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Could Herbalife's New Buyback Finally Squeeze Bill Ackman?

A new report by S3 Partners says Pershing Square's big short could get smaller, if its borrowed shares are called into a tender.

  • Michelle Celarier

A new stock buyback plan initiated by Herbalife, the multilevel marketer of nutrition products that is the focus of a big, four-year short bet by Pershing Square Capital Management's Bill Ackman, could squeeze the activist out of at least some of his short position, according to a new report by financial analytics firm S3 Partners.

Herbalife announced Monday that, following the breakdown of buyout talks with a private equity firm, it will purchase $600 million worth of shares between $60 and $68 each in a reverse Dutch auction, and it threw in a kicker that will give shareholders additional cash should Herbalife get acquired at a higher price during the next two years. Shares surged 10.5 percent by Tuesday, to close at $69.41.

Herbalife has been buying back stock for some time now, and Carl Icahn, Herbalife’s biggest investor, owns 24 percent of it shares. As a result, of its 93.6 million shares outstanding, only 66.94 million are tradable. A year ago, Icahn tried but failed to find a buyer for his stake, and now both he and Herbalife executives have agreed not to tender their shares into the Dutch Auction, which means that the buyback has to come from free-floating stock.

[II Deep Dive: Ackman’s Latest Run at Herbalife: The Fundamentals]

“If the Dutch Auction gets fully tendered as expected, Herbalife’s float will be reduced by 8.82 to 10 million shares, and will drop to 56.94 to 58.11 million shares,” wrote Ihor Dusaniwsky, managing director of predictive analytics at S3, in a note to clients. He points out that 24 million of those shares have been shorted.

“While not all of the shares that will be tendered into the Dutch Auction are in stock lending programs and actively lend to short sellers, we can assume that a portion will come from lending programs or margin accounts,” Dusaniwsky wrote. “With Bill Ackman making up 75% of Herbalife’s total short interest, most of the stock borrow recalls will be directed his way. If the Dutch Auction is fully tendered, as expected, there is a good chance that Bill Ackman will be on the receiving end of 3 to 5 million shares of stock loan recalls.”

Ackman declined to comment on the analysis.

Dusaniwsky estimates that Ackman’s short accounts for about 75 percent of the total short sales, or 18.6 million shares, based on the January 2017 annual report of Pershing Square Holdings, his publicly traded hedge fund, which stated the Herbalife short made up 9 percent of its assets.

However, that number could be lower, according to investors, as Pershing Square’s total AUM was $10.98 billion at the time, of which Pershing Square Holdings is a portion. Other Pershing funds had a smaller Herbalife short position. Moreover, Pershing Square has said that its short consists of both stock and options, and the latter wouldn’t be affected. The precise number of Herbalife shares Pershing Square has shorted is unknown, and this year other shorts have joined his crusade, as short interest has risen.

There are other caveats to the S3 analysis, according to short sellers. In the first place, they point out that most stock loan programs come from index funds that aren’t likely to tender into the auction. Furthermore, Herbalife can cancel the Dutch Auction should its stock go above $68.15, and it has already surpassed that price. Meanwhile, a look at the fine print of the Dutch Auction terms shows that Herbalife can reissue those shares at any time to raise capital or pay employees, among other items.

Still, there’s no question that Ackman has stubbornly held onto his short, despite the hundreds of millions of dollars it has cost him. In a call with investors last week, Ackman said that Herbalife, whose stock had surged this year despite its various troubles, was his fund’s biggest loser for the year. It is now up 44 percent year to date.

None of that is stopping Herbalife — or Icahn, who more than four years ago first suggested Ackman might face the “mother of all short squeezes” if someone were to take the company private. Herbalife’s latest effort to go private, which the company says began in late 2016, ended August 16, just two days days after Chinese media reported a new government crackdown on multilevel marketing companies, leading Herbalife shares to fall as much as 7.8 percent to around $62, down from a high of $74 in late June.