Tide of the Herbalife Battle Shifts

 | Jan 17, 2013 | 8:13 AM EST
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UPDATE: We just got preliminary HLF earnings and they look in line to slightly better. The company also announced a continuation of its buyback. That cuts to the notion that HLF isn't going away, which is all that matters when you consider Ackman and potential government vs. Loeb and Icahn.


This war over the soul and stock price of Herbalife (HLF) may come down to a simple equation: who has the best allies? When the war started, remember, hedge fund manager Bill Ackman drew first blood.

Ackman shorted 20 million shares of the multi-level-marketing company and then told everyone and his brother that the company is a pyramid scheme that should be shut down by the government.

Of course, given the coverage of the event Ackman was speaking at coupled with his love of the microphone there -- no sin as Ackman is nothing but good copy -- Herbalife's stock swooned. How could it not when Ackman used every media outlet to spread the gospel about how Herbalife is wrecking peoples' lives with its pyramid-scheme ways.

Think about the odds against Herbalife. A smart guy, a rich guy, unlimited firepower shouting form the rooftops that Herbalife is going to zero and that he's going to take it there with, alas, the help of the U.S. government, which his going to suddenly see the light behind Herbalife's myriad abuses.

Just to drive the story home in what is rapidly developing into a parody of the buy side, Ackman slapped a $0 price target on Herbalife. You want to be a hero and take the other side of that trade? You want to work at a big pension fund or a mutual fund and be seen buying a stock that's a Ponzi scheme, especially when your investors all watch CNBC and have seen the charges?

So, the battle lines were drawn. On one side you have Ackman, buttressed by his batter of fancy lawyers that have somehow blessed this crusade, and on the other is the little old hapless Ponzi scheme of Herbalife, which is making destitute whole families with its nefarious tactics.

How can Ackman not win? All he has to do is convince the government, the U.S. government and any of its myriad arms, to look at TheFactsAboutHerbalife.com and shut the darned company down.

Not a fair match.

Suddenly, along comes one of the most shrewd and tough-minded investors of our time, Dan Loeb of Third Point Capital, and he's taken a more than 8% stake in a company that has 113 million shares, of which 20 million are sold short by Ackman.

And then yesterday we learned that Carl Icahn, who has had a very public spat with Ackman over a relatively small amount of money, now owns a position in Herbalife. Ackman not that long ago notoriously and very publicly said he had no respect for Icahn, while Icahn fired back that he considered any criticism from Bill Ackman a compliment. Say what you want about Icahn, not respecting him given the rigor with which he actually approaches his investments seems pretty insulting and I have known Icahn and his work for 30 years, so I have a little perspective.

But with the addition of Icahn to Loeb's side of the equation, we are beginning to see different battle lines. Now it is Loeb, Icahn and Herbalife vs. Ackman and the U.S. government. That's a different battle entirely.

Plus the war's turf has changed. It is no longer about Ackman wiping out Herbalife with the help of a probing and consumer-friendly government, it is about Herbalife and some equally rich hedge fund managers destroying Ackman and his potential government lackeys.

Now it has gone from an unfair fight against Herbalife to an unfair fight against Ackman.

Here's why.

First, relying on the government to do the right thing is about as silly as silly can be. At this juncture Ackman needs an injunction by the government against Herbalife selling product in the United States. Who is going to seek that injunction? Ackman doesn't have standing. The Federal Trade Commission? Are you kidding me? How is that going to happen? They haven't cared before about Herbalife, so who is to say they will now? The SEC? Why? Herbalife under Michael Johnson's been incredibly scrupulous about its public filings. The Justice Department? I think it has its hands full with other issues. I don't envision Attorney General Eric Holder or the Southern District of Manhattan's Preet Bahara indicting Herbalife or Johnson any time soon.

In the meantime, the unlimited firepower has switched. Loeb and Icahn could easily scoop up hundreds of millions of dollars of Herbalife stock and virtually take the float out of the vault, making it so Ackman can't borrow the shares.

As long as Herbalife was headed down, and it was virtually cut in half during the Ackman assault, then Ackman looked like he could win. You get the stock low enough the institutions will flee for certain and some arm of the government is more likely to examine Ackman's charges.

But now the stock's about where Ackman initiated his short and that means the clock is now ticking.

And that's where Herbalife comes in. I don't know any of the men who are involved in the tussle very well. But I have interviewed CEO Michael Johnson more than anyone and have studied the earnings and cash flow of the company.

Johnson's basically created this online selling juggernaut. In the last five years he has taken cash flow to $3.4 billion from $2.3 billion and actually doubled sales in Asia Pacific while moving up North America sales by more than a third. The company's got a booming Mexican business and a terrific European business, aided by the worldwide downturn, which has brought people into the Herbalife sales force to make additional income.

Now one could argue that none of these new salespeople has a clue about what they are doing. You could argue that they will be hurt by Herbalife. You could argue that all they do is really try to get other people to sell the product.

But you can't argue with those numbers and unless some arm of some government issues an injunction is hard to imagine the good distributors in  Korea or Mexico no longer selling selling the stuff because a New York hedge fund manager has told them they will lose everything, Clearly somebody's making something or the thing would have fallen apart years ago instead of being taken to heights that have made Johnson and his team very successful.

Again, you have to put aside the so-called nefarious way that Herbalife makes money and accept the fact that it makes a ton of money. You have to put aside that it might be a pyramid scheme and accept the fact that willing individuals join the salesforce and prosper, particularly in other countries, and they don't give a darn about any of the warnings that they are hearing.

After all, the people who join Herbalife do so because they want to run a small business and most small businesses fail anyway. Judging by the success of sales, I bet that HLF distributors, or franchises, do better than most. That's what matters.

When it was Ackman and the government against Herbalife it was an unfair fight. But when it is Ackman isolated -- with no government help to speak of, meaning no injunction save a possible slow-moving non-criminal SEC investigation -- vs. Johnson, a passionate and very successful leader of Herbalife and two of the toughest investors in the business in Icahn and Loeb, the battle goes to the latter for certain, especially when you consider that long buyers have a real edge in that they don't need to borrow stock to sell short. Ackman must constantly have stock to borrow to stay short.

A squeeze could wipe out anyone because stocks can theoretically go to infinity if they can't be borrowed. But they can only go to zero otherwise. So Loeb and Icahn only have to keep the balls in the air and count on Johnson to do his part by maintaining sales and cash flow.

Now here's the real rub. Herbalife has a beautiful balance sheet. It went private in 1996, led by a team from JH Whitney and Golden Gate Capital. And then it came public again a few years later in 2004, run by a man who had a very successful career at Disney (DIS), concluding with the running of Disney International. I have never heard a bad word about his tenure.

Why can't Johnson just take it private again? He's taken the share count from 145 million six years ago to 113 million now. He has told me over and over again that the stock is inexpensive and that was from much higher levels. It traded at $70 at its peak last year when, arguably, the company wasn't even doing as well as it is today.

What's to keep him from announcing a huge buyback or a going-private transaction as the stock might be artificially low because of Ackman's bashing.

I think either one is a distinct possibility.

So, to me, it is no longer a war against Herbalife. It is a war that is predicated by a hedge fund manager who believes the government should act vs. a government that has never acted along those lines, two hedge fund managers with virtually unlimited capital because of their reputations and their records and a company that's hitting the ball out of the park.

I think this is a battleground and I hate battlegrounds, but when it comes to allies I would take Loeb's any day of the week.

That's how the matter stands for the moment with much more of the war to come.

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