Seeking Alpha

Quoth the Raven's  Instablog

Quoth the Raven
  • on Long Ideas
  • on Consumer Goods
  • on Short Ideas
Send Message
Follow QTR on Twitter: https://twitter.com/QuoththeRavenSA PLEASE READ FULL DISCLOSURE BELOW Quoth the Raven has been a part time investor for the last fourteen years, specializing in technology and emerging markets. QTR loves playing option spreads on volatile stocks that are leading up to a... More
My company:
QTR on Twitter
View Quoth the Raven's Instablogs on:
  • Watch Me Shoot Down Robert Weinstein's One Dimensional Herbalife Bull Thesis

    (This article is a respectful rebuttal to Robert Weinstein's article today on TheStreet.com)

    When you title an article, "Watch Me Shoot Down Bill Ackman's Herbalife Bear Thesis", readers would suspect that you have, in fact, put together an article with enough substance to thoroughly "shoot down" the bearish thesis on Herbalife (HLF).

    Such was my lofty expectations this morning when I saw The Street contributor Robert Weinstein and pal Rocco Pendola gloating about Robert's recently penned article on Twitter. Weinstein claimed that shorts were in for a "world of hurt", and then encouraged me to read his article. So, I did, and now I'm writing about why it's wrong.

    (click to enlarge)

    Immediately, I wanted to check it out. Rocco, I know from our notorious difference of opinion on Pandora (P) - as I screamed it was a short up to $40, Pendola took unprovoked jabs at me before conceding de facto defeat and reversing his thoughts on the company. Pendola and I have since made nice through a series of e-mails, but it looks as if I'm going to have another bone to pick with The Street, who I'm otherwise cool with.

    I was interested in what Weinstein was going to bring to the table with this bull thesis, and I'm always interested in looking at both sides of the coin on a trade before ultimately making my decision on how I'm going to invest.

    Herbalife is a Textbook Definition of a Binary Event Right Now

    First, Weinstein claims up front that Herbalife stock "isn't a binary event." That's just wrong. I mean - really, really wrong. So, let's just clear that up right off the bat. Submitted for your approval is the Motley Fool definition of "binary outcome":

    (click to enlarge)

    You can't tell me if the FTC were to come out and exonerate Herbalife tomorrow that the stock wouldn't shoot all the way through $80 once again. On the contrary, if the FTC shut down operations in the U.S., Herbalife would crumbled down to $30 or under, on its way to eventual single digits.

    So yes, the FTC decision hanging over Herbalife is actually the textbook definition of a binary event waiting in the wings.

    Weinstein's Bull Thesis Offers Zero Nuance or Detail With Regard to Herbalife's Flawed Business Plan

    Then, he looks at Ackman's short thesis from an entirely one dimensional point of view:

    Ackman's first problem is his entire bear thesis: a 34-year-old company operating in 91 countries is an illegal enterprise. The short thesis also assumes Herbalife can't strategically adjust if needed to comply with any given jurisdiction. That's a fatally flawed assumption in a global marketplace.

    Think about that for a moment: Herbalife operates in 91 countries. Modification of the business model in a few jurisdictions doesn't necessarily result in the collapse of the company.

    However, that's exactly what short sellers are arguing, that Herbalife is a binary play and if the FTC drops a hammer on the company it will simply disappear. Nothing could be further from the truth.

    It doesn't matter if Herbalife has been operating for 31 or 131 years - that doesn't make its business model any less of a pyramid scheme. And, we've already seen Herbalife "strategically adjust" in China to the tune of reverse engineering fake consulting hours and hiding expenses in SG&A - just wait and see what that gets them when the Chinese government is done reviewing the evidence and the SEC is finished combing through how Herbalife has booked their Chinese royalties to obfuscate recruiting rewards. Weinstein predicts nothing, I'm predicting either an SEC comment letter or PwC making changes with how the royalties are booked. Let's see what happens here.

    Herbalife's Case is Absolutely Nothing Like BP's Case

    Weinstein then goes on to compare the BP oil spill crisis to Herbalife - citing BP's comeback (when their legal issues haven't even been resolved yet) as proof that the same will happen to Herbalife if hit with an FTC consent order.

    First, that's a farce because BP is still going through their legal issues with billions of dollars hanging in the balance.

    Secondly, there is a massive difference between BP's case and Herbalife's case. BP's risk surrounds a one-time event that has caused concern. Herbalife's risk is a perpetual risk based on the ongoing dynamics of the company's business model. (i.e., at the end of the day, it isn't illegal for BP to keep producing oil). If BP gets over this hurdle, the company will likely continue onward and upward. If Herbalife has changes made by the FTC or even escapes unscathed, its business model is still going to be the subject of question.

    There's many different examples one could choose to make a bullish argument. Comparing Herbalife to BP, who just leaked ANOTHER 400,000 barrels of oil into a lake somewhere and is currently still in a $9.2 BILLION debacle in a court where the judge doesn't seem to like them is not a good comparison. BP is doing anything but kicking ass right now.

    Again, in true one dimensional fashion, he cites Amway as a reason that Herbalife won't be effected. On the contrary, it should be looked at the other way around - any sanctions set on Herbalife are likely going to set precedents for other multi-level marketing companies, like Amway.

    The tools that Amway has in place to prevent outside of network sales, they enforce. Even Tupperware requires weekly numbers to show how much product is sold outside of the network versus in the network. Herbalife does not enforce this, as per the Herbalife deposition cited by Ackman in his original thesis. Herbalife, with regard to the "in network vs. out of network" sales issue, can't seem to get this answer right with any consistency. ValueWalk.com had a brilliant article on this yesterday, where they pointed this out in their article "Herbalife: A Changing Message to Distributors":

    • "Discount buyers [...] have signed up as distributors to enjoy a discount on their purchases [...] were approximately 47%. [HLF 10-K for 2010]
    • "Discount buyers [...] have signed up as distributors to enjoy a discount on their purchases [...] were approximately 29%." [HLF 10-K for 2011]
    • According to Herbalife Ltd. (NYSE:HLF) 's 8-K Form Filing in May, 2012, "discount buyers were 27 percent (distributors who receive a 25 percent discount)" [HLF 8-K for 2012]
    • Kate Kelly: "Can you give us a percentage figure though, Mr. Johnson, as to what percentage of your sales are outside that distribution network?" //Michael Johnson: "90%." //Kate Kelly: "So the vast majority?" //Michael Johnson: "Absolutely." [Michael Johnson on CNBC 12.19.12]
    • "Our distributors are club members, just like Costco…" [Des Walsh on CNBC 1.10.2013]
    • Referring to his previous "90%" figure, "It was a misstatement."/ "90% buy for one reason…self-consumption."[Michael Johnson on CNBC 1.10.13]
    • Herbalife just launched a new website (iamherbalife.com) which says "Most members join simply to receive a discount on products they consume; some join to make part-time income as well, and a small percentage join in search of full-time income."

    And as I said in my last article, Herbalife takes another stab at the pesky question of how many people are signing up to be distributors for personal consumption, by producing this gem of an answer:

    (click to enlarge)

    Oh, I'd love to see the audited math behind coming up with that number. And, also, the pretzel of names and nomenclature likely twisted to be able to word it like they have. We can now add "73%" to the list of different answers we've gotten to this question over the last couple of years.

    The point is, Mr. Weinstein, Herbalife seems to have no idea as to where their product is going. Zero.

    If Herbalife Is Shut Down in the U.S., the Company is Toast

    His grand finale is that even if the FTC shuts the operation down in the U.S., the U.S. only accounts for an 18% loss of revenue! Yes, seriously, this is what he says:

    Don't count on the FTC to end network marketing anytime soon, but if a regulatory agency entirely shut out Herbalife from the U.S. market, it would amount to less than an 18% loss of revenue. China represents another 10%. The rest of the worldaccounts for over 70% of sales. In the most extreme bearish thesis with other countries following suit and banning Herbalife as a result of actions taken by China and the U.S., the company may face a loss of 50%.

    There you have it, the most extreme bear case where the wheels come off in two of the largest free market economies of the world results in an enterprise sustainable 50%. A drop in sales is already priced in.

    You know what isn't priced in? The United States setting a precedent for the rest of the world to regulate or shut down Herbalife. Why isn't that explored? What happens when Herbalife is shut down in the U.S. AND China? More precedents. Further, what if the SEC finds that they were misleading through their China numbers and the way they were booked. What if the BOD is found to be guilty of breaching their fiduciary duties?

    Further, what happens when an FTC decision in the U.S. puts pressure on Herbalife to shut down U.S. offices and then, eventually, the whole shebang in the Caymans?

    Further, even if an order is put in place to govern Herbalife's retail sales, this company is going to be incapable of growth the way that it has been growing, and will likely fade away, as opposed to burning out.

    Mr. Weinstein has clearly not thought this out.

    Weinstein Does Not Have His Money Where His Mouth Is, and Advocates a Bearish Trading Strategy

    Weinstein's "grand finale"-esque conclusion advises people to write covered calls against their Herbalife positions (he's essentially saying hedge your bets after writing a "bullish" article), and then, naturally, disclosing that it's such a great idea, that he has no position in the company.

    In other words, it's one of my favorite covered call setups. Heads I win, tails I break even. Of course, I can lose, and anyinvestment includes risk, but I'm more worried about a market crash causing a loss than Herbalife closing its doors.

    At the time of publication, Weinstein had no positions in securities mentioned

    Ever hear the expression, "money talks, bulls*it walks?"

    Say what you want about me, but the conviction I have that Herbalife is a short has at least compelled me to take a large short position through puts in the company. Mr. Weinstein hasn't yet found the backbone to stake a long position - as a matter of fact, he's telling those long to hedge and limit upside by writing covered calls.

    Mr. Weinstein, I'm willing to put my money up against yours - name the amount, in third party escrow that Herbalife sees $34 before it sees $84 again. I'm game - are you? If so, message me and we'll set it up.

    Best of luck to Mr. Weinstein either way. His views are appreciated, but I do find his thesis to be flawed fundamentally. I continue to contend that Herbalife appears to be a global confidence game that is in breach of direct selling laws in the U.S. and China. I see only potential in betting on the downside here, and remain short Herbalife.

    Disclosure: I am short HLF.

    Tags: HLF
    Mar 28 6:51 AM | Link | 5 Comments
  • Icahn's Extremely Uneasy CNBC Interview Shows That He May Be The Richest Person In History To Be Duped By A Multi-Level Marketer

    (This is in response to Carl Icahn's interview on CNBC today, which you can stream and listen to in its entirety here).

    There are a lot of unfortunate people that fall victim to the promise of riches from multi-level marketing. 96.4% of those, per Herbalife's (HLF) Statement of Average Gross Compensation referenced in my earlier article today, are failed multi-level marketing distributors.

    Now, we might be adding one of the greatest track record investors of all time. After listening to Carl Icahn's interview on CNBC today with Scott Wapner, it's becoming clear that his disdain for Bill Ackman and fundamental misunderstanding of Herbalife's business model has made him the most recent to be duped.

    For a while, usually citing the example of Icahn mispronouncing Herbalife's ticker symbol on the first CNBC battle with Ackman, I've been pushing the argument that Icahn may have simply not done his due diligence.

    Today's CNBC interview with Carl Icahn was extremely revealing. Let's look at some of the statements that Icahn has made with regards to his position in Herbalife:

    Icahn, when asked if it was his idea to stack the Board, said it was mutual and to lend credibility to the company.

    This means, very simply, that there was some part of the company that came to Icahn and either said, "we have directors resigning and not seeking re-election and we need board members" or they could have said, "we've never needed credibility more than we need it now with the FTC investigation looming, some come on."

    Icahn said "UHHH" an awful lot.

    In general, Icahn simply didn't sound like he had a grasp on how the Herbalife model works. He wasn't able to explain clearly and confidently answers to simply questions, like those asked about the FTC investigation and its potential outcomes.

    Icahn said "Herbalife is not a ponzi scheme."

    This rivals Icahn mispronouncing "H-A-L-F" has Herbalife's ticker symbol as his biggest bonehead move thus far. Clearly, the accusation is that Herbalife is a pyramid scheme, not a ponzi scheme (although there's some runover between the two). The poor choice of wording here, one again, indicates that Icahn does not have a serious grasp on the intricacies of the controversy surrounding Herbalife right now.

    Icahn admitted he wouldn't have looked into Herbalife if Ackman wasn't in.

    This is enormous. Icahn is basically saying that the only thing that put Herbalife on his radar was Ackman. He's admitting that this trade is based on a personal vendetta, and did not (at least at first) have anything to do with the fundamentals, products involved, or financials. This is a major admission by the Icahn camp.

    Icahn admitted that in the short-term, Herbalife stock could get rough.

    Icahn knows that there could be rough seas ahead for Herbalife. If I'm a long and an Icahn supporter, this is a statement I'd pay attention to. The shareholders' fearless leader, simply admitting on air, that Herbalife stock in the short term could be a poor investment.

    Icahn admitted that distributors are getting paid to bring in other distributors.

    He also failed to name one Herbalife product, with the exception of their "shake". He is betting his entire position on the sales of one Herbalife product, it sounded like.

    Icahn said he no longer has beef with Ackman.

    This would be the very first thing I would say if I was considering laying down my Herbalife hand or reducing my shares. This is the beginning of a plan for Icahn to potentially not have to eat crow. Too bad Ackman is looking to take this trade "to the end of the earth".

    ------

    Conclusion

    These statements go to serve that Icahn doesn't really seem to have a grasp on Herbalife's business model. As Matt Stewart pointed out, it took Ackman years worth the research to establish his position and it just took Icahn a matter of hours to jump on the other side. He clearly didn't look at Ackman's presentation and clearly failed to do ample due diligence on his end.

    Icahn is tipping his hand. He has been out researched by Ackman and duped by the Herbalife confidence game. And, in judging by his tone with Scott Wapner, it might not be long before he figures it out. In November of 2013, I wrote an article called "Herbalife Could Damn Well be the Next MBIA." In it, I also explored the battle between Icahn and Ackman, predicting that the outcome here could mark a sea change of sorts with regard to who the "sharks" were on Wall Street. I wrote:

    You have to remember that the best in every industry, no matter what it is, are at some point replaced. Sometimes, it's ceremonious, like the turning over of quarterback passing records in football, or when one hall of famer inducts another into the NFL hall of fame.

    Sometimes, it isn't ceremonious, like when Leno's timeslot was replaced by Conan O'Brien.

    But, hey, that's Darwinism. And we could very well be witnessing a sea change of massive proportions about to take place here.

    What we have here is one 48-year-old hedge fund manager in the fight of his life with the three pictured below [Icahn, Stiritz, Soros], worth tens of billions and weighing in at a combined age total of over 1,000.

    Sometimes, not unlike the original aristocrat, C. Montgomery Burns from the Simpsons, guys that have had success their whole lives are less interested in the ethics behind a situation and more interested in simply crushing those who have the moxie to stand up to them. This could very well be a case study in that, and then, the psychological effects of the underdog eventually winning.

    One thing you can say about Ackman over all of 2013 and into the Robin Hood conference/interview is that he's kept his head. As a matter of fact, that seems to be one of the things that Carl Icahn hates the most about him. During their original CNBC interview, Icahn alluded to a statement similar to, "no one is more sure of Bill Ackman than Bill Ackman." I don't know about Bill, but I'd take this as a compliment.

    Ackman, despite what the bulls will tell you, has really always conducted himself in a classy and respectable manner during interviews and when presenting his case. He's persistent and calm, and rope-a-dopes you over and over with this case.

    Ackman was even noted for, against the advice of his lawyer, volunteering much more information than necessary while he was being interrogated by the attorney general and SEC over the MBIA case. He wants you to hear his case - he feels if he can just get the sun to shine on his case, the people will eventually come to the right conclusion. And, I happen to agree with him. His first step was in late 2012, when he finally introduced his case to the world on Herbalife. Now, it's had some time to stew - and stirring the pot is the regulatory agencies and the general public's skeptical eye on the company.

    This is because Ackman knows how to separate emotion from his trades, one of my other cardinal rules of investing.

    Emotion is what prevents real success for many novice traders. Emotion is the catalyst behind making trades that make no sense on paper. Emotion is why people sell off positions after the crash and why they begin buying at the tail end of rallies. Emotion makes idiotic things run through your head, like:

    "This stock may never stop going up! Better get in no matter what cost!"

    And conversely:

    "This company is doomed! We are going to zero right here, right now, on this crash!"

    This may seem like idiocy when you read it now, but even the savvy investors know this voice still comes out in their head when they're in the midst of a rally or crash. Ackman is showing a great example how to ride out emotional situations with resolve and class over 2013 and into 2014.

    By bringing attention to Herbalife, he's doing two things - aside from handing regulators everything they could possibly want on a silver platter, he's forewarning potential Herbalife distributors for what they're in for. It's a legal, ethical, two-pronged effect to make his point. And, I'm convinced his point will be made.

    Remember the original CNBC interview with Icahn? Ackman was cool and collected, while Icahn sounded like the maniac; screaming, cursing on live television, interrupting, and generally making himself look like a whiner.

    I am sticking with this analysis. A legacy that Icahn has is at risk of finishing with possibly one of the biggest blunders in years.

    When Herbalife starts to pull back, there is no doubt that Icahn could have his hand on the trigger.

    Additionally, Charlie Gasparino reported at 12CST that sources close to Icahn claim that he is "99% sure that it is not a pyramid scheme."

    What the hell kind of a comment is that?

    Aside from clearly showing he has no clue with regards to how the model works versus what is and isn't legal, why not 100%? For instance, I can come out and say "I'm 100% sure that Apple isn't a pyramid scheme." Further, what if Carl's 1% happens to be the objective truth? Yikes!

    Also, Gasparino claimed that Icahn is pushing for more of a buyback - what a great idea! Maybe the company will take on another $1 billion in debt. Additionally, Gasparino repeated that Icahn thinks that Attorney General offices could piggyback on the FTC's investigation and that there is going to be "volatility" in the stock in the short-term.

    Following Icahn's interview, the stock - which had been trading at its highs of the day near $53.60, promptly fell down into the $52 region and looks as if it will potentially continue its descent.

    On the most unsure I've heard Icahn since taking his stake in the company, I continue to contend that Herbalife is a pyramid scheme that will ultimately be shut down by the FTC, post-investigation.

    Best of luck to all investors.

    Disclosure: I am 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.

    Tags: HLF, short-ideas
    Mar 24 5:50 PM | Link | 3 Comments
  • Regarding Bill Ackman Swiftly Dropping The Firm Hammer Of Justice...

    (HLF)

    For those of you that laughed at my article title, "Bill Ackman Will Swiftly Drop The Firm Hammer Of Justice Against Herbalife On Friday", I would like to simply show the picture in this morning's NY Post Business section:

    That is all.

    Disclosure: I am short HLF.

    Tags: HLF
    Mar 13 8:34 AM | Link | 3 Comments
Full index of posts »
Latest Followers

StockTalks

More »
Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.