I was online yesterday and found this fabulous picture on a funny blog that can be found here. For those unfamiliar, this is a photograph of Faith Healer Benny Hinn. Note the veneer of legitimacy Mr. Hinn establishes with his all-white uniform and "Hand of God". If only what he did were true. Certainly all of the money donated to things like cancer research could be shuffled elsewhere just for starters.
Q. Who is more tragic? Benny Hinn or the victims of his confidence game? Isn't it amazing what you can get away with in the name of religion?
I thought of Mr. Hinn today when I read the news that Herbalife (NYSE:HLF) CEO Michael Johnson has cashed out $13 million worth of stock. Mr. Johnson not only exercised his options but he then sold the equity he bought for around $60 per share.
Everything the company has been telling investors lately is trying to convince us that HLF common is deeply undervalued. Why else would the company engage in such an aggressive recapitalization plan?
Still, Mr. Johnson decided to let go of 250,000 shares nonetheless.
By now it has been well-articulated that Herbalife is a pyramid scheme. More specifically, it is an endless chain recruiting scam. The ingredients are simple.
Ingredient #1 - The Product (Rocket Fuel)
Herbalife Formula 1 is an overpriced product that has many less expensive substitutes available in the market. There is nothing unique about shake mix. All pyramid schemes need rocket fuel. What do I mean by this? In order for a product based pyramid scheme to work you need a product that has extraordinary gross margins. Why? By now, the answer should be obvious. 80% gross margins are the rocket fuel required to unleash an endless chain of recruits that proliferates 11 layers deep. Absent the 80% gross margins, there would not be enough fuel in the rocket for the scheme to proliferate worldwide. Herbalife's product of choice is shake mix. Other scams have used equally over-priced and undifferentiated products like vitamins, lotions, potions, etc. Sans le rocket fuel the scam can't take off.
Ingredient #2 - The Pyramid Scheme (The Rocket)
Herbalife dumps its rocket fuel into its pay plan. The pay plan is designed to take off like a rocket. Specifically, flighthe pay plan is designed to duplicate and duplicate quickly. Deliberate and intentional saturation is the desired end state. Participants emphasize recruiting over retailing in an obvious chain scheme. Participants who try to climb aboard the rocket late get scammed. Why? Easy. There is nobody left to fill out your downline and there is no retail profit to be earned reselling an undifferentiated product.
Ingredient #3 - The Promoters (PT Barnum Would be Proud)
Herbalife recruiters and promoters are a shameless bunch. They sell a mathematical fallacy to the masses in much the same way Benny Hinn sells miracle cures to the sick. Trouble is, capitalizing on ignorance isn't entrepreneurship - it's fraud.
Mike Johnson has made a lot of money running the Herbalife pay plan. Yesterday's stock sale adds another $13 million to the hundred million plus he has earned the past 5 years cashing out stock and collecting his salary. All the while, he travels the world on a private jet peddling nonsense to the company's most recent recruits. Whether he realizes the sociopathic nature of what he does for a living intrigues me as a question. Still, we have to think that Mr. Johnson knows that the Herbalife business model leaves behind a trail of failed distributors at the bottom of the pay plan at a dizzying pace. 1.6 million alone last year. 400,000 in Q1 of 2014. The beat goes on.
One of the more interesting questions regulators must be thinking about is how to recover damages for Herbalife victims. It strikes me as obvious that if Herbalife is prosecuted, transactions like the one executed by Mr. Johnson today could amount to fraudulent conveyance. Might authorities like the DOJ go after Mr. Johnson's estate in a prosecution? Seeing as the company has looted its own coffers in order to fund a buyback, one would hope so.
I am going to predict that there is a good chance that Mr. Johnson may end-up in jail or prosecuted for conspiracy to commit wire fraud or other RICO violations by the time this tragedy is all said and done.
Seeing as how Mr. Johnson has cashed out another $13 million in stock, I wonder if he is a flight risk. I guess we will find out in time.
Finally, John Hempton published another nonsensical blog post this week on Herbalife. John doesn't see himself as a victim of this pyramid scheme yet. My guess is that in time, he will discover just how obvious it is he is on the wrong side of the trade. My own public service message to John continues to be: "Get out while you still can John. There's an Iceberg dead ahead!"
Of course product base pyramid schemes are designed to fool folks like John. Yes they can generate retail sales, of course there can be retail customers. Just remember, the question before the house is:
How much retail sales volume is generated?
How much retail profit margin is generated?
Is the retail profit margin enough to pay for recruiting rewards and overhead?
Are most of the people who join the pay plan to pursue the business opportunity destined to fail because the pay plan is a pyramid scheme?
Are most of the revenues tied to participants trying to get ahead in the pay plan?
John continues to focus on what he sees behaviorally without asking himself what is happening economically.
What is happening economically, John, is that the Herbalife pay plan is transferring money from those who have no chance of succeeding as profitable retailers to those who keep lying to them by telling them that they can.
The clue that you are still wrong, John, is in the churn data.
If people were making money, why would they leave?
To close, make no mistake if you are an investor in Herbalife. This company is destined to be shuttered by regulators.
- no way the government is going to allow these executives to keep the spoils from their 34 year old confidence game
- no way the government is going to allow this endless chain to perpetuate
- no way the government is going to allow "The Faithful" affinity groups who chase this fraudulent dream to be victimized any more.
As to how long the prosecution takes?
Hard to say - but my psychic powers tell it can only be a matter of time.
Gotta run - I am off to buy a lottery ticket...
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.