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When a company's share price dives lower and stays lower based mainly on the silence of anyone including David Einhorn, you have to wonder why, especially when it's a company that has growing cash flow and growing earnings combined with large company share buybacks which have resulted in an even faster growing EPS. Now shorts have to come up with a strategy to cover their positions without driving up the share price to quickly. Since shorts are still adding to their short positions to combat recent rapid share price increases, they have to wonder if they are creating an even bigger problem especially with the increased probability of an even better 3rd quarter financial report looming ahead.

On May 1st of this year, Herbalife (HLF) shares were trading as high as $70.75 but within 3 days after some questions by Einhorn that a lot of people considered innocuous on a conference call, Herbalife's share price plunged over 35% to as low as $45.55 from high volume trading (almost 79 Million shares traded equivalent to almost 20 X normal share volume) including a dramatic rise in shares shorted of almost 5 1/2 million (4/30/12 short interest 6,338,044; 5/15/12 short interest 11,818,628).

The questions asked by Einhorn on the call have been asked and "already answered" many times over the years per the Direct Selling Association.

As the Federal Trade Commission stated in a January 2004 Staff Advisory Opinion, internal consumption is not considered to indicate impropriety. Instead, "the critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture."

In short, what the FTC watches for - and what the DSA Code of Ethics is designed to protect against - are compensation systems that are funded primarily or exclusively by payments made for the right to recruit other participants. Compensation must primarily be based on the sale of products and services to the ultimate consumer - whether or not that consumer is also a seller of the products.

It appears that most of Herbalife's share price drop can be attributed to investors' belief of the brilliance in Einhorn's capability to find problem companies, to short them, and then to let everyone know why the company's shares are overpriced. With Herbalife's situation, Einhorn hasn't even let people know whether he was short or long, or even given one single explanation as to why Herbalife's shares were overpriced.

To date, Einhorn has not made any public statements about Herbalife.

Some people may say that Herbalife's share price drop wasn't just because of Einhorn's conference call questions and now his silence. Some of the usual investment reporters and commentators jumped in to dig up anything and everything bad that they could come up with on Herbalife which made some additional investors concerned about owning shares of Herbalife.

You might think shares diving straight down in 3 days is good for shorts but actually the object for shorts is to sell their shares at the highest possible price and then to try to cover at the lowest possible share price. If there was a real problem with Herbalife's business, it would have been much better for them to gradually short shares over time as the share price slowly fell and then for them to expose major legitimate issues about the company so the share price either continued down or only gradually increased while they took their profits as they purchased shares to cover their short positions.

After those 3 days of share sell off, Herbalife's shares did drop to as low as $42.15 on May 15th but even with very critical reporting by some investment reporters, Herbalife's share price immediately started to climb back up while shorts actually continued to add to their positions, as documented below:

Settlement DateShort Interest+/-Short InterestClosing Share PriceIncreased Share Price
5/15/201211,818,628----$42.44----
5/31/201212,756,583+937,955$44.79+$2.35
6/15/201212,973,912+217,329$45.87+$1.08
6/29/201212,230,753-743,460$47.23+$1.36
7/13/201212,475,753+245,301$48.15+$0.92
7/31/201212,422,168- 53,585$54.89+$6.74

5/15/12 to 7/31/12 +603,540 short interest +$12.45 increase share price

Links to above info: Short interest chart & Stock share price chart

Obviously shorts had to be very concerned with Herbalife's share price rising over $12 while they were still adding to their short positions. After Herbalife's reporting of extremely good 2nd quarter financial information with dramatic increases in total earnings, cash flows, share buybacks, and earnings per share on 7/31/12, shorts have continued to add to their positions and are trying to take back control so they can prevent Herbalife's share price from continuing its dramatic rise from prior lows. Feeble attempts by investment reporters to report stories critical of Herbalife combined with additional selling by shorts temporarily helped shorts drive back down HLF's stock share price to as low of a closing price as $50.59 on Friday 8/10/12.

Since Einhorn's innocuous questions on Herbalife's conference call, CNBC's Herb Greenberg has worked harder than anyone else, reporting multiple stories which have all been very critical of Herbalife. His most recent report about Herbalife was typical of his reporting style and was headlined "The SEC's Back and Forth With Herbalife." From reading his headline, you would think he was reporting about a serious ongoing SEC investigation but when you begin reading his article, Greenberg openly admits, "These kinds of exchanges, often routine and painfully mundane in nature, are tagged on the SEC's website." Then, to top that off, you find out near the end of his article this: "that was pretty much it, with the SEC sending a formal 'we have completed your review' letter", and then Herb finishes his article by revealing, "Herbalife told me today that the 'documents speak for themselves and the matter has been closed. There is no SEC investigation.'"

So within 5 minutes of Greenberg's report about "routine, painfully mundane exchanges with the SEC," over 400,000 high volume shares of HLF were traded and Herbalife's share price was traded down to as low as $48.97. However within an hour after that supposed "Breaking News" by Greenberg, and after a lot less shares were traded, Herbalife's shares were already back up to where they were trading when Greenberg came out with his report.

Not to be outdone by Greenberg, Jim Cramer, another CNBC investment reporter, recently changed from being a Herbalife bull to a bear. The reason for the change is, as he said in this 8/8/12 video "Lightning Round" (see video at 2:50) from his CNBC show, "I didn't know that - I found out later that" when referring to the fact that 4 years ago, Herbalife had paid off Barry Minkow, a convicted felon, to shut up. Prior to that announcement, Cramer had been an ardent supporter of Herbalife as documented by this very informative video of Cramer interviewing Michael Johnson, Herbalife's CEO, in January of this year.

The timing of Cramer's change of support surprised a lot of people, including those Herbalife longs that had relied on his recommendation to buy Herbalife's stock when it was at a much higher price, since Cramer seems to have a photographic memory about stock information. He appears to want people to believe he didn't have any idea about the Minkow payoff before his 7/31/12 interview with Michael Johnson, Herbalife CEO even though his fellow CNBC reporter, Greenberg, had reported via commentary and articles on CNBC about the Minkow payoff multiple times since reporting about the issue on May 2nd of this year. Apparently Cramer was watching another TV channel other than CNBC when he was preparing for his May 2nd Lightning Round.

Four years ago then-convicted felon Barry Minkow, who had turned from white-collar criminal to claiming to be white-collar fraud-buster, had a new target: Herbalife.

Current indisputable facts for case against Herbalife shorts -

  1. All of Einhorn's questions have been answered by Herbalife and the Direct Selling Association. Einhorn has not disclosed either a short or long position in Herbalife. Einhorn has not made one public statement critical of Herbalife or even asked for additional information from Herbalife since his May 1st appearance on Herbalife's investor conference call.
  2. No one has presented any information as to the existence of a real SEC investigation of any type concerning the business activities of Herbalife.
  3. No one has presented any information as to any review or ongoing investigation activities by the FTC currently against Herbalife.
  4. Not one investment reporter has disclosed any new information (all reports have only included previously publicly known information) as to any ongoing problems with Herbalife's business since Einhorn's May 1st appearance.
  5. Before and after May 1st, Herbalife's business has continued to grow at a dramatic rate. No one (Einhorn, investment reporters or shorts) has presented any case as to why Herbalife's business will slow down in the near future.
  6. For the year as of July 31st, Herbalife has repurchased $428 million worth of stock and has announced another $1 BILLION share buyback plan.

The use of fear mongering or pumping combined with high volume trading only works over the short term as Benjamin Graham stated, "In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine."

It is very unfortunate that something like this had to happen to Herbalife or for that matter could happen to any other legitimate company since I am sure there were a lot of long investors that had to have been hurt by this escapade. It is another reason why a lot of investors have been scared away from this marketplace. The good news for Herbalife longs is that unless the shorts and their reporters can come up with some new better material to try to drive Herbalife's stock price back down, you will see Herbalife's share price quickly rise back up to and above the $70+ range where it was before this unfortunate event started.

Source: Herbalife Shorts' Problems Could Be Great Buying Opportunity For Longs