It's tough to be sure whether Bill Ackman, the Pershing Square founder and a savvy investor, is right or wrong about his Herbalife (HLF) short position. After all, the stock is up by more than 130% year-to-date and Ackman is losing well over $500 million. In addition, other great investors such as George Soros and Carl Icahn have made fortunes by betting on the company's shares. That said, it's tough to deny the company has been defending itself in dubious manners against the investor's tough accusations.
The Pershing Square founder claims that Herbalife's share price should collapse since its business model is a pyramid scheme designed to trick its network of self-employed salespeople it calls distributors. While the Herbalife brand appears on the shirts of famous athletes around the world, its products do not appear in stores and Ackman says the sales occur only between people inside the pyramid structure or to new recruits joining the structure, instead of reaching final consumers.
The Company Defends Itself
According to the Financial Times, “The investment bank Moelis & Co contacted Pershing Square investors in recent months urging them to assess whether Mr Ackman’s Herbalife bet revealed poor judgment and lax risk controls that meant the fund was unsafe for institutional investors.” And, according to Bill Ackman's last letter to his investors on his Herbalife short bet, “The company has hired public relations firms, lobbyists, law firms, an investment bank, and paid-for spokespeople to attack us in the media, on social networks, and in the halls of Congress.”
Even when I can understand that a company and its management should defend themselves when the company is accused of running a pyramid scheme, I also think Herbalife has gone too far, above all taking into account that the company's shares have outperformed the S&P 500 by more than 100% so far this year. If you are sure about the solidness of your business and you are the company's CEO, you should limit yourself to buying back shares. As Warren Buffett says, if you are an investor and you are sure about the value of the business you are buying, you should be happy when Mr. Market offers you to buy him out at a low price. Remember, “Price is what you pay and value is what you get.”
Will Herbalife be a second J..C Penney (JCP) for Mr. Ackman? As I mentioned before, it's tough to tell whether Ackman is right or wrong about Herbalife but the company has been defending itself from his accusations in a suspicious manner. Legitimate businesses shouldn’t spend shareholder's money to defend themselves from accusations such as “you own an illegitimate business.” They should be confident on their own venture and competitive advantages.
Despite the share's recent outperformance, I believe Mr. Market might be wrong. Long story short, at the current valuation level - 15 times 2014 earnings - I would stay far away from Herbalife's shares since I think you could get better risk-reward opportunities in today's market. After all, financial history shows us Mr. Market can be wrong for longs periods of time.