I admire Carl Icahn if for no other reason than he doesn't pretend to be something he is not. He is unashamed of his avarice nor his appetite to make money.
When I listen to Michael Johnson, CEO of Herbalife (NYSE:HLF) speak, I get the sense that he considers himself somewhat of a Messiah. An emissary of God curing the world of its obesity epidemic perhaps? But like all faith healers there is something obviously cynical about Mr. Johnson's claims.
Could it be that he is the chief sponsor of an endless chain known as a pyramid scheme that pays him multiple millions of dollars every year?
On Herbalife's Q3 conference call yesterday, Mr. Johnson revealed some exciting changes to Herbalife's Marketing Plan. As part of the company's "Build it Better" initiative(internally referred to as "Build it Better for Me") the company revealed the following alterations to the Marketing Plan.
1. New Members will get to actually see and now must acknowledge the company's annual Statement of Average Gross Compensation when they sign-up. (What took you so long I wonder? How kind of you.)
2. New Members will have to take a training course. I have an idea for the title "HOW TO ENDLESSLY RECRUIT"
3. New Members will now be allowed to return product and/or receive their Money back on their IBP within 90 days with the company willing to pay for return Shipping and Handling on unused product within a year. Herbalife is now in the business of offering Money Back Guarantees.
Sounds benevolent, right? Not a chance.
Aside: Why would a "Member" purchasing strictly for personal consumption need to sign a disclosure and complete a training program in order to qualify as a distributor? HMMMM
Money Back Guarantees are a hallmark of many scams and an obvious inducement to help unsuspecting people sign up for illegitimate businesses. If you don't succeed, don't worry. We'll give your money back.
If only inventory risk was the only risk people take when starting a business. Remember, when people invest in a business money for working capital is not the only thing that they risk. People also risk their reputations, their time, their energy, and their intellectual capital.
Investing in Herbalife's Marketing Plan has an opportunity cost. Specifically, if new Members don't pursue Herbalife they are free to allocate their human and financial capital in other directions.
Herbalife's Money Back Guarantee may now serve as an additional inducement for prospects to join the Herbalife scheme. This kind of outcome is a calamity for low-income Latinos and others around the world. Why?
Let's go back to first principles. Herbalife is a pyramid scheme because its Marketing Plan encourages an endless chain of recruitment.
This endless chain of recruitment bids all profits out of the retail economy leaving only recruiting rewards as the residual income available to plan participants. Herbalife's new Money Back Guarantee is not some arbitrary outcome make no mistake. This new policy is a deliberate effort by the company to immunize itself against a pyramid scheme charge that features inventory loading as an indicia. The company will argue that if they are willing to buy-back inventory then the inventory loading argument is a fallacy. Whether or not that is the case is a subject for debate.
What is not a subject for debate is the following:
- Herbalife's Marketing Plan encourages and endless chain of recruitment and
- All commissions in the plan are paid on product purchases not product sold. i.e. it encourages recruiting over retailing.
Specifically, the company's Marketing Plan does not limit the number of distributorships it grants. In practice, the Marketing Plan encourages the opposite. The company wants each and every geography it competes in to be fully and completely saturated with Herbalife distributors. The logical end state of this incentive system is that the last person in has to lose money because there are no retail customers left to serve.
Evidence of saturation is literally everywhere in Herbalife's disclosures.
- 90% of Members resign
- 50% of Sales Leaders Resign
- the company is reporting flat sequential revenue and operating income growth QoQ
- Specific geographies reveal negative YOY comps (specifically the Asia Pacific Region)
- There is no evidence of any kind of Operating Leverage in the company's S,G & A
And of course, there is the damning piece of evidence known as the company's Annual Statement of Gross Compensation that reveals that most of the people in the world who pursue the business opportunity don't make any money at all.
Plus we have the revelation that Junior level distributors are not distributors at all but just discount customers. Is this evidence of "retail" activity or the level of desperation that upline sponsors have when recruiting new distributors? Better to nurse a new recruit along with some shake samples before hitting them up with the big SUPERVISOR opportunity. No?
But - Good News! Now this compelling non Business Opportunity is "Money Back Guaranteed".
Fear not if you waste your time. Fear not if you work your network of family and friends and associates for goodwill. Fear not if it doesn't work out because the good ship Herbalife will gladly recompense you for your inventory. As for all of the other losses you take. Not our problem. How benevolent.
If you are an investor, don't be fooled by Mr. Johnson's largesse.
Herbalife is a pyramid scheme "Money Back Guarantee" or not. If anything this new guarantee permits Herbalife and its distributors to defraud even more unsuspecting entrepreneurs around the world with the promise of a great business that doesn't exist. If anything Herbalife's "Build it Better" program is even more sinister today than it was before yesterday's conference call with analysts.
- The Herbalife Retail Business Opportunity is a fiction
- Retail Sales at SRP are a fiction
- Retail Profits are a fiction especially for "Members"
- The company recruits ad nauseum with purpose
- The last people in on the marketing Plan get left holding the bag and
- The SEC and FTC need to shut it down
Money Back Guarantees are not a safe harbor for what is obviously a Marketing Plan that is an endless chain. Attacking a specific clause in Webster v. Omnitrition does not neutralize the endless chain argument. Nor does it change the fact that Herbalife's Marketing Plan obviously meets the Koscot test.
If Herbalife wants to truly "Build it Better" here's a list of ideas for Mr. Johnson to really get excited about.
- Start capping the number of distributorships/memberships you give out by territory.
- Grant your Sales Leaders territorial exclusivity.
- Reduce the number of levels in your MLM.
- Pay commissions based upon retail sales not purchases.
- Flatten your wholesale pricing.
Maybe then your distributors might actually be able to make some money for themselves instead of just for you.
Just please stop advancing gobbledygook to the investing public about what a great business opportunity Herbalife is for low-income Latinos.
Also, riddle me this? What marketer with a product that actually had material Brand Equity would give away distributorships like candy? Does McDonald's (NYSE:MCD) give out franchises on every street corner? Does Coca-Cola (NYSE:KO) let anyone on earth sell its syrup? Of course not. The entire premise is absurd.
If F-1 shakes were the unique cure for obesity that you claim it to be your distributorships would be worth a fortune - not worth $59 to anyone with a heartbeat.
Of course the reason Herbalife gives out distributorships like candy to anyone with $59 and a heartbeat is because all of the economic value in this business model lies in recruiting distributors not retail sales. The over-priced powder is a ruse. The distribution model is a pyramid scheme.
As for the Messiah act? Healing the obese one shake at a time? Why would such benevolence require a Money Back Guarantee at all?
Herbalife is a Short. Hopefully the SEC will shut it down sooner than not.
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.