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Summary

  • FTC investigation into Herbalife will likely result in changes to the MLM industry.
  • Other MLMs are preemptively starting to reform their business models.
  • The FTC has "guns" and they're not afraid to use them.

"I always want to stay on the good side of the FTC because they have guns"

- Vemma CEO, Benson K. Boreyko

I bet Bill Ackman is content, despite the fact that people continue to bid up Herbalife (NYSE:HLF) shares for some strange reason. His fund had a great first quarter, and he's on the path to regulatory success with Herbalife. As shares rise, I continue to add to my short position. I would imagine Ackman is doing the same.

So much of Ackman's original presentation and public spotlight was simply to get regulators to begin looking into the company. Once there, he often assumed the rest of the story would take care of itself. I tend to agree.

After reviewing the evidence presented from both sides of the case - both the bears and Herbalife - it seems like the FTC simply issuing Herbalife a "clean bill of health" is a fallacy at this point. There's too much to be concerned with at Herbalife. Pick one: inventory loading, commodity products sold at higher than normal prices, endless recruiting chains, lead generation, promises of making $10k/month by a member of Herbalife's own Board of Directors, nutrition clubs - the list goes on and on.

As such, as I realize it could take a while for this FTC investigation to play out - as the regulators are methodical and careful in their approach no doubt - I'm simply going to continue to buy long-dated puts and add to my short position. No matter what outcome comes from the FTC investigation, it's likely to be materially negative for Herbalife, whether it's shutting down its entire business up front, or changing MLM sales rules that will prevent the company from its faux-growth as it churns in-and-out 3 million new distributors every year.

Action taken in the U.S. will likely set a precedent for other countries to investigate how the company, which is actually based in the Cayman Islands, is being run in their countries. For instance, if the U.S. acts on Herbalife before China does, China is likely to be paying damn close attention.

And, apparently, so are other MLMs.

Michelle Celarier reported yesterday, via the NY Post:

Vemma, the high-flying company behind Verve energy drinks, wants to stay off regulators' radar.

Founder and CEO Benson K. Boreyko said the nine-year-old multilevel marketing company is changing its business practices to get ahead of any possible fallout from the Federal Trade Commission's investigation into Herbalife, which has a similar business model.

"I always want to stay on the good side of the FTC because they have guns," Boreyko told The Post.

Vemma, which recruits students to sell its caffeine-fueled drinks on college campuses, will no longer require salespeople to make minimum monthly product purchases of $150 to qualify for commissions. The company will also end sign-up fees.

The changes, which went into effect on April 1, set Vemma apart from many MLMs, including Herbalife, which requires distributors and their sales recruits to make minimum product purchases of more than $2,000 to qualify for royalties.

Even those uninterested in recruiting have to buy an introductory "member pack" and pay an annual membership fee after the first year.

Let's think about this - if MLMs are legal, and Vemma isn't being investigated why would the CEO voluntarily start to change the makeup of his $200 million business?

And, why choose to change the two items that he did?

As we know, two of the biggest arguments against Herbalife are that you must purchase $3,000 worth of product to reach "supervisor", the level where you can start to make money off of recruitment. Vemma is doing something similar to volume points in making salespeople make $150 monthly purchases in order to make money recruiting. Same shtick, different business - at least Vemma is getting wise.

Additionally, the company is ending sign up fees. A lot of MLMs call these "initial investments", but they're really just "funneling your money to the top of the pyramid." Notably, these are the items probably cited first and foremost by those who feel they've been bilked by MLM companies.

Herbalife, on the other hand, seems to either be demonstrably ignorant of the plan that they're perpetuating, or is simply waving their tail in the air at the FTC yelling "come get me". No matter what action the FTC takes, they're likely to end Herbalife as we all know it. Again, the question is whether it is going to be a slow bleed, or a quick death in the U.S.

This also comes on the news out this week that Whitney Tilson continues to reaffirm his questions surrounding Herbalife's business model. Additionally, Jim Chanos was on CNBC yesterday morning and with regards to Herbalife said that he "sides with the bears".

Combine this with the precedent that was set days ago when the SEC shut down another pyramid scheme, and it's looking pretty grim for Herbalife, to be honest. As the stock continues to trade upward, back to pre-FTC levels (which baffles me), I'll continue to get short.

Also, anybody catch the $400 million charge GM is going to be taking in Venezuela due to currency rebalancing? Isn't Herbalife in Venezuela, and don't they have cash located there, as well?

Again, as I stated in my last article, this is now a waiting game:

The reason the SEC/FTC et al. have not acted yet is because this is an extremely complicated case concerning an extremely complicated company. Regulators like to take their time, think critically, and get their work done right. This has to be a slam dunk if they're going to go after it, so it's going to take some planning. Planning that, no doubt, should result in a negative outcome for Herbalife.

I remain short Herbalife and have full confidence that the government will do its job, protect consumers and low income minorities, by eventually shutting down Herbalife and then reforming the MLM industry.

Source: The FTC Will End Herbalife As We Know It