This article is being written as a rebuttal to the article "Ackman Will Lose: Regulatory Action is a Low Probability Event".
Let's look at the executive summary from Achilles Research's bullish article on the company:
- Herbalife (NYSE:HLF) booked an important victory by securing a clean audit from PricewaterhouseCoopers.
- I judge regulatory action with the intention of shutting down Herbalife to be of extremely low likelihood.
- The long side of the trade consists of highly successful value investors with a convincing long-term track record.
- Leveraged Buyout/Taking private transaction would be major catalyst for Herbalife's stock.
And now, let me present a rebuttal to each one of these points.
1. Herbalife did not book an important victory with the PwC audit.
Yes, the audit was certainly a point of contention and there was no doubt that Ackman was pushing for PwC to try and find certain items in the financials worth questioning. At the end of the day, PwC issued a clean audit.
However, one Jim Cramer was very quick to point out that the purpose of an audit isn't to investigate whether or not the company's business model is viable, it's to ensure that the numbers reported have been done so accurately, and in accordance with generally accepted accounting principles.
Reminder, companies like Enron all had audited financial statements signed off by major companies - this did not preclude them from having a non-viable business model.
2. Regulatory action is already taking place and could get broader.
It's already been reported that Canada's regulatory agencies are looking into Herbalife. Additionally, China's recent inquiry into Nu Skin (NYSE:NUS) and a U.S. Senator's plea to the FTC to investigate Herbalife also shed light as to sentiment with regards to regulators. Most recently LULAC came out on Bloomberg TV and called the company a "scam" and "fraudulent".
As the wheel gets squeakier, the FTC is more and more likely to reach for the grease.
3. The short side of the trade also consists of a highly successful value investor with a convincing long-term track record.
Yes, there are whales on the sides of the longs - no questions asked there. For how long? Who knows. It has been my argument that Icahn, Stiritz, and others got themselves into this trade sans proper due diligence and for personal reasons (to try and squeeze Ackman out). With the squeeze thesis off the table due to Ackman's restructuring, it could possibly become a game of trying to draw out HLF to get Ackman to bleed theta. The market, however, has been on Ackman's side so far this year.
Again, Mr. Ackman is a guy who went up against the world (similar to the way he's doing here) with MBIA (NYSE:MBI) and ultimately made a boat load of money off of his contrarian thesis. So, it's not as if there isn't a track record of success on the short side.
4. Regardless of an LBO or being taken private, both unlikely, it doesn't change the business model.
"A rose by any other name would still be a pyramid scheme". Shakespeare said that - or, something like it. The point is that regardless of whether Herbalife is public or private, the company continues to remain non-viable.
With this new $1 billion in debt on the balance sheet, an LBO seems extremely unlikely. Regardless, should it happen, it doesn't change the main tenants of the company and won't help the company elude regulatory scrutiny.
Finally, let's look at AR's point to the shorts' main thesis, which is that the company will eventually be shut down with regulators:
The second pillar of Ackman's thesis relates to regulatory action, domestic and/or abroad, that would classify the nutrition and weight loss company as a pyramid scheme. I personally think that regulatory action is a low-probability event. Regulatory agencies have educated, experienced staff at disposal that has dealt with multi-level marketing companies before. Regulators now have had more than a year time to conduct the necessary due diligence.
And you have to ask yourself as a long investor in the company - the FTC saying nothing with regards to HLF for a year - does that qualify as validation? Absolutely not. Don't be tricked into thinking that this is validation by omission - regulatory agencies have been known to take their time, get things right, scrutinize over every deal, and then act accordingly. Sometimes, that takes well over just one year.
While I'm sure that AR is right when they state that regulatory agencies have experienced MLM people on staff, that would be more the reason for me to worry. Herbalife is, as defined by the SEC's own nomenclature, a pyramid scheme. If the regulatory agencies don't figure it out right away, the public will continue to. When the outcry for action continues, regulators will have no choice but to look at the cold hard facts: Herbalife's products are nothing special and are overpriced, distributors recruit more than they sell, 99% of distributors don't make a livable wage, and the company doesn't have a clue as to whether its product is being bought by recruits or sold to retail.
This isn't exactly the argument that should make people want to go in on Herbalife with a long position.
But, as time unwinds, more of the story will be clearer. I continue to argue that Herbalife remains a massive risk, and should be avoided as an investment vehicle for anything other than a short position.