An important truism in the financial markets is that there’s no such thing as a “toxic asset,” tout court; everything is toxic/dangerous/Bad at some (high) price and attractive/safe/Good at some other (much lower) price and there’s a wide area in between where things mostly live and you fight about their pricing. You can apply that insight to junk bonds or CLOs or really any number of things, and you should, but today it’s sort of fun to apply it to Herbalife. As far as I can tell the argument over Herbalife goes something like this:
Herbalife opponents: Herbalife is a horrible pyramid scheme that preys on disenfranchised, mostly poor and minority people and convinces them to part with their life savings through misleading advertising and high-pressure sales techniques.
Herbalife supporters: True! And … ?
Opponents: And therefore it will be shut down by the FTC and the stock will go to zero.
Supporters: That’s … wow, that’s just hopelessly naive. I’m gonna go buy some HLF.
Today CNBC’s Herb Greenberg has a good statement of the “horrible pyramid scheme” case, which of course has been most memorably taken up by Bill Ackman, who is betting a billion dollars on “shut down by the FTC and go to zero.” And last week Bronte Capital’s John Hempton gave the classic statement of the “hopelessly naive” case.1 As one Herbalife shareholder put it when I asked if he thinks HLF is a pyramid scheme, “in the colloquial sense, yes; in the legal sense, no.”2
Here’s how another Herbalife shareholder put it today:
The short thesis rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for over three decades, and will shortly awaken (at the behest of hedge fund short seller) to shut down the Company. We find this thesis to be preposterous, particularly since the FTC has been sensitive to frauds of this kind. … All multi-level marketers (MLMs) by definition operate under a so-called “pyramid” structure and have some internal consumption, facts which do not render them patently illegal, as FTC guidance makes clear. … Our analysis shows that the current, well-vetted regulatory framework provides plenty of room for multi-level marketers to conduct business legally, and we believe Herbalife operates squarely within the FTC’s boundaries.
Or, in other words, “a pyramid scheme, but not an illegal one.” That shareholder is of course Dan Loeb, whose Third Point just announced that it’s the proud or proud-ish or let’s say unembarrassed owner of 8.2% of Herbalife, or a little less than half of Ackman’s short position.3 One picture you could have of Herbalife’s shareholder base is that the actual shareholders are the same as they were before Ackman got involved, while off to the side anti-Ackman hedge funds own 20% of the company that they bought more or less directly from Ackman. So, synergies.
Where does that leave us? Oh, I don’t know, it’s a market, man, you figure it out. Is the FTC going to shut down Herbalife? Your answer is almost certainly much better than mine.4 Let’s talk about a few other things instead.
Like: Is Herbalife going to sue Ackman? So sayeth Gasparino:
Ackman’s attorneys believe the possible lawsuit could be filed at or before Herbalife is scheduled to hold its much-anticipated investor day in New York on Thursday. … If filed, the lawsuit could involve alleged “tortuous5 interference,” implying Ackman intentionally damaged Herbalife’s business relationships, people close to Ackman said. On Tuesday, a large Herbalife distributor said he was leaving the company and called on other distributors to join him amid the controversy. …
As of late Tuesday, people with knowledge of the matter said no decision on timing or even if a lawsuit will actually be filed had been made. The company has told FOX Business it is weighing legal action against Ackman. … Herbalife has hired famed attorney David Boies to launch possible litigation against Ackman as well as the investment bank Moelis & Co., as its financial adviser.
This seems extremely unlikely to me, no? Ackman can’t actually do anything to interfere with Herbalife’s distributor relationships except tell distributors that they’re being ripped off; if that’s false, then the distributors will presumably ignore him, while if it’s true suing him over it doesn’t seem like a great PR or regulatory strategy. But what do I know; it wouldn’t be the craziest David Boies news this week, so.6
Or: how should Ackman feel about this? Not the suing, I mean; the fact that everyone’s piling in on the long side? “Bad,” I think, is the answer, which sounds obvious, but maybe isn’t. After all Ackman’s stated thesis is not, like, “multiples will contract,” but rather “this stock will go to zero through some combination of FTC enforcement action and Herbalife running out of people to dupe.” If that’s right then the bump provided by Loeb’s buying is just an opportunity to add to the short.
And maybe that’s right. But my sense of the Ackman Herbalife play is that it’s at least in part not about convincing the FTC to shut down Herbalife, but about convincing other investors that multilevel marketing is a toxic business to be in – that what John Hempton calls “scumbags working for stock market investors” are not the sorts of people whom stock market investors should want to hang out with. And Loeb’s purchase seems like a rejection of that. Herbalife may be “toxic” in the abstract, but that means nothing. At the right price, even toxic assets are a buy.
Fund titans Loeb, Ackman square off on Herbalife [Reuters]
Loeb Counters Ackman’s Bet Against Herbalife [DealBook]
Dan Loeb’s Herbalife Thesis [Kid Dynamite]
Ackman Braces for Legal Battle Over Herbalife [FBN]
From High Energy Clubs to Dashed Dreams: Herbalife Tales [CNBC]
I agreed with Bill Ackman that Herbalife is mostly about ripping off distributors and people at the end of the chain. The product is more than twice as expensive as competitor shakes. I called Herbalife “scumbags” … but they are scumbags working for stock market investors. …
Bill Ackman is shorting a profitable company – and his argument is that they run an illegal pyramid scheme. By implication his argument that the government is going to somehow close them down.
That is a really truly awful short thesis – the short thesis that Government is going to come and help poor people and a billionaire hedge fund manager! Normally neither group is high on the agenda!
2. And, “would I let my grandmother sign up? No.”
3. To be fair, he also addresses the horribleness questions, saying:
The FTC, by all accounts, receives a very low volume of complaints annually about Herbalife – fewer than forty per year – and we find it hard to believe the short seller’s theory that hundreds of thousands of people who have been scammed supposedly are too ashamed to speak up. Herbalife is well-known for its generous return policies, buying back product from exiting distributors for up to twelve months. The Company repurchases an average of only 1% of sales volume pursuant to this policy. It is difficult for us to understand why the buyback volume would be so low if there are in fact so many unsatisfied consumers and distributors who presumably would not hesitate to be reunited with their cash.
Ackman’s presentation gets into this a bit – e.g. required outside-sales certifications that he claims make it difficult to actually demand a refund – and Greenberg notes that a lot of the losses to distributors come from paying for leads, not paying for product. Also: forty fraud complaints a year is not zero! But, yeah, I hesitate to imagine how many, like, Goldman Sachs gets.
4. I’m … today, at least, I’m kind of persuaded by the Hemptons and Loebs of the world who think that the FTC doesn’t exactly go around doing the bidding of hedge fund short sellers? But it’s not like Ackman is without D.C. clout; one scurrilous rumor that I’ve heard is that he’ll be working his ties to Chuck Schumer to get some politico-regulatory attention focused on the multilevel marketing industry in general. I for one would love some congressional hearings on this; it’s like:
Senator: Aren’t you ripping off poor illegal immigrants who are afraid to complain to the authorities?
Herbalife guy: Won’t this hearing benefit a big New York hedge fund that’s shorting our stock?
All: How ’bout that recent sporting event?