Seeking Alpha

Shane Dinneen  

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  • Herbalife: Analyzing Through The Speculation [View article]
    How do you arrive at a NAV of $53.10 per share?

    Even on a gross asset basis, HLF only has $24.43 per share (assets as of 12/31/13 = $2.474bn / 101.2mm shares = $24.43).

    Most people subtract liabilities when calculating NAV. I'd argue you should also adjust for Herbalife's intangible assets and mark its Venezuela dollars to market.

    That calculation yields a negative NAV of ($0.52) per share:
    $2.474bn of assets
    Less: $1.922bn liabilities
    Less: $105mm goodwill
    Less: $310mm trademark
    Less: $190mm Bolivar mark-to-market (@ 49.3x per SICAD II as of 4/16/14)
    Equals: Negative $52mm (or $0.52 per share)

    That NAV gets more negative in a hurry if one considers the potential liability that could arise from an investigation.
    Apr 21, 2014. 04:35 PM | 5 Likes Like |Link to Comment
  • Herbalife: Here's Why You Won't Hear Ackman's Defense This Time [View article]
    I did read your most recent article, I just didn't find it all that compelling. To the contrary, I found the following statement to demonstrate a particular lack of understanding:

    "If a product X is sold by a non-MLM company and a MLM company, and distributors/retailers make same amount of money selling product X at the same price to retail clients, gross margin of MLM Company will appear artificially inflated. This is because the net sales number for the MLM Company will contain Royalty overrides (a part of distributor's P&L in case of normal company) which will reduce COGS as a percentage of net sales. So, to do apple to apple comparisons, one needs to subtract royalty overrides while calculating the adjusted margins."

    If two companies are selling the same product for the same price, the gross margin will be the same. HLF sells products to distributors who then try and mark up the product at retail just like "a normal [CPG] company" sells products to retailers who then mark up the product at retail.

    And just as HLF has royalty overrides, "a normal company" has marketing expenses, neither one of which should be included in COGS. Your argument makes no sense.

    Finally, the net sales number for an MLM company does not "contain" royalty overrides. You don't calculate revenue by adding up the costs.

    Regarding your claim that "Wiliam Keep was working for [us] all along," I suggest you reread the comments to your first article, "Herbalife: What Exactly Is In Peter Vander Nat's Paper And Why Bill Ackman Is Wrong." William Keep very clearly states " I had nothing to do with Ackman's analysis or presentation. I have received no compensation from Ackman or anyone related to Ackman."

    Keep making false accusations. It really helps your credibility.
    Mar 7, 2013. 09:12 AM | 5 Likes Like |Link to Comment
  • Herbalife: Here's Why You Won't Hear Ackman's Defense This Time [View article]
    Since February 21st, Fusion Research has published multiple articles on Seeking Alpha and other blogs that question Pershing Square’s short thesis on Herbalife. Though Fusion Research has no position in the stock, the articles were “written with substantial inputs from an [undisclosed] investor who has a long position in ‘in the money’ call options of Herbalife.” Pershing Square believes that contrary points of view can be helpful in elucidating the relative merits of an investment opportunity.

    In Fusion Research’s most recent Seeking Alpha post, “Herbalife: Why You Won’t Hear Ackman’s Defense This Time,” Fusion Research speculates that Pershing Square will choose option one of the following two options: (i) silently cover its short or (ii) continue to raise vague questions and defend its original analysis. This comment explores a third option, namely, pointing out the aspects of Fusion Research’s analysis and underlying assumptions with which we disagree.

    Fusion Research has failed to adequately respond to the questions we published to the article “Herbalife: What Exactly Is In Peter Vander Nat’s Paper And Why Bill Ackman Is Wrong.” Specifically, this post will focus on the questions responded to in Fusion Research’s “Reply To Bill Ackman’s Questions On My Herbalife Analysis (Part 1).”

    Question #5:
    Fusion Research assumes that the “basis of [our] pyramid ‘proof’” is the economic model in the second half of Vander Nat & Keep’s 2002 paper. The implicit assumption here is that since we use the definition of a pyramid scheme in the first half of the paper, then it follows that we are reliant on the economic model in the second half of the paper for our pyramid scheme “proof.”

    This conclusion is not correct. The definition of a pyramid scheme found in the first half of the Vander Nat & Keep paper has been used by the FTC in the prosecution of pyramid schemes and is part of the case law. For example, in FTC v. Five Star, the Final Judgment defined a pyramid scheme thusly (

    “’Prohibited marketing scheme’ means a pyramid sales scheme, Ponzi scheme, chain marketing scheme, or other marketing plan or program in which a person participates under a condition that he or she make a payment, directly or indirectly, to receive the right, license or opportunity to derive income as a participant primarily from: (1) the recruitment of additional recruits by the participant, program promoter or others; or (2) non-retail sales made to or by such recruits.”

    The same definition was employed in the Final Judgment of FTC v. Futurenet (

    More recently, in November 2012, the FTC published a consumer alert on its website that similarly focuses on how an MLM’s compensation plan incentivizes distributors – without regard to the company’s profit or “indirect retail commissions”:
    “One sign of a pyramid scheme is if DISTRIBUTORS sell more product to other distributors than to the public – or if they make more money from recruiting than they do from selling.” (emphasis added)

    This is the effective equivalent of the definition of a pyramid scheme employed in our presentation, and it has a solid foundation in the case law. On the other hand, the model in the second half of Vander Nat & Keep’s paper is purely academic. I would challenge Fusion Research to point to any Final Judgment in any pyramid scheme case law (FTC or otherwise) that employs the term “Advance Retail Commissions.”

    A court will determine what a pyramid scheme is and how to distinguish one from a legitimate MLM. In doing so, the courts will rely on the case law, not the economic model in the second half of Vander Nat & Keep’s paper. After careful review of the case law, it is our opinion that when a court compares the profits earned from retail sales versus recruiting rewards to determine whether or not participants obtain their monetary benefits primarily from recruitment, the profits earned by the company (aka “indirect retail commissions”) will not factor into the equation.

    Instead, we believe the courts will focus on factors such as (i) the failure rate of participants, (ii) financial harm, (iii) the extent to which upline rewards are skewed toward the top of the pyramid, (iv) the extent to which marketing materials promote recruitment and the business opportunity, (v) enforcement of the company's so-called "Amway rules," (vi) the structure of the compensation plan, including whether it provides greater rewards for participants who actively recruit, (vii) whether or not participants can receive commissions without purchasing product, (viii) whether commissions are based on the sale of product to ultimate users, (ix) the relative merits of the retail opportunity, and, last but not least, (x) the extent to which sales occur "outside" the distributor network. With the exception of #10, none of these factors are incorporated into the Vander Nat & Keep model.

    Fusion Research says our pyramid scheme analysis is flawed because we don’t rely on the economic model in the second half of Vander Nat & Keep’s paper. I say Fusion Research’s analysis is flawed precisely because it does rely on that model.

    Question #2:
    Fusion Research’s claim that Herbalife is not a pyramid scheme per the economic model in the second half of Vander Nat & Keep’s paper hinges on an interpretation of “full production costs” that excludes SG&A.

    To sidestep our question, “why have you excluded SG&A from your calculation of ‘full production costs’ or ‘f’?”, Fusion Research attempts to show that any MLM would be a pyramid scheme if one were to deduct SG&A AND DISTRIBUTOR REWARDS (emphasis added) from ‘W’ for the calculation of ARC. By also subtracting distributor rewards from ‘W,’ Fusion Research manipulates our question to produce a result that would imply that any MLM is a pyramid scheme.

    For example, Fusion Research argues that “Avon will be classified as a pyramid scheme according to [Pershing Square’s] (mis)interpretation. Here’s the calculation.

    0.9 x (11,291.6) – 4148.6 – 6025.4 = -11.56 <0”

    Had Fusion Research correctly responded to our question, it would have only deducted the portion of SG&A that refers to true SG&A (i.e. SG&A excluding distributor rewards).

    Though Avon is careful not to clarify what portion of SG&A is distributor rewards, let’s re-run the math assuming 50% of Avon’s SG&A excludes distributor rewards. Let’s also exclude “other revenue” from Avon’s total revenue as it largely refers to freight income.

    0.9 x (11,112) – 4.148.6 – (50%)(6025.4) = $2,840 (“ARC”)

    Note that ARC in this example is greater than half of distributor rewards because $2,840 > (50%)($3,013). Including SG&A in the calculation of ARC does not de facto imply that Avon is a pyramid scheme per the economic model in the second half of Vander Nat & Keep’s paper. Therefore, Fusion Research’s implication that any MLM would be a pyramid scheme if one were to include SG&A in “full production costs” is verifiably false.

    More importantly, Fusion Research accuses us by saying, “Clearly, your assertion that Peter Vander Nat declared that one should include SG&A in f is you putting your words/faulty assumptions in Peter Vander Nat’s mouth.”

    However, prior to publishing our questions, we emailed William Keep, co-author of the Vander Nat & Keep 2002 paper, to ask for clarification as to whether it was the author’s intent to exclude SG&A from “full production costs.”

    From my email to William Keep:

    I am considering posting the following questions for the author of the Seeking Alpha article you reference below, but I would be interested to get your opinion on the questions to the extent you have any.


    b. Why do you only include Herbalife’s COGS in your interpretation of “full production cost” for the term f? In Vander Nat’s declaration in FTC v. Trek Alliance, he asks the following question “are the revenues from the sales of the goods and services to general consumers sufficient to cover the following costs and expenses: immediate productions costs, the various marketing expenses, general overhead, and the promised rewards for enrolling new members?” This would seem to suggest you should incorporate SG&A into your calculation to determine the residual profits from which Herbalife can pay “upline rewards” – why don’t you?”

    From William Keep’s response to my email:


    Your emphasis on including all cost in point "b." is consistent with our paper:

    "In addition to the preceding definitions, the main concept introduced expressly for purposes of pyramid analysis is advance retail commissions (ARC). These funds refer to the portion of actual retail volume (in monetary terms) that is available for the payment of upline rewards."”

    The email exchange above should put to rest any accusation that we have “put [our] words” into the mouths of Vander Nat & Keep by questioning whether or not “full production costs” should include SG&A costs.

    Intuitively, it makes no sense to think of an SG&A expenditure as a “retail commission” – direct or indirect. As Mr. Keep explains above, Advance Retail Commissions represent the funds available to pay upline rewards. In light of the fact that Herbalife must pay its SG&A expenditures, by definition, those funds are not available to pay upline rewards.

    Finally, it is worth reiterating that MLMs are inherently complex enterprises, whose GAAP reported metrics do not fit neatly into the equations in the Vander Nat & Keep model.

    For example, Herbalife discloses in its 10-K that SG&A includes “non-income tax expenses such as value added tax and sales tax,” though it does not specify the exact amount of these items. Think about that for a second. VAT and sales taxes are supposed to be “pass-through” items – from Herbalife’s 10-K on Revenue Recognition: “The Company currently presents sales taxes collected from customers on a net basis.”

    In other words, Herbalife collects VAT/sales taxes from distributors, remits the VAT/sales taxes to the government, and nets out the “tax revenue” and “tax expense” in its GAAP financials. If Herbalife is including VAT and sales tax expense in SG&A, it is reasonable to assume some of the “tax revenue” is showing up in Net Sales. This would serve as a double-win for Herbalife if one is to use Fusion Research’s (flawed) interpretation of ARC: (i) it increases ‘W’ by increasing Net Sales, and (ii) the offsetting expense goes into SG&A, which Fusion Research conveniently does not deduct from ‘W’ to calculate ARC.

    The point of the example above is to show that, if SG&A is excluded from “full production costs,” then Herbalife could artificially inflate its ARC by altering its accounting treatment of value added and sales taxes. An MLM’s accounting practices should not determine whether or not it is a pyramid scheme. Moreover, complex issues such as the example above highlight how difficult it is to fit an MLM’s GAAP reported metrics neatly into the Vander Nat & Keep model – all the more reason to look to the case law and not the economic model in the second half of Vander Nat & Keep’s paper when establishing the basis to determine whether or not an MLM’s participants derive their monetary benefits “primarily from recruitment.”

    [We further note that a new Seeking Alpha blogger has recently entered the moot Vander Nat & Keep debate, publishing an article entitled “Herbalife: Legitimacy Determination Using Dr. Vander Nat’s Methodology.” Notably, the author includes SG&A in his calculation of “full production costs,” despite arriving at the (wrong) conclusion that Herbalife is not a pyramid scheme per Vander Nat & Keep’s model (wrong because the author totally overlooks the variable ‘r’ in Vander Nat & Keep’s paper that accounts for internal consumption). The fact that so many different analysts can plug the same company into the same model and get widely divergent calculations of ARC further demonstrates our point.]

    In the article, “Why Bill Ackman’s Key Argument Is Flawed,” Fusion Research puts forth an example of an “MLM” (I put the term in quotes because the example is set up in such a way that no commissions are paid on sales made by downline distributors so technically this is not a traditional MLM) where distributors earn more from “recruiting rewards” than they do from “retail profits.” The example is also set up to ensure that all distributors make money. Fusion Research then asks if we would deem this a pyramid scheme given that recruiting rewards are greater than retail profit but no one is harmed.

    Unfortunately, this example is a fallacy. As was the case in Koscot, “a marketing program [that is] structured so as to maximize recruitment earnings at the expense of retail earnings” will cause distributors “to devote their energies to recruiting by virtue of the apparent opportunity to make big money fast.” This recruitment effort will come at the expense of the retail effort, and, inevitably, saturation will follow. With saturation, the opportunity to earn retail profit will dissolve. To wit, “by encouraging the recruitment of any person who had or who could get sufficient money to buy into the program, regardless of their qualifications or their location in reference to other distributors, the Koscot program virtually foredoomed the retail effort to failure.”

    We would put forth the following counterexample for Fusion Research. Imagine an MLM where the company is largely profitable, but 99% of the distributors lose money. Perhaps the company is profitable because it prices its commodity products so high that, even at wholesale, the company earns more than an 80% gross margin. Perhaps the distributors lose money because the Suggested Retail Price of the products they purchase from the company is set so high that they cannot even recoup their wholesale basis upon reselling the products to the public. Internal consumption (the cost of product that cannot be resold at retail) and indirect costs such as the purchase of leads, advertising expenses, training, rent, travel, merchant fees, telephone and Internet costs only make matters worse. And though the company pays substantial upline rewards, they are heavily skewed to the top 1% of distributors.

    In this case, ARC would be substantial because the company is profitable, but, after netting out distributor expenses, direct retail commissions would be negative. Assume further that ARC is sufficiently large that it accounts for more than half of upline rewards. Even though direct retail commissions (less expenses) are negative, 99% of distributors lose money, and upline rewards are only received by the top 1% of distributors, would you argue that the MLM described above is not a pyramid scheme because ARC is more than 50% of upline rewards?

    Finally, your disclosure notes that your article was written with substantial inputs from an investor who has a long position in “in the money” call options of Herbalife. Would you care to disclose who that is?

    Disclosure: See the disclaimer in the presentation Who wants to be a Millionaire? posted on for a disclosure of the opinions expressed in this comment and for further detail on Pershing Square and its position in Herbalife.
    Mar 7, 2013. 03:56 AM | 6 Likes Like |Link to Comment
  • Herbalife: What Exactly Is In Peter Vander Nat's Paper And Why Bill Ackman Is Wrong [View article]
    Vander Nat & Keep offer a theoretical model to analyze MLM compensation schemes. However, MLMs are inherently complex enterprises, whose GAAP reported metrics do not fit neatly into the equations provided in their paper. With that in mind,

    1. Why have you included Shipping & Handling revenues and literature and promotional revenues in your calculation of ‘W,’ which you equate to Herbalife’s reported GAAP Net Sales? Because these items are, in fact, distributor expenses, shouldn’t you exclude them from your calculation of ‘W’?

    2. In Vander Nat’s Declaration in FTC v. Trek Alliance, he asks the following question, “Are the revenues from the sales of goods and services to general consumers sufficient to cover the following costs and expenses: immediate production costs, the various marketing expenses, general overhead, and the promised rewards for enrolling new members?” In light of Vander Nat’s Declaration, why have you excluded SG&A from your calculation of “full production costs” or ‘f’?

    3. Correcting for the exclusion of distributor expenses from GAAP Net Sales and inclusion of SG&A into “full production costs” yields a very different calculation of ARC. Based on your numbers, ARC is $1,740mm. However, correcting for #1 and #2 above, ARC is only $185mm.

    [‘W’ = GAAP Net Sales ($3,455mm) – S&H ($510mm) – Lit/promo ($173mm) = $2,772mm;
    “Full production costs” = COGS ($680mm) + SG&A ($1,075mm) = $1,775mm;
    “Full production costs” / ‘W’ = $1,775mm / $2,772mm = 0.63;
    Therefore, ARC = (0.7 – 0.63)W = 0.07 * $2,772mm = $185mm]

    In light of the fact that the ARC calculated above is only a fraction of “upline rewards,” why wouldn’t you conclude that Herbalife is a pyramid scheme?

    4. How do you incorporate other relevant variables into the analysis, such as (i) wholesale commissions (which “disappear” in Herbalife’s income statement above the GAAP Net Sales line item but should be thought of as “upline rewards”), (ii) recruiting rewards in SG&A, and (iii) distributor expenses (such as the purchase of leads, nutrition club rent, etc…)?

    5. Finally, you say that Ackman misinterpreted the term “primarily from recruitment” in his analysis based on the Vander Nat & Keep economic model. However, their paper explicitly leaves the definition of this phrase to policymakers (“any definition of the term ‘primarily’ implies a policy decision.”) Therefore, why do you rely on the economic model in the second half of Vander Nat & Keep to define this phrase instead of case law that incorporates definitions of a pyramid scheme that are similar to that found in the first half of Vander Nat & Keep’s paper (e.g., FTC v. Five Star
    Feb 25, 2013. 05:43 AM | 7 Likes Like |Link to Comment
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