On Thursday, January 23rd, Massachusetts Senator Edward Markey sent letters to the SEC, the FTC and the board of nutrition multilevel marketer Herbalife (NYSE:HLF), requesting more information about the company's business practices.
There is nothing nutritional about possible pyramid schemes that promise financial benefit but result in economic ruin for vulnerable families...Herbalife may be a purveyor of health and wellness products, but some of its distributors are suffering serious economic ill-health as a result of their involvement in the company. I have serious questions about the business practices of Herbalife and their impact on my constituents.
There's little about Herbalife that hasn't already been shouted from the rooftops. The epic clash of the titans between Icahn and Ackman over the company's legality was one of the most followed financial stories of 2013. And as Bloomberg notes, Senator Markey is only a junior member of the Senate Commerce, Science & Transportation Committee, and has no power to initiate a hearing on his own initiative.
What the Senator does have is the power to request a hearing from the Committee Chairman Senator Jay Rockefeller IV and Ranking Member Senator Thune. Such a development would be ominous, indeed; but in the absence of an FTC or SEC investigation, the odds of Herbalife being slaughtered by Committee in an era of divided government are slim to none.
And while Ackman will no doubt put together a formidable PowerPoint presentation, his financial interest in a negative outcome for the company will mitigate against him. China is cracking down on everything in an attempt to mirror Singapore. The fact that Senator Markey had to submit a formal request to the FTC and the SEC at all says a lot about where those agencies are in terms of making a move against Herbalife.
Expiry of 16B
On March 19th, 2013, I posted the following public service announcement:
In brief, what section 16 states is that if you're a) a beneficial owner, b) up your stake in the company, c) don't hold that stock for 6 months, and d) the value of the stock subsequently declines, you can be sued by the remaining shareholders for the difference between the price you bought at and the price you sold. (Unless you were forced to sell at a loss, in which case, you're free to exit the trade.)
When Interests Align
One reply I received to my original article stands out in light of Thursday's developments, namely:
That was true in March of 2013, but is it true today? I think so. Yes, the expiration of section 16 means that Icahn can now exit the trade, but that doesn't make it profitable to do so. With 17% of the float Herbalife is now effectively a subsidiary of Icahn Enterprises (NASDAQ:IEP). Yes, Icahn has already punished Ackman's short position to the tune of hundreds of millions in paper losses, and those paper gains might very well evaporate if the FTC or the SEC comes down on Herbalife like an avalanche.
However, Icahn's position (16,966,485 shares) is too expensive to hedge and all but impossible to unwind without absorbing substantial losses. One letter to the SEC doth not an investigation make, and Herbalife has a lot of heavy hitters matching IEP's play, including Fidelity Investments (12,836,374 shares), Soros Fund Management (5,039,175 shares) Morgan Stanley and BlackRock Investment Trust (2,030,970 shares).
A Contrarian Conclusion
Given Mr. Icahn's knack for financial engineering would be to do just the opposite and use his clout with the board to lobby for a bigger buyback, a special dividend or even a spinoff. Investors may wish to consider taking a contrarian position and buying on weakness in light of these incentives.