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Bill Ackman Full Of Praise For Company He Thinks Is A Blood-Sucking Pyramid Scheme

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Well, the praise was brief but extravagant, specifically "this is the best managed pyramid scheme in the history of the world," which I at least would be proud to have on my resume, but I might be in the minority there. What do you think Ackman's goal was in this morning's 340-slide, nineteen-hour Herbalife presentation featuring phrases like "Shane's going to come up here and talk about the accounting again" and "now I'm going to bring on our lawyer for the next 200 slides" and "here's where it gets really interesting: shipping and handling," and, at the 2 hour 28 minute mark, "feel free to go to the men's room, ladies' room, it's at the top of the stairs, but I'll keep going"?1 Ackman thanks several team members for working tirelessly for a year or more on this presentation, and if you watched all of it you have a pretty good sense of how they must have felt.

One model of this fight is that Ackman and Herbalife are attempting to wage regulatory battle by proxy. Presumably some SEC and FTC lawyers are watching this and the respective hopes are:

  • Ackman hopes that the Federal Trade Commission will conclude that Herbalife is a pyramid scheme and shut it down, bringing the stock to zero-ish and making him a zillion dollars on his short position, and
  • Herbalife hopes that the SEC will conclude that Pershing Square is a market-manipulation scheme and shut it down, causing HLF's stock to soar.2

Neither, either, or both of these things could happen, I suppose; the FTC and the SEC are their own dogs and so you could have each running around investigating one of the protagonists here. But generally relying on a regulator is sort of a dicey proposition; even if you're right, the regulator may have better, or possibly worse, things to do with its time than inflicting pain on your adversaries. So what does that leave you?

I dunno. Speaking as a guy who has not pondered the multilevel marketing industry much previously, I was pretty persuaded that this company seems Not Good. But I was persuaded of that by their own 10-K, so. Per Ackman's math something like 99% of Herbalife "distributors" who pay to sign up to sell the product never make any money, while Herbalife's marketing videos - one of which he played - show the one guy with a Bentley and a Ferrari and a comically underused home office. But there's a long way - a way partially paved with 200 PowerPoint slides delivered by a hedge-fund lawyer - between "hey that's pretty shady" and "that is an illegal pyramid scheme"; if advertising pretty low-probability business opportunities via results-not-typical car porn were illegal, who would pay for late-night television? Who would trade stocks, for that matter?3

The first question in Pershing Square's Q&A, from a Barron's reporter, was a great one: paraphrasing, it was "you are presenting this information to a bunch of overeducated people in this room who can influence the stock price, but how will it affect the actual people who are, shall we say [and here the paraphrasing gets looser] Herbalifing it up with negative results for their personal and financial lives?" The answer was to the effect of "you're a reporter, go tell them."

But it's a fair point. The gist of Ackman's presentation was not "here's why I think Herbalife's margins are unstable" or whatever, but rather "here is why it is a really bad idea to invest your life savings in becoming an Herbalife distributor." That ... I mean, color me convinced, but that wasn't a career opportunity I was going to be pursuing anyway, and I'm currently a blogger. It may not be a message best disseminated to its target audience by a presentation at a midtown conference center, even if there's also a live webcast.

The second question, from an analyst and Herbalife distributor, was less great - it was basically "what do you think of the cash flow and where would a private equity firm buy it?" - but got a great answer, which was "our target price is zero" because in Ackman's view HLF is an unstable pyramid scheme that will soon run out of victims. He never answered the cash flow question though.4

What is your math here if you're short? There are about three ways to win:

  • FTC shuts company down, stock -> zero.
  • Company runs out of distributors due to exceeding population of world and/or people being tipped off to the risks by watching Ira Sohn conference webcast, cash flow goes to zero-ish, stock -> zero-ish.
  • Company continues along doing the thing that it's been doing - a thing that Bill Ackman doesn't like but that has doubled its net income since 2009 - but the multiple that the market puts on that thing decreases substantially.

The presentation was I think well constructed to target those first two bullet points - get the FTC and/or the press involved to reduce Herbalife's ability to recruit distributors - but even more exquisitely targeted at the third: to making other big investors uncomfortable with the idea of owning Herbalife's stock regardless of its business success. When you tell a long, heartfelt story about pyramid schemes and broken dreams, one thing you want to achieve is to make multilevel marketing, like guns and cigarettes, a tough business for oh say TIAA-CREF to own - even if none of the story rises to the level of illegal pyramid scheme in the FTC's eyes. But you gotta believe that story, and act like you believe. Ackman announced that he will be donating all his (personal) profits from this trade to charity, saying "I view this as blood money" and repeatedly stressing the purity of his motives.5

Of course one can't be too cynical: Ackman's plan to donate all his profits may help in pitching his moral-short thesis to the market, but then that doesn't bring him any financial benefits, because he's donating all his profits. Presumably the moral-short thesis here really is driven by Ackman's views of the badness of this company, rather than by calculation of how to make the most profit.6 It's nice that he can afford to do that: bring down an evil company, make money for his investors, and give $25 million to cancer research, all in one day, while remaining staggeringly wealthy. And it's ... well it's statistically unusual that he got to that point by picking stocks, a crapshoot if ever there was one. In investing, as in selling powdered diet shakes, it's good to be at the top of the pyramid.

1.But also: "Ghana? They're selling weight loss products in Ghana?," which got an exhausted laugh.

2.This oversimplifies: Ackman raised an eyebrow at Herbalife's CEO's own share sales, so maybe he can get both regulators on his side. [Update: though maybenot?] Then he wins!, is I think how it works.

3.Or FX, really. FX is where retail investors go to get fleeced these days, isn't it?

4.Also the last question was fabulous, from a Bloomberg reporter who asked the Pershing Square analyst and lawyer how big Pershing Square's short is while Bill was out of the room.a That's how you do it! They didn't answer though.

a.Presumably in the bathroom.

5.And he notes that, even though this presentation would predictably drag down the stocks of other multilevel marketers, he's only short Herbalife. That prediction is, incidentally, full of interest, but doesn't seem overwhelmingly true (NUS down ~4%, AVP down ~0.5%, as I type this).

6.Obvs fiduciary duties to investors, management fees on those investors' cash, etc. complicate that calculation.


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