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Summary

  • Murky case law allows the market to shake off pending investigations, barring an 'event.'
  • Besides the pending investigations, externalities could arise that precipitate otherwise unforeseen action.
  • There is no substitute for your own due diligence. Big names are no source of comfort, they can all make mistakes.

Herbalife (NYSE:HLF) got a bit of bullish news on Friday with the report of Capital Research reportedly increasing their stake in the company. As they say, there is no accounting for taste. I would not generally recommend parking your car (or your retirement fund) on a railroad crossing in front of an oncoming train with suspected brake failure, which is what this Herbalife situation is like at this point.

No case is proven until it is proven, but if you follow the comments on this site, an interesting new angle was recently suggested by the comments of Laura Taylor Townsend, posting here in the comments as "Hell on Deals."

Enter Treasury/FinCen

As of some time ago, Laura began to make some comments about the potential obfuscation created by Herbalife's accounting in "Value Points." Her line of inquiry then culminated in:

  • A letter to FinCen/Treasury about this issue, detailing the fact that under extant regulations Value Points functions as an unlicensed virtual currency, of uncertain value.
  • Follow-up letter on the same issue to the SEC, because of the implications on financial reporting.
  • On Sunday 8/10 she then reported receiving a confirmation from FinCen of an investigation here.

At first, when I followed her questions, I was pretty sure she was on to something, and I'm blessed with access to an SEC lawyer friend who I knew to have had experience in these particular issues in regard to virtual currencies and their regulation. He agreed that her approach had merit on the face of it. That was before she reported having received the confirmation of the investigation by FinCen/Treasury. For now, this is just a report on SA, by someone who has disclosed their identity and produced copies of her relevant correspondence with the regulator (note the response). The question is how does this fit in with the overall picture. For one thing, Herbalife might have to disclose the issue once they receive information on the investigation.

Externalities arrive

I have previously reflected here on the very evident difficulty the market has with pricing in ambiguous information, and this issue was commented on again by a more recent SA article on "The Big Short," and the need for an externality in such a circumstance. Something that cuts through the fog.

It would appear that such an externality may have just arrived, and in fact the bridge watch on the MS Herbalife is working overtime, or as "Hell on Deals" put it, Herbalife's lawyers are looking her up on LinkedIn.

Compared to the hard-to-interpret "pyramid scheme" accusations by Pershing Square, which the market clearly has had trouble digesting, this current matter is a very succinct, and cut and dried issue, where there is a potential for a finding of a very clear regulatory infraction. Until such regulatory action is completed, there will still be uncertainty about the issue, but its nature is very clear and unambiguous.

Recent background

In recent posts I, and some others have already argued that with the current overhang of regulatory clouds a rational valuation of HLF might be in the range of $30, if you can't make up your mind about the likelihood of those outcomes. And the market certainly seems to have shrugged off issues, including Ackman's presentation on July 22nd about the Nutrition Clubs, and how they form a pyramid within a pyramid. Apparently the ambivalence rests simply on the lack of a clear outcome at the moment the information is reported. There is at best an increased likelihood of certain outcomes, but the market has shrugged it off with an indifference that is the equivalent of 50/50 odds.

All this began to change a bit after the earnings miss, which was a surprise, and bigger than it seemed after you take the buyback into account. Then, there are the reports of the bond market valuing the Herbalife CD at 78 cents on the dollar. The bond market may be more astute in their ratings than the stock market. And there is the issue of the misreporting of the Venezuelan currency hiding another $109 million in losses. The Volume Points reporting, among other things, would obfuscate the currency arbitrage opportunity that existed in Venezuela because the company continued to use SICAD I (10 Bolivars/US$) in its reporting, instead of SICAD II (50 Bolivars/US$).

Conclusion: Short thesis strengthened

Now a new issue enters the picture that is independent of the others, and right now it must look from the bridge of the MS Herbalife like an incoming torpedo to the midships section. It would seem likely that with such a clear cut event, involving a key financial regulator who was not previously on the scene, that a catalyst has entered the mix, and this stock could be headed for trouble, with a very probable interim stop at around $30, until all has been validated and verified.

Source: Bridge Watch On The MS Herbalife