Yesterday morning, Bill Ackman appeared on CNBC. He had a number of things to say about Herbalife (NYSE:HLF). Anyone who thinks that Mr. Ackman's remarks are made "off the cuff" is a fool. Mr. Ackman knows exactly what he is saying and exactly why he is saying it.
So, what did Mr. Ackman say?
For starters, he articulated that he expects the next shoe to drop in the Herbalife case will be in the form of arrests. Specifically, he suggested that the government will likely start to arrest Senior Distributors or recruiters as a way to disrupt Herbalife's business.
Who might they arrest?
How about this guy, for starters? Watch the Youtube video and tell me if it doesn't make your skin crawl. For more details on this perpetrator of obvious wire fraud, visit herbalifepyramidscheme.com
Why might the government arrest the likes of Mr. Burton other than because he is a fraudster?
Arresting senior recruiters hits the confidence game where it hurts. It also gains prosecutors leverage over the corporation itself. Wire fraud may be easy to prove. Conspiracy to commit wire fraud may be a tougher nut to crack. Rounding up a bunch of Herbalife's top distributors would create quite the game of Prisoner's Dilemma. Who wouldn't like to be a fly on the wall for those interrogations?
Unquestionably, somebody would be likely to roll on Michael Johnson and the rest of the Herbalife gang who pay out huge Mark Hughes bonuses and travel the world in private jets with top recruiters the world over.
Mr. Ackman also said he would love to find a way to help Carl Icahn sell his position in Herbalife. Say what? Can't you just imagine Mr. Stiritz choking on his bowl of Honeycombs as CNBC blares in the background in his kitchen?
Could it be that Mr. Icahn and Mr. Ackman are cooking up a bought deal for Pershing Square to take "Uncle Carl" out of the stock? How "out of the box" might that idea be?
Right now, Herbalife's short interest is 25 million shares or so. We don't know how many shares Pershing Square is still short. Still, there may be a number of ideas at play to structure a deal.
Recall how complicated the Herbalife convertible debt deal was. Never underestimate just how creative hedge fund managers and their advisors can be if and when they want to get a deal done.
Other hedge fund managers who are short may also want to help Carl out of his position.
Mr. Icahn must be asking himself, how on earth do I get out of this trade? What if I am dead wrong on my pyramid scheme position? Do I want to give back $1 BILLION?
The full effect of the share buyback now seems to be priced into the stock. The stock has ticked to $65 or so, giving Mr. Icahn roughly 100% gain on his position mark to market. Why not get out while the getting is good?
What if hedge fund managers pre-hedged a bought deal with the acquisition of put options and simply bought out Carl's equity with surplus capital? Selling the shares in the open market should then drive the stock price down - hedged, perhaps, by an equal number of puts. Could this transaction affect a long squeeze, taking Stiritz and Soros along with it?
Is it even legal? I don't know. Certainly it seems both juicy and intriguing as an idea.
If you were Mr. Stiritz, would you be inclined to hit the bid on your shares before Mr. Icahn decides to exit stage left or after?
The BurnLounge ruling seems to create quite the conundrum for Herbalife longs. Obviously, Herbalife has a number of "pro-pyramiding" policies that will trouble regulators. In the video of Michael Burton above, we can identify a number of them right out of the gate.
- Exaggerated Income Claims
- A Complicated Compensation Scheme
- The Marketing of a Mathematical Fallacy ("Pays to Infinity")
- An Emphasis on Recruiting
- Overstating the Probability of Success
Layer on top of that:
- A commission system untethered from actual retail sales
- No retail sales data
- No retail profit data
- No enforcement of sell-through policies
- Huge failure rates in the business model
- Extraordinary profits for upline participants
- An uncompetitive SRP for products made worse by S&H costs
- Few make any money at all
Pyramid schemes are not legitimate MLMs, because the focus on recruiting new salespeople trumps the focus on retailing the product to consumers. This leads to inevitable economic loss for those at the bottom of the downline.
Don't believe me?
Watch Mr. Burton's video above one more time.
Herbalife is a confidence game. Bill Ackman knows it. The government knows it. My guess is that by now, Mr. Icahn knows it too.
Q. If you are long. Do you stick around to wait for news that Mr. Burton has been taken away in handcuffs or that Mr. Icahn has sold his stock, or do you hit the bid right now that you know the share buyback is about to end?
Herbalife's share price is an illusion right now. Financial engineering has supported the price beyond its fundamental value.
In time, intrinsic value will emerge. Don't be surprised if it starts with a $0.
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.