Seeking Alpha
What is your profession? ×
Long/short equity
Profile| Send Message|
( followers)

Herbalife (NYSE:HLF) investors awoke this morning to the news that Mr. Bill Stiritz (and family) have increased their stake in Herbalife to over 7% of the company.

The 13D/A can be found here. The cover page could just as easily read "How to lose $10 millon in 30 days" but mark to market losses only become permanent as and when an investment thesis plays out.

I am fascinated by Mr. Stiritz's involvement in Herbalife for a number of reasons.

Recall, Mr. Stiritz is still the chairman and CEO of a public company POST that primarily sells breakfast cereal. Background on POST's business can be found here. This company has over a 100-year tradition and sells many trusted brands. The company's business plan is to win market share at the breakfast table. Full Stop.

Mr. Stiritz is also 77 years old and obviously very wealthy. His position in Herbalife has been purchased in his personal account, and now exceeds $200 million. This is certainly not chump change.

Herbalife is in the meal replacement business. Its top product is Formula 1 shake mix. As such, Herbalife's business plan is to compete for market share at the breakfast table with the likes of POST.

For starters, I have wondered from the get go.

Why is the CEO of a public company buying shares of a competitor?

Why is the CEO of a public company lending his gravitas to a company that is the target of a pyramid scheme probe?

How is any of this okay with the POST Board of Directors?

As time has gone on, the story has become even stranger. This past week, we learned that POST has hired Mr. Tim Ramey as a consultant. As I read this headline, Mr. Ramey's move struck me immediately as a patronage appointment.

Why is POST paying Mr. Ramey's salary? Did they post the job internally and externally? Were minority candidates interviewed? Was the best candidate chosen from a pool of applicants?

Again, what does the POST Board of Directors think about this transaction?

Investors who are long HLF should understand that Mr. Stiritz's personal account and POST are not the same animal. If anything, the fact that Mr. Stiritz owns so much Herbalife common personally introduces an obvious conflict of interest in his duties as POST's CEO.

What do I mean by this?

Longs seem to hold out some hope that POST may be a potential acquirer for HLF in an LBO. This hope was amplified by Fox News, when it was reported that Mr. Ramey had joined the company.

Q. How does POST buying HLF help anyone other than Mr. Stiritz's personal account? Isn't even the idea of such a transaction a complete shark jump as it applies to sound corporate governance and ethical behavior?

Many investors may recall how David Sokol blew up his career at Berkshire Hathaway (NYSE:BRK.A) by introducing his mentor, Mr. Buffett, to a company that was acquired. Later on, it was discovered that Mr. Sokol's personal account was enriched when the deal closed. Presto. Career over.

Whether or not Mr. Stiritz has designs on Herbalife as a private company, investors should be aware too of the following realities.

Whether or not HLF is private or public does not change its pay plan, and therefore does not change whether or not it is an illegal pyramid scheme. Fortune High Tech Marketing was shut down by regulators as a private company.

Herbalife as a private company is also no less of a competitor for POST.

I must admit, I don't really understand fully what Mr. Stiritz is up to. For certain we know he seems to love HLF. He has gone so far to call it a "national treasure". He has thrown down the gauntlet with Mr. Ackman too. "May the best analyst win." His 13D also reveals that he acquired shares as recently as January 24th after the stock price fell from $80 to $60. His conviction seems genuine.

As for his exit strategy, your guess is as good as mine.

Option 1 - POST buys HLF in an LBO

This outcome seems highly unlikely for a number of reasons.

  1. Conflict of Interest between Stiritz PA and interests of POST shareholders
  2. $1.8 billion company acquiring an $8 billion company is risky
  3. POST Board may be reluctant to tie the 100-year POST franchise to HLF

Option 2 - Stiritz and Icahn take HLF private

This outcome seems more likely than Option 1, but still:

  1. Big debt raise required on the order of $5-$6 billion
  2. Unclear how Icahn exits post privatization
  3. Pyramid scheme allegation remains outstanding

Option 3 - Hang on for the Ride

This outcome seems most likely for the following reasons:

  1. Valuation is suppressed during investigation cycle
  2. Company can aggressively buy back shares at accretive valuation if the business model holds up
  3. If exonerated by an investigation, clear skies should lead to multiple expansion
  4. Leaves Stiritz and Icahn to vend their shares into a healthy secondary market

Of course, for Option 3 to be successful, Mr. Ackman needs to be wrong and Mr. Icahn and Mr. Stiritz need to be right.

I am not a POST shareholder, but if I was I would be very uncomfortable with Mr. Stiritz's very public support of Herbalife.

It is my hypothesis that DA Davidson grew equally uncomfortable with their connections to this company. Like it or not, POST's reputation is now tied to Herbalife's fate. Perhaps this is important, Perhaps not.

What is certain is the following. Mr. Stiritz is clearly up to something. Whether he is acting in concert with Mr. Icahn, alone or otherwise - time will tell.

Together these two individuals own over 25% of HLF common through their personal investment vehicles. This is a large amount of the float that rests in friendly and seemingly committed hands.

Frankly, I am not sure why a 77 year-old would take a huge percentage of his life's earnings and sink them into an opaque company like Herbalife that is an alleged pyramid scheme. Then again, it's not my money to toy with.

Mr. Stiritz has set himself, very publicly, to be either a hero or a goat in the Herbalife tragedy. With Herbalife at $80 in December, he could have been a seller and rode off like Dan Loeb with a healthy profit. Instead, he has acquired over 800,000 new shares at prices around $80. So far, this trade is underwater.

How it turns out is anyone's guess.

Has Mr. Stiritz "jumped the shark" or is he crazy like a fox?

We are sure to find out soon enough. One thing seems certain. Mr. Icahn and Mr. Stiritz don't seem to be going anywhere anytime soon.

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.