The ongoing saga of Herbalife (HLF) continues to grab headlines, especially since the controversies and the subsequent gyrations in HLF shares have centered upon high visibility characters and their actions, more than metrics and fundamental analysis. The Ackman vs. Icahn struggle is like a "title bout," and it has taken on story-book, if not comic-book proportions. Indeed, the drama continues to grow, and the multi-billion dollar stakes have attracted the attention of average investors, the moguls of Wall Street and the 2.7 million Herbalife distributors in 75 countries around the world. Finally, adding additional fuel to the fiery story is that Mr. Ackman's claims actually threaten the very existence of HLF, so it's not just a controversy based upon differing opinions about valuations.
In the past several months, I've written two articles concerning HLF which were published on Seeking Alpha. The first article provided an overview of HLF's business model, and the second addressed the prospects of Mr. Icahn taking the company private. In both articles, I was a supporter of HLF, and I've been bullish on its stock. I continue to believe that shares of HLF are still undervalued and can offer investors substantial upside potential, but investors should be aware of the inherent risks associated with a potential "going private transaction" and a stock that trades off headline news on an almost daily basis.
The Tale of Two Titans
As most everyone knows, in December 2012, Mr. Bill Ackman (Founder of Pershing Square) dramatically, and in a "Don Quixote" like fashion, announced that Herbalife was a scam, a pyramid scheme, and that it should be put out of business. He literally called upon FTC regulators to rid the planet of the "evil" HLF business scheme. Not surprisingly, he also announced that Pershing was short some 20,000,000 shares of HLF stock, and he expected it to go to zero. Spurning the very basic tenets of Wall Street, he ostentatiously proclaimed that all of his profits from his HLF short position would be donated to charity.
Alas, and to make for a really terrific story, Mr. Carl Icahn, the legendary billionaire, corporate raider, shareholder activist, and archenemy of Mr. Ackman, entered the fray as the swashbuckling supporter of HLF, who possessed "Superman-Like" strength, and more importantly, billions of dollars, to rescue HLF from the ominous Ackman bear raid.
Mr. Icahn's first move was the purchase of 14,015,151 shares of HLF stock, representing approximately 13.6% of the Company. In his SEC filings relating to the transaction, the activist tycoon suggested the prospects of a recapitalization or a going-private transaction. HLF shareholders should be delighted, and Mr. Ackman should be horrified. Shortly after the announcement became public, shares of HLF jumped 10 points in the after hours market, exemplifying the power Icahn wields in the eyes of investors.
A Step Toward a "Buy Out" - Icahn's Agreement with HLF Management
From the perspective of HLF management, Mr. Icahn is obviously the guy wearing the "white hat," and on Friday, March 1, 2013 the Company announced that it had reached an agreement with Mr. Icahn. The headline news announced that HLF had agreed to provide Mr. Icahn with a two seat representation on its Board of Directors, and the right to increase the size of his ownership position in HLF up to 25% of the outstanding common stock. In my view, this extremely material event confirms the alliance between Mr. Icahn and the Company, and the accord also confirms Mr. Icahn's serious interest and commitment to HLF and his strong belief in the underlying value of the Company.
In Summary - Here's the Bottom Line.
Mr. Icahn's position is based upon fundamentals which tell him that HLF is undervalued and has great upside potential. Mr. Ackman's position is not based upon any fundamental analysis, but to win his multi-billion dollar bet, he "hopes" that regulators will intervene and find that HLF is an illegal pyramid scheme. After HLF operating for some 32 years, I don't believe that's ever going to happen. In my view, when objectively analyzing the facts, the history of HLF, the industry and the FTC regulations, Mr. Ackman's position is untenable.
Since I agree with Icahn's position, and consider HLF a legal and a well established global enterprise, I believe that a huge short-squeeze is about to occur which will result in significant profits for HLF shareholders and massive losses for Mr. Ackman and his company.
Understanding the MLM Business Model
The buzzwords of "pyramid scheme" and "scam" used by Mr. Ackman attracts attention, but have no place in reality. In my view, Mr. Ackman and other HLF detractors don't truly understand the dynamics of the HLF model.
In its most simplistic form, the MLM direct sales model is a method of distribution. Unlike traditional distribution methods where the manufacturer of a product sells the item to retailers at a substantial discount so the retailer can generate a profit, MLM companies sell their products to distributors at a discount to the suggested retail price so they can re-sell the product at a profit or use the product themselves. While Mr. Ackman has criticized the percentage of distributors who consume the product instead of selling it to others, the actual goal is to develop a base of consumers.
In the case of HLF, upwards of 71% of the distributors are simply consumers of the products and come on board as "distributors" to enjoy the discounted price. In my view, this is a good thing, not a negative.
Concerning earnings of distributors which Mr. Ackman cites as proof of a scam, the MLM model is just like any other business. In the retail sector, for example, there are small owner-operated retailers that earn a modest living, while there are huge companies that generate huge profits re-selling products.
Broad criticisms such as those leveled by Mr. Ackman are suspect and aren't supported by facts. A MLM business model is not, by definition, a "pyramid scheme" or a "scam." For example, in 1979 the Federal Trade Commission issued a decision relating to Amway Corp. which indicated "Multi-level marketing was not illegal per se in the United States."
Furthermore, the FTC advised that multi-level marketing organizations with greater incentives for recruitment than product sales are to be viewed skeptically, and may be a pyramid scheme. The FTC indicated that the practice of getting commissions from recruiting new members is outlawed in most states as "pyramiding." HLF's compensation plan is quite clear and shows that distributors can generate profits by selling its products, and can also generate override commissions on the sales of persons they may recruit into the business, but there's no commissions paid for "recruiting."
Finally, in April 2006, the FTC proposed a Business Opportunity Rule intended to require all sellers of business opportunities (including MLMs) to provide enough information to enable prospective buyers to make an informed decision about their probability of earning money. In March 2008, the FTC removed Network Marketing [MLM] companies from the proposed Business Opportunity Rule. Not withstanding this exclusion, HLF has always, and continues to provide what I would consider to be significant disclosure regarding earnings, it's compensation plan and the statistics relating to distributor earnings.
A Look At the Fundamentals
Like Mr. Warren Buffet (Berkshire Hathaway) who recognized the growth and profit potential of the MLM system, and purchased Pampered Chef in 2003, Mr. Icahn is looking to the metrics and continuing growth of HLF as the basis of his investment. Here are some of the more significant metrics:
√ A 5 year Growth Rate of 25.43%
√ A Price Earnings Ratio of 10.17
√ A Forward, 2014 PE of 7.64
√ A current Dividend Yield of 2.9%
√ Return on Assets (TTM) 26.25%
√ Return on Equity 97.29%
√ A 52 Week High of $73.00 and a Low of $24.24
√ A Current Price of around $41.00
Mr. Icahn may not be Superman, but a Superman isn't needed for HLF stock to go up. The stock will increase in value because of the dynamic HLF business model and the profits generated by it. In my view, it's inevitable that a "going private" transaction will materialize, or that a buy-out will occur.
With Mr. Ackman being short some 20,000,000 shares of the stock (20% + of the Company), and Mr. Icahn leaping onto the Board of Directors, being long HLF is a very good place to be.