Likely it's the problems inherent in multi-level marketing, but, whatever the cause, Herbalife Ltd. has once again been tripped up by its own success.
Earlier this month, Chief Executive Michael Johnson shocked investors when the company he's turned into a Wall Street darling lowered its 2007 sales expectations.
The problem? Some distributors in Mexico, now the company's largest market, were selling goods at discounts and had enlisted unauthorized sales people, which is likely to dampen overall sales until the problem is fixed.
A startled Wall Street lopped 24 percent off the nearly $38 share price of the herbal supplement marketer on Jan. 5, leading longtime company critics to quip that Johnson, a former top Disney executive who assumed his post three years ago, had lost some of his pixie dust. The stock, which had fallen below $30, rallied a little thereafter and closed just below $32 on Jan. 18.
But other company observers say the early warning was actually a savvy move on Johnson's part, enabling the company to move quickly to rein in renegade distributors who were creating dissention in its Mexican market before full 2006 earnings are reported in late February. Sales in Mexico have tripled over the last three years and account for 20 percent of global sales.
"Yeah, I was surprised and as you can see from the market's reaction, so was everybody else. But the best thing about having large international exposure is that one market has less overall impact," said Scott Van Winkle, a Canaccord Adams analyst.
The company and some analysts attribute the troublesome Mexican situation to growing pains for the 26-year-old multi-level marketing company, whose ability to surpass its $3 billion retail sales goal last year was largely due to its more difficult-to-monitor overseas markets.
Herbalife, which sells weight loss and nutritional supplements via an estimated 1.4 million direct distributors in 63 countries, said fourth quarter 2006 net sales likely will range between $482.7 million and $484.7 million. That reflects a year-over-year increase of at least 18 percent. But 2007 sales growth will likely stay between 6 and 10 percent, well down from prior guidance of 10 to 15 percent.
A key component of Herbalife's mixed success in Mexico is its innovative Nutrition Club format, a cross between a Weight Watchers meeting and the home sales parties that are a mainstay of the direct sales industry.
Instead of paying for a month's worth of product in advance beyond the means of many Mexican families customers can pay as they go by stopping by their distributor's home or office each morning. While sipping a protein shake, herbal energy tea and aloe-based digestive aid the core weight-loss package they also receive diet counseling and get to socialize with fellow customers.
The weight-loss line has become well enough known to inspire a company-sponsored story line in upcoming episodes of the Mexican telenovela, "La Fea Mas Bella," a hit that was the inspiration for the ABC's hit series, "Ugly Betty."
In multi-level marketing schemes, sales agents sell to customers directly but also recruit other sales agents, who send some of their revenue upstream to the agent who recruited them. They also seek to recruit sales agents under them.
But as Herbalife's popularity grew in Mexico, some distributors began bending the rules, taking on unauthorized distributors below them, selling products at discount to drive volume and running their clubs more like a retail coffee house that is, without requiring longer-term purchase commitments from customers.
That prompted loud complaints from more ethical distributors who were competing for the same customers. The company responded by suspending some distributors and has committed to improving the training of the rest. They'll also have to rebuild enthusiasm among their top sellers.
"Direct sales is a very emotional business, and distributors need to know there's a level playing field," said Greg Probert, Herbalife's chief operating officer. (Johnson was not available for comment.) "It was less than 5 percent of the people, but that dampens the spirits of the other 95 percent and once they get distracted that affects your sales. It may take a quarter or two to get back on track."
Morgan Stanley analyst William Pecoriello told clients that top distributors also complained to him that the Mexico City and Guadalajara markets, which account for 75 percent of sales in Mexico but have only 20 percent of the country's population, were becoming saturated, with few distributors expanding their networks into rural areas.
Probert said the company was well aware of its substantial problems in the market and planned to address them.
"By making it public now, we could go down to Mexico to talk with our distributors and tackle some of the issues without having some (regulatory disclosure) problems," Probert said.
Monitoring independent contractors is an ongoing challenge in multi-level marketing, and Herbalife throughout its history has garnered its share of criticism over products and policies.
From its early years under charismatic founder Mark Hughes, the company's distributors were notorious for tagging neighborhood power poles and bus shelters with rudimentary "Lose Weight Now Ask Me How" posters.
And more than two years ago, the company and a group of its top-earning distributors paid $6 million to settle a 2002 federal class action lawsuit that alleged a marketing scheme started in the late 1990s called "The Newest Way to Wealth" was really nothing more than an illegal pyramid scheme.
In order for a multi-level marketing model not to be considered a pyramid, the majority of sales must ultimately be made to retail users. Herbalife did not admit wrongdoing in the settlement, but agreed to change some of its practices.
Also in 2004, Canadian officials wound up a several-year investigation resulting in fines and guilty pleas for a group of local distributors who investigators said had engaged in a pyramid scheme.
Directing a turnaround
But the company's greatest challenge came with the death of its founder in 2000. Hughes, who cultivated a health-conscious image and led sales meetings that resembled fundamentalist tent meetings, was found dead in his Malibu mansion from what was determined to be an accidental overdose of alcohol and prescription anti-depressants.
His lieutenants scrambled through an awkward transition, initially replacing Hughes with a team of its top distributors at sales meetings. Johnson, a former president of Walt Disney International, is the company's third boss since Hughes, and, in Van Winkle's opinion, by far the most successful.
"Michael Johnson is a charismatic leader, just not in the same way as Mark Hughes," said Van Winkle, who along with other analysts lowered projections but didn't change his "buy" rating on shares. "But more important, he's certainly a much better manager than Hughes. Five or 10 years ago, there's no way the company could have gone from $200 million to $600 million in Mexico in two years."
Under Johnson, Herbalife burnished its image as a diversified nutritional supplement company, expanding into energy sodas, targeted nutritional supplements and a skin care line.
The company also raised its profile in the sports world, with major sponsorship deals with 45 events and more than two dozen athletes and teams, including the JP Morgan Chase Open women tennis tournament and the Los Angeles Galaxy soccer team.
Herbalife has a longtime relationship with Galaxy owner AEG, the developer of the L.A. Live sports and entertainment district. Herbalife plans to relocate corporate headquarters to L.A. Live from Century City by 2008.
And the company is ramping up operations in China's huge, but still nascent consumer market, where the government puts tight controls on direct selling. For now, the company's distributors must do all their sales out of 42 company-owned retail stores, which Herbalife operates in 21 of the country's 30 provinces.
The company, which historically has used third-party manufacturers, operates its own manufacturing plant in China to meet government requirements. It's a level of vertical integration that the company may adopt elsewhere, Probert said.
"When you hit $3 billion (in sales) you have to ask, 'Maybe this makes sense?" said Probert. "We're a growing, changing company."
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