Herbalife's Earnings A Case Study In Smoke And Mirrors

| About: Herbalife Ltd. (HLF)


Herbalife's non-GAAP earnings beat is deceiving.

The company is now horribly overleveraged and has squeezed a ton of its equity out of the company, leveraging the balance sheet and destroying its debt to equity ratio.

Suspending years of dividends to institute a buyback with a "we want it now" attitude goes to show that Herbalife is grasping for straws.

Mr. Icahn could very well be setting up for his exit from the company, leaving the executives and Mr. Stiritz wondering where it all went wrong with Carl.

Hilariously, the company is excluding all money spent defending itself from its guidance.

As I had predicted yesterday morning, Herbalife (NYSE:HLF) beat the streets expectations this after on both lines. The stock climbed today, up 1.76% during yesterday's trading session. After popping after hours on the headline, it then pulled back as investors began to digest the news behind the headline.

The details, all neat and tidy courtesy of Seeking Alpha:

  • Herbalife Ltd. : Q1 EPS of $1.50 beats by $0.21.
  • Revenue of $1.26B (+12.5% Y/Y) beats by $30M.
  • Global volume growth: 9%. EPS: $0.74 (-32.7%).
  • CF Ops: $190.6M (+39%).
  • Q2 guidance:
  • Net sales growth: 10% - 12%, volume growth: 7% - 9%.
  • EPS: $1.51 - $1.55.
  • Common shares to be repurchased: $581M.
  • 2014 guidance:
  • Net sales growth: 10% - 12%, volume growth: 8% - 10%.
  • EPS: $6.10 - $6.30.
  • Quarterly cash dividend terminated. Cash will be used to buy back shares.

Massive beat! Another amazing quarter for the Herbalife juggernaut, right?

Not really. Take a look at that massive "remeasurement loss relating to Venezuela". That's a figure that really makes the non-GAAP EPS much higher than it really should be. Remove that, and EPS for the quarter was $0.84. Additionally, it makes up almost 40% of the total EPS for the quarter, whereas a year ago in the same quarter it wasn't even 10%.

Sure, everyone is catching a bit of bad luck with charges related to Venezuela, but depending on how much money Herbalife has there and what business operations are going to look like there over the coming year, this may not qualify as a one time issue. Time will tell the tale here.

Also in the humor department, the company stated their guidance is going to be issued without including money spent on defending itself from Mr. Ackman and regulatory agencies. As The Specialist pointed out earlier this morning, every company has its critics - but not every company gets to deduct the amount spent on PR and advertising, etc., from its P/L:

Next, Herbalife's guidance excludes "the impact of expenses (primarily for legal and advisory services) relating to the company's response to information put into the marketplace by a short seller." That short seller is, of course, Bill Ackman. The fact that the company is spending so much money on publicity to counter somebody's opinion, instead of just proving him wrong with retail sales logs, is a bit odd. Since apparently this cost is so high that it has a material effect on the results to the point where the company wants to separate it out, isn't this a real expense for the operations and a real cost of doing business and generating revenue? If it's not, why bother fighting Ackman and wasting shareholder money? If it is vital to the business operations, then it is a very real expense. Companies like Herbalife, legitimate or not, legal or not, are always going to have their critics. Should McDonald's not count its marketing response to Taco Bell's breakfast launch in its guidance? Of course it should count it all.

And, in what is clearly an act of desperation once you look at the facts surrounding it, Herbalife said they were going to terminate their dividend to continue funding their buyback:

The company's board of directors also announced today that it has approved terminating the company's quarterly cash dividend and instead utilizing the cash to repurchase additional shares of the company's outstanding common stock during the second quarter of 2014. The company now expects to repurchase a total of $581 million of its outstanding common stock during the second quarter of 2014 as part of its previously announced $1.5 billion share repurchase program. The $581 million is comprised of the approximately $315 million expected to be purchased in April as part of a 10b5-1 trading plan ($255 million already completed as of Friday, April 25); plus the $50 million included in previous guidance and $216 million that otherwise was expected to be returned to shareholders in the form of quarterly cash dividends over the next eight quarters.

Suspending the dividend, which paid about $30 million quarterly for the next 8 quarters, to rush and spill $240 million on shareholders for a buyback says something to me. It says we're in a hurry to keep our share price propped up now - and that acting now is the only important thing.

It says we've been keeping a bid under our own share price in the face of regulatory investigations, and need to continue to do so.

If I were the SEC, I wouldn't be amused with this.

So, basically, the company has been propping up its own stock. On low volume, that's relatively easy to do - if people come in this week and decide they're less amused with Herbalife's antics, it may get a little tougher. The more volume and the higher the share price, the less time Herbalife has to keep an artificial bid under their stock.

So then the question is raised, why do this?

1. They think they're going to squeeze Ackman out - this is the less likely scenario, especially now since two-thirds of Mr. Ackman's position is in options. (source: Herbalife in China call factsaboutherbalife.com)

2. They're afraid of the stock price falling without it - this is probably the most prudent explanation. They don't want the stock price to fall to the $30s, where I predict it should be in the face of all of these enormous regulatory investigations.

3. Mr. Icahn is setting up for an exit - I love this idea. And it's one that actually holds water - Mr. Icahn, pushing the idea of getting the equity out of the company now, making amends with Mr. Ackman - could he be setting up for his exit from the company? It's classic Carl Icahn, if so.

Further, this prevents Mr. Icahn from receiving quarterly dividends, prevents Mr. Ackman from having to shell them out, and simply rushes to try and bring the stock price up. I'm not sure that once the street digests this information that they're going to be happy with it.

Additionally, in the "Icahn exiting Herbalife" news, Yahoo reported via Wall Street Journal this morning that Mr. Icahn and Mr. Ackman seemed to have made peace:

Carl Icahn and William Ackman, who clashed on their views about nutrition company Herbalife Ltd , could team up on activist investments in future, the Wall Street Journal reported.

The two sparred on live TV last year. In a tirade that included expletives, Icahn said he would never invest with Ackman, calling him a "liar" and "the most sanctimonious guy I ever met in my life." Ackman in return called Icahn "not an honest guy." Ackman and Icahn's dislike of each other is well known in financial circles. Some of the tension stems from the fact they both specialize in the same game - taking big positions in companies and agitating for management changes.

The hatchet was buried on Thursday when the two spoke for about 30 minutes and agreed that they saw eye to eye on some issues, the Journal said.

"In the future, there is a much greater possibility that we are on the same side than the opposite," the newspaper quoted Ackman as saying.

Surely a far cry from Mr. Icahn's statement that he wouldn't invest with Mr. Ackman if he was the last guy on Earth, made during the original CNBC Billionaire Showdown. Mr. Icahn looks to be potentially preparing himself to concede the Herbalife battle, if you ask me.

Another point in question with regards to the company's buyback is whether or not there is a clause in the 10b5-1 plan that allows company insiders to dump stock as part of a buyback without having to file typical Form 4 disclosures. I'll be consulting with a securities lawyer today to get an answer on this.

So many companies get this type of bloated right before they fall - insiders potentially cashing out, balance sheet leveraged as far as it can go - Herbalife seems to be squeezing all of the equity out of its company that it can. One can only hope that if the regulatory agencies are going to freeze the assets of the company, they do so before executives and continue to pry it from shareholders.

After hours, investors seemed less amused. Herbalife gave back all of its gains and finished Monday off $0.15 in after hours trading.

This Friday, Mr. Ackman is preparing his documentary on Herbalife victims, which will likely be simultaneously webcast on factsaboutherbalife.com.

Herbalife's conference call is slated for 8AM EST this morning.

I continue to contend that Herbalife is a global confidence game that needs to be shut down by regulators - the sooner, the better. I will likely be adding puts today, should the stock see green territory.

Best of luck to all investors.

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.