Is Herbalife (HLF) “the best managed pyramid scheme in the history of the world,” as fund manager Bill Ackman suggests? Is the maker of weight loss and nutrition products being unfairly maligned by a man who will make money if investors flee the stock? Did you really care about Herbalife before Ackman’s marathon critique of its business on Dec. 20? You may well not own it, as it’s not exactly a blue-chip play. But now that Herbalife CEO Michael Johnson and Ackman are blasting each other on the media circuit, the question is what to make of this drama.
This isn’t your typical short seller’s fight. Start with the fact that Ackman presented his case against Herbalife at a special complimentary event hosted by the Sohn Conference Foundation. The Sohn Conference, now in its 17th year, famously brings together billionaire investors each summer to share their top investment pick and raise money for pediatric cancer research. This is the first time it’s held an event featuring one person, according to organizers. The reason became clear at the end of Ackman’s three-hour show: any money he makes on this bet will go to charity, with $25 million slated for Sohn, regardless of how it turns out.
Why not make a ton of money and use some for a good cause, like Ackman normally does? Because profiting from Herbalife’s alleged exploitation of its distributors feels like “blood money,” Ackman said. His goal: to let the Federal Trade Commission take this research and shut the company down. Herbalife’s Johnson, meanwhile, is calling on the Securities and Exchange Commission to pursue Ackman for “blatant market manipulation.”
The most intriguing thing about Ackman’s high-profile crusade against Herbalife is the fact that it’s Ackman. The founder of Pershing Square Capital Management is best known these days as an activist investor, buying up huge stakes in companies like Canadian Pacific (CP), JC Penney (JCP), and Target (TGT) to force changes that he hopes will drive up the stock price. While he famously made more than $1 billion by betting against bond insurer MBIA (MBI), Ackman prefers to put his money on businesses that can improve versus those poised to crash.
All the more reason to wonder why he’s spent more than a year to research the case against a company that’s arguably an easy target. Multi-level marketing companies, from Avon (AVP) to Amway, have long dealt with the criticism that they’re built on the backs of gullible distributors. People make an upfront investment to sell products on behalf of the company–usually to family and friends–in the hope that they’ll make a decent commission off the sales. Moreover, they’re rewarded for recruiting others to do the same. For most sellers, that system rarely leads to a lucrative income. For investors, the question is what portion of sales are fueled by signing up new recruits versus selling to consumers who want the products.
In Herbalife’s case, Ackman contends, it’s not much. The model is so stretched worldwide–Ackman used the term “pancake scheme”–that Herbalife has resorted to selling weight loss products in Ghana. (With KFC (YUM) making major inroads there, that might not be a bad thing.) He’s not the first to make that case. David Einhorn of Greenlight Capital, who is well known for his success in shorting stocks, was asking tough questions of management months ago. The SEC even looked into the matter.
Although Herbalife’s Johnson was brimming with vitriol against Ackman on Dec. 19, telling CNBC that the world would be better off without him, the company emailed a statement after the presentation to say the inaccuracies were too “numerous” to address right now and complain about being denied a chance to participate.
What we do know is that Bill Ackman hates this flavor of multi-level selling, so much so that he’s planning to put up a web site to warn away people seeking a career through Herbalife. He’s used to being a shareholder’s friend in fighting management, not some villain who profits from others’ misfortune. Try telling that to Fidelity, Herbalife’s largest investor with more than 17 million shares in its funds. While a spokeswoman says the company doesn’t comment on individual holdings, it has also been selling down its stake in recent months. Herbalife will need to find some fresh recruits.
