Lesson For Herbalife: When Your CEO Gets Arrested, It's Bad For Business

| About: Herbalife Ltd. (HLF)


Amway's India CEO was recently arrested for pyramid sales and money laundering.

His incarceration is not having a great effect on the company's ability to recruit new distributors.

Herbalife is going to face the same issue, regardless of whether or not Michael O. Johnson winds up behind bars.

Herbalife's Got 19 Problems And Being A Pyramid Scheme Is All Of Them

As another day passes in the Herbalife (NYSE:HLF) saga, I continue to wait for what I feel is going to be inevitable justice from the numerous regulatory agencies that the U.S. employs to prevent the commonfolk from being fleeced from their money.

Until then, we just have to sit back and watch as common sense unfolds elsewhere, for the time being. We continue to see, over and over, cues in the MLM field and related to Herbalife that all seem to allude to one coming outcome for Herbalife: major changes are going to take place.

Whether those changes are going to be the residual result of MLM reform, or the result of people like John Tartol winding up being criminally charged, we've yet to see. My brain says the former, my heart wants the latter. Either way, Herbalife is in no way going to be the same company coming out of the back end of these investigations that it once was; I can say that with almost complete certainty.

I believe it's simply going to be a question of whether or not Herbalife has a quick demise, or a long one. Ackman seems to think Herbalife going to $0 would be an "overnight phenomenon", and I hope he's right. If there's MLM reform, it's going to wind up draining Herbalife slowly, like a leaking sieve instead.

Since the saga has developed in late 2012, the amount of "interesting" items to take place has been plentiful, including:

  1. A formal investigation into the company by the FTC
  2. A formal investigation into the company by the SEC, who has in a de facto sense, already called Herbalife a pyramid scheme
  3. A formal investigation into the company by the DOJ
  4. A formal investigation into the company by the FBI
  5. A formal investigation into the company by two state attorney generals
  6. Senator Ed Markey sent a list of questions to Herbalife that were basically ignored and answered through many layers of obfuscation
  7. What appears to be demonstrable proof that the company is operating illegally in China
  8. Formal investigations into the company by Canada, as reported by the NY Post
  9. Fortune Hi-Tech, another pyramid scheme, was shut down permanently
  10. ABC Nightline did an expose of the company's distributors, where they were caught making absolutely insanely extraordinary health claims to move Herbalife product
  11. Dan Loeb and Kyle Bass are out of their Herbalife stakes
  12. Herbalife CEO shrieked at Bill Ackman on a conference call
  13. Herbalife outspent Bill Ackman on lobbying in 2013
  14. Herbalife launched a ridiculous PR effort through Twitter
  15. The SEC shut down a pyramid scheme that looked like an exact carbon copy of Herbalife
  16. Barclay's beefed their analysis of the company, setting a mid $90 price target days before the stock dipped on news of an FBI investigation
  17. Other MLMs like Vemma are going through significant reforms to preempt what should be an FTC takedown of Herbalife
  18. Former distributors have told the public how they were duped out of thousands among thousands of dollars

And now, today, we can add to the list:

19. Amway's India CEO has been put in prison!

We already knew this to end the week last week. But, the addition today? Apparently, when your CEO gets arrested, it's not good for business!

The article read:

Amway India is finding it difficult to sign up new distributors after the arrest of the company's India head William Pinckney last week, said top executives at the company.

"Post the arrest, we have seen a short-term blip in new distributor sign ups. There is definitely a concern among our new distributors," said Samir Behl, regional president, Europe, Africa and India. "Our focus right now is to get a bail for Pickney and ensure that these episodes do not repeat themselves."

Longs will argue that this is an accident, Indian rules are strict, he'll be exonerated, etc. My followup to that is, why don't we ever see Ford India's President "accidentally" arrested? What about General Electric's India division president? 3M?

What is so damn quirky about these MLM models that they continue to incite controversy and provoke "false" arrests? Will it still be a "fluke" when they come for Herbalife executives and top distributors?

Why Does This Matter to Herbalife?

Aside from the most obvious at the fundamental level - that this arrest further moves the needle forward in the argument that MLM simply isn't a sound model and that Herbalife's executives are under criminal investigation - this news means that distributors scare easily. Who's going to want to sign up as a distributor for a company that's under regulatory scrutiny? Perhaps this is why we continue to see the millions upon millions churn out of the bottom of the Herbalife pyramid, quarter after quarter.

For a moment, I'd like to return to one of the long's favorite arguments regarding the litany of regulatory agencies that are currently looking into Herbalife in the U.S. Longs and supporters of the company continue to argue that even if the worst case scenario were to happen in the U.S. - a total shutdown for the Herbalife U.S. business - that the company would be fine due to the fact that the rest of its business is global.

Look, I even think they allude to it in their Twitter feed.

That's some good, ole' fashioned, preemptive excuse making.

As I noted in a previous article focused on dismantling Herbalife's PR efforts via Twitter:

This post reeks of "don't worry if the FTC shuts us down in the U.S., because we're global!"

We've been hearing this argument since the FTC was first mentioned with regards to Herbalife. The company seems to already be preparing for the worst in its "kind of home country."

Fundamentally, this boils down to a question of whether or not you think the U.S. FTC shutting down Herbalife would do well to set a precedent across the globe of other countries doing the same. I do.

What today's Amway India news goes to show is the residual damage that bad headlines are going to do to Herbalife, regardless of whether or not the FTC shuts them down and throwing Johnson et al. behind bars.

So, to reemphasize the risk that this new nugget of information presents for Herbalife:

  • First, to emphasize the point that even in the best case scenario, Herbalife is going to find it difficult to continue to recruit at the rates that the company historically has. The cloud of uncertainty over the company from this yearlong saga cannot be undone.
  • Second, it shows that MLM is a sketchy way to do business. When I compare Herbalife to Nu Skin (NYSE:NUS), Avon, and Amway, Herbalife's model looks the shakiest.

We already know from the Herbalife in China conference call that it's the opinion of Pershing Square's attorney that Herbalife is operating illegally in China, from his understanding of the law.

If you don't think a U.S. crackdown on Herbalife is going to set precedents for MLMs worldwide, it's this investor's opinion that you're mistaken.

If you think that nothing is going to come of the vast investigation into the company, it's this investor's opinion that you're mistaken.

I remain short and bearish on Herbalife, which I believe to be a global confidence game that bilks people out of their money under the guise of a business opportunity.

The sooner the regulators step in here, the better.

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.