A Dramatic Preview for Herbalife Earnings

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Cue up dramatic music (at 2:42 of the Carmina Burana) while a gravelly voiced narrator intones slowly, "In a world where shorts and longs collide on one battleground stock frightened investors seek leadership. One man (tight shot on the late Jerry Orbach playing Carl Icahn) has something to prove and his nemesis (pan in on character actor David Strathairn playing Bill Ackman) is gunning to prove him wrong. The future of global company Herbalife (NYSE: HLF) hangs in the balance (shot of guy hanging by fingertips off the side of a skyscraper) as they duke it out (footage of boxing kangaroos.)"

Show fast tight montage of head shots of Ackman and Icahn and more explosions and narrator concludes, "Things are about to get very, very ugly (show clip of silhouetted actors barely escaping explosions). This time it's personal. Coming to an earnings call on February 19 a hero... will...riiiiiiiise!!!!"

Backstory

After last week's verbal battle on CNBC between Herbalife advocate Carl Icahn and Herbalife short Bill Ackman investors may wonder whose highly polished wingtip is stepping on the fingers of the guy hanging from the tower. The multi-level marketer of nutritional supplements has been the target of heated debate since Pershing Square's Bill Ackman lambasted the company in an investor presentation in October. Ackman has been leaning hard on his 20 million share short as Daniel Loeb holds 8.9 million shares long for his Third Point LLC but Carl Icahn never actually admitted if he had a position in Herbalife.

Ackman further pressed the point with a neatly wrapped up website summarizing his December 20 presentation at the inaugural Sohn Conference, www.factsaboutherbalife.com. Ackman called Herbalife," the $2.2 billion brand nobody's ever heard of." He questioned their moat with multiple competitors for their products and notes they charge three times what equivalent products cost. He also questioned the company's claims on their R&D spending, responsible for one patent compared to 21 patents for competitor GNC Holdings.

But his main point, (shots of a giant pyramid crumbling), is that the 3 million distributors, "obtain their monetary benefits primarily from the recruitment rather than the sale of goods and services to consumers. Herbalife inflates the Suggested Retail Price ("SRP") of its products and overstates "Retail Sales" in its public filings to conceal the fact that Recruiting Rewards are substantially greater than the Retail Profit they generate." The three hour presentation is both exhaustive and exhausting.

When Ackman spoke in October the stock dropped from the mid $50s to $45 but after the Sohn conference it dropped from the low $40s to a 52 week low of $24.24 on huge volume. Yet it shot right back up in early January (cue people screaming on roller coaster rides). It offers a 3.20% yield and is trading at a 9.39 P/E. Loeb isn't the only large shareholder with FMR LLC holding a 15.82% stake of 17,082,774 shares.

If You Listen To Only One Earnings Call This Year

Analysts expect 5 year EPS growth of 14.90% for Herbalife and give a median price target of $65.00 but the company was downgraded by Argus on December 20 to hold. Herbalife, based in Grand Caymans, The Cayman Islands and in business for 33 years, is one of the fastest growing companies since it began. Even Ackman admitted that. But corporate governance risks are high on shareholder rights and compensation and medium on the Board.

The company has issued multiple press releases in rebuttal to Ackman and vigorously denies it is a pyramid scheme. It almost doesn't matter what they say on the earnings call because the Q&A session will be heated and it already released preliminary earnings results (unaudited) on January 17. Some bullet points quoted from the release are:

  • Net sales for full-year and fourth quarter 2012 are expected to increase approximately 17.9% and 19.9%, compared to the prior year periods, respectively.
  • Fourth quarter EPS is expected to be in a range of $1.02 to $1.05, compared to prior year reported EPS of $0.86.
  • Fully-diluted EPS for the full-year 2012 is expected to be in a range of $4.02 to $4.05, compared to prior year reported EPS of $3.30.
  • The company expects to begin repurchasing shares of Herbalife stock, pursuant to its existing share repurchase authorization.

Finally CEO Michael O. Johnson said, "Over the twelve months ended September 30, 2012, Herbalife has generated more than $700 million in EBITDA — which does not yet include fourth quarter results — has returned approximately $1.9 billion in capital to shareholders since 2007, and has a strong balance sheet."

Now For The Chase Scene

There's a 36.50% short interest in Herbalife. Herbalife should be looking over its shoulder at two main competitors. Health and wellness specialty retailer GNC has a yield at 1.30% and a 16.70 P/E. Headquartered in Pittsburgh; it's a bricks and mortar and franchise business model at a mall near you. It's up 26.68% over 52 weeks. It has a 15.50% short interest but is still benefiting from a multiyear trend toward health and fitness. Analysts see better 5 year EPS growth in GNC at 22.08%.

Herbalife and GNC have another competitor in Vitamin Shoppe (NYSE: VSI) which has outperformed since its 2009 IPO, more than doubling. Although it's mostly a domestic health and wellness chain (it recently opened two stores in Canada) it has 650 stores and in December agreed to acquire Super Supplement, a small health and wellness chain in the Pacific Northwest, with cash. It has the highest P/E at 30.06 and no yield. Analysts see a little less EPS growth (5 year yoy) of 18.30% but it also has little corporate governance risk and very little debt.

The Dramatic Climax

Whose shiny wingtips are on whose fingers? If Ackman is wrong and he has to cover this immense short it would be what Icahn called the mother of all short squeezes. Then CEO Michael Johnson, Dan Loeb, and Carl Icahn are heroes. This earnings call is likely not the first installment but one of a number in the Herbalife saga. While it's suspenseful, you might want to skip the drama and spend your money on a boring consumer staple.


leglamp 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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