Herbalife: Will Icahn Cash Out Sooner Than Not?

| About: Herbalife Ltd. (HLF)

If you've been following Herbalife's (NYSE:HLF) share price lately you will notice the stock has traded into the $70s. D.A. Davidson Analyst Tim Ramey argues that he expects the company to release audited financials forthwith including the announcement of a leveraged share buyback that could total as much as $2 billion. At a price of $75 per share, HLF could theoretically retire 25 million shares on that basis or 25% of the float. This $2 billion program seems aggressive to me, but even if we assume $1 billion of buybacks the float drops materially.

In all likelihood, the company has resumed its buyback program since August 29th. CFO John Di Simone indicated that because the company had visibility on the release of its audited financials that they would be back in the market to the tune of $50 million de minimus. By the time Q3 data is released, HLF's share count could be trending towards 100 million outstanding fully diluted.

HLF's recent share price may have some interesting implications for investors, most notably Mr. Icahn.

Earlier this year, Carl Icahn secured 2 board seats on the Herbalife Board of Directors. In exchange for these seats, Herbalife and Icahn agreed to a standstill provision. The details of this provision were outlined in an 8-K filing and are as follows:

3. Sale Restriction . In consideration of the Company's agreement set forth herein, so long as the Company has complied and is complying with its obligations under the first and second paragraphs of Section 1(a), Sections 1(b), 1(c) and 1(d), and Section 7, and has otherwise materially complied and is materially complying with its other obligations set forth in this Agreement, the Icahn Parties agree that from the date hereof until February 28, 2014, the Icahn Parties shall not, and shall cause their controlled Affiliates not to, directly or indirectly, voluntarily sell any common shares of the Company (or Beneficial Ownership thereof) or any securities convertible or exchangeable into or exercisable for any common shares of the Company (or Beneficial Ownership thereof) (including, without limitation, any derivative securities or instruments having the right to acquire common shares of the Company) unless such sale involves a sale, transfer, tender or other disposition involving a tender or exchange offer (whether commenced by a third party or the Company), or a merger or other business combination transaction that is not in violation of Section 2 of this Agreement.

This Section 3 terminates and ceases to have any effect at such time as the VWAP for a share of the Company's common stock on the New York Stock Exchange (defined as dollars traded for each transaction ( i.e. , price multiplied by the number of shares traded) divided by total number of shares traded) for any five (5) consecutive trading day period is at least $73.00, as adjusted to account for any stock split or stock dividend.

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Investors who follow Herbalife's recent stock price may have noticed that HLF has closed above $73 per share the last two trading days begging the question: "Will Icahn start to cash out?"

Q. What would you do?

There's a saying on Wall St. "Bulls can make money, Bears can make money but Pigs get slaughtered."

Q. Why look a gift horse in the mouth?

If you are long HLF one might assume that Mr. Icahn will continue to be along for the ride, that a leveraged recap is in the cards, that the demand for the company's common shares will skyrocket, and that Pershing Square will be forced to cover their short position unleashing the "mother of all short squeezes."

Alternatively, one could take the view that in all likelihood, Icahn's exit strategy will be to sell his 17% position into the bids the company will be making to retire its shares.

Icahn is "in the money" significantly on his long position in HLF. The rough total is likely $500 million, perhaps more.

HLF may generate $600 million in free cashflow next year. Alternatively, it may not. Recall, 2 million distributors are resigning every year. Last quarter, 700,000 resigned. Continued growth is no certainty.

Additionally, the waters may remain shark-infested if you are long. SEC, FTC, State AG's, Class Action Suits, etc. all have the potential to disrupt the long thesis in a heartbeat.

Does Mr. Icahn like the game of Russian Roulette or not?

If even one bullet in the gun is enough to get regulators to intervene in the HLF business model then HLF's equity could get wiped to $0 per share. This would be one tremendous giveback to make.

Q. If you were "in the money" $500 million, what would you do?

Over the next three trading sessions if HLF's share price closes above $73, Icahn could be a seller. He will be free from the shackles of his standstill provision to liquidate his long position into the marketplace. Alternatively he could, too, hedge his long position in the options market.

Overall, you have to give Mr. Icahn credit where credit is due. If regulatory intervention is a 1 year to 2 year process including investigation, he has arbitraged this time value extraordinarily well in the interim while placing Pershing Square in an uncomfortable headlock in the process.

Does pride go before a fall or not?

Why tempt fate any further?

Why not collect the spoils of this bold maneuver and get out of dodge while the getting is good?

I remain convinced that HLF is a pyramid scheme. It has all the Hallmarks of a pyramid scheme including:

  • Overpriced Products
  • Usurious Gross Margins
  • Exaggerated Earnings Claims
  • High Distributor Turnover
  • No Direct Evidence of Legitimate Retail Sales
  • A Compensation Scheme that encourages Inventory Loading
  • The Lion's Share of Earnings going to the top 10% of Distributors
  • High levels of Internal Consumption
  • Opaque Disclosures and
  • Misleading Accounting

Most participants lose money.

I am confident that an independent assessment of HLF's compensation model by FTC or SEC experts will conclude that the company is a deceptive marketer that markets a business opportunity to participants that is, in practice, a rigged game. What I don't know is "When".

At a bare minimum I do not think any rational investor can handicap the notion that HLF is not a pyramid scheme to 0%. At best, such a conclusion seems like speculation.

If you are long HLF, it may be irrational, too, to assume that Mr. Icahn will remain your silent partner for much longer.

$73 x 5 days in a row is the magic number to watch. After that, Uncle Carl may "hit the bid" and ride off into the sunset.

Dan Leob sung a beautiful song about how HLF was a "serial compounder". Investors who read his letter might have assumed that he was going to own HLF long-term. As it turned out, he took his money and ran.

Nobody ever lost money making money which is why odds may be that Mr. Icahn will be gone soon too.

Mr. Ackman remains convinced that HLF is pyramid scheme. He has not covered a single share of the stock he is short. We are told he has reason to believe that "aggressive, regulatory intervention" may be imminent.

Might it be conceivable that both Mr. Icahn and Mr. Ackman make money on their thesis? That all seems to depend upon who cashes out and at what price.

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.