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Alexander Teicher
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Analyst at Ithaca Partners, L.P., a multi-strategy hedge fund based in Westport, Connecticut. Ithaca was launched in January 2000, and primarily invests in value, special situation and event driven equities as well as quantitative trading. I am a Certified Public Accountant in the State of New... More
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  • Herbalife: “The Reports Of My Death Have Been Greatly Exaggerated.” – Mark Twain. Upside Of 50%+ With Limited Downside

    Situation:

    The hedge fund debate over the legitimacy of Herbalife Ltd. (NYSE:HLF) has been in full swing for over a year now and the situation entered a new phase on March 12, when HLF disclosed that the Company received a Civil Investigative Demand (CID) from the Federal Trade Commission (NYSEARCA:FTC).1 While there is a risk that the FTC finds HLF to be operating an illegal pyramid scheme and in a worst-case scenario shuts down the firm's U.S. operations, the fear of a negative outcome has overwhelmed the stock, which is trading at attractive levels with significant upside and limited downside.

    (click to enlarge)

    Background:

    HLF is a "global nutrition company founded in 1980 that sells weight management, healthy meals and snacks, sports and fitness, energy and targeted nutritional products as well as personal care products."2 The Company operates its business through a "multi-level marketing" ("MLM") platform vs. a traditional retail business model. As a MLM company, HLF sells its products through a network of ~3.7 million independent members in over 90 countries. Historically, MLMs have dealt with accusations of being illegal pyramid schemes (see Webster v. Omnitrition International, Inc.3), the latest of which has been brought by Bill Ackman, founder of Pershing Square Capital Management, L.P., who has waged an impressive marketing campaign against HLF.4 Ackman has the financial power and connections to ultimately force the FTC's investigation;5 however, the length at which he has gone to prove his thesis indicates that this is not black or white and HLF's successful operation over the past 34 years puts the Company in the dominant position.

    The Ackman Argument

    Though there are almost 200 slides in his presentation, the ultimate point that Ackman makes is that HLF members are joining primarily for a financial gain and there is no "real" consumption of the products. One of his more publicized examples is the fact that heavily discounted HLF products can be purchased on eBay, which begs the question, if one can obtain these products for less on eBay, then why bother going through the Company unless you are trying to sell the product yourself? Ultimately, neither the FTC nor investors will be able to track down every consumer of the product; however, there are some anecdotes6 out there that paint a different picture where overweight/obese individuals with limited means are part of a support group that helps them reach their weight loss goals. As such, the cost of HLF products is much more than just the raw materials.

    Furthermore, Ackman's push to force an investigation (e.g. hiring lobbyists, donating to Latino charities, establishing a hotline for HLF "victims") over the past fifteen months reeks of desperation and political maneuvering. He has laid down a very risky $1B short bet that could have disastrous results. As a portfolio manager who has blown up previously,7 Ackman is setting himself up for another embarrassment.

    Opportunity - Downside (15%); Upside (55%+):

    I would argue that HLF's recent slide (down 18% since March 12, down 35% from the 52-week high)has created a buying opportunity as many investors are either unable to own the stock (due to the current investigation) or have been swayed by Ackman's continued smear campaign against the Company.

    First off, let's look at the downside. HLF operates in 91 countries, and according to its most recent 10-K filing, sales in the United States account for ~18% of total sales. Using 2013 numbers, I calculate that if the FTC review results in a complete shutdown of HLF's U.S. business (unlikely), the stock should still trade in the mid-$40s as shown below:

    Furthermore, the downside is conservative as the $45 (~15% downside) does not take into account the higher earnings that HLF is expected to achieve in 2014.

    I believe that the FTC will most likely issue HLF an immaterial fine as these regulatory agencies are inclined to do (revenue for the government and demonstration of the FTC doing its job), and without the regulatory overhang, the stock should return to at least a mid-$80s level. I reach this number on multiple conservative approaches:

    1. Historical P/E: Since January 2010 (includes period of allegations), HLF has traded at an average forward P/E multiple of 13.5x. At the mid-point of Company reported guidance of $5.95 in FY14, the stock should trade at $80.32.
    2. Relative P/E: While HLF has better than average five-year EPS and EBIT growth vs. comps,8 the average forward P/E for comps is 14.25x. Applying the multiple to EPS of $5.95 in FY14 gets me to a stock price of $84.79.
    3. Average Analyst Target: Three analysts have released reports since the FTC investigation was announced and have an average target price of $82.67.

    Taken together, the average upside price is $82.59 (~55% upside).

    Conclusion:

    I believe that the FTC will find HLF's business practices to be sound and Bill Ackman to come out on the wrong side of this bet. Once the overhang is lifted, investors will be able to see a company with impressive margins (e.g. profit margins of 10.6% vs. 7.4% for comps), strong growth prospects (EPS growth has averaged 35% since 2009), a clean balance sheet (the Company has net cash and an investment grade debt rating [BBB-] by Egan-Jones), and generates significant cash (cash flow from operations has consistently been higher than net income).

    Additionally, as obesity becomes a worldwide epidemic9, the demographics for HLF's business become increasingly attractive, which should lead to outperformance on both a sales and profit basis, providing for further upside than the numbers I have reached.

    There will likely be volatility in the stock price before the investigation is resolved, but at current levels, this is a great opportunity for event-driven, value and contrarian investors given the attractive risk/reward profile of HLF.

    1 ir.herbalife.com/releasedetail.cfm?Relea...

    2 files.shareholder.com/downloads/ABEA-48Z...

    3 www.mlmlaw.com/library/cases/mlm/federal...

    4 factsaboutherbalife.com/

    5 www.nytimes.com/interactive/2014/03/10/b...

    6 brontecapital.blogspot.com/2013/01/notes...

    7 www.reuters.com/article/2010/10/14/us-he...

    8 Comps include: NUS, TUP, USNA, MED and NATR

    9 www.newscientist.com/article/dn24838-obe...

    Disclosure: I am long 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.

    Additional disclosure: I may change or exit my position without updating this article and without informing the Seeking Alpha community

    Tags: HLF, long-ideas
    Mar 27 11:44 AM | Link | 7 Comments
  • JGWPT Holdings Inc. - Ripe Fruit On The Peachtree

    JGWPT Holdings Inc. ($17.59)

    Background

    JGWPT Holdings Inc. ("JGW") is one of the world's leading purchasers of deferred payments from illiquid financial assets, such as structured settlements, annuities and lottery receivables. The Company operates by collecting the spread between the purchase discount and its financing costs.

    The stock completed its initial public offering ("IPO") on November 7, 2013 at $14.00 and after falling on the first day of trading to as low as $12.82 (down 8.4%), the stock has risen 37.1% since then, and given the significant discount it still trades at relative to comps, the stock has significantly more room to run (30%+).

    (click to enlarge)

    Company Description

    Since 1995, the Company and its predecessors have purchased over $9.1 billion in future payment obligations from customers. The Company drives revenue from the following four "segments:"

    Structured Settlements: These are contractual agreements to settle tort claims involving physical injury or illness. The claimant is compensated for damages through regular payments over time. Every purchase must be reviewed and approved by a judge before settlement.

    Annuities: These are insurance products that entitle a beneficiary to receive pre-determined streams of periodic payments. Unlike structured settlements and lotteries, annuity payments do not require court approval.

    Lotteries: These prizes are usually backed by state lottery commission obligations or by insurance company annuities. Currently, 24 states allow lottery winners to voluntarily assign all or a portion of their future prize payments. Similar to structured settlement payments, each purchase of lottery receivables requires approval from a judge.

    Pre-settlement funding: These are agreements with plaintiffs with pending personal injury claims. JGW will generally advance funds that are less than 20% of the estimated potential proceeds of the claim. Approximately 65% of all lawsuits related to automobile accidents, and the majority of these cases involve a common set of injuries. Unlike other payment streams the Company purchases, JGW carries repayment risk with pre-settlement funding, since repayment is contingent upon the successful settlement of the plaintiff's claim.

    A key piece to the business is generating leads, and as such the Company spends 25 - 30% of its revenues on marketing and advertising, including television, online ads and search engines, social media and direct mail.

    Opportunity

    Firstly, JGW has a strong moat in the structured settlements business with over a 70% market share and a strong brand name with their J.G. Wentworth (you might be familiar with their daytime television ads) and Peachtree (which caters to premium customers) businesses. Additionally, the Company has spent years developing a database of structured settlement holders, which would be very difficult for competitors to duplicate due to the lack of publicly available information.

    Secondly, the Company's expected revenue streams are quite secure as the majority of their revenues (90%+) require court approval, hence there is minimal risk of any potential regulatory or litigation risk post transfer.

    Thirdly, the valuation seems very attractive as the stock is trading at ~40% discount to peers (FNF, FAF, SYA, LEAF, RM, CACC and WRLD) on a P/E multiple, and in light of the positives outlined above, the stock should trade at maximum at a 20% discount if not lower. With a current price of $17.59 there is at least ~31% upside as shown below:

    Upside

     

    Comps Avg. 2014 P/E

    12.52

    Discount to Comps

    20.0%

    Implied JGW P/E

    10.02

    JGW 2014E EPS

    $2.32

    Implied Price

    $23.20

    Current Price

    $17.59

    Upside

    31.9%

    Additionally, there are seven analysts covering the stock, all of which have a BUY rating for an average target price of $20.57 (an upside of ~17%). The targets are also very tight, ranging from $19.00 - $22.00.

    Lastly, like catastrophe bonds, JGW's portfolio is uncorrelated to the credit/business cycle (i.e. lawsuits will occur regardless of macroeconomic issues) and nearly 90% of its counterparties to the structured settlement payment streams are investment grade.

    Risks

    The main risk here is that interest rates will start to rise, which could result in the Company's financing costs growing more rapidly than its asset purchase discount rate, which will certainly hurt earnings.

    Secondly, the Company has so far failed to provide earnings guidance, which might justify a lower multiple.

    Additionally, there are not many direct public comps in the space, which might deter some investors from taking positions and continue to put pressure on JGW's trading multiple.

    Lastly, the Company did declare bankruptcy in 2009 due to a liquidity crunch, which seems to be resolved as they have increased their warehouse facility from one lender and $250M in 2009, to three lenders and $600M today. Nonetheless, some investors might still remain on the sidelines until the stock has proved its staying power.

    Conclusion

    Overall, JGW is a company with a strong, defensible moat and a unique business that should lead to continued financial success. The Company's slightly checkered past (2009 bankruptcy) and limited peer group might turn some investors away; however, that is where the opportunity lies. The stock looks to have at least a 30% upside if not more, and the downside is limited. While it might take a few months for investors to get comfortable with the name, the stock should continue to do well in 2014.

    Disclosure: I am long JGW, .

    Jan 09 8:09 PM | Link | 1 Comment
  • Imperial Holdings Inc. (IFT) - Life After "Death"

    Imperial Holdings, Inc. ($6.75)

    Company Description

    Imperial Holdings, Inc. ("IFT") is a specialty finance firm based in Boca Raton, FL. The Company operates in a niche industry, which buys, owns and services life settlement contracts. Typically, policyholders sell their policies to IFT, which in turn pays the premiums on the policy until death of the holder, at which point the Company receives a lump sum payment from the insurance company.

    The stock is still down 37% from its IPO and a panic situation has created a unique opportunity with dramatic upside.

    Investigation

    Founded in 2006, the Company completed its IPO in February 2011 at a price of $10.75 and reached a high of $10.99 that same month. The story started to unravel in September 2011 when the U.S. Attorney's Office for the District of New Hampshire ("USAO") launched an investigation into the Company's involvement in the making of misrepresentations on life insurance applications in connection with its premium finance business. In addition, the SEC launched an investigation into the Company in February 2012 generally related to the Company's premium finance business.

    Stepping back, "premium finance" is the business of providing loans to individuals to pay their life insurance premiums and using the policy as collateral for the loan. Given the high interests rates associated with these loans, and the view that companies like IFT were looking for individuals to default so that they could take ownership of the policies, the USAO did not look favorably at the business.

    As a result of the investigation, which concluded in April 2012, IFT entered into a Non-Prosecution Agreement with the USAO, which agreed not to prosecute the Company. As part of the agreement, IFT voluntarily agreed to terminate its premium finance business, and terminated certain senior sales staff associated with the premium finance business. In addition, the Company paid $8.0 million to the U.S. Government. The SEC investigation is still ongoing.

    (click to enlarge)

    Opportunity

    While the history is tainted, the Company has many positives that investors will focus on due to the following:

    Firstly, the largest shareholder, Bulldog Investors, is a shareholder-friendly activist investor, whose founder Phil Goldstein is also the Chairman of the Board. Bulldog has an excellent track record dating back to the 1990s and its interests are fully aligned with minority shareholders.

    Secondly, while the Company has historically used a 15% - 17% discount rate on the policies on its books, it is currently using a 19.6% rate given the slightly negative view of the industry and the Company's personal history. As detailed in the Company's 10-Q filing, an improvement of 0.50% in the discount rate would increase book value by $0.42/share. And while the rate remains above historical levels, it continues to improve (the rate was 20.61% in 2Q13).

    Thirdly, there are a couple of catalyst-type events that should positively impact the stock.

    1. Resolution of the SEC investigation, which has been dormant for quite some time.
    2. Resolution of the Company's lawsuit with Sun Life Assurance Co. of Canada (profiled in The Deal Pipeline on December 3, 2013), which could impact the entire life settlement business.

    Lastly, the stock is trading at a significant discount to book value of $8.89 (~24%) and arguably the discount is even higher if one considers the conservative nature of the discount rate currently being applied by management. The breakdown of the Company's BVPS is shown below:

    As of September 30, 2013

     

    ASSETS:

     

    Life Finance Settlements

    $242,270

    Structured Settlements

    $50,113

    Total Life Settlements

    $292,383

    Cash

    $13,437

    Restricted Cash

    $13,502

    Other Assets

    $10,825

    Total Assets

    $330,147

      

    LIABILITIES:

     

    Note Payable (Est. Fair Value)

    $114,784

    Accounts Payable

    $9,057

    Income Taxes Payable

    $6,295

    Other Liabilities

    $22,609

    Total Liabilities

    $152,745

      

    Total Book Value

    $177,402

    Shares Outstanding

    21,223.02

    BVPS

    $8.36

    Add'l increase in BVPS from sale of Structured Business

    $0.53

    Total BVPS

    $8.89

    Current Price

    $6.75

    Discount to Book Value

    -24.1%

    Risks

    One risk is that the Company runs out of cash and is unable to pay the premiums on the policies they own (though this is unlikely given the recent $300M credit facility they secured in April 2013 and the upcoming rights offering for $60M that they announced in August 2013).

    Additionally, if interest rates rise dramatically, the Company may need to increase the discount rate which will reduce book value.

    Furthermore, its policy holders may very well live beyond expectations, which will increase the amount of premiums they will have to pay out.

    Lastly, there is a risk of an unfavorable outcome from the SEC investigation.

    Conclusion

    Imperial has many of the elements of an exciting investment opportunity. The Company's history has turned many investors away causing the stock price to be depressed, there is an activist investor with a solid track record who is on the board and has the largest equity position in the Company, and the stock is trading at a significant discount to its intrinsic value. Given an upside of 20%+ over the next twelve months assuming the stock trades at 100% of book, this is a very attractive situation with limited downside.

    Disclosure: I am long IFT.

    Dec 12 4:02 PM | Link | 1 Comment
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