Bill Ackman Isn’t Backing Down From His Herbalife Bet

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Contrary to recent speculation, it doesn't appear that Bill Ackman’s fund, Pershing Square, is backing down from its big bet against multi-level marketing firm Herbalife (NYSE: HLF).

DA Davidson analyst Tim Ramey suggested that Ackman could be getting cold feet. In an appearance on Bloomberg TV Monday, Ramey noted that the short interest in the stock had dropped from 37 million shares to 31 million shares.

If Ackman does throw in the towel, Herbalife shares could rally significantly. But for now, the stock continues to be a battleground.

The Nielsen study

Last week, Herbalife shares spiked after the company released the results of a study. According to Nielsen, roughly 8 million US households had purchased Herbalife products sometime in the last three months.

If that’s truly the case, it appears to cast doubt on Pershing Square’s premise. If (as the fund alleges) Herbalife is a pyramid scheme, then its products should be consumed largely inside the pyramid, among its base of “distributors.”

However, if Herbalife is a legitimate company with real demand for its products, then one would expect to find millions of Herbalife consumers among US households -- exactly what the Nielsen study suggests.

Pershing Square’s response

But Pershing Square finds fault with the Nielsen study. Specifically, the fund notes that it appears to contradict a previous study conducted by Lieberman Research last year. According to the Lieberman study, Herbalife’s demand was far greater.

Given that the company’s revenue has not meaningfully declined, Pershing Square argues that there’s reason to doubt Nielsen’s results.

Moreover, if Herbalife wanted to, it could simply request that its distributors supply it directly with sales data -- Herbalife compels its distributors to keep detailed sales records. Pershing Square notes how curious it is that Herbalife has to commission studies to find out its sales penetration; a consumer products company should already be highly interested in this data.

What investors should watch for

At this point, investors playing Herbalife should watch for two developments.

If Ramey is right, and Pershing Square is trimming (or even exiting) its Herbalife short position, it would be a big win for the company’s shareholders. Although Ackman did not go public with his short position until last December, shares of Herbalife have been weighed down since May 2012.

That month, David Einhorn hopped on an earnings call and began asking the company’s management some critical questions. Given Einhorn’s reputation as an aggressive short seller, investors had begun to price in an attack on Herbalife well over six months prior to Ackman unveiling his thesis.

If Ackman is backing out, Herbalife shares could return to levels seen last spring -- perhaps near $70. In fact, they could probably break above $70, given that Pershing Square would be in the market buying up 20 million shares and thereby creating significant buying pressure.

On the other hand, further political developments could weigh on Herbalife’s shares. Congresswoman Linda Sanchez asked the Federal Trade Commission to investigate Herbalife last week.

Ultimately, Ackman’s trade rests on a full-blown regulatory shut down of Herbalife’s business. If that were to happen, the next step would be for the FTC to begin investigating Herbalife (as Sanchez has asked).

If the FTC finds nothing, it would certainly vindicate the company’s bulls and eviscerate Ackman’s thesis entirely. But in order for Herbalife to hit Ackman’s price target of $0, an FTC investigation is necessary.

Other multi-level marketing stocks should move

Year-to-date, Herbalife shares are up over 50%, as are the shares of other multi-level marketing firms. Nu Skin (NYSE: NUS) shares have rallied 68%, while USANA (NYSE: USNA) shares are up over 125%.

Like Herbalife, both Nu Skin and USANA use multi-level marketing to sell their products. And although Ackman has not targeted them, if he were to be right, the legitimacy of their businesses could be thrown into doubt.

Citron Research has targeted both Nu Skin and USANA in the past, arguing that the companies are running pyramid schemes in China. Unlike the US, Chinese law forbids multi-level marketing companies entirely.

Along with being a Herbalife bull, DA Davidson’s Ramey is also bullish on Nu Skin and USANA. In a note released last month, Ramey reiterated his $80 price target on USANA and his $78 price target on Nu Skin.

Multi-level marketing stocks in focus

At any rate, all three of the major multi-level marketing stocks should remain volatile in the coming months. Releases from Pershing Square and Herbalife’s management could continue to shift the stocks from session to session, but the larger, long-term question centers around the FTC.

If Ackman is to be right, the FTC will have to launch an investigation into Herbalife and subsequently move to shut the company down. However, If the investigation never comes, shares could continue to slowly drift higher.

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Joe Kurtz 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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