When billionaire investor Bill Ackman publicly declared last December that his New York hedge fund, Pershing Square Capital Management, was short-selling Herbalife, few could have predicted the ensuing public spectacle.
But nearly a year later, the downtown L.A. company has remained in the center of a standoff that features Wall Street’s wealthiest investors engaged in a peculiar, high-stakes theater.
Ackman’s position – that the marketer of weight-loss products is an illegal pyramid scheme soon to be shut down by the government – and the billion dollars he staked on it, kicked up a swarm of warring investors. Names such as Carl Icahn, Dan Loeb and George Soros soon took positions opposing Pershing, investing hundreds of millions in Herbalife stock.
Since then, the stock has continued to rise, while Ackman has refused to back down. At the inaugural Robin Hood Investors Conference to be held in New York this week, he is expected to once again lay out his case against Herbalife, promising to reveal new information to bolster his position.
It might be his closing argument. Before the end of the year, accounting firm PricewaterhouseCoopers is scheduled to release a report compiled from a reauditing of the last three years of the company’s financials. Should the vetting show no past or present wrongdoing, it could finally end this particular chapter in Herbalife’s interesting history.
The faceoff has been largely personal; for the last year, the two camps have been sniping at each other in nearly every cooperating outlet while dredging up decades-old gripes. Icahn and Ackman called in to a show in January on financial network CNBC and proceeded to spar in a live, expletive-filled segment.
But despite the investor sideshow – or in small part, because of it – shares of Herbalife have doubled. The stock closed at $64.64 on Nov. 13, up from $31.45 on the first trading day of the year.
And the company remains very profitable. For the quarter ended Sept. 30, it reported net income of $152 million on revenue of $1.2 billion. Among Herbalife’s assets are $892 million in cash, which the company might use to repurchase outstanding shares.
Meanwhile, Ackman has given himself an ultimatum: Either Herbalife’s stock will go to zero or he’s wagered a billion on the wrong health shake.
There is, however, a bigger duel over the company that goes beyond a battle of billionaires’ pocketbooks and wills. Pershing’s stance comes down to a question of whether Herbalife’s business as a multilevel marketer – in which products are only sold through a network of individual distributors – crosses into an illegal pyramid scheme.
It’s a thinly defined line. A direct seller is acting illegally only when its revenue is derived more from recruiting members than selling products. In 1979, multilevel marketer Amway was forced to clean up its business under these guidelines. But with other longstanding companies such as Tupperware Brands Corp. and Nu Skin Enterprises also operating as multilevel marketers, making a specific case against Herbalife will be tough.
“If one of those is an illegal pyramid scheme, then they are all pyramid schemes,” said Tim Ramey, an analyst with brokerage firm D.A. Davidson & Co. in Portland, Ore. “This is not a new question.”
The company has faced other accusations. An October convention of Herbalife distributors in downtown Los Angeles was met with protests from the League of United Latin American Citizens, an activist group that alleges the company engages in predatory recruiting. Executives flatly disagree, but with Hispanics making up at least 60 percent of Herbalife’s U.S. sales force, the issue remains salient and sensitive. In response, Herbalife brought in former L.A. Mayor Antonio Villaraigosa as an adviser to help fend off these attacks from the Latino community.
There is also a lawsuit wending its way through the U.S. District Court for the Central District of California that makes direct allegations Herbalife is a pyramid scheme. The company has sought to have it dismissed, but a judge ruled last month that it will proceed. Although this case stands little chance of being the game-changing element Ackman is looking for, a drawn-out litigation could finally push the company on its heels.
“With a lawsuit, all of a sudden the company has to (face) the allegations and try to dispel them,” said Gary Lincenberg, an attorney and former chairman of the American Bar Association’s white-collar crime committee. “Time is not on the company’s side.”
Herbalife representatives did not return calls seeking comment.
If this recent spotlight has brought Herbalife its greatest public scrutiny, it certainly isn’t the first inquiry it has faced since it was launched in 1980 out of an abandoned Beverly Hills wig factory.
Mark Hughes, the company’s captivating founder, built the brand through massive conventions that promoted business opportunity with the zeal of a motivational speaker. Herbalife meet-ups, which happen regularly around the world, are a showcase for testimonials from people who lost weight using the company’s shakes and health food snacks, as well as success stories from distributors who tout the tens of thousands of dollars they pull in monthly.
Product distributors are encouraged to develop a so-called “down-line” network of other sellers, from whom they receive a small percentage of each product sold. The larger the network, the more commissions a higher-level distributor makes.
The current entry-level product package necessary to buy into the Herbalife system costs $59, paid for upfront. Representatives can purchase more expensive bulk packages as well as leads designed to help them build a network. Between product boxes and leads, it’s not uncommon for Herbalife distributors to quickly invest thousands of dollars.
The company has disclosed, however, that last year 71 percent of its distributors have no down-line, using the Herbalife products either for themselves or to sell to friends and family. Of the remaining 29 percent, more than half are so-called “sales leaders,” who purchase in bulk wholesale and attempt to build large networks.
According to company figures, 41 percent of these leaders – 39,151 people in 2012 – generated average sales revenue of $292.
Since the beginning, the company has emphasized international growth and today the products are sold in more than 80 countries. Last month, Herbalife announced it was bringing its sales of shakes and snacks into Cambodia.
When Hughes died in 2000 from a toxic combination of alcohol and anti-depressants, he left the business in shambles. It was purchased by a pair of private equity firms that, after shuffling through leaders, named Michael Johnson, a high-ranking executive at Burbank’s Walt Disney Co., chief executive in 2003. The company went public the following year.
Under Johnson’s leadership, Herbalife has seen its stock skyrocket – $10,000 invested in Herbalife in 2004 would be worth more than $102,000 today. But there have also been setbacks: A decade ago, the government banned the stimulant ephedrine, then an essential ingredient in Herbalife’s products. More recently, the company was forced to fire accounting firm KPMG after one of its employees confessed to leaking inside information.
And then there are the warring investors.
That, too, might be ending. Other than critics of the multilevel marketing industry, Ackman has been nearly alone in his fight to bring further scrutiny to the company.
As the stock price has continued to rise, whether due to the company’s finances or investors’ belief it will soon repurchase shares, the activist investor has finally blinked. In an October letter to Pershing investors, Ackman wrote he had bought back 40 percent of the shares he had initially sold short in a move to cover losses. Icahn is now the biggest shareholder at 16 percent; Soros’ family fund owns 4.9 percent.
In the letter, Ackman reiterated that he’s steadfast in his belief that “it is only a matter of time before the company is shut down and prosecuted by regulators.”
But with the fire from his rhetoric on the wane, and the company perhaps releasing clear finances before the end of the year, the Herbalife fight might be entering its twilight.
“I think we’re awfully close to the end,” said Davidson analyst Ramey. “Ackman will want to forget the horrible year he had in 2013.
His folly, Rainey continues, was mistaking the high turnover and relatively low income from some distributors as a crime. Sure, plenty of Herbalife customers go into the business expecting to make money and more than 90 percent do not return the next year, but many other businesses go under, too.
“That doesn’t make (Herbalife) a pyramid scheme,” Ramey said. “Greed is still legal in the United States. And in this case, it’s a motivating factor.”
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