Yesterday Pershing Square published another video featuring testimonials from victims of the Herbalife (NYSE:HLF) fraud. Most of these victims were Latino. You can watch the video at facstaboutherbalife.com. As I watched the video yesterday, I found myself experiencing a visceral response. I felt so sorry for these people who had clearly acted in good faith.
"Follow the step by step program!" they were told. "This is the pathway to income of $5,000 per month." (To paraphrase)
Of course, that is not how money transfer schemes actually work in practice. In practice, the harder late entrants try to climb the levels in the Herbalife Marketing Plan the more capital they are destined to lose.
Ostensibly, Herbalife would argue that the company has made decisions to reduce the risk of capital loss for its participants. In practice, the opposite is true.
The entire Nutrition Club DMO sees participants investing material amounts of start-up capital in leases, leaseholds, signage, etc. This is a tough row to hoe as markets like Daytona Beach or Las Cruces became over-run with these facilities.
Herbalife has made it easier for people to qualify for Supervisor over time. Of course, this just allows them to spread out their inevitable capital loss over a longer time frame and to stay in the game longer. Over 50% of Supervisors still fail. Cumulatively, the turnover at the Sales Leader level is 100% over a 2 year basis in nominal terms.
Of course, the folks at the top of the Herbalife pyramid rarely turnover at all. These are the folks who got in early. Guys like John Tartol have global downlines. Guys like Edgar Balbas took advantage of greenfield opportunities in South American markets. Success in Herbalife isn't determined by how hard you work per se. Rather, it is determined by your vintage. If you were early to join you are upline. If you are downline you are cannon fodder. That is how the pay plan works by design.
Nonetheless, deceptive marketing claims made by both the company and its disciples continue to sell the idea that a participant's chances of success are as good today as they were in 1984. "There's never been a better time to join Herbalife!" they are told. In practice, there has never been a worse time to join Herbalife.
Pyramid schemes are illegal for a very simple and obvious reason. The more you push out the supply of salespeople, the more harm the algorithm causes.
- retail profit margins collapse if not outright disappear
- geographies get saturated with salespeople
- competition for market share becomes a bloodsport
- participants suffer a negative ROIC
- most fail and leave the marketplace altogether
The marketplace sustains itself, however, because new victims are ushered into the pipeline each and every year to the tune of 2 million people. Each and every one of these people is seduced by false claims and deceptive statements made by the company's recruiters. People who act in good faith get scammed. The results are tragic for sure.
Successful consumer products companies deliver value. The goods they sell are consumed by people who value them for their utility. The price they pay represents an exchange of value. The manufacturers, distributors, and retailers of the product all manage to earn a positive ROIC for their troubles. That's the American Way.
In contrast, money transfer schemes like Herbalife earn their money by victimizing entrepreneurs. It is 100% possible that an end consumer could consume Formula 1, enjoy the benefits of the product, lose weight, and walk away happy. Unfortunately, the poor distributor who sells them the product is the person who gets victimized. Selling product at SRP is a pipe dream due to competition. Retail margins are scarce.
As a result, participants then turn to recruiting. This, of course, makes the algorithm even more sinister. Saturation is the name of the game. The more successful the pyramid scheme is at recruiting, the more harm that is caused in the marketplace.
Along the way the sponsors and promoters and upline recruiters make out like bandits. Along the way the cumulative number of victims is just staggering. 6 million people have churned out of Herbalife just in the past 3 years. Each and every one of them sent their capital to the likes of Carl Icahn and Bill Stiritz and Michael Johnson.
Some people don't have a conscience. Some people turn a blind eye to activity that occurs in our macro-economy that causes harm to our fellow citizens. Some people actually strive to victimize their fellow man such that they might enrich their own coffers.
Q. As you look at Mr. Ackman's latest videos, doesn't it become somewhat obvious that this is what the good ship Herbalife is all about?
As I've argued many times before, there is nothing particularly unseemly or offensive about the idea of selling protein powder. Have at it!
However, when you choose to use that protein powder as the central currency in a pyramid scheme of epic proportions then surely something is amiss.
Federal regulators have been examining Herbalife for quite some time now. Here's my guess as to what they have found:
- Statistical evidence of massive failure rates for participants
- Mountains of evidence of deceptive claims by recruiters
- A conspiracy of epic proportions tracing back to Mark Hughes
- No evidence of legitimate retail profits
- A trail of destruction around the world
Q. Isn't it about time that the government shuts this recruiting juggernaut down once and for all?
As you watch the testimony of the victims in the video, what does your conscience tell you?
As for investors, if you think that the government is going to allow this company to continue to recruit millions and millions of new people to generate $5 billion FCF over time, good luck with that thesis.
I remain short.
Disclosure: I am/we are 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.