HLF - Herbalife

[innerscorecard]

Very interesting post by John Hempton:

 

http://brontecapital.blogspot.hk/2015/06/herbalife-very-long-post.html

[TwoCitiesCapital]

It's going to be another bad year for Ackman.

 

http://www.bloomberg.com/news/articles/2016-05-05/herbalife-expects-to-pay-about-200-million-to-resolve-ftc-probe

[glorysk87]

It's going to be another bad year for Ackman.

 

http://www.bloomberg.com/news/articles/2016-05-05/herbalife-expects-to-pay-about-200-million-to-resolve-ftc-probe

 

Not so sure about that.  I think the reaction is positive based on the headlines (ie. "HLF IS NOT A PYRAMID SCHEME"). But if you look at the terms of the settlement, it pretty much completely changes how they are going to have to do business. They need to prove that 80% of their sales are retail driven. No idea how they're going to do that considering the large majority of their sales now are to distributors.  Ackman's got 2017 puts (I believe). I think by '17 HLF is going to be collapsing.

[glorysk87]

Highly suggest anyone interested in this read through the FTC complaint.  The headline may say "Herbalife is not a pyramid scheme" but everything in this complaint screams that it is:

 

https://www.ftc.gov/system/files/documents/cases/160715herbalifecmpt.pdf

[glorysk87]

I know I'm spamming the thread at this point but I really am in shock that HLF is up almost 20% today.  First off, items 81 through 94 are pretty much a glaring indictment of HLF as a pyramid scheme. I mean there's no real room for interpretation there.

 

But further, once you get into the details of their compensation plan, it becomes pretty clear that the FTC action today is going to severely impair the business.  In its current state, HLF massively incentivizes distributors to buy the product, but has almost no incentive for those same distributors to actually sell any of that product at all.  Distributors are paid more based on how much product their recruits buy from HLF as well, but again there's no compensation for any of that product actually sold to end users.  This basically sets up a system where if you want to make money, your only goal should be to recruit stupid/naive people who will buy HLF product in an obviously impossible attempt to make money.

 

However that all changes with the FTC decision.  The compensation/incentive/reward structure is completely changed so that participants are rewarded based on what they SELL to end users, and not based on what they buy. Since there ARE no real sales to end users (demand simply isn't there for this shit) I can't imagine anything other than huge step downs in financial performance and with it, the stock price.

 

And if you don't believe me that there are no real end users/consumers for the HLF products, just read the complaint.  There's one section that basically says that distributors are buying the product, finding that they're unable to sell it, and then slowly consuming it themselves because they're stuck with a huge load of shakes and mixes that no one wants and they want to derive at least SOME benefit from it.

 

Crazy.

 

*Since I started this post, the company has falled from +20% to +14%. I think people are going to slowly realize that just because the FTC didn't outright call this a "pyramid scheme" doesn't matter at all, and that the business restructuring is going to be the nail in the coffin. I bought long-dated puts earlier today.*

[Picasso]

Interesting points glory.  I've also shorted into this rally.

[TonyG]

I agree they pretty much claim it is a pyramid all but in name. the only thing I would be worried about is icahn's statement where he says they might roll up other MLM's to sort of paper over this problem. that worry anyone or you think this implodes faster than they can do that?

[glorysk87]

TonyG - I thought about that as well. But I guess I don't see any obvious benefit to rolling up competitors.  If you use HLF as the vehicle to do that, you're still stuck with the crappy HLF business. If the intention was to consolidate the space, wouldn't there be a better way of doing that?

 

Regardless, I agree that the main risk to shorting here is either Icahn's roll-up plan or HLF being taken private (which I also see as unlikely).

[Pelagic]

I know I'm spamming the thread at this point but I really am in shock that HLF is up almost 20% today.  First off, items 81 through 94 are pretty much a glaring indictment of HLF as a pyramid scheme. I mean there's no real room for interpretation there.

 

But further, once you get into the details of their compensation plan, it becomes pretty clear that the FTC action today is going to severely impair the business.  In its current state, HLF massively incentivizes distributors to buy the product, but has almost no incentive for those same distributors to actually sell any of that product at all.  Distributors are paid more based on how much product their recruits buy from HLF as well, but again there's no compensation for any of that product actually sold to end users.  This basically sets up a system where if you want to make money, your only goal should be to recruit stupid/naive people who will buy HLF product in an obviously impossible attempt to make money.

 

However that all changes with the FTC decision.  The compensation/incentive/reward structure is completely changed so that participants are rewarded based on what they SELL to end users, and not based on what they buy. Since there ARE no real sales to end users (demand simply isn't there for this shit) I can't imagine anything other than huge step downs in financial performance and with it, the stock price.

 

And if you don't believe me that there are no real end users/consumers for the HLF products, just read the complaint.  There's one section that basically says that distributors are buying the product, finding that they're unable to sell it, and then slowly consuming it themselves because they're stuck with a huge load of shakes and mixes that no one wants and they want to derive at least SOME benefit from it.

 

Crazy.

 

*Since I started this post, the company has falled from +20% to +14%. I think people are going to slowly realize that just because the FTC didn't outright call this a "pyramid scheme" doesn't matter at all, and that the business restructuring is going to be the nail in the coffin. I bought long-dated puts earlier today.*

 

Good post.

 

I enjoyed the anecdote (item 86) about the distributor who paid $8 million for product and then donated it to charity and STILL made a net profit thanks to the various rewards received.

 

 

[Haasje]

I came to the exact same conclusion this morning wrote up my take http://seekingalpha.com/article/3988705-ackman-emerges-victorious-herbalife

 

Don't understand how it is trading up today  :-\

[Pauly]

This looks like a fantastic short. This disgusting company just had it's business model shredded and it's stock price is up? Looks like it's coming down though as more people actually read the report.  How long before Icahn issues a release thanking the company and revealing that he's sold out and is moving on?

 

[walt373]

US sales are only 20% of total. If you just assume the US business is a zero, I think the stock is still worth more than $64. A short thesis really needs to address China, where it's growing 30% per year.

 

Btw the convertible debt is trading up as much as the stock, from 97 yesterday to 106 today. There is still a lot of skepticism in the stock.

[plato1976]

does this incentive ruling also apply to markets outside of the U.S.?

I don't think there's real end-demand in China either

(though Chinese will be "more" maniac to distribute in the pyramid scheme if the old incentive scheme can be kept - as a Chinese I just know it. however, if the incentive changes the whole thing will collapse more quickly in China - they can buy these crap replacement more cheaply and easily on tmall, taobao, whatever)

 

US sales are only 20% of total. If you just assume the US business is a zero, I think the stock is still worth more than $64. A short thesis really needs to address China, where it's growing 30% per year.

 

Btw the convertible debt is trading up as much as the stock, from 97 yesterday to 106 today. There is still a lot of skepticism in the stock.

[TonyG]

I'm pretty sure all MLM's are illegal in China. I also don't think the FTC is going to sit on it's hands and let citizens outside the US be fleeced by Herbalife. either it is going to work with other regulators to help them understand or other regulators are going to look at this ruling and apply it also.

[Picasso]

US sales are only 20% of total. If you just assume the US business is a zero, I think the stock is still worth more than $64. A short thesis really needs to address China, where it's growing 30% per year.

 

Btw the convertible debt is trading up as much as the stock, from 97 yesterday to 106 today. There is still a lot of skepticism in the stock.

 

It seemed to me like those convertibles are a way to express a hedged short position on HLF, which is why it was so bid up today?  What do you think is the right multiple for this business?  It's no longer trading for 8-10x and then there's the added leverage.  Which admittedly could make this run up on the short interest if earnings don't implode.

[walt373]

US sales are only 20% of total. If you just assume the US business is a zero, I think the stock is still worth more than $64. A short thesis really needs to address China, where it's growing 30% per year.

 

Btw the convertible debt is trading up as much as the stock, from 97 yesterday to 106 today. There is still a lot of skepticism in the stock.

 

It seemed to me like those convertibles are a way to express a hedged short position on HLF, which is why it was so bid up today?  What do you think is the right multiple for this business?  It's no longer trading for 8-10x and then there's the added leverage.  Which admittedly could make this run up on the short interest if earnings don't implode.

 

This used to be a growth stock and growth seems to be recovering. I think 15-20x is not unreasonable at all. I think it still comes down to if you believe the business is fundamentally a pyramid scheme. If so, implementation of the new rules should precipitate a collapse of the US business. And if not, US sales will take a one-time hit, then stabilize. But even if the US business does really crater, the downside still isn't enough to justify a short. The short thesis is really incomplete without considering the other 80%.

[glorysk87]

I don't think it's a stretch to imagine other regulatory bodies following FTC's footsteps. With Ackman on a crusade one might anticipate restrictions on parts of the business in the ROW.

[Picasso]

You may be right that the downside to a short isn't that much anymore. Something in the back of my mind tells me that HLF can find some workarounds to the new rules.  This has been a stock to trade around extreme sentiments, and I don't see how this is a big home run long from current levels either.

[Pauly]

US sales are only 20% of total. If you just assume the US business is a zero, I think the stock is still worth more than $64. A short thesis really needs to address China, where it's growing 30% per year.

 

Btw the convertible debt is trading up as much as the stock, from 97 yesterday to 106 today. There is still a lot of skepticism in the stock.

 

It seemed to me like those convertibles are a way to express a hedged short position on HLF, which is why it was so bid up today?  What do you think is the right multiple for this business?  It's no longer trading for 8-10x and then there's the added leverage.  Which admittedly could make this run up on the short interest if earnings don't implode.

 

This used to be a growth stock and growth seems to be recovering. I think 15-20x is not unreasonable at all. I think it still comes down to if you believe the business is fundamentally a pyramid scheme. If so, implementation of the new rules should precipitate a collapse of the US business. And if not, US sales will take a one-time hit, then stabilize. But even if the US business does really crater, the downside still isn't enough to justify a short. The short thesis is really incomplete without considering the other 80%.

 

Would the US cratering not likely be the first domino to fall though? If US sales fall through the floor wouldn't that basically prove that it's a pyramid scheme? I doubt that the Chinese will let HLF operate as they have been if their business has been proved a sham by the US.

[walt373]

My guess is US sales will get hurt but not fall off a cliff. But even if they do, it's hard for a foreign regulator to point to declining US business as proof that it's a pyramid scheme. There are many reasons businesses can fail - it's possible HLF just bungled the rollout of the new rules.

 

My point is even in a best-case scenario as a short, you are only guaranteed a drop in the US business. For this short to really win, more things need to fall your way regarding international sales, and I have seen minimal analysis on the international business at all. I get the impression that the short thesis is solely focused on the US business and kind of hand-waving the international side away, which is weird to me because it accounts for the majority of the stock's value.

 

By the way, MLMs (not just pyramid schemes) are already illegal in China, so HLF is structured differently there.

[Foreign Tuffett]

Did anyone notice the comment on the FTC website by user "John Hempton"? See attached.

 

[Haasje]

It does sound like him.

[Liberty]

http://www.nytimes.com/2016/08/02/business/dealbook/the-activist-and-herbalife-just-maybe-ackmans-a-hero.html

[glorysk87]

The last line of the article sums up my thoughts completely:

 

"But Mr. Braun says that if the company genuinely changes its business model to conform with the settlement, “I can’t imagine a way for them to be profitable.”"

[glorysk87]

Wow - hilarious: http://www.wsj.com/articles/carl-icahn-mulled-selling-herbalife-stake-to-group-that-included-bill-ackman-1472198581

 

I think this begins the slow slide downward for the company. My short working out phenomenally.