Since writing my Seeking Alpha article - "Herbalife Information Disputes Pyramid Allegations," I have heard from people who have challenged the legitimacy of Herbalife's (NYSE:HLF) claims that up to 40% of global sales are from its relatively new daily consumption business model as discussed below by Michael Johnson - Herbalife's Chairman and CEO "Herbalife's CEO Discusses Q2 2012 Results - Earnings Call Transcript," so I have researched the available information to see if I could determine if that claim was reasonable.
Michael Johnson - Chairman and CEO: "Over the past several years, a growing portion of our business has been driven by our distributors around the world moving to daily consumption business methods with long-term sustainable customers. We believe that daily consumption business methods now generate approximately 40% of our volume. With more than 36,000 non-residential nutrition clubs operated by our distributors around the world, Herbalife products and distributors are more accessible to more customers than ever before."
NOTE: Actually Herbalife in investor presentations currently give a range of 35% to 41% of global sales are from nutritional clubs.
I derived the below 3 month net sales number for the 2nd quarter of 2012 from Herbalife's Form 10-Q for the period ending 6/30/2012.
(1) 2nd quarter Net Sales
(2) (1) X 40% of sales attributable to Club Sales
(3) Non-residential nutrition clubs world wide (From above quote)
(4) (2)/(3) = Average 2nd quarterly sales per club at wholesale
(5) (4)/ 3 months =Average monthly wholesale per club
(6) (5)/ 4.34 weeks =Average weekly wholesale per club
(7) (6)/ 6 day week = Average daily wholesale per club
With the calculations on the above chart, based upon the assumption that 40% of all sales are from club sales, I have determined that the daily average sales per club (based on 6 day sales week) is equal to $147 of wholesale product sold each day. This number would be the average daily wholesale sales of all nutritional clubs worldwide. With some clubs having been in existence for many years, it is only logical that there are some clubs which are probably doing a lot more sales than that average which would make up for those clubs doing a lot less.
As to determining the actual retail sales volume and profitability of individually owned clubs, it's impossible to know since these clubs are privately operated and no one, including Herbalife, has presented any information related to this matter. These clubs obtain money for daily, weekly or monthly membership fees to cover operational costs plus from their inventory of product sold at retail. Some clubs may even have multiple distributors each working with their own personal members that they recruited to the club. Here is a link to a website that offers nutrition club training as well as some success stories.
The point of this article is not to determine how profitable an Herbalife Nutritional Club is to those operating them but to provide logical explanations as to the possibility that these type of clubs could generate hundreds of millions of dollars in sales for Herbalife. Here is an excerpt from a Seeking Alpha article- "Herbalife, Nutrition Clubs, And End Consumers: A Look At The Company's Rules" which questions Herbalife's claim that 30% to 35% of Herbalife's sales volume in the U.S. is sold directly to consumers through nutrition clubs since Herbalife requires the clubs to operate under highly restrictive rules-
"Now I think it goes without saying that it is quite questionable how any establishment which meets all of the above listed requirements could possibly generate hundreds of millions of dollars in retail sales per year in a single country."
When someone is talking about hundreds of millions of dollars in questionable sales volume, it could easily make an investor wonder about Herbalife's claims of the overall sales volume from these clubs. However when we actually break it down to an average club volume of $147 of wholesale product sold on a daily basis, it should be easier for an investor to believe these clubs could be responsible for those sales especially since a group of distributors can work together as a team to create the volume for one nutrition club.
For us to believe Herbalife's claims, we must determine the reasonableness of the existence of 36,000 or more people or groups of people within Herbalife's existing 3.0 million global distributor network that could build nutrition clubs that approximates the $147 average. To be fair to readers evaluating this information, Herbalife's nutrition clubs operate under severe limitations as per this excerpt from Section 2 - Herbalife Nutrition Club Rules- USA
Nutrition Clubs are social gatherings publicized exclusively through word of mouth and attended only by persons who are personally invited by the Club operator, another independent Distributor or a customer, either through oral conversation or through conversation accompanied by the provision of a written invitation. Nutrition Clubs are not intended to attract "walk-in" traffic; therefore, Nutrition Club advertising is limited solely to promoting services that are offered at the Club's location, such as a Weight loss Challenge, a wellness evaluation or wellness presentation. Advertising such services may
include the following details:
• Name of Club and Club operator
• Address of Club
• Phone number
Herbalife has established many more highly restrictive rules on these clubs that you can find at the above link. The type of people that establish these clubs must be able to use word of mouth to find most of their customers to be successful. In addition to the normal word of mouth that occurs from customers who have found something they like, club operators are allowed to provide incentives to other people who spread the word and attract new customers to the club as per this excerpt of Herbalife's USA rules-
2-E Member Referral Incentives
Club operators may offer reasonable rewards, such as free products, for the referral of new members, but Club operators are prohibited from paying cash or cash equivalents for such referrals.
When trying to determining whether this $147 per day of wholesale sales volume is reasonable, you also need to know that many of these nutrition clubs have been around for years as documented by this 9/21/2010 article- "What is a Nutrition Club?"
In 1999 a Herbalife coach and his wife in Mexico City, Enrico Varella, started a new concept which they called Nutrition Club, no longer is a one-on-one session with a client, but is a group based daily health program. People were encouraged to attend the club on a daily bases and were enticed to bring new friends to the club. They duplicated their first clubs many times in Mexico and attached a training program to the system for new club owners to learn in a very practical and hands-on concept.
It took a few years to catch on in Mexico (2003) and a few more years to make its way to the U. S.(2006) as well as to a few other countries as documented by these club numbers reported by Investors Business Daily in the 1/25/2012 article - "Herbalife Continues To Display Strength."
"Mexico now has an estimated 25,000 clubs; the U.S., 8,500; Brazil, 1,000; China and India, 800 each. That's according to a Dec. 15 research note from Janney Capital Markets, which sees the potential for big gains."
Herbalife Nutrition Clubs are different from other types of popular businesses, which may see some customers 3 or 4 times per month, since most of their nutrition club customers (over 55% here in the U.S.) actually visit the club on a regular or even a daily basis as per the below chart which is based upon a 2010 survey conducted by Herbalife. These clubs develop a loyal following which allows them to produce more sales from fewer customers. After a customer joins one of these clubs, it's a lifestyle change for them, and they can become a long term regular customer of the club.
Nutrition Club Frequency and Longevity*
U.S. > 55% attend every day
U. S. >55% attending longer than 6 months
MEXICO > 50% attend every day
MEXICO > 45% attending longer than 6 months
KOREA > 30% attend every day
KOREA > 30% attending longer than 6 months
*Based on 2010 survey conducted by the company (slide 13 of 2nd Qtr IR Update)
Herbalife nutrition club members replace one or more unhealthy meals from some fast food joint on a daily basis with a low calorie healthy Herbalife shake. By visiting the nutrition club for their meal, they usually don't spend more money than they would have purchasing unhealthy food, and are getting a more nutritious meal. Over time this new healthier lifestyle for the club's customer usually ends up helping them to have a better more healthy outward appearance.
As to marketing any weight loss product, or any product that helps improve a person's appearance, you can't get a better referral than someone personally witnessing a change in a friend or an acquaintance. I can personally testify to this since I know several people who are always looking for ways to lose weight and to improve their appearance. In fact, you can listen to this investment presentation by John DeSimone, CFO of Herbalife at the 9/25-26/2012 Barclays Back-to-School Consumer Conference where he indicated the results of a recent survey-
"60% of consumers who found the club found it through another customer who had lost weight at the club."
Over the years these clubs have refined their methodologies and have created a formula to increase daily sales based mainly on sales to a few loyal customers and using word of mouth to grow their business. This is why many people outside of Herbalife can't quite figure out where Herbalife's sales growth is coming from.
Weight Watchers International (NYSE:WTW) is the largest player in the growing weight-loss industry. Here is how Chad Henage of The Motley Fool Network compares Herbalife to the industry leader in his 10/2/2012 post- "Don't You Dare Short This Company."
"Weight Watchers' business model is somewhat different from Herbalife's. The company opens centers for in-person support, and provides on-line help, but does not focus on person-to-person sales. By at least three different measures, Herbalife seems like a better value than Weight Watchers. The company's dividend yield of 2.6% is exactly double that of Weight Watchers at 1.3%. Second, the company's P/E ratio on 2012 earnings is 11.51, versus Weight Watchers, which trades for nearly 13 times its anticipated earnings. Last but not least, analysts expect Herbalife to grow earnings at almost 15%, versus Weight Watchers' expected 11%."
If these nutritional clubs truly are the reason Herbalife is growing, we should not only be able to determine that Herbalife total sales overall are growing as we have witnessed by the record 2nd quarter Herbalife results but we should also be able to see that those core products specifically relating to sales at nutrition clubs are growing as a percentage of total sales. As you can see from the chart below since 2002, those core Top 3 products sold in nutritional clubs has grown from 35% to 52% of Herbalife's total product sales mix. That's almost a 50% increase of the overall percentage of products sold specifically relating to nutritional clubs.
Also as a result of these improved nutritional club results, Herbalife has achieved an increased retention of sales leaders (27% in 2002 to 52% in 2011) and an increase in activity by sales leaders (37% in 2002 to 57% in Q2 2012) as well as a decrease in inventory buybacks (2.2% in 2002 to 0.3% in Q2 20112) per the below chart.
Metrics Indicative of Consumption
Key metrics illustrate significant shift to daily consumption*
2012 Q2 YTD
Top 3 products % of total volume
(Formula 1, Tea and Aloe)
Retention of Sales Leaders
Sales Leader activity rate
Buyback % of retail sales**
* Excludes China because of its different marketing plan
** HLF offers to repurchase product from resigning Distributors for up to 12 months in most countries
* slide 14 of 2nd Qtr IR Update (slide can be found at same link for slide 13 above)
Here is the conclusion Janney Capital Markets came to about Herbalife's nutritional clubs as reported in this Investors Business Daily in the 1/25/2012 article - "Herbalife Continues To Display Strength" which I previously provided a link to above.
"according to a Dec. 15 research note from Janney Capital Markets, which sees the potential for big gains."
"While not all daily consumption practices have equal opportunity or measurement, the math is staggering when you consider other much larger markets where the club concept is taking hold," the note says.
Apparently Bank of America has also observed this shift towards nutritional clubs per this excerpt for the 9/26/12 article- "Bank of America Positive on Herbalife's Potential Share Repurchase."
"HLF notes that qualifying volume from new sales leaders accounted for just 14% of company volume in 1H12, down 2pts from 2011 levels, and close to half of 2007 levels, as volume increasingly shifts toward the nutritional club format of distribution (the three main products consumed at nutrition clubs now account for 52% of company volume). The low percentage of sales from distributors qualifying as new leaders contests a common criticism that the majority of sales at MLMs come from new distributors."
I have to agree with these two analysts. I believe Herbalife's daily consumption nutritional club model is similar to the process that many of the large consumer based companies used to grow their businesses. Herbalife found a formula that worked in several locations and now they are duplicating it across their entire global network. You can see the effect of this by looking at the financial numbers being reported as documented by the below chart derived from Herbalife's 2011 Annual Report Consolidated Statements of Income (see page 96)
(in thousands, except per share amounts)
Herbalife Net Sales
Diluted Earnings Per Share
I believe all of the arguments by shorts about Herbalife being a pyramid including those from my prior Seeking Alpha article "Herbalife Short Attack: History Repeats Itself" have once again been proven wrong. There is always a chance that David Einhorn, who is credited with starting the current short attack from questions he asked on a May 1st 2012 Herbalife investor conference call, could come out with a bad evaluation of Herbalife. However shorts will really be disappointed if he continues his present stance as per this Business Insider headline about the 10/2/2012 Value Investing Conference - "Watch A Stock Surge After David Einhorn Says He Won't Bash It."
My advice to Herbalife longs is to thank those shorts for driving Herbalife's share price down and putting them on sale. I believe anyone who is long or purchases shares at the current share price will be richly rewarded and thank me a year from now because 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."