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Herbalife (HLF) shares have performed well recently and the shares have risen more than 40% in 2013. Investors and analysts are very familiar with the contentious battle between short-seller Bill Ackman and high-profile holder Carl Icahn. As noted, the HLF shares have recovered sharply from the mid $20 level where they first traded after Mr. Ackman disclosed his material short position in the stock.

Market rumors have now focused on possible takeover action with Mr. Icahn seen as the leading investor to take the company private or to encourage an LBO firm to acquire the company. Before HLF investors plan on their closing dinners, however, they should take a close, detailed look at the HLF balance sheet which may not be able to support a 'go-private' transaction.

Over the past several years, HLF has been executing a material stock repurchase plan that has dramatically changed the balance sheet. During the period from 2007 through the first quarter of 2013, HLF reported total net income of $1.92 billion, and operating cash flow of $2.4 billion. HLF used this liquidity to buy back a total of $1.71 billion in its stock. Capital spending over the same period came to just $509 million (from 2012 Form 10-K). On July 30, 2012, HLF's board authorized a new buyback of $1.0 billion which has been utilized to purchase shares through the March 2013 quarter. As of March 31, 2013, HLF had $787.6 million remaining for future share purchases under that authorization (March 2013 Form 10-Q).

While HLF has been profitable over the 2007-present period, the company's stock repurchase program has sharply reduced its total shareholders' equity account. At March 31, 2013, total equity was $342 million, down from $560 million at the end of 2011. Total equity has declined from 38% of total assets at the end of 2011 to just 16% of total assets at March 31, 2013. Net debt has risen to $252 million at March 31, 2013, from a net cash position at the end of 2011, and is now 73% of total equity (i.e., the debt/equity ratio is 0.73). Book value per share is down to $3.40, less than 8.0% of the current $47 market price level.

Two other matters deserve attention. The company is in the process of building a new manufacturing facility in North Carolina that will raise self-manufacture to 65% from the current 30% level (HLF Investor Day Presentation, January 10, 2013). Capital spending needs for that plant will force the company to slow down its stock buyback program or issue new debt to complete the financing for the facility. In addition, the March 31, 2013, balance sheet reports 'Other Assets' of $48 million, and 'Market Related Intangibles' of $311 million (March 2013 Form 10-Q). Any impairment or write-down of these assets could take the Total Equity balance down into negative territory. Surely, banks asked to consider financing a takeover bid will be focusing on this relatively small equity account. Calls and an email request for comment on these items by the company's investor relations office have not been returned. HLF bulls will argue that the net income and operating cash flow easily support the buybacks and could be used to finance a go-private transaction, but investors who ignore a decreasing equity account and equity/assets ratio may regret their decision to wait for a takeover whose financing prospects may be damaged by an already over-leveraged balance sheet.

Source: Herbalife As An LBO/Private Equity Target? Balance Sheet Says Maybe Not