By now, Herbalife (NYSE:HLF) investors know there is a running feud between the longs and shorts on this board and in the media. One of the more vociferous longs is a fellow by the name of John Hempton from Australia. John is a shy fellow often seen hiding on CNBC Asia, or on his blog at Brontecapital or on Twitter. John attacked one of my early blog posts by calling me a "clueless short-seller." That seemed like an invitation for a knock-down drag out kind of ad hominem cage match maybe?
Alternatively, I suppose we could argue the fact base. Mr. Hempton has visited a number of so-called Nutrition Clubs in various countries around the world. The product is being consumed it seems. Presto. Legitimacy is obvious. "Proof" I think was the terminology employed. Einstein should be rolling in his grave. Alas, "E" does not equal "MC2" on the back of Mr. Hempton's envelope.
This week on Mr. Hempton's blog he argued that the number of "packets" consumed around the world implicit in HLF's revenue numbers makes it proof positive that HLF is legit.
Let us tackle this argument head on. By "us" I mean me and my good friend "Matilda" who is not a huge fan of Mr. Hempton's logic and has a wonderful way of deconstructing Mr. Hempton's nonsense and "packeting" it into bite size morsels. Here's what "us" has to say.
Herbalife's Number 1 product is not Formula 1 John. "In practice" it is not its line of nutrition bars nor its canisters of sugar-laced shake mix.
Herbalife's number 1 product is (drumroll please) "the solution to these tough economic times" aka "a stable monthly income" aka "escape from your old life in favor of a new one" aka "changing people's lives." If this point has not been made clear, perhaps these pictures will help drive the point home.
You don't become a Sales Leader by selling, you become a sales leader by BUYING.
The whole host of assumptions made to arrive at "meals served" figure, percentage of meals served as "meal replacement," and "meals served per distributor" - simply put: it don't work like that.
By the way, that cylindrical 750mg thing you call a packet that serves "15 meals" is called a canister or a container and it actually serves 30 meals but who is counting? (i.e. your numbers are light)
But, it doesn't matter because here's how it works John. It costs $3,000 to qualify for SUPERVISOR - roughly the same to graduate from Club Ciento. $5.0 billion in sales/3.9 million salespeople = $1,200 or so. Or, if you prefer, the average distributor is somewhere on the Climb to the Top of Mount Supervisor at any given point in time. Why else do the company's revenues track perfectly over time with the number of new recruits it acquires? Why else is there no operating leverage in the business model? Why else do revenues per Distributor overlay perfectly with the qualification levels in the pay plan?
A. Because it is a pyramid scheme.
Are you looking at a different eBay? Because the one on the internet actually has TONS of listings.
I have said enough on the buyback policy. But I'll say this - just because people CAN (technically) return something doesn't mean they will, or do- and having the policy alone does not absolve a company that's simultaneously working a million other angles to discourage that person from returning a product.
Point #6 "Bluntly - there goes the bear case..."
Bluntly - Mr. Market seems unconvinced.
Oh this blasted volume point chart again. Can we just talk about WHY the "heck" "North America" and "Mexico" are two different things according to Herbalife? By North America they must mean "the US plus that other country that is kinda like the US, but boasts such tragic volume that you'd choke on a beavertail if you knew what it was." Or maybe they count Mexico twice. You know, just for fun.
But seriously, why should anyone believe a single thing that Herbalife says about anything? Their own CEO has no idea how many people drink their shakes or why, and pretty much every top distributor (to employ Hemptonese) has been proven to be a lying scumbag.
This leads me to my final point, which I will simply call the Personal Consumption fallacy. Personal Consumption does not equal legitimacy.
Pyramid schemes are not found to be not pyramid schemes if we can demonstrate that their over-priced, high gross margin, competitively weak products are actually purchased and consumed by real, live poor people.
What the law actually says John if you read Koscot and Webster v. Omnitrition and US v. Gold Unlimited or the Burnlounge appeal is simple. Pyramid schemes feature incentive systems that deliberately promote the proliferation of an endless chain of recruits. The only way to even have a chance to defeat a pyramiding charge is to actually tie compensation directly to retail sales. Then, even if your compensation system is tied to retail sales, if the participants "in practice" focus their efforts on recruiting new distributors at the expense of their efforts to retail the product the courts will have a problem with the business model.
Because endless recruiting chains are mathematical fallacies which cause economic harm. The last round of recruits simply cannot earn the income promised by the recruiter. (I will take Dr. Vander Nat's mathematical proofs if that is okay.)
Herbalife is, simply, one of the single most obvious pyramid schemes on the face of the planet. It just hasn't been regulated yet. "Consumos" is driven by its connection to the Volume Points in the pay plan. Plain and Simple.
People buy the product primarily because "they get caught up in their plan of success." - Ligon.
As for the pay plan:
1. It has no limits to the number of levels wide nor deep nor the number of geographies it will saturate. If there were people on Mars you can bet that Herbalife would be there.
2. All of its Top People are Recruiters not Retailers "In Practice."
3. An Endless Recruiting Chain is the Goal of the Compensation System not something guarded against by the company with silly things like Territorial Exclusivity or a Limited Number of Downline Levels.
4. Participants who Sign-Up for the Business Opportunity (see images above) fail in predictable and massive quantities.
5. Shake Mix is not the product, it is the device that is used so participants can earn Volume Points. Volume Points, by the way, are those little bitcoins that get participants closer to "The Bling" (See Club Ciento, SUPERVISOR, Requalification, etc.) except of course for the idea that the more bitcoins new recruits buy the poorer they actually become.
6. Because there are so many distributors recruited around the world, there is not a retail business opportunity with actual PROFITS. (Have we seen P&Ls for the salespeople from the company John? How can you sell a proven business opportunity without "proof"?)
The hyper-competition unleashed by the business model bleeds all retail pricing down, retail profits away, and renders the distributor a loser. Meanwhile, the uplines skate away with commissions. This is called SATURATION. This is why pyramid schemes are illegal!
7. This result occurs by design. It is not an accident. It is intentional.
8. Why? Because Herbalife is a prohibited marketing scheme.
9. If Herbalife is Not a Pyramid Scheme Why is it Always Recruiting?
10. Does the fact that Herbalife recruited 2 million plus new people last year offer any evidence that its participants focus on recruiting.
11. Does the fact that most of these people fail to offer any evidence that Herbalife might just be a scam?
12. Do I really need to go on John?
And finally - if Herbalife is not a Pyramid Scheme why does it price discriminate, have a SUPERVISOR program, sponsor Club Ciento, skew heavily to low-income communities in Spanish markets, fall flat on its face in middle to upper class zip codes or rational and skeptical countries like Canada, promote recruiting and duplication vs. health and wellness at its core, and why does management not simply answer the original list of questions presented by Pershing Square over a year and a half ago?
Also, why are 7 regulators, LULAC, etc. concerned when you are not?
To close, I suppose Herbalife is a weight-loss cult in the same way that AA is a social club or SpeakEasies were places to have a chat during the prohibition era.
I suppose these young, skinny and fresh-faced optimists on this bus tour in Argentina are visiting this Nutrition Club to get "more skinny." (TY Salty Robot) I suppose all of the people in these auditoriums on Salty's blog praying to a big chart with a diamond studded pendant on top are concerned with counting calories.
I suppose I may still be a "Clueless Short Seller" though I must admit that the fact that the common equity trades almost $150 away from your $200 upside price target gives me some degree of comfort.
Also, I continue to contend that this confidence game will end-up victimizing you and your investors fully and completely but I suppose we will see in time.
Is it good for society for the world's poor to risk their capital on a business opportunity with a proven track record of ubiquitous economic failure for those in the downline? Or, might the FTC, SEC, DOJ, FBI, NYAG, Illinois AG take some level of interest in arresting this result from continuing?
Frankly, taking the side of the "scumbags" not only makes me question your sanity but your values too.
From Your Friend,
The Clueless Shortseller (and his buddy Matilda)
Disclosure: The author is short HLF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.