(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 (NYSE: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.
Immediately, I wanted to check it out. Rocco, I know from our notorious difference of opinion on Pandora (NYSE: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":
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:
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.