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Carl Icahn vs Bill Ackman and Herbalife

February 15, 2013 | About:
EconMatters

Todd Sullivan

22 followers
Herbalife (HLF) is a ponzi scheme. Period. Why?

For me it is pretty simple. They do not sell their products through retail channels. They sell them through distributors who are recruited by other distributors. Step one in the “increase sales” process is to recruit more distributors. Without adding distributors, sales are stagnant as the company has presented no evidence existing distributors are able to increase sales without also increasing recruiting.

“[T]he organization is deemed a pyramid scheme if the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers”
Without continual recruiting, the organization falls stagnant and enters into decline due to the natural attrition of existing distributors who like 99.9% of them, make no money and in fact are poorer than when they started. Note, again, there is no evidence existing distributors are able to increase sales without additional recruiting. Because that is true, the company derives it monetary benefits primarily from recruiting, not sales. Without recruiting, sales go into decline which means recruiting drives sales.

A ponzi scheme

Ackman v Icahn

This has nothing to do with HLF. This about a decade old grudge Icahn has decided to try and settle. Now, we always read everywhere not to let emotion guide our decisions and that is precisely what Carl is doing here. While we will tell everyone we think investing on pure emotion is stupid and eventually doomed, we sure as hell like watching other people do it. It makes for great drama.

The media and blogs will run with this declaring a winner based on the daily price change of the stock and while that will garner page views, it is a fundamentally flawed way of looking at the situation. The two parties have different objectives here.

Icahn is in this to make a quick buck and do a victory dance which is why he bought a load options, not stock. The options also limit his down side should he be wrong to a fraction of what it would have been had he bought all stock. Because he is Carl Icahn, he will get a bump in the stock and make money on the trade. Then he can go on TV and thump his chest bragging about getting the better of that Ackman guy” this time. Does that mean he wins? No. Why? Ackman is in this until the bitter end. For those thinking he might be tempted to call it a day and move on, read “Confidence Game” about his 7 yr, battle with MBI. What the price does now is wholly irrelevant to him. When he says he welcomes Icahn getting into it he means it. The thing he wants more right now is publicity on this and Icahn is giving it to him. The more publicity, the more likely someone agency or AG decides to see what is going on.

At the Harbor Investment Conference Wed Ackman did an hour Q&A. As one would expect, a large percentage of the time was spent on HLF. During the discussion Ackman revealed that both Pershing and his law firm have been contacted by “numerous regulators and other authorities (read: AG’s)” over the past few weeks. He also, without saying gave the impression (at least that was my take) there are currently ongoing discussions with those entities. He was also quick to point out “it only takes one”. One State AG to file a suit and start doing depositions under oath and the whole thing comes tumbling down. That’s it. There are currently 31 1st term AG’s in office in the US, would be a nice feather in the cap and some pretty sweet publicity to take down the largest corporate ponzi scheme when you are running for re-election. All he needs in one agency/AG to start digging and the others will pile so fast keeping the roster straight will be difficult. Ackman has been begging….begging HLF to sue him since he went public and despite HLF calling his claims “slanderous and libel”, they have not done a thing.

Silence can speak far louder than any spoken word.

Now, many folks who doubt the thesis say “the SEC won’t want to admit they missed this so will ignore it”. This line of thinking ignores the new head of the SEC, former Prosecutor Mary Jo White. Is there any better way for a former prosecutor to make a splash at her new job and signal a new direction and new toughness at the SEC that to take down HLF less than a month after her being in office? Does anyone think that White being sworn in on Jan 25th and Ackman’s statement that regulators have reached out to them “recently” is just some odd coincidence of timing? I mean White prosecuted John Gotti, HLF is a spa day of harp music, massages and tea compared to that.

Other will say, “Ackman laid it out, if regulators were going to act they would have done so by now” … Well, I am more than a little sure that 18 months of work and a 342 page presentation are being looked at rather closely for errors and that does take some time. Since this is such a public debate, people are going to cross T’s and dot I’s before jumping in. That takes time.

Still others will use the ludicrous argument that it is a 30yr old company, so it has to be legal…….. um Madoff? The very essence of a ponzi scheme it is runs undetected (often for decades) until new recruits dry up or the schemer slips up, then it collapses. We should note that the recent high profile ponzi schemes (Stanford, Madoff etc) were NOT discovered by authorities but rather collapsed when they ran their course. Time in existence and legality are not synonymous nor should it be an investment thesis.

Lastly, there are those saying that Ackman is just trying himself to manipulate the stock down himself for a quick profit. This argument fails the “common sense” test. Ackman has declared this to be an illegal activity and a ZERO. Further he has publicly called out authorities to look into it and shut it down. For him to cut and run before the conclusion of this would ruin his reputation forever and make any future proclamations from him on anything else immaterial. An activist investor exists on their reputation. There is no chance he ruins his now for a quick buck and at the same time tarnishes the rest of a very long career. Additionally, making the statements he had made and then covering his short for some quick money would in fact open himself up to legal actions from HLF and probably the SEC on attempts of price manipulation. This “manipulation” line of argument borders on stupid

So, if we have to pick “winners” here we should say that Icahn will “win” in the short run, but only if he cashes in his chips in time. Ackman will be right on this in the end….

About the author:

Todd Sullivan
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.5/5 (15 votes)

Comments

vgm
Vgm - 1 year ago
Todd,

Comes across as a superficial and anti-Icahn, unbalanced, presumptuous, repetitious. Essentially no fact, all inferred. Your own emotions are showing.
supratik
Supratik - 1 year ago
Not only is this article unhinged, it shows a complete lack of understanding of the MLM industry and makes illogical assumptions. Just because you don't like the way the industry operates does not make it illegal. The FTC has laid out certain rules and regulations for the MLM industry to operate under. If Herbalife is following those rules then it is a legally operating business. Just like Tupperware, Amway, Mary Kay and others. And cigarette, alcohol and casino companies do more arm than simple MLM.

As Berkowitz says you have to kill a company to see what can go wrong. Let us assume therefore that there are "issues"at Herbalife though Icahn, Loeb, Chapman and others will disagree. These issues however are not problems that Herbalife cannot solve by changing its processes and policies to comply with existing FTC regulations and be back in business. Why? Because they have a real product with real consumption going on among users. Even PrePaid Legal, which had many run-ins with the regulators, sold at double the share price than its price when it first got into trouble.

I looked at Ackman's initial presentation, at his 40 page (as if the number of pages matter) questionnaire and then again at his interview at Harbor. Barring a few relevant questions most of his questions are complete red herrings. Of his relevant questions, the answers really lie in grey areas, where it is difficult to prove or disprove if HLF is legal. At the very worst Herbalife may have to change its reporting processes and tweak its business model. Perhaps a consent order tochange the compensation model. The downside is definitely NOT zero. Look at their operating model in China - its not even MLM!

The comparison with Madoff and Stanford are disengenuous. Madoff didn't operate a publicly held company that had to file onerous reports to the SEC and shareholders every quarter. Ditto for Stanford. Madoff claimed to specialize in trading in a very niche area of the market which hardly anyone understood, including the people at SEC. A lot of Stanford's dealings were in Montserrat/Antigua outside normal US oversight. He also ran a privately held private bank and submitted falsified filings. Herbalife on the other hand is a public company which has to divulge a lot of information to the public. Also their filings are nothing as complex as Enron's. If you were a pyramid scheme would you prefer being public or being private?

Lastly, this is not about Icahn vs Ackman. There are many many other players who have their skin in the game and most of them are long. They are also veteran investment managers. On Ackman's side, there is Witney Tilson and that's about it. Even Einhorn is not backing Ackman on this. On the long side are Carl Icahn, Dan Loeb, Ken Heebner, Robert Chapman, John Hempton, Sahm Adrangi (Kerrisdale) and the Tiger cubs Tiger Consumer (Patrick McCormack) and Coatue Management. Each of these men have increased their stake or bought new stake in HLF after Ackman's short. What is the likelihood that each of these men has put tens of millions of dollars into Herbalife, just for a quick trade? One or two maybe but all of them, that is quite unlikely. Interestingly some of these investors are known as aggressive short players - Loeb, Hempton and Adrangi among others. Not only this, even some forensic accounting specialists (also professors) have gone through the filings - Wesley Gray (http://turnkeyanalyst.com/2013/01/herbalife-hlf-is-it-a-fraud-not-likely/) at Drexel and Anthony Catanach (http://grumpyoldaccountants.com/blog/2013/1/30/what-do-herbalifes-financials-tell-us) at Villanova. They don't find any signs of financial fraud.
warren.buffett.sr
Warren.buffett.sr - 1 year ago
This is classic Pre-Paid Legal mirror.

A simple balance sheet analysis will reveal that HLF's Return on Asset is incredible with a enviable cash-flow.

With P/E of 10, HLF will only have to operate another 10 years to completely buy-back their shares from their own earnings. Any earnings above that will go direct to your pocket.

Considering that they are not in technology, it is very safe to say, that their product has a longer shelf-life than that.

This is game over for Bill Ackman.
sww
Sww - 1 year ago
Herbalife is a pyramid scam - truth.

Ichan is a disgruntled billionaire that was scorned by Ackman 10 years ago - truth.

Ichan try to screw/squeeze Ackman on HLF - truth

Ichan thought Ackman is a hedgefund highway/freeeway road kill 10 years ago and lost his case sued by Ackman - truth.

Herbalife is a pyramid scam and should go to ZERO - Again,


When I look at Ichan, I think of the movie - "Christmas Carol" by Jim Carrey, rich in money poor in EVERYTHING ELSE.

I hope he find his peace before his last day.

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