Say what you want about Herbalife (NYSE:HLF), but alleged global pyramid schemes are indeed profitable. Herbalife looks like it will gush over $600 million in free cash flow this year, give or take. Herbalife is pretty clear on where it wants that money to go.
If investors have been wondering who has been buying HLF common since the FBI, NY AG, SEC, Illinois AG, and DOJ confirmed that they are all investigating the company, they needn't wonder any more. The answer is Herbalife's Treasury. Netting off share issuance for HLF executives, the share count has dropped to roughly 100 million, fully diluted. We are also told an additional 4.5 million shares were retired in April for around $56 per share. Bloomberg offers a nice analysis of this buyback activity here.
The buying will continue in May and June. The company cut the dividend to zero so that all shareholder capital is used to put a bid under the stock.
Q. Is this capital allocation decision:
b) thumbing your nose at regulators
Is it wise?
Herbalife may be in a bit of a binary situation. Heads, it is exonerated. Tails, regulators take it out behind the woodshed. With nothing to lose and seemingly everything to gain if the coast is clear, the aggressive buyback makes sense at an FCF yield north of 10%. Is it aggressive considering the regulatory uncertainty too? Absolutely. But, maybe it is a wise move that becomes a precursor for a short squeeze.
Is it thumbing your nose at regulators?
A conservative mind could take the position that the prudent course of action for HLF's board of directors while under a cloud of suspicion would be to suspend all share repurchases. This kind of decision would demonstrate a sensitivity towards the company's estate on the balance sheet and a modicum of respect for the regulatory process. Free cash flow could be accumulated for future share repurchases. Alternatively, value could be built in order to settle any successful claims for litigation expenses and/or other fines. Instead, HLF doesn't seem to take the threat of regulatory intervention very seriously.
Is it reckless?
If ever Herbalife wanted to agitate regulatory authorities, suspension of the dividend to purchase additional shares would be the way to do it. Greed is what motivates Mr. Icahn and his efforts at a short squeeze. Longs, seemingly, are indifferent to the obviously high failure rates experienced by HLF business opportunity seekers. Big deal, I guess. It seems more important to attack Mr. Ackman than it is to eliminate the fact you price discriminate against low-income Latinos, for example. Ultimately, these priorities may prove misplaced.
Is it cynical?
Ultimately, I think all stock market investors would have to conclude that the answer to this question is a resounding "Yes". Greed is in vogue, unabashedly so. As an observer of this company, I remain puzzled, if not outright perplexed that the executive suite has the energy to finance a share buyback, accelerate the recapitalization of the balance sheet, hire PR firms and high-profile Latinos for consultancies and board seats, and yet still -- over 15 months into a defence of its legitimacy -- not a single dollar has been spent on implementing a retail tracking system.
Q. Are regulators likely to ignore this small point?
- or the fact that recruiting activity is endless?
- or the fact that the company still price discriminates?
- or the fact that senior recruiters make "advance fees" selling leads?
- or the fact that recruiting rewards are only available to those who pay, up-front, for Supervisor status?
Herbalife Q1 results are now in the bank. Presumably, we will gain additional color on tomorrow's conference call. Make no mistake, this aggressive recapitalization and share buyback is Mr. Icahn's idea, no doubt supported by Mr. Stiritz. Ostensibly, the shares look cheap as the cash flow continues to roll in and the multiple remains low.
Just remember, very few consumer products companies enjoy 80% gross margins without attracting waves of competitors for market share. Very few companies with undifferentiated products sustain these kinds of metrics over time. Unless, of course, the main product the company sells is "The American Dream" itself.
As to how and where Herbalife grew? Investors can find that data here. Perhaps not all geographies are doing so well?
Herbalife continues to function with the veneer of legitimacy, even as its pay plan is a pyramid scheme that promotes an endless chain of new recruits.
Herbalife continues to act as if its pay plan is innocent.
Just remember, Herbalife ended 2013 with 3.7 million distributors. At the end of Q1, that number grew to 3.9 million.
599,000 new people were recruited in this past quarter alone. Solving for X, this means that 400,000 also quit.
Looking at the data since the beginning of 2013, 2.7 million new members were recruited. Herbalife opened 2013 with 3.2 million distributors. It now has 3.9 million distributors. Solving for X, 2 million people were also churned out of the pyramid over the last 5 quarters.
I wonder what could have possibly gone wrong for them?
My guess is that regulators will want the answer to this question too. Herbalife is victimizing close to 2 million people a year now.
How many got suckered to buy leads? How many ponied-up to become a Supervisor?
Who cares - they just printed a beat and raise quarter, don't you know!
Still, the share repurchases persist.
Mr. Icahn and Mr. Stiritz indeed play poker, and have pushed "all-in" with an aggressive recapitalization of the company.
Only the River Card is left to be played.
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.