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Summary

  • Mr. LaRosa penned a baffling piece yesterday, which focuses on product safety, as opposed to Herbalife's business scheme.
  • Regardless of whether Herbalife is selling protein shakes or used tires, it's running an illegal business model.
  • Government intervention is a likely outcome, in this investor's opinion.

(This article is being written as a respectful rebuttal to John LaRosa's article, published yesterday, and entitled "Why The Chances of the Government Shutting Down Herbalife are Zero")

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In what could be one of the most far-reaching articles I've read from the bullish side, John LaRosa penned a piece yesterday claiming, in short, that "Mr. Ackman and other critics are fighting a losing battle." That, we already know in and of itself is farcical, simply due to the fact that the FTC is investigating Herbalife (NYSE:HLF).

Mr. LaRosa calls himself an independent analyst of the U.S. weight loss market for 25 years - I don't contest that - but what I do contest is that he's looking at the Herbalife case through the complete wrong set of glasses here. This isn't a case about weight loss products, it's a case about running an illegal business model.

This is a classic case of missing the point, many times over, to create a one-dimensional bullish argument for Herbalife. So, let's run through Mr. LaRosa's bullish arguments and offer some insight as to why his ship has run way off its course.

Mr. LaRosa Misses the Point #1

This Isn't a Product Safety Issue

The first argument that he makes is with regard to the products - he claims that they're inexpensive, which we know isn't true, and that they're so popular through MLM channels that the FTC is unlikely to do anything about it.

The bears' argument isn't that there's anything wrong with the products - aside from being too expensive and being forced on distributors as a segue to being able to recruit, there really is nothing wrong with the products. This isn't a product safety/efficacy issue, it's an underlying business model issue. Why, when I met one of my good friends in 2008, that was on a Herbalife-sponsored soccer team years ago, did he try to offer me a box full of expired Herbalife products? That's the question. This is a question about inventory loading and selling otherwise commodity products at sky-high prices, because distributors are being forced to buy them if they want to recruit. So, point missed in its entirety by Mr. LaRosa.

Mr. LaRosa Misses the Point #2

Seriously, This Isn't a Product Safety Issue

Mr. LaRosa then prattles on about over-the-counter diet pills that are sold by Herbalife - he claims that they have come "under scrutiny in the past, as they sometimes produce rapid heartbeats, nervousness, etc. They are stimulants. The FTC has scrutinized these diet aids for a long time, and has fined companies selling them (deceptive advertising, outrageous weight loss claims), in some cases asking the manufacturer to remove the product from the market"

Well, again - that's all good and well, but this isn't an argument about Herbalife's diet pills and whether or not they're safe. (Ultimately, they likely aren't, but that's another discussion for anther day). The FTC is looking at Herbalife because the company operates as a pyramid scheme - it doesn't matter if they're selling diet pills, wheat germ, pastries or used tires. The argument isn't about the products, it's in the manner in which they are moved from company to distributor, what promises are made to get distributors to offload their money while on-loading their inventory, and where the money ultimately winds up - at the top of the pyramid.

Mr. LaRosa Misses the Point #3

Seriously, Seriously This Isn't a Product Safety Issue - Really!

Mr. LaRosa states:

In any case, I am not aware of any past action over the past 25 years where a meal replacement shake or bar was taken off the market, and these are the products that comprise the bulk of Herbalife's weight loss product sales. Therefore, at most, if there was a problem with HLF's other diet pills, at most they'd have to reformulate the product to eliminate any possible side effects. This is easily accomplished.

Secondly, since there are at least two dozen MLM companies operating in the U.S., all following basically the same sales model. If the government shut down HLF, they'd be forced to investigate the other MLM operators. The FTC is understaffed as it is, and conducting 24 separate company investigations would be an impossible task.

Again - this is not about past precedents being set for a PowerBar being pulled off the shelf - the FTC is looking at Herbalife because the company operates as a pyramid scheme.

Secondly, there are not at least two dozen MLM companies operating in the U.S. with "basically the same sales model." The enormous difference between companies like Tupperware and Herbalife is that Tupperware keeps air-tight weekly records of how much product the company sells inside of the network versus outside of the network. Herbalife simply doesn't have these numbers, despite claiming to enforce a mythical 70% rule, which company executives admitted, under oath, that rarely ever gets looked into. What's the difference? Tupperware sells outside of their network - they're not a pyramid scheme. Herbalife sells primarily in network to "distributors", "members" or whatever they're calling distributors this week - Herbalife is a pyramid scheme.

Conclusion

One of the last arguments that Mr. LaRosa cites is the fact that the company has been around for 30+ years. The simple, lawyerly answer to that question is that length of existence does not equal credibility.

The facts are that the MLM industry needs to be looked at and reformed as a whole, and that this opportunity has served itself up to the FTC on a golden platter. All we need is someone with a keen mind focused on doing the right thing and protecting future "distributors", and we should see major changes implemented not only with Herbalife, but across the MLM industry.

Thus, it's clear to me that the chances of the government shutting down Herbalife are much greater than zero.

Mr. LaRosa says it himself to conclude his article - basically making the bears' point:

Granted, the earnings are paltry, both on a part-time and full-time basis, with the exception of a lucky few that got in on the company in the beginning.

This leads me to believe he somewhat understands the pyramidal nature of the company. Why he would write a two-page article defending the products, as opposed to the business model, is beyond me. Mr. LaRosa, read that last sentence of yours over a few times - that "lucky few" is a group of executives and lifelong distributors that have made their riches by promising distributors they could do things like earn $10,000 a month after being a distributor for just ten months. If the "earnings are paltry", do you think that's a fair statement for someone on Herbalife's Board of Directors (John Tartol) to make?

Investment thesis: I believe Mr. LaRosa has completely missed the point of the FTC investigation, and the results of the FTC action will likely prove that in the coming year. I continue to contend that Herbalife is a worldwide confidence game that will ultimately be shut down by regulators.

Source: Why The Chances Of The Government Shutting Down Herbalife Are Much Greater Than Zero