Ackman’s Latest Run at Herbalife: The Fundamentals

Despite Herbalife’s recent stock surge, hedge fund manager Bill Ackman told investors on a call Wednesday that the multi-level marketing company’s fundamentals have been in decline since 2013.

Herbalife has been on a roll of late. Outgoing CEO Michael Johnson called out Ackman while speaking at the Milken Institute Global Conference two weeks ago. Johnson — veering from his sponsored slot on “Leading a Healthy Life” — labeled Ackman’s claims as “fake news.”

But an Obama-era Federal Trade Commission agreed with most of the short-seller’s criticisms, and last summer reached a settlement with Herbalife forcing it to restructure its business. Yet shares have been soaring ever since Herbalife’s first quarter earnings came out last week, which showed an 11 percent drop over the year-prior quarter. The stock is up 51 percent this year, after a smaller-than-expected earnings decline disclosed on May 4 sent the stock up 16 percent. As it hit $72, rumors abounded on Wall Street that Ackman — who remained silent in the face of Johnson’s goading and the latest earnings report — was covering his big short.

Ackman, however, remains painfully short on a stock that isn’t, and the saga continues.

In a by-the-numbers presentation on Herbalife on his quarterly conference call with investors in Pershing Square Holdings Wednesday, Ackman gave an uncharacteristically sober presentation on Herbalife to date. Its sizeable business in China is under investigation by the Securities and Exchange Commission and Department of Justice for potential violations of the Foreign Corrupt Practices Act. And, as Pershing Square senior counsel David Klafter pointed out, for the first time Herbalife acknowledged in SEC filings that China’s “anti-pyramiding” laws posed risk.

But Ackman’s big takeaway was that the company’s financial trajectory looks crummy. Operating earnings have fallen 40 percent since he called the company a pyramid scheme in December of 2012 from a Manhattan stage. Ackman said North American sales fell 7 percent in the first quarter, China looks worse than reported sales suggested, while South Korea and Brazil also saw double-digit decreases. Overall, revenues have been in decline since 2013, when they topped out at $4.8 billion. The FTC’s terms of settlement go into effect later this month in the U.S., which Ackman expects to further dampen sales.

“Fundamentals are clearly deteriorating,” Ackman argued. “The company is doing a remarkable job of misleading the market about the business.” Herbalife is also in the process of buying back stock with the proceeds of a recent loan refinancing, and its biggest investor, Carl Icahn, holds a 24 percent stake.

To make sure it’s not acting like a pyramid scheme, the FTC is forcing the company to clearly differentiate between distributors — those people who have signed up to sell products and recruit more sellers — and a new group of “preferred members,” who can buy discounted products for their own use. For distributers to get paid, 80 percent of the company’s sales must be profitable retail transactions, which the settlement forces Herbalife to track.

In the meantime, Herbalife has a massive recruiting effort underway for preferred members. “The company gave a 25 percent coupon if you signed on as a preferred customer, then added it back into earnings,” according to Ackman. Just how much retail consumer demand exists for Herbalife’s pricey protein powder remains a mystery. Pershing Square expects some clarity by the third quarter.