Herbalife's Shaky Ground Disguised As Good News?

| About: Herbalife Ltd. (HLF)

Herbalife (NYSE:HLF) bulls have gotten some good news, amongst the bad, over the last couple of weeks. Bill Stiritz is stepping to the forefront, ahead of Mr. Icahn, as the face in the spotlight for Herbalife bulls - hiring (likely fired) analyst Tim Ramey, upping his stake in the company to 7.39%, and concluding that "[Herbalife] has a sound business model, a strong distribution system and a positive outlook for long-term growth opportunities."

And then, look at this slew of good news served up to us this morning, Monday, in concise bulleted form by Seeking Alpha:

  • Herbalife expects Q4 adjusted EPS of $1.26-1.30, well above consensus of $1.17.
  • The company also projects net sales growth of 19.8% vs. estimates of +15.5%, and volume of +12.7%.
  • The company increases its stock repurchase program to an available balance of $1.5B; the previous $1B plan had a balance of $653M.
  • Herbalife sees Q1 EPS of $1.24-1.28 vs. estimates of $1.40, with the figures hurt by $0.20 in adverse currency fluctuations. (PR)
  • Herbalife intends to pay for the buyback by offering $1B of five-year convertible debt, with the initial buyers being BofA, Credit Suisse, HSBC and Morgan Stanley. The banks have an option to purchase another $150M.

Wow, a buyback increase! A slam dunk fourth quarter! Look at all that great news - great news, mired in other - less interesting - news for bulls. It's when you scratch a little bit below the surface here and start to think of this news from a forward-looking perspective (as opposed to what are you doing for me today?) that the questions start to pop up.

  • Herbalife is guiding for a poor first quarter and blaming it on currency fluctuations. This could point to the company's exposure in the "emerging markets" that are currently the cause of the market's pain. Or, it could just be an excuse. Either way, the company is expecting Q1 to come in light.
  • The bank is offering $1 billion in five year convertible notes to finance a buyback. I may be old school, but that reads to me: we're going to issue debt, buy the shares back, then reissue those shares again. This goes to show that the company needed a way to finance this buyback to make the point that they still can do it for shareholders. However, financing it with convertible debt definitely isn't the most ideal way to do it. It's not truly a buyback, it's just shares being moved around on the balance sheet.

Additionally, while this is all taking place, we have the subplot of regulatory scrutiny bearing down on the company. As the executives "engineered" another great quarter for the company, two things loom: continued regulatory scrutiny and questionable guidance.

The market seems to get this. Herbalife was up 5% pre-market today, and is now trading lower, albeit amongst a macro market that's shedding points.

It was reported Sunday night by the NY Post that the U.S. FTC chief is going to be meeting with consumer activists with regards to Herbalife acting a pyramid scheme:

Federal Trade Commission Chair Edith Ramirez is feeling the heat.

One week after Sen. Ed Markey (D-Mass.) sent the FTC boss a letter asking her to investigate Herbalife, Ramirez agreed to meet with minority and consumer activists to hear their pyramid concerns about the company, The Post has learned.

Brent Wilkes, executive director of the League of United Latin American Citizens, which asked for the meeting Jan. 27, said more than a dozen activists from around the country will also meet with Ramirez on Feb. 5.

The group, while in Washington, will bring former Herbalife distributors, who say they are victims of the company's alleged pyramid activities, to meet with Congressional representatives.

The meeting with Ramirez is the latest effort by critics of the nutritional supplements distributor to press regulators to probe Herbalife. Last week, Rep. Linda Sanchez (D-Calif.), who last year asked the FTC to look into Herbalife, held a briefing on pyramid schemes for staffers of fellow lawmakers.

I wonder what Shane Dinneen is up to tomorrow.

Anyway, for those that are keeping score at home, over the last two weeks this represents:

  • Chinese scrutiny over Nu Skin (NYSE:NUS) forcing media scrutiny of Herbalife and MLMs
  • NY Post reporting that Canada has launched a probe into Herbalife's business model
  • A letter written by U.S. Senator Ed Markey urging the FTC to investigate Herbalife
  • Rep. Linda Sanchez held a briefing on pyramid schemes with lawmaker from several other states
  • Our first real report that the FTC in the U.S. acknowledges that there's something worth looking into with Herbalife

I say, "where there's smoke, there's a fire".

There are way too many red flags for investors to seriously consider Herbalife as a long-term investment vehicle for their portfolio. We know the company is going to come in lower than expected for Q1 and we know they are taking out less than desirable debt to finance a buyback - a move that seems like simply throwing the buyback on the 22% APY credit card just so that you can say you did it.

I remain extremely cautious of Herbalife for the long-term.

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.