Herbalife: This Is The End

| About: Herbalife Ltd. (HLF)

Summary

It's been a long three years, but I now believe FTC action is imminent and will happen within weeks.

I lay out my case for why this is and also why Herbalife is in terrible fundamental shape no matter what the regulators do.

I'm proud of the nearly 100 articles I've written exposing Herbalife over the last three years and thank you, the reader, for being a part of it.

For better or for worse, the Herbalife (NYSE:HLF) saga will be over within a matter of weeks, I believe.

I believe that enormous change is coming for the multi-level marketing industry - and that this change is going to be a result of a forthcoming decisive action by the FTC suing Herbalife and alleging the company is a pyramid scheme. In this article, I want to talk about why I think FTC action on the company is imminent, and why I think we are going to have a resolution within the next month.

As I believe society to be on the precipice of true public awareness of why multi-level marketing companies are fraudulent, I believe the beginning of a sea change in the industry could just be starting.

The time has finally come - we are at a new epoch for both multi-level marketing companies and for the Herbalife saga. For the last three years, I have been writing critically about Herbalife and these are some of my final thoughts on the company before we move into what I believe will be the last chapter.

Unlike analyst Tim Ramey, who incorrectly predicted the FTC probe would be over last summer, I believe that I will be proven correct that action from the FTC is likely imminent.

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I expect a resolution to the Herbalife saga to happen within weeks.

I have devised this assumption based on publicly available information - most notably, the company's new disclosures and Charlie Gasparino's report last Friday that the company may enter litigation "depending on the charges".

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To explain:

1. I think that the company's changed regulatory language in their latest 10-K filing indicates that, in terms of procedure, they already understand the "charges" that could be brought against them. For a full explanation of what the company's disclosure says/omits - and what it means - read this. The same language also dictates to me that Herbalife has had a chance to examine the FTC's case and there may be a Vemma style complaint on the way.

2. Fox Business News' Charles Gasparino has, despite my occasional protests, done a good enough job reporting on the "other side" of the story throughout the last couple of years for me to trust that he has a source at, or close to, Herbalife. Charlie and I have had it out on Twitter in the past, but we have made amends and are civil to one another of recent. He stated last Friday, in a report that was exclusive to Fox Business, that the company could enter litigation or settle, depending on the charges. I believe that Mr. Gasparino has a direct tie to the company and I don't believe that litigation would have been brought up if there wasn't a chance of it happening.

The combination of these events leads me to believe that the government inquiry will soon end, bearing the final judgment on whether or not Herbalife is operating an illegal pyramid scheme, in practice, as it operates today.

My formal prediction is that the government files a Vemma-style complaint against Herbalife, ending the company's current marketing and compensation plans as we know it and offering a shockwave through the multilevel marketing industry.

Herbalife has made a mockery of the FTC for over 30 years. In watching the founder's testimony in front of Congress in 1985, it is clear that he is a swindler and was a con man from the get go. Here's a write up of Herbalife's founder's Congressional testimony from 1985, including an exchange with Senator Warren Rudman:

"Isn't it true that you have no college degree." Rudman then asked Hughes. "You completed the ninth grade in school, but consider yourself an authority on nutrition?"

"I know that this plan works," responded Hughes. Later he called himself "an authority on helping people lose weight."

Rudman focused much of his questioning on an early edition of Herbalife's Official Career Book, a training manual for distributors, and read statements of claims for cures of cancer, arthritis, and other diseases. Hughes replied that the copyright laws required picking up significant amounts of material where Herbalife products are endorsed -- "in order not to take statements out of context." Therefore, said Hughes, the Career Book had reproduced many pages from magazines, in which the authors may make unrelated claims.

"Because some quack somewhere said something might cure cancer, you thought it all right to publish?" Rudman exploded.

"No, I am not saying that," insisted Hughes.

"That's one of the most incredible bits of snake oil I've ever heard!" the Senator declared.

Read the full Senate hearing write up here. There used to be a video of an old CNN broadcast showing the Senator screaming at Hughes (it was great), but it was mysteriously removed from YouTube.

The multilevel marketing model in and of itself should be illegal on the basis that it is very easily pushed into pyramid scheme territory. I don't think that the FTC will be able to outlaw all multilevel marketing, but I do believe it will take action against Herbalife that is strenuous and that will send shockwaves through the industry.

I believe that former FTC Commissioner Brill's leaving the commission to go work for a law firm that has ties to the Direct Selling Agency is a clue that there are new stringent regulations that will be put in place, and I do not expect Herbalife to survive in their current way shape or form.

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Regardless of what the FTC does, Herbalife is falling apart.

Lest we forget, Herbalife was supposed to be doing $6.80 to $7.40 in earnings in 2015. At least, that was the narrative back when this whole story started in 2012 and 2013. While those estimates have come down to around $4.00 - $4.35 for 2016, the stock has remained in the $60 region. This means the multiples have simply blown out, not taking into account the regulatory risk at this point.

Look at how badly they missed historical estimates for 2015. Meredith Adler gets the "bonehead of the month" award for her call of "20% EPS growth for the next ten years" back in March of 2012. Not quite, Meredith:

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The boat started to sink in 2014, as you can see by this chart showing the company starting to badly miss Wall Street's estimates:

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Through all of the Ackman controversy and headlines, we have watched the business fundamentals crumble before us. Herbalife is a broken company that is not going to be able to restart its growth anytime soon, let alone if the FTC winds up filing a civil complaint against the company.

According to Factset, estimates for FY 2016 went from $9.06 to $4.52 - nearly a 50% decrease as we converged upon early 2016 - astoundingly terrible.

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And for FY2015 according to FactSet, it was ugly too - the $7.24 EPS analysts were predicting when this whole fiasco started wound up reverting to near the $4.60 adjusted that the company actually posted.

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Everybody knows that China is the only thing holding Herbalife up. When China starts to give way, the growth of the company will dissipate and disappear.

Nu Skin recently showed investors what happens after you saturate China. Here's a chart of NUS getting their licenses in China alongside the revenue the company has posted.

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And what happens after peak saturation.

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Now, how far along is Herbalife with their direct-selling licenses?

  • They had 1 license in China in Q3 2007.
  • They had 6 licenses in China in Q1 2009.
  • They had 16 licenses in China in Q1 2011.
  • They had 24 licenses in China in Q2 2012.

And most recently?

As of December 31, 2014, we had direct selling licenses for 25 of the 29 provinces in which we were operating.

How much of China is left to saturate before we see a repeat of Nu Skin?

Whether the FTC acts first (which I believe will happen) or China collapses, one way or another Herbalife is in for a rocky ride.

**

On a personal note, it has been quite the journey over the last three years. As I have said before, I harbor no ill will towards those on the other side of the trade and I even tried to reach out to those individuals and let them know that this is not personal for me. Some of them have accepted my olive branch - some of them have not. That's just the way life goes.

Despite what some people think, I was never really involved in this trade strictly for the money - nor do I work for Pershing Square. If you haven't already, you can read the post where I reveal my identity and talk about why I am fighting Herbalife to begin with.

Through my coverage of this company, I have had a chance to meet many individuals. Some of these people were interested in the Herbalife story and some of them simply were just investors and people from the industry. I'm immensely appreciative of the contacts that I've made and the help that I've received along the way.

I plan to continue my commentary on Twitter, but this will likely be one of the last articles that I write about the Herbalife saga.

To read of some of my previous work on Herbalife, you can click here.

I'm proud of the work I've done, and I'd like to thank you, the reader, for being a part of it.

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. I have no business relationship with any company whose stock is mentioned in this article.