One Thing Is Clear After Herbalife's Decline Yesterday - There Won't Be Any MOASS

Gayatri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Herbalife's (NYSE: HLF) stock tanked yesterday and closed with a decline of over 8% on a FTC action that wasn't even related to the company. At one point the stock was even down 11%. Although, I am not a direct participant in the Herbalife battle (I have no position in the stock), I believe that the yesterday's price movement is a clear indication that there won't be any "Mother of All Short Squeezes" (MOASS) for the stock which some analysts are talking about. The following are the key reasons for my opinion:

  • There is still too much fear around. I can understand the initial decline in the stock price yesterday- the stock market doesn't like uncertainty. However, what baffles me is the post 1 pm decline when it was made abundantly clear that the FTC was talking about Fortune Hi Tech and not Herbalife.

<img src="/media/images/user_13280/hlf_large.jpg" />

Also, there was nothing in the FTC's conference call which suggested that Herbalife is doing something wrong. Fortune Hi Tech is a completely different case. They were charging upfront and recurring fees of $250 from the participants and were using a part ($100) of this fee from the new distributors to pay the older ones. This clearly is a classic Ponzi scheme: recruit new people who pay $250 out of which you get $100 and $150 goes to the promoters of the scheme. Herbalife doesn't have this hefty recurring and joining fees. Yesterday's decline clearly suggests that "fear" still rules the mind of Herbalife investors and they are still not "greedy" enough to buy more on declines.

  • Management is just not interested in orchestrating a short squeeze. It's not a game of "who blinks first" anymore. Mr. Ackman has already blinked. He has gone from saying that Herbalife runs a pyramid scheme under the current laws of US and he has "proved" it (Dec 20th - His presentation day)

to

"If the government comes out and determines that this is a legal business then I will lobby congress for them to change the law" (January 8 quote)

With Carl Icahn and Dan Loeb on their side, Herbalife's management could have easily exploited the situation and caused panic among short sellers. However, they didn't do enough. And forget about the short squeeze, Herbalife's management has even failed to provide enough support to the stock yesterday despite having $950 million buy back authorization at its disposal. The stock was trading in the $42.50-$55 range before Mr. Ackman's bear raid. If the company's management isn't willing to aggressively buy back shares at the bottom of this range and provide support against misinformation/rumors, this clearly signifies a lack of will on their part.

  • Still a lot of weak hands holding the company. The problem with Herbalife is that its ownership is fragmented unlike Volkswagen where Porsche was 42.6% owner (with options to acquire another 31.5%). On the other hand, the short position in the stock is highly concentrated in the hand of Mr. Ackman who can handle notional losses to a good extent. There are too many longs willing to sell at a right price, while a big (and strong) short seller is unwilling to cover. Clearly not the best condition for a short squeeze.

To sum up, although I believe Mr. Ackman is wrong in his analysis, I don't see any Volkswagon-type short squeeze happening in Herbalife. Fear is still ruling investors minds, the company's ownership is fragmented and management lacks the will power to orchestrate such a squeeze. However, if you are a long term investors not intending to bet on the short squeeze "pop" you may consider buying the stock at the bottom of $42.50-$55 range. In my opinion any price below $42.50 is a good entry point.


GayatriSharma has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $50 Calls on Herbalife Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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