even more near-term, we see that the share volume has gotten lower every day for the past 8 days and has averaged 5.6 million for the past 7 days. In fact, it hasn't been over 5 million in any of the last 5 days (3.5 million average).
So couple the exercise of options representing a large portion of the shares, a share price that already has a large number of short sellers underwater, and lower stock volume, and you get the potential for a large squeeze.
Obviously, if a large number of the shorts have covered since that last report date, it would make my analysis moot. However, volume has been extremely low, so I discount this probability somewhat. It is also possible that counterparties are sitting on stock that was previously loaned out and has now been covered. But this too, seems unlikely as Icahn has only paid for half the stock so far. They paid the other half up front, and they don't get the other half until he exercises. To just finance an interest free $250 million loan doesn't make sense. The stock might be loaned out in the market at lower stock-loan rates, but in my analysis the fact that it's loaned out and needs to be called back is what matters.
The real wildcard is Bill Ackman. Up until recent events, one would have thought it would be extremely hard to separate him from his large short position in HLF. Yet, he just so happens to be the largest shareholder in J.C. Penney (JCP) which was down over 20% at one point today (2/28). This is interesting because he had to finance his $1 billion short position in HLF with something. That something was likely the other securities in his portfolio. These collateral positions are marked to market daily. Depending on how thin he is stretched, these could present a problem for him or possibly in the future. He may be forced at some point to cover some of the HLF for financing reasons. At the very least, it ties up capital that could be used elsewhere.
As it stands, the chances of a short-term squeeze have enhanced dramatically. Icahn has set himself up to reap some substantial rewards. But if for whatever reason Ackman also had to cover the HLF short, that would really be the "strawberry on the ice cream" for Icahn.
Additional disclosure: I am long May 45 Call Options