Bill Ackman's Analysis on Herbalife (Part I)

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Bill Ackman recently attacked Herbalife (NYSE: HLF) aggressively. In the interview with Bloomberg, he made it public that he shorted an enormous amount of Herbalife’s stock, more than 20 million shares, with the total position value of more than $1 billion. He believed that the company was a pyramid scheme based on “very careful and thorough analysis of every fact.” He said: “This is the highest conviction I have ever had about any investment I have ever made, full stop.” I had a chance to watch the live webcast of his presentation. He gave all the findings in a 342-slide presentation starting with the question: “Who Wants to be a Millionaire?”

Tremendous Growth and Extremely High Margin

Like other multilevel marketing, Herbalife bundled its products with business opportunities to make money and get rich. Since 1980, the “retail sales” of the company have grown from $2 million to $5.4 billion in 2011, marking tremendous annualized growth of 29% in more than 30 years. Ackman compared it with several other well-known consumer and household product companies with long history legacies such as Church & Dwight (NYSE: CHD) and Energizer Holdings (NYSE: ENR). Both Church & Dwight and Energizer were founded in the 19th century, with trailing twelve months revenue of $2.8 billion and $4.6 billion respectively, and they had enterprise value of $7.2 billion and $6.7 billion respectively. Herbalife was founded in 1980, and it has already generated revenue of $3.9 billion with total enterprise value (pre-Einhorn question) of $8.1 billion. Over the last 12 months, the other two companies had a gross margin of 43.9% and 46.8%, but Herbalife enjoyed a questionably high gross margin, of 80.2%, and that raised the question.

Significant Volume on High Price Products

Interestingly, Bill Ackman pointed out that Herbalife Formula 1, the nutritional powder reached sales of 6 times higher than that of Ensure (Abbott), Slim-fast (Unilever) and Lean Shake of GNC combined. It might be because the products were much cheaper. However, he showed that the retail price per 200 calorie serving of Formula 1 was $2.87, much higher than Ensure, of $1.03, Slim-Fast, of $1.04 and Lean Shake, of $1.74. In addition, the Multivitamin tablet was priced at $0.26 per tablet for Herbalife, more than triple the average price among Centrum, One a day, of only $0.08. 

… Not a Product Company

The higher retail price was absurd because Herbalife’s products were not “proprietary products for which there is limited competition,” it also didn’t spend much money on advertisement. The company said it did a lot of research and development in the company, but Ackman pointed out from the company’s report that the R&D expenses were not material and the company had only 1 US patent relating to the herbal supplement for weight loss. Furthermore, unlike other consumer companies, which their products were often advertised to the end users, Herbalife advertised its own name, not its products. Ackman quoted the Herbalife Annual Report in 2005:

“We generally do not target promotions or advertising at any particular product or brand. Our significant promotions are generally aimed at generating increased levels of recruiting and retention of distributors.”

Ackman went to the conclusion that Herbalife was not a product company, but a company to sell business opportunity.

<img src="/media/images/user_14219/screen-shot-2012-12-21-at-125929-pm_large.png" />

Source: Business Insider

In the next article, I would go on to recoup Ackman’s analysis of the compensation scheme and Herbalife’s business models. Different investors might have different opinions and perspectives. It is worthwhile for investors like us to consider all the facts and figures from all aspects to determine our own course of actions. 

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Energizer Holdings. 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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