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Response To JJJ Comment

|Includes: Herbalife Ltd. (HLF)

JJJ wrote a comment on the "Now It's The Shareholders Turn to Feel Cheated" article on the HLF board.

I wrote a long response, too long for a reply there.

Here it is.

Original JJJ comment:

"Sure, this is the link to the report from Forbes magazine. Herbalife Paid a $200 Million Fine. Then the FTC Screwed it Up

"But now that almost 350,000 checks have been mailed, a curious pattern has begun to emerge: Many of the people receiving money from the FTC don't appear to be victims at all. In fact, of those who received the checks, the largest of which are more than $9,000, many are actually happy customers who still use the meal supplements. Some still work for Herbalife. Even members of the company's president's team, a special status that confers a larger product discount on high-volume distributors, have received a cut of the FTC settlement. What's more, some check recipients say they plan to "flip" their settlement payout, i.e. use the money to buy more products from Herbalife."

I hope this helps."



Thanks for publishing this link, yet again. I've read that story a couple of times, as well as the settlement agreement.

It's been my experience that for investments to work the "story" has to be relatively simple and straightforward. Just for one example, Ackman's initial presentation was over 350 slides, but they were eventually able to get it down to a single concept: They believed HLF was an illegal pyramid scheme, as soon as their evidence was presented to the FTC and any other appropriate regulatory authorities the regulators would see the error of their ways that allowed HLF to previously grow and prosper, the regularors' response would be to immediately shut down the company and the stock would go to zero. That was it. Simple and stratight forward. I've written in the past why I believe Ackman chose to use over 350 slides to say that, but that's not relevant to what follows.

Currently, if you are a short, your simple story goes something like this: If Ackman wasn't right, he was mostly right, the company IS a pyramid scheme even though the FTC didn't call it one, the company is now struggling and as the FTC restrictions fall into place the combination of FTC restrictions plus the natural self-destruction of any pyramid scheme will cripple HLF in the U.S. and the stock will go down a lot. Oh, and BTW, China, their 2nd largest market is struggling, too.

Now, of course, both the "old" and the "new" short thesis did not account for techincal factors in the stock, such as I vs A, the huge short interest, etc. I won't address those here.

In the face of the above, I am still a long. The reason I am repeating that here is that re-reading the Fortune story reinforced one of my fundamental beliefs from the very beginning. The FTC totally and 100% rejected the concept of a discount buyer. The settlement was based on, "If you bought $1,000 worth of HLF products and never got any money back from HLF that is proof positive you were a victim" The implication, and my inference, is that the only possible reason you bought it in the first place was to re-sell it and, if you never got any money back that alone is proof you were scammed.

Ever since I did my very first research on HLF I simply never believed that concept. I've read dozens (actually, probably hundreds) of SA articles and many thousands of comments on those articles over more than 4 years. I can't count the number of other stories, articles and analyses I've read that argue both sides of the story. I've paid particular attention to those which argue the "other" side. I don't believe the FTC's fundamental belief.

Before I say my reasons for that, let me say that in any business with a sample size of a half million or so, any generalization will clearly have lots of exceptions. So, when I speak in what may seem like absolutely, below, understand that I fully understand there will be exceptions to anything I say. I am discussing MY belief and MY conclusions AFTER reading the endless commentary on the other side of the issue. It could very well be that my generalizations are not right, but, as I said, I've read -- endlessly -- the other side. And, I've put my money where my mouth is. You can believe this or not, and I'm not going to expand on it, but except for some diversified index funds, HLF is by far the largest indiviudal stock I own; it's 25% larger than my second largest, AMZN.

I still don't believe the FTC's concept that there is essentially no such thing as a discount buyer. I looked at the question from the top down (how many times does one need to be exposed to the Table of Average Compensation before one gets it?) and what I've always believe is at least important in an investment, from the bottom up -- the customers' perspective. Of course, I have to speculate on that, but understanding likely consumer behavior is pretty key to making good investments in consumer stocks.

Here's what I believe happens from the consumer's view.

1. Premise: Fat people can't sell weight loss products. Would you buy a weight loss product from a fat person telling you how great it is?

2. At the first level, a fat person is introduced to HLF as a way to lose weight. That consumer, who has probably tried lots of different weight loss methods over the years, decides to try it, and pays retail.

3. It works for her! She loses weight.

4. She loves her HLF, and, because it's working, she decides she could pay less by becoming a first level distributor to get a discount.

5. She likes it a lot, and she enjoys showing her friends her new shape (she never got to be model-thin, but may have lost 10 pounds of the 40 she needs to lose and feels great about herself).

6. Her friends like what they see, and she decides to sell a few cans to her fat friends and family to try.

7. Some of them like it and buy more. Maybe over time, one or two of those become first level distributors and sell some to their friends and family, too.

8. Then it all stops. Why? As is well known, although a lot of people are successful at losing weight, a very small percent of those keep it off. The original distributor, and probably some of her friends and family, start regaining most or all of the weight they lost, and, since the product doesn't work for them any more they stop buying it for personal consumption. And, sales to friends and family, who also re-gain weight, also stop.

9. It doesn't mean some people aren't successful in the long run, but most fail at losing weight and keeping it off, fat people can't sell weight loss products and, because they haven't been successful at losing weight, they are no longer cheerleaders for the product.

10. BUT, SOME PEOPLE REALLY ARE SUCCESSFUL. They become enormous cheerleaders. HLF products have helped them achieve something they had never been able to do before, and they love it!

11. It is my speculation that nearly all of HLF long-term successful distributrors are, if not slender, fit. Fat people can't sell weight loss products.

It is that entire group, above, that it was and is my belief, constituted the vast bulk of HLF 1st level distributors. It is the reason most never made any money -- fundamentally, they weren't trying and separating out their personal consumption from the little bit of stuff they gave or sold to friends and family would be impossible, anyway. And, it is the reason for the huge distributor turnover.

Peter Lynch is famous for having told people to use their own experiences, try to understand if their own experiences can be generalized, and, if they can, use that as part of your investment decisions. Like many, I'd been heavy most of my life and tried lots of methods. I finally succeeded (not with HLF). The experience I had and observed, that, in turn, I am generalizing, is the process of trying to lose weight -- people are always trying anything, failing, then trying something else -- but a few succeed at each "method".

The other thing I observe is that people -- whether wealthy, poor, educated, uneducated, "underserved" or "overserved", are not stupid. No one (again, maybe a few) would buy more product they can use or sell simply to get a larger discount to buy future stuff they can't use or sell. It defies the common sense test. And, although as some once alleged, people were too embarrassed to return stuff, that is yet another concept that did not reflect common sense.

And, I believed, and still believed, that an individual would have to be dumb as a stone to lose $10,000 or more trying to sell HLF products.

As what I believe is evidence of my perceptions and beliefs, no one has yet to produce either of two things that are crucial to the claim that an organization is a pyramid scheme:

1. Any evidence of systematic inventory loading.

2. Any significant number of what I've called "verified" -- vs claimed or alleged -- victims. I've defined "verified" on these boards in the past. Essentially, people can claim anything they want -- see Ted Braun's movie -- but to my knowledge no one -- not Ackman nor any regularoty agency -- has tried to check out their stories. In America these days, it's easy to claim you are a "victim"; it's a lot harder to prove it. The only real evidence I know of in the search for verification is when the AGs of CT and NV checked out all the allegations presented to them by paid-by-Ackman Hispanic interest group, the AG's could not find a single alleged victim whose story turned out to be true once they investigated.

On both of those items... At the beginning, I thought that if either real victims or systematic widespread inventory loading existed the FTC would find it. Later, I decided they might not have enough investigative resources for that. But, then when I saw that Ackman spent literally tens of millions of dollars trying to find systematic inventory loading or "verified" victims, and failed, my belief in my conclusions became stronger.

Expanding on one of those items... victims. At one point, Ackman claimed to have had a roster of over 1,000 alleged victims. But, as it turned out, all of them were the same kind of victims shown in Ted Braun's film -- they all had dramatic allegations, but Ackman never spent a dime of his tens of millions trying to check out their allegations to see if, a. they really had lost the money they claimed and 2. even if they had lost the money whether or not HLF was to blame. The most famous of all was the couple in MA which figured prominently in Markey's original letter. They claimed to have lost over $100,000. But, it turned out that Markey's people had never even talked to them, their names had been presented to Markey's people by Ackman and when the Boston Globe actually investigated their claims, their claims turned out to be bogus.

All of the above evolved over a number of years. With each development, the detractors and shorts claimed and "Ah ha" moment and said that it was the end. I was concerned each and every time, but, when I looked into the then-current claim, my conclusion was either it was wrong or, even if right, it would have no impact on the stock (one example: the "whistleblower" who was a low level management employeed at an HLF factory, who had been fired, and who Ackman promised a payment of up to $1 mm).

Then the FTC settlement was, IMO, the icing on the long case! Several things were clear:

1. The FTC simply could not identify any verified victims.
2. The FTC could not find any indication of systematic inventory loading.
3. The FTC totally and completely rejected the concept of "discount buyer", which, as I discussed above, is what I believe to be the vast bulk of all buyers.
4. Their entire claim was based on their belief -- expressed many times on this board by Mr. Keep and others -- that the top down numbers meant there MUST be victims, even if they couldn't find them.

I believe, and still do, that the entire illegal pyramid scheme concept rests on just a couple of concepts:

1. 100% of the people who enter the HLF system do it only for the Biz Op, they expect to work hard at it (or maybe they believe someone who told them it's an easy get rich quick scheme) and they expect to get rich.

2. Essentially none of the members are primarily discount buyers.

My own belief is and has been that I was sure there was at least some of that going on, but it wasn't the main stream at all. To me, the main stream is the consumer I describe above, someone who is a discount buyer who likes the product and might try to make a few bucks extra spending money by selling some to friends and family and never, ever had any intention to make it a business.

Now, I don't need yet another quote from the FTC decision to try to convince me I'm wrong. I already read it. I believe the FTC got it wrong. So, of course what is in the decision will contradict everything I said above. Let me say I believe in the regulatory system. I've had broad exposure to many of the agencies over the years. Almost all of the time, they get it right. But not always. Virtually the entire staffs of most regulatory agencies are lawyers, not business people. The other companies they shut down were dealing with products that were not consumables -- the only way to use those products or services was to sell it to others. HLF was and is different -- it is a consumable, which means a discount buyer can buy it and buy it and buy it and not have to sell any of it.

So, for better or worse, all of the above is what I believed about the fundamentals that made me remain long -- although as I said previously, I sold the stock twice, only to buy it back at higher prices later.

Going forward, there is little doubt the company is facing a significantly different future from its past. I believe the company settled on terms if believed it could live with -- if the company really thought the decision was going to cripple their business they would have had no alternative but to go to court. If the FTC was certain they would win, they would not have settled. So, I think the odds of the fundamentals improving from here are very good.

And, on top of that, as a stockholder the Ackman/Icahn battle is pretty fundamental. I believe Carl holds the cards. Despite what is said on the board by detractors and shorts, as I've written here previously I think Carl has multiple ways to make money by taking it private -- the detractors think the company is no different once it is private from when it is public and is a lousy company either way. To those, I say read the history of LBO's and how those doing them fundamentally restructured struggling companies and found liquidity options that made them fortunes. Or, look at Ackman's activist successes and see how he's done the same thing without doing LBOs. and is slowly squeezing. I think the odds are strongly in Carl's favor. Yes, there are multiple possible outcomes different from what I expect. But, IMO, Carl is driving the train.

Disclosure: I am/we are long HLF.