Friday, January 11, 2013

Analyzing Loeb's rebuttal to Ackman's Slam of Herbalife

Herbalife product brochure Cover GR Greece Ell...
Herbalife product brochure Cover
GR Greece Ellas Ellada
(Photo credit:
Yesterday we reported on SEC opening an investigation into Herbalife. Now we learned that Dan Loeb has basically placed a $300 million bet against Bill Ackman on Herbalife. Ackman believes that Herbalife is a pyramid scheme, Loeb believes the exact opposite: it's a "classic compounder", in Wall Street-speak, i.e. high growth company.

Instead of checking each and every point that Ackman and Loeb had made, I'll just go over Loeb's rebuttal. It can be read in full here:  (Thanks to "The MLM Attorney" Kevin Thompson's hosting )

Here's an excerpt from it, which is most of the counter argument.
The short seller’s lengthy argument against the Company can be boiled down to three principal smoking guns: the first, a claim that Herbalife has been operating an “illegal pyramid scheme” under the nose of the Federal Trade Commission for the past 32 years; the second, that Herbalife’s loyal customer and distributor base has been exploited and harmed despite the low number of consumer complaints and generous company return policies; and the third, a claim that Herbalife’s products are commodities sold at inflated prices not supported by sufficient levels of advertising or R&D.
Taken in reverse order, the third claim misses an essential truth that invalidates the indictment. No one believes Starbucks is a scam because you can buy a cheaper cup of coffee at your local bodega. A key contributor to Herbalife’s growth has been its distributor-led “Nutrition Clubs”, where consumers can purchase single servings of the Company’s signature beverages. The short seller’s assertion ignores the significant value customers place on every consumer brand and its community “experience” – whether at a Herbalife Nutrition Club, a Starbucks, or a corner bar. The markup is merited by community and brand identity, not by the commodity itself.
This counter-argument somewhat sidestepped Ackman's actual point... Ackman did not say Herbalife did not advertise. In fact, several of the slides shows Herbalife ads, as Herbalife sponsors David Beckham, Formula One cars, and more. However, is it enough? Ackman's presentation actually compared Advertising and R&D budget as quoted from Herbalife's balance sheets to companies of similar size and industry (as well as those NOT in the same industry), and Herbalife STILL fell short. Furthermore, what good is brand recognition if this stuff is NOT sold at retail? It's almost as if Loeb just constructed a strawman argument and defeated it.

However, I do acknowledge that this is a good argument... that it *could* be argued that the product is NOT overpriced... or it *is* overpriced but it's NORMAL for the nutra-ceutical industry. It is needed to support the margins to do MLM payout.

Strangely, this seems to be the best argument, as the next two are weaker.

Loeb continued...
The second claim seems similarly dubious. 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.
Fundamental question... has the "loyal customer and distributor base" been exploited? if you look solely at the number of complaints, lawsuits, buybacks, and such, the incident counts are quite low for a company of Herbalife's size. However, if you take it as a whole, in that there really is little to no retail, and most of the products is simply sold to distributors (who needs it to qualify for payout), then there really is little reason for distributors to complain. Ackman also documented instances where Herbalife initiated audits for 70% rule only when distributors requested company buyback, thus discouraging buybacks and complaints. Adding to this high churn rates at lower ranks and extremely stable top ranks, this rebuttal is medium at best (and IMHO, quite weak).

Again, this almost smells like a strawman, as it ASSUMES that Herbalife have plenty of retail, which again, sidesteps Ackman's allegation that most products are sold to distributors.

And here's counter-argument number three...
The pyramid scheme is a serious accusation that we have studied closely with our advisors. We do not believe it has merit. 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. Since 1997, the FTC has brought 13 separate cases against alleged pyramid schemes. None of the companies that the FTC pursued had been in business for more than ten years and 11 of the 13 companies involved were less than five years old, suggesting the FTC actively protects consumers subjected to this type of behavior. The FTC has also aggressively pursued enforcement actions against similarly odious “deceptive business opportunity schemes” [see] under the “Business Opportunity Rule” (although this rule does not apply to multi-level marketers such as Herbalife).
This is the weakest argument of them all. This basically says "FTC don't sue old companies, and Herbalife is an old company."  Need I remind you about Bernie Madoff, who was probably scamming for 30+ years?

Makes you wonder who the **** wrote this? In an essay, you usually start with the weakest argument, and conclude with your strongest. This is the exact opposite.

Overall, Loeb's counterargument rates a C.

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  1. for those Americans who don't follow soccer, the man on the photo is Messi(world's best soccer player in the years 2009/10/11/12). It's so funny to see people believing(and trying to make me believe) that he really drinks Herbalife's shake every morning, not just in ads

  2. You forgot to mention Loeb's weakest argument of all:

    "Finally, even if there were some regulator intervention, we are comforted by the fact that 80 percent of Herbalife's revenues come from overseas."

    Given the company is HQ in the U.S. and the stock trades in the U.S., overseas sales won't make a bit of difference if the stock is halted and the company is prosecuted for fraud. Not to mention that other jurisdictions would likely follow suit...

    1. Herbalife already lost in Belgium, actually, and was declared a pyramid scheme there. Thus, its outlook in Europe is not that rosy.