Herbalife (NYSE:HLF) investors woke up today to an article out of China articulating that Nu Skin (NYSE:NUS) is being investigated by Chinese authorities for sponsoring a "cult like" business model. News like this is interesting. Let's say that I wake up today and it is a bright and sunny day. Evidence that the sun is shining today is not evidence that it will be sunny tomorrow. Or the next day for that matter.
Herbalife longs have settled-in with a level of complacency, it seems, as it applies to the litany of regulatory risks facing the good ship Herbalife. Herbalife common trades around $80 or $8 billion market cap. Is this the present value of the future cashflows HLF equity investors will receive from the company over time?
Don't count on it.
Let's be clear. If you are long Herbalife common you are a speculator. Specifically, you are speculating that government regulators around the world are going to allow Herbalife to skate away scott-free from the cornucopia of allegations leveled against it by Pershing Square and other whistle blowers.
Herbalife is currently running the gauntlet, so to speak.
We know categorically that the SEC is investigating the company.
We know that the FTC is watching the diet and weight-loss space.
We know that there are company insiders who are acting as whistle blowers with regulators.
We know the Chinese authorities are skeptical of the Direct Selling business model.
We know Pershing Square is forwarding reams and reams of evidence of illegal marketing practices to state and Federal regulators.
We know that hundreds of thousands of Herbalife distributors quit the scheme every quarter.
We know that Herbalife continues its geographic assault around the world.
We know that the scheme produces windfall profits for executives, shareholders, and recruiters.
We know that the folks at the bottom of the barrel don't make money at all.
Why anyone who is long would conclude that Herbalife is out of the woods escapes me.
In less than 48 hours, Nu Skin's share prices has fallen from over $130 per share to $90 per share. Poof, this equity value evaporated overnight.
In all likelihood, this is a harbinger of what is to come for Herbalife longs too.
Definitively, we know that Pershing Square will be making a presentation to demonstrate how Herbalife violates China's direct selling laws. It would seem that Beijing is paying attention.
Picking-up nickels in front of a bulldozer is a dangerous way to invest. All it takes is one bad headline to wipe out your capital. What might we expect to read over the next calendar year?
Would it be preposterous to read that:
China is investigating Herbalife or
Mr. Icahn is selling his long position or
The SEC has concluded its investigation with an indictment or
The FTC has uncovered evidence of deceptive marketing practices or
the NY Attorney General has uncovered evidence that Herbalife sponsors an endless chain?
What are the odds that "all of the above" might happen?
To be long Herbalife here at $8 billion so many things have to go right. The company must continue to recruit successfully to replenish the hundreds upon hundreds of thousands of distributors who quit every year for starters. Then you have to dodge all regulatory bullets too, not to mention what will inevitably be a relentless campaign by Pershing Square to derail the Herbalife pyramid scheme.
Dark days lie ahead for Herbalife even if it is sunny today. Two days ago all looked swell for Nu Skin until overnight the darkness settled in.
Herbalife longs who ignore this lesson do so at their own peril.
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.