Bye Bye Bolivar - Hello Writedowns

| About: Herbalife Ltd. (HLF)

Herbalife (NYSE:HLF) consolidates its Venezuelan Operations at an exchange rate of 6.3 per U.S. dollar.

An article published in Caracas yesterday suggests that this "mark to market" price may turn out to be "mark to myth".

Specifically, an additional devaluation of the Bolivar from 6.3:1 to 30:1 may be required if this journalist for EL Universal turns out to be correct. The implications of this devaluation would be material for two reasons:

  1. Assets carried on HLF's balance sheet are currently converted at 6.3:1. Assuming a 30:1 conversion rate, these Bolivar denominated assets would be worth less. Herbalife has $125 million in cash marked at 6.3:1. This cash would become worth $26 million (pre-tax) in the event of an additional devaluation.
  2. The company's most recent 10Q tells us that such a devaluation would push the Venezuelan operations into a net loss position. The consolidation of these operating results would, therefore, lead to a decline in sales and EPS on a go forward basis.

The company writes in its most recent 10-Q:

To illustrate our sensitivity to potential future changes in the CADIVI rate or using unfavorable alternative legal exchange mechanisms to exchange Bolivars to U.S. dollars, if the exchange rate was approximately 75% less favorable than the current 6.3 CADIVI rate and this unfavorable exchange rate was used to convert our Bolivar denominated cash and cash equivalents as of June 30, 2013, our $124.6 million Bolivar denominated cash and cash equivalents as of June 30, 2013 would be reduced by $93.2 million and result in a corresponding foreign exchange loss to our operating profit.

This 75% less favorable exchange rate is not necessarily representative of exchange rates which could be available to us for future exchanges, but is used for our sensitivity analysis above as it represents the actual weighted average rate that we received when using alternative exchange mechanisms during the three and six months ended June 30, 2013.

If Herbalife Venezuela's ongoing operations were subject to the 75% less favorable exchange rate, Herbalife Venezuela would operate at a loss and this could have a significant negative impact to our consolidated financial statements.

Our ability to access the CADIVI rate could impact what exchange rates will be used for remeasurement purposes in future periods.

We continue to assess and monitor the current economic and political environment in Venezuela.

In the first quarter of 2013 the Bolivar was devalued from 5.3:1 to 6.3:1.

Again, from the most recent 10-Q:

We recognized approximately $15.1 million of net foreign exchange losses within our consolidated statement of income during the first quarter of 2013, as a result of remeasuring our Bolivar denominated monetary assets and liabilities at this new CADIVI rate of 6.3 Bolivars per U.S. dollar. The majority of these foreign exchange losses related to the approximately $16.9 million devaluation of Herbalife Venezuela's Bolivar denominated cash and cash equivalents.

If the article written in Caracas proves to be prescient, another $50 million charge de minimus may be the order of the day with a potential exodus from the Venezuelan market entirely on the horizon.

Further devaluation seems inevitable. As for how much?

Herbalife's books are marked at 6.3:1, 2013 Guidance is offered at a 10:1 rate and El Universal predicts 30:1 as a reasonable mark.

The spread is pre-tax $100 million it would seem. A 30 cent haircut to the EPS forecast for 2013 might seem prudent in the end along with an adjustment for the loss of about $150 million in revenue from the company's top-line going forward.

Hurricane Hugo may blow an ill wind if you are long. One way or another, HLF's Venezuelan assets seem destined for further impairment.

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.

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