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The World’s Biggest Short: Bill Ackman’s $1B bet against Herbalife

In Short selling on March 15, 2013 at 5:08 pm

Herbalife

Multilevel marketing (MLM) is sweeping across North America. You may have heard the names: Herbalife, Nu Skin, Melaleuca, Usana, ViSalus and a host of others. These companies seemingly offer not just unique and amazing products but also an opportunity to earn spectacular income while working from home. Their commercials feature rags-to-riches stories of average Americans once desperate who find salvation and fortune in becoming an MLM distributor. Now they live a life of fulfillment and luxury.

But as we all know, when something is too good to be true, it is. The reality is that many of these businesses are pyramid schemes. Most of the participants lose money – somewhere in range of 98%. And not only that, the money being made by the few is not made from selling products; it is made from selling the opportunity to others. When a new entrant joins the MLM scheme, he is required to purchase overpriced inventory, sign up for automatic monthly re-orders, purchase sales training materials and buy customer leads. Some participants spend five or ten thousand dollars on this “investment” before giving up or going broke. The profits from new entrants fund the bonuses of those upline.

Enter Bill Ackman, billionaire investor and principal at Pershing Square Capital Management, an 11 billion-dollar hedge fund. Ackman made his name taking concentrated positions in large companies including Wendy’s International, Target, JC Penney, CP Rail, Proctor and Gamble and MBIA. Ackman is an activist investor who isn’t afraid to challenge management teams, analysts and regulators.

Ackman spent over a year researching a Herbalife (NYSE: HLF), an MLM company selling weight loss shakes, supplements and other products. He then presented his work in a 3 hour presentation at the Ira Sohn investment conference in New York last December. His conclusion: Herbalife, a $4B publicly traded company, is a pyramid scheme.

Ackman’s fund bet $1 billion against Herbalife by short selling 20 million shares. This is one of the largest short positions ever taken by one investor on a single company. Ackman argues that Herbalife’s business is worthless because it will be ruled illegal by the Federal Trade Commission and will also eventually collapse under its own weight as it struggles to find new recruits.

I watched Ackman’s presentation. He is rational, brilliant and makes a compelling case against Herbalife. But will he make a profit on his short position?

The mother of all MLMs is a company we have all heard of. It’s called Amway. Just hearing the name might make you cringe.  Amway (short for American Way) has been around since 1959. Amway does an incredible $10 billion in sales and has millions of distributors. Amway is growing like gangbusters overseas with 90% of its sales made outside of the U.S.

In 1983, a 60 Minutes expose on Amway concluded that most of Amway’s distributors lose money and that the company “sells hope not soap”. That was over 30 years ago! Since then, Amway and the MLM industry have grown to many multiples in size. Given this information, it could be many years before Herbalife runs out of steam.

To complicate matters for Ackman, Herbalife may opt to become a private company. It has already received support from legendary financier and bitter Ackman rival Carl Icahn who has accumulated a 13% stake in the Company. A privatization at any price above $48.58/share would result in a permanent loss for Ackman.

Ackman has vowed not to give up on his quest to put this company out of business. Says Ackman: “If the government comes out and determines that this is a legal business then I will lobby congress for them to change the law”. Ackman might be right about Herbalife, but it might be a long time before he makes money on his investment.

Related links:

NPR’s Planet Money podcast – The Fight Over Herbalife

Ackman’s presentation and other materials put together by Pershing Square

Vanity Fair – The Big Short War

False Profits Blog – MLM expert Robert Fitzpatrick’s blog

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  3. […] my last blog post, I wrote all about Bill Ackman’s $1B bet against Herbalife. Ackman heads Pershing Square Capital […]

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