Herbalife: The Upcoming Catalyst Expected To Bring The Company Down

| About: Herbalife Ltd. (HLF)

Summary

Herbalife is running out of time and tools to keep the stock price at such inflated levels.

I suspect Herbalife extended the Modified Dutch Auction to close in the beginning of Q4 in order to give 13F filers more time to liquidation shares.

This move now allows for 13F filers to report any liquidation of Herbalife stock in February of 2018 and gives them three more months to sell more shares.

If active managers are selling, as judged by their SEC filings coming in February of 2018, the reduced float will serve as a major force to take the stock down.

The past 40 days have proved to be an example of the effects the reduction of the float has on the stock - down by 15%.

Herbalife (NYSE:HLF) has implemented a variety of financial engineering tactics over the years to prop up or manage the decline of their stock price. The most recent, and especially powerful tactic, has been their share buyback campaigns.

In February of 2017, Herbalife levered up to launch $1.5 billion share buyback program. To blunt the impact of their failed attempt to take the company private, Herbalife launched a Modified Dutch Auction to buy back up to $600 million worth of their own stock, with the seller to receive CVR to protect the seller from not realizing a higher price if the company was taken private.

The transaction was set to close, originally, on September 19th, 2017. The company then extended the expiration date to October 5th, 2017. The final results of the tender offer were announced on October 11th, 2017, where Herbalife

accepted for purchase 6,732,300 common shares of the Company at a cash purchase price of $68.00 plus a CVR per share, for a total cash cost of approximately $457.8 million.

We find shift of the closing date to be a material event for the following reasons:

  1. If the transaction settled in Q3 as it was intended to originally, the 13F filers who were not insiders, would have had to disclose their change in ownership in their upcoming Q3 13F filing (which is due quarterly, while 13G is due annually), if they sold into the MDA.
  2. Because the MDA was, initially, due to close before the end of Q3, the change in ownership would have been detected by the market in the Q3 13F filing which were due in mid November.
  3. Since the transaction close date was changed so it closed in the beginning of Q4 of 2017, the 13F filers would then be able to file their amended 13G (if applicable) for Herbalife at the same time as they file their 13F filing.
  4. By extending the time frame each 13G/13F filer has to disclose any change in ownership (perhaps through selling into the MDA), the company and the remaining shareholders delayed the panic-selling that would occur if the market saw large, major shareholders selling.
  5. This is yet another form of an unsustainable confidence scheme that Herbalife has perpetuated, both in their financial and operating business model.

According to Morrison & Foerster LLP, a Schedule 13G must be amended when a:

material increase or decrease in the percentage of the class beneficially owned, the person or persons who were required to file the statement must promptly file with the SEC an amendment disclosing such a change. For example, an "acquisition or disposition of beneficial ownership of securities in an amount equal to 1% or more of the class of securities shall be deemed 'material'."

One of the main confidence fixtures Herbalife uses to their benefit, currently, is their Top Holders list, which can be found on their website. The ownership breakdown shows the market and stakeholders that the business is owned by seemingly sophisticated investors. This helps perpetuate the confidence scheme needed to operate the business model.

If, however, there was indications that such institutions where selling, confidence would be lost by the market, which would cause the stock price to decline materially.

Let's use the SEC's EDGAR database, in conjunction with the Top Holders list to:

  1. identify each of the 13F filers who are not considered an insider;
  2. classify them as either an active portfolio manager, or passive shareholder to see if they can be expected to behave in a way that mirrors the index (not sell into MDA), or as an active investor who may have sold into the MDA.
  3. assess how the delay in the close of the tender offer may have allowed the active, non-insider, 13G and 13F filers to push the ownership update off until February of 2018:

Here is the schedule of filing requirements for 13D, 13G, and 13F filers:

INSIDERS

Icahn Associates Corporation: considered insider, would have to report immediately after any liquidation occurred. Is not a potential seller.

Michael O. Johnson: considered insiders, would have to report immediately after any liquidation occurred. Is not a potential seller.

Capital Research Global Investors: considered insiders, would have to report immediately after any liquidation occurred. Is not a potential seller.

HBL Swiss Financing GmbH: considered insiders, would have to report immediately after any liquidation occurred. Is not a potential seller.

PASSIVE

BlackRock Institutional Trust Company: not considered insiders, files 13F, will have to file 13G and/or 13F in February of 2018. Most likely passive holders - assuming that most of the shares are held in index-mimicking products in wealth management segment of their business, therefore, it's unlikely they are meaningful seller into MDA.

Fidelity Management and Research Company: 13G filers, not considered insiders, files 13F, will have to file 13G and 13F in February of 2018. Most likely passive holders - assuming that most of the shares are held in index-mimicking products in wealth management segment of their business, therefore, it's unlikely they are meaningful seller into MDA.

The Vanguard Group: 13G filers, not considered insiders, files 13F, will have to file 13G and 13F in February of 2018. Most likely passive holders, therefore, it's unlikely they are meaningful seller into MDA.

Merrill Lynch: 13G filers, not considered insiders, files 13F, will have to file 13G and 13F in February of 2018. Possibly passive holders - assuming that most of the shares are held in index-mimicking products in wealth management segment of their business, therefore, it's unlikely they are meaningful seller into MDA.

UBS Financial Services: 13G filers, not considered insiders, files 13F, will have to file 13G and 13F in February of 2018. Possibly passive holders - assuming that most of the shares are held in index-mimicking products in wealth management segment of their business, therefore, it's unlikely they are meaningful seller into MDA.

ACTIVE, NON-INSIDERS

Route One Investment Company, L.P.: 13G filers, not considered insiders, files 13F, will have to file 13G and 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

Deccan Value Investors L.P.: 13G filers, not considered insiders, files 13F, will have to file 13G and 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

D. E. Shaw & Co., Inc.: not considered insiders, files 13F, will have to file either 13G and/or 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

Farallon Capital Management, LLC: not considered insiders, files 13F, will have to file either 13G and/or 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

Goldman Sachs: not considered insiders, files 13F, will have to file either 13G and/or 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

Credit Suisse Securities: not considered insiders, files 13F, will have to file either 13G and/or 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

Wellington Management Group LP: not considered insiders, files 13F, will have to file either 13G and/or 13F in February of 2018. Active investor. Potential seller that benefited from MDA close date movement.

In aggregate, the top active, non-insider shareholders, as of their last filing date, control around 1/3 of the outstanding shares of the company. I anticipate the next 13F filings, which are due in February of 2018, will show that a meaningful percentage of the 6,732,300 share bought in the MDA came from the shareholders who would have had to disclose the ownership change in their November 13F, had the transaction taken place on its original date.

It would also not be surprising if the same groups that we expect to have sold into the MDA continued selling into the short-covering volume that appeared to have took place after the MDA transaction closed. I would also expect for them to continue to sell as much as they can before the next round of 13F/13G's come due. There may even be a flurry of insider selling days before the non-insider 13G/13F filings.

Remember, the float has been sizable reduced by the reduction in shares outstanding from the MDA. But, there are other transactions that Bill Ackman highlighted in his recent letter to shareholders; namely the 2014 Forward Share Repurchase Transaction and estimated shares held by dealers to support the Capped Call transaction, which locked up even greater amounts of share from being sold. Thus, when taking this into account with the inability for insiders to sell meaningful amounts of shares, you have the exact inverse of a short-squeeze.

What we have seen since October 15th,2017 is a 15% decline in the stock price - on low volume. When panic begins, the stampede to the exit will not be pretty.

By extending the close date, and thereby prolonging the 13F and 13G filers potential disclosure of ownership change to February of 2018, Herbalife has yet again turned what should be quite alarming to the shareholders, to an event that could spun as a positive.

But, for the reasons highlighted above, we believe this is only a temporary fix that has just intensified the expected future decline of the stock price come February of 2018.

Disclosure: I am/we are 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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