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When Carl Icahn disclosed his massive stake in Herbalife (NYSE:HLF) in the middle of February, Bill Ackman was quick to comment:

"We invest based on a careful analysis of the facts. After 18 months of due diligence, we have concluded that it is a certainty that Herbalife is a pyramid scheme. Our conclusions are unaffected by who is on the other side of the investment."

Bill Ackman was confident that he has "proved" or "demonstrated" Herbalife is a pyramid scheme (Slide 60-150 of his December presentation). He was sure about it in December and nothing had changed in the two months for him to alter his opinion in February.

However, we recently ran a series of articles showing that the basic tenet of his argument is wrong. Bill Ackman's unshakable confidence was actually based on his flawed interpretation of what should be classified as recruitment rewards, and what should be classified as retail commissions (direct/indirect). If we apply the same definition of a pyramid scheme he was using and properly classify retail versus recruitment rewards, Herbalife will come out to be a 100% legitimate MLM company. Here are some of the links to our work:

Bill Ackman's Herbalife analyst Shane Dineen was fast to react after we posted our first article. He commented on that article asking us some questions which further demonstrated his lack of the understanding of a pyramid scheme. We were prompt to respond to his questions and we haven't heard from him again. In all likelihood, he now understands that he and Bill Ackman misunderstood the basic concept of retail sales commissions and wrongly classifying $1,740M as earnings with no retail basis.

This is not all, though. There are more errors in his work and we will continue to bring them to Bill Ackman's, Shane Dineen's and Pershing's notice in our future articles. Our aim is to help them better understand the flaws in their arguments.

It is nice to see that in addition to Pershing, some of the sell side analysts are also taking a deeper look at our work. D.A. Davidson analyst Timothy Ramey was recently on CNBC and talked about "a research published recently that has shown that the basic tenant of his (Ackman's) argument is wrong". I believe as institutional investors/sell side analysts continue to take a harder look at Ackman's thesis it won't take much time for them to realize the key flaws in it; and investors, majority of whom are sitting on the sidelines, will continue to become more comfortable with the company's prospects.

One important question Herbalife's bulls and bears have at this point is what happens to Ackman's core short thesis now? Here's the answer.

Success of Bill Ackman's short thesis was based on two components:

  • Mass exodus of distributors so that the company fails. It is definitely not happening which is clear from Herbalife's recently increased guidance for the current year.
  • Bill Ackman "shouting from the roof top" till FTC takes action against Herbalife. I don't see it happening now as mistakes in Ackman's analysis are becoming evident. You can't just coerce a government agency to bail you out of an investment/short which was a result of your flawed analysis. (May be you could if you were bank or insurance company. But alas! It is not the case.)

So, what are Bill Ackman's options?

Option I: To silently start covering his short position. He had a solid disclaimer on slide 2 of his December presentation which frees him from any liabilities.

  • Pershing Square may change its views about or its investment positions in Herbalife at any time, for any reason or no reason.
  • Pershing Square makes no representation or warranty, express or implied, as to the accuracy or completeness of the Presentation or any other written or oral communications it makes with respect to Herbalife, and Pershing Square expressly disclaims any liability relating to the presentation or such communications (or any accuracies or omissions therein).

Option II: To continue raising vague question on Herbalife's ATM machine in Mexico and defending the work of his analyst who, after 18 months of work, cannot even understand the difference between recruiting rewards and retail commissions (direct/indirect).

Option II is likely to increase the chances of a short squeeze as investment community will better understands Herbalife's business model and flaws in Ackman's analysis with time. In addition, Carl Icahn's continued stock purchases (which he, in all probability, will not lend to short sellers) and Herbalife's stock buy back is likely to reduce the float with time.

Option I will mean that Bill Ackman is one lucky man who, despite of being wrong, still has a chance to exit his position profitably (his cost basis for the short was around $50).

I see there is a good likelihood that Ackman will follow Option I and silently start covering his short position. So, when Reuters reported that "the usually chatty" Ackman was not ready to publicly discuss yesterday's development; and telephone calls and emails, which he often returns immediately, went ignored, I was not surprised.

Of course I may be wrong. After all, as Albert Einstein has said, "Only two things are infinite, the universe and human stupidity, and I'm not sure about the former."

Source: Herbalife: Here's Why You Won't Hear Ackman's Defense This Time