Is Herbalife (HLF) “the best-managed pyramid scheme in the history of the world,” as fund manager William “Bill” Ackman suggests? Is the maker of weight-loss and nutrition products being unfairly maligned by a man who will make money if investors flee the stock? Did you care about Herbalife before Ackman issued a marathon critique of its business on Dec. 20? You may well not own the stock, as it’s not exactly a blue chip play. But now that Herbalife Chief Executive Officer Michael Johnson and Ackman are blasting each other on the media circuit, the question is what to make of this drama.
This isn’t your typical short-seller’s fight. Start with the fact that Ackman presented his case (PDF) against Herbalife at a special complimentary event hosted by the Sohn Conference Foundation. The Sohn Conference, now in its 17th year, famously brings together billionaire investors each summer to share their top investment picks and raise money for pediatric cancer research. This is the first time it has held an event featuring one person, according to organizers. The reason became clear at the end of Ackman’s three-hour show: Any money he makes on this bet will go to charity, with $25 million slated for Sohn regardless of how it turns out.
Why not make a ton of money and use just some of it for a good cause, as Ackman normally does? Because profiting from Herbalife’s alleged exploitation of its distributors feels like “blood money,” Ackman said. His goal: to let the Federal Trade Commission take this research and shut the company down. Herbalife’s Johnson, meanwhile, is calling on the U.S. Securities and Exchange Commission to pursue Ackman for “blatant market manipulation.”
The most intriguing thing about Ackman’s high-profile crusade against Herbalife is the fact that Ackman launched it. The founder of Pershing Square Capital Management is best known these days as an activist investor who buys up huge stakes in such companies as Canadian Pacific (CP), JC Penney (JCP), and Target (TGT) to force changes he hopes will drive up the stock price. While he made more than $1 billion by betting against bond insurer MBIA (MBI), Ackman prefers to put his money on businesses that can improve, vs. those poised to crash.
All the more reason to wonder why he has spent more than a year researching the case against a company that’s arguably an easy target. Multilevel marketing companies, from Avon (AVP) to Amway, have long dealt with criticism that they’re built on the backs of gullible distributors. People make an upfront investment to sell products on behalf of the company—usually to family and friends—in the hope that they’ll make a decent commission from the sales. Moreover, they’re rewarded for recruiting others to do the same. For most sellers, that system rarely leads to a lucrative income. For investors, the question is what portion of sales are fueled by signing up new recruits vs. selling to consumers who want the products.
In Herbalife’s case, Ackman contends, it’s not much. The model is so stretched worldwide—Ackman used the term “pancake scheme”—that Herbalife has resorted to selling weight loss products in Ghana. (With KFC (YUM) making major inroads there, that might not be a bad thing.) Ackman’s not the first to make that case. David Einhorn of Greenlight Capital, well-known for his success in shorting stocks, was asking tough questions of Herbalife’s management months ago. The SEC even looked into the matter.
Although Johnson was brimming with vitriol on Dec. 19, when the Herbalife CEO told CNBC that the world would be better off without Ackman, the company e-mailed a statement after the Sohn Conference presentation to say the inaccuracies were too “numerous” to address right now and to further complain about having been denied a chance to participate.
What we do know is that Bill Ackman hates this flavor of multilevel selling so much that he’s planning to put up a website to warn people against seeking a career through Herbalife. He’s used to being a shareholder’s friend in fighting management, not some villain who profits from others’ misfortune. Try telling that to Fidelity, Herbalife’s largest investor with more than 17 million shares in its funds. While a spokeswoman says the firm doesn’t comment on individual holdings, it has also been selling down its stake in recent months. Herbalife will need to find some fresh recruits.