Two of the great investing names of our times, Carl Icahn (Trades, Portfolio) of Icahn Capital Management LP and Bill Ackman (Trades, Portfolio) of Pershing Square Capital Management, L.P. are both friends and bitter rivals. That rivalry arises out of their diametrically opposed views about Herbalife, the nutritional supplements company. And more specifically, about the compensation of independent distributors who sell those products to consumers.
You can find both on the list of successful investors, or gurus, at GuruFocus. Both are activist investors, which is to say, they like to gain control of companies and then shake them up, with the goal of generating better returns for all investors in those companies.
The Big Bet
When it came to Herbalife, Ackman didn’t want to just change it, he wanted to drive it out of business. It was a personal, as well as business decision. In fact, many would argue the personal came first and business second. As a Forbes article noted after a key Federal Trade Commission (FTC) ruling,
“Ackman has suggested that he would continue to pursue his crusade against Herbalife even if his effort to get U.S. regulators to shut the company down was unsuccessful. He once said he would go “to the end of the earth” in his battle against the company and became teary eyed on a stage when describing the damage he believed it had done.”
In December 2012, Ackman put his money (or Pershing Square’s, at least) where his mouth was; it shorted Herbalife by a billion dollars, an enormous bet. He was also giving Herbalife a lot of grief beyond the stock markets as well. As a New York Times article observes,
“. . . Mr. Ackman’s attack is unprecedented in its scale. . . . To pressure state and federal regulators to investigate Herbalife, an act that alone could cause its stock to dive, his team has helped organize protests, news conferences and letter-writing campaigns in California, Nevada, Connecticut, New York and Illinois, although several of the people who signed the letters to state and federal officials say they do not remember sending them, an investigation by The New York Times has found.
“His team has also paid civil rights organizations at least $130,000 to join his effort by helping him collect the names of people who claimed they were victimized by Herbalife in order to send the leads to regulators, the investigation found. Mr. Ackman’s team also provided the money used by some of these individuals to travel to Washington to participate in a rally against Herbalife last month.” (this article was published in March 2014)
A Contrary Voice
Carl Icahn (Trades, Portfolio) wasn’t having anything to do with Ackman’s short position or his arguments. Just a few months after Ackman laid down his short position, Icahn went long. A Bloomberg article quoted Icahn:
“ “While Bill Ackman (Trades, Portfolio) and I are on friendly terms, we have agreed to disagree (vehemently) on this subject. Simply stated, the shorts have been completely wrong on Herbalife.””
The Times article continues, “Icahn’s investment in Herbalife, announced in February 2013, set up a public showdown with fellow billionaire Ackman. Icahn quickly became a high-profile advocate for Herbalife and installed five board members, putting his inner circle behind the nutrition company.”
At issue is the way the independent distributors are compensated; they sell both products and dealerships, and collect a portion of the income earned by newer dealers that they recruit. It is generally known as network marketing. Ackman, though, considers it a pyramid scheme and a fraud.
Icahn had a response for that argument, the key argument made by Ackman. In the Bloomberg article, Icahn recalled selling Fuller Brush products during summer holidays when he was a teenager.
““I ended up earning more during the summer than my father,” he said. “Many of my friends who also started with me but were not willing to work as hard failed as salesmen. But no one would believe their failure made Fuller Brush a ‘bad’ company.”
He reiterated some of his arguments after the FTC announced its decision earlier this month, in a statement on carlicahn.com,
“A significant part of my investment success is directly tied to our in-depth investment research and understanding of often complex and unique issues facing companies. One can be sure that this was the case with Herbalife where we spent considerable time and resources studying the false pyramid scheme accusations made against the Company. Unlike many of those that “shorted” Herbalife, we did not rely on one or two research papers prepared by non-experts. As a result of our research, over three years ago we concluded that Herbalife was not a pyramid scheme.”
What the FTC Said (and Ruled)
A July 15, 2016 news release from the FTC announcing the decision had stinging words for Herbalife’s recruiting and compensation practices:
“This settlement will require Herbalife to fundamentally restructure its business so that participants are rewarded for what they sell, not how many people they recruit,” FTC Chairwoman Ramirez said. “Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered as a result of what we charge are unfair and deceptive practices.”
It also said that Herbalife had agreed to ‘fully restructure’ its U.S. business operations and pay $200-million to compensate consumers.
But the FTC did not call Herbalife’s marketing a pyramid scheme or a fraud. It rebuked Herbalife, and fined it $200-billion.
Herbalife said it would pay the fine and make changes to its business practices, essentially closing the door on its encounter with the FTC.
The New York Times also investigated the battle. As this sub-headline makes clear, it did not like what it found about Ackman’s campaign, “Staking $1 Billion That Herbalife Will Fail, Then Lobbying to Bring It Down”.
The newspaper noted that since many Herbalife distributors come from minority groups, Pershing Square had paid three Latino groups to lobby against Herbalife. The Latino groups then tried to pressure several state attorneys general to investigate Herbalife. The content of the letters sent by these groups was identical, except for the letterhead and signatures.
More damning, as a result of the letters, Nevada’s AG invited the groups to submit the names of victims of the allegedly abusive practices. None of the groups could or would identify victims. A similar scenario played out in Connecticut as well, and the Times article pointed to several other ethically dubious initiatives by Ackman and his firm.
In any case, with the FTC door closed, Icahn has declared the matter finished. Ackman, though, is still hoping that he can bring down the company somehow. As we noted above, this became an intensely personal matter for Ackman.
The fight may get tougher for Ackman if he continues it. The board of Herbalife gave Icahn a green light to increase his holding from 25% to 35%, making Icahn even more entrenched.
What’s Ahead for Herbalife?
The market apparently liked the news that one major piece of uncertainty is behind Herbalife. Note how the price has jumped over the past week:
In the July 15 statement on his website, right after the FTC decision was announced, Icahn included this comment,
“Now that the Company has reached a settlement with the FTC, it is time to consider a range of strategic opportunities, including potential roll-ups involving competitors, as well as other strategic transactions.”
As for Herbalife’s fundamentals, they continue to look good:
- 5-Star predictability, meaning a strong record of growing its earnings
- 5-year EBITDA growth averaging 5.7%
- Return on Assets of 14.75%
- P/E Ratio (ttm) of 15.88, which puts in the middle of the pack for its sector
- PEG Ratio of 1.03, putting it at the low end of the fair-value range
Overall, the company has strong fundamentals, has removed a major source of uncertainty, and Icahn suggests the company could now start buying potentially accretive assets.
Conclusion
Herbalife seems poised for even stronger growth and earnings in coming years. No doubt the controversies will continue, but the FTC decision will make it much tougher for Bill Ackman (Trades, Portfolio) and Pershing Square to find any winnable fronts beyond the moral front.
For investors who agree with Icahn’s perspective, this nearly under-valued and predictable stock offers promise of capital gains to come (if I were to buy this stock, though, I’d want downside insurance with protective puts, just in case).
As to the friendship between the billionaire gurus, media references suggests Icahn is magnanimous in defeat, claiming that he and Ackman remain friends. So far, we haven’t heard if Ackman feels the same way.
Disclosure: I do not own stock in any of the companies referenced, nor do I expect to buy any in the foreseeable future.
