Months before the recent Sturm und Drang surrounding nutritional-supplement maker Herbalife, my firm took a long, hard look at the company. On the surface it was a value investor’s dream: great balance sheet, high return on capital, high revenue and earnings growth, and attractive valuation. Of course, there was one problem: The validity of its multilevel marketing (MLM) pyramid structure was being questioned by some investors.
To my surprise, despite its name, there is little that is “herbal” about Herbalife. I thought I’d see a lot of exotic plants reincarnated as wonder miracle supplements. What I discovered is that the majority of Herbalife’s sales come from its Formula 1 product, a meal-replacement supplement. If Herbalife’s products were sold at Walgreens or GNC, the story would be very simple, but it is not. The company’s business model is in question because investors suspect that its products are bought just as “trading sardines” (they might as well be bricks or wooden sticks). If at the end of the day its supplements are not consumed but instead rest peacefully in the garages of its distributors, Herbalife is nothing but a Ponzi-like scheme that will run its course — they always do.
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