Herbalife (NYSE:HLF) investors awakened this morning to a fantastic article written by NY Post columnist Michelle Celarier, which can be found here. The article exposes potential director liability and further evidence of Mr. Ackman's relentless and precise campaign against this pyramid scheme. One has to wonder how many sleepless nights Herbalife's most senior people have had in the past year. I am curious to find out which board member resigns first and which executive turns state's evidence first - quite the Prisoner's dilemma.
In this article I would like to discuss a couple of things. The first is Carl Icahn.
Carl Icahn does not like Bill Ackman. This is common knowledge. Mr. Ackman defeated Mr. Icahn in a court case. Elephants never forget they say. Whether or not Mr. Icahn has a revenge motive as part of his Herbalife investment is hard to say. Still, sometimes in life we bite off more than we can chew.
I would like to draw investors' attention to Mr. Icahn's original 13 filing on Herbalife. This document can be found here. Specifically, I think all investors should focus on the timeline of Mr. Icahn's purchases. Pershing Square made its original presentation to investors on why Herbalife was a pyramid scheme on Dec 20, 2012. This presentation was made after more than a year of in-depth due diligence into Herbalife's business model, the case law. etc. Mr. Icahn initiated his first purchases of HLF common the very same day and then continued to buy aggressively over the coming weeks.
Q. Is it reasonable to conclude that perhaps Mr. Icahn's due diligence into this company was a tad on the skinny side? Is it possible that this trade was not just about a compressed valuation but also an opportunity for revenge?
Hard to say. But, here's what we do know. As Herbalife common climbed from $30 per share to $80 per share through most of 2013, Mr. Icahn started to strut like a peacock. During almost every interview he granted on TV he was not shy to take an ad hominem swipe at Mr. Ackman. Mr. Icahn built his position to 17 million shares. My abacus tells me that 17 x $30 = $510 million. This is the mark to market give back Mr. Icahn has surrendered since the start of 2014. Meanwhile, Mr. Ackman took advantage of the run-up in HLF shares to add to his short position and lever it with puts.
This begs the question: Who is getting squeezed now?
Through my lens, Mr. Icahn has invested in a criminal enterprise and crossed over to the dark side by accepting two board seats. The FTC's investigation is destined to turn up numerous legal transgressions.
For starters, the company violates the Clayton Act, which is an anti-trust violation by charging its distributors different wholesale prices for product. This is called price discrimination and it is a no-no. I could go on, but by now investors should be more than familiar with the harmful practices applied by this company's chief recruiters and its culture of deception.
At this point, if you are long Herbalife, it strikes me that you have to consider the following question. Does the FTC negotiate with criminals or not?
The idea that Herbalife's Marketing Plan is going to survive an investigation with a clean bill of health seems downright preposterous at this point. Investors seem to be awakening to this truth as Herbalife common has backed off from $68 to $50 per share in less than two weeks. Yet still, I remain amazed by the optimism embedded in the market cap of roughly $5 billion.
As Quoth the Raven highlighted in a recent article found here, how much of this support for the stock is blind faith placed in Mr. Icahn? How much of it is support offered by the company's buyback program? How much is simple inertia or outright delusion? I wonder to myself, if there a data point or announcement that might cause Mr. Stiritz to question his thesis and cut his losses? Hard to say.
Right now if you are a Herbalife long, it strikes me that your best case scenario is an FTC Consent Decree. Rest assured, the Herbalife Marketing Plan as it is written today is as good as dead.
- Exaggerated Earnings Claims will not survive
- Lead Generation Businesses will not survive
- Price Discrimination will not survive
- Selling Supervisorships instead of Product will be a thing of the past.
And so, you now have to discount into your analysis of the company the following simple question:
What is the intrinsic value of Formula 1 shake mix when divorced from the perverse incentives the pyramid scheme proliferates with its Get Rich Quick scam? How much of this over-priced placebo will the company sell in the future?
Make no mistake if you are long, a Consent Order is likely your best case scenario. Your worst case scenario is a stock price that goes to $0.
Unless, of course, you are an executive or board member in which case, according to Mr. Ackman, your liability may be unlimited.
Mr. Icahn may be staring squarely in the face of a complete reversal of fortune. Not only might he give back 100% of his mark to market profits on this trade but he may burn his original capital too. Now layer on potential damages due to a breach of fiduciary duty as a director of the company and the entire foray into HLF common could turn out to become a total dog's breakfast.
How he gets off his 17 million share position now escapes me entirely.
Yogi Berra famously said "It ain't over til it's over."
Seemingly every day, longs aren't sticking around to find out who gets left holding the proverbial bag.
Then again, isn't schadenfreude what's really at stake here between Mr. Icahn and his young nemesis?
Judging by the timing of his initial purchases, one has to think "Yes."
Investment thesis: Herbalife is a criminal enterprise that will be shuttered by regulators. I remain short the stock.
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.