Should You Believe Ackman or Icahn?

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Herbalife (NYSE: HLF), the marketing company that sells nutritional supplements, has recently been having an extremely bumpy ride, after mega-investor, Bill Ackman of Pershing Square, disclosed that his fund had shorted 20% of this company’s total float. From my perspective, Herbalife’s management gave a superb presentation in response that calmed the nerves of its investors.

However, the recent announcement that FTC has seized the assets of a multi-level marketing firm on the premise of its being a pyramid scheme has led to a parabolic decline in Herbalife’s share price. On one side of the coin, we have Ackman and this recent incident that are compelling investors to go short at the stock. However, on the other side, we have bullish comments from billionaires like Carl Icahn. Investors are asking only one question: Whom to trust?

What I liked about Herbalife’s ‘rebuttal’ conference

Management covered the following points that gave investors some comfort:

  1. Detailing the amount spent on Research & Development and what areas it was spent on.
  2. Clarifying the number of product pick up points globally, including third-party partnerships.
  3. Providing a more accurate comparison of the retail price of the products relative to competitors.
  4. Giving more details on the prior two studies conducted by Lieberman Research, as well as providing data on a new study conducted of former Herbalife distributors.
  5. Providing the percentage of sales that are shipped directly to non-distributor customers.
  6. Outlining a breakdown of volume points by buying patterns and the potential rationale for those purchases.
  7. Detailing some additional statistics around the success of new President’s Team members in the US.
  8. Giving the dollar amount spent on distributor promotions that is embedded in SG&A.
  9. Stating that the number of distributors re-qualifying as sales leaders in January was similar to the rate during other months and not materially higher.

Shorties still had some doubts in mind after the presentation:

  1. The company has a lot of data on its distributors but it does not have perfect information on its end customer: The company presented several studies from Lieberman Research, some of which were rather telling. Lieberman Research’s surveys were even conducted with a sample size of 2,000, double the 1,000 sample size that the company generally uses to conduct surveys, in order to try to be more representative. Despite these efforts, some investors were not convinced by this analysis.
  2. Rulings from previous court decisions were not discussed: This was not entirely surprising because the company was not trying to make a case that it has figured out ways to circumvent historical court rulings, but rather that it is a legitimate company.
  3. Management did not address all of the issues that were brought up in the Pershing Square presentation: Ackman’s presentation lasted more than three hours and encompassed over 300 slides, covering numerous topics. The company chose the issues that it thought were most pertinent and addressed those in their presentation. Ackman is expected to emphasize any topics that he thought were not addressed when he responds to the company’s latest presentation.

Role of Fortune Hi-Tech case

The recent news that Simon Davies, the CFO at Fortune Hi-Tech marketing (the company under FTC’s inquiry) is a former director of internal audit at Herbalife has raised many questions. Pessimists have regarded this as a second chance to short the stock. However, I would like to make the following comments:

  1. Simon Davies left Herbalife in 2005. That is a long way back. In fact, one of the reasons of a professional leaving a particular job is that he/she is not satisfied with the work/remuneration. That says a lot in favor of Herbalife.
  2. Fortune Hi-Tech is a privately held company and frauds like pyramid schemes are hard to find in such closely held firms. It will be relevant to point out here that it has been 7 years since Simon left Herbalife. Had a pyramid scheme been going on in this company, this fraud would have been brought to the surface much earlier than Dec. 20.  
  3. Richard Goudis, the current COO and the former CFO of the company, has lately been increasing his stakes in the company. This insider buying (especially from a finance officer) seems to be a bullish signal.

Following actions from the company will be met with optimism by the market:

  1. Change the  title of distributors who don’t qualify as sales leaders
  2. Announce new tools (invoice-type tool) to increase the transparency of its business model
  3. Vetting of all distributor marketing presentations. Several of the videos and marketing slides in the Pershing Square presentation were from Herbalife’s distributors and not Herbalife.

Fundamentals

Herbalife is one of the cheapest stocks in the nutritional industry space.

 

<img src="/media/images/user_15808/herbalife_large.PNG" />

Nu Skin Enterprises (NYSE: NUS) has been another stock in the same industry that has lately been alleged to run on a pyramid scheme. In fact, the high level of margins for both Herbalife and Nu Skin has dented their reputation rather than honing positive investors’ sentiment. However, the market felt strange when Ackman went out of his way to say good things about Nu Skin, but kept on opposing Icahn’s point of view that Herbalife (built on a similar business model as Nu Skin) will be the mother of short squeezes.

Church & Dwight (NYSE: CHD) is another company in the same space. This is one of the rare unfortunate companies whose name is unfamiliar to most but whose products are used by millions of people every day. Though the company has been impressive in terms of raising its dividend on a yearly basis (40% growth in the last five years), still its valuations remain much expensive as compared to that of Herbalife’s. Its margins are also almost of half of Herbalife’s.

Final words

Cramer believes that given that the stock will play as a battleground, investors should stay away from it. I also suggest the investors to stay away, but for a different reason. I believe FTC will launch an inquiry against the company which will send the price down. I recommend the investors to take a long position then. Given super high margins, cheap multiple and a decent dividend yield, I like Herbalife as a long-term play.


SuperbAnalyst 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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