Pershing Square Capital vs 'Herbalife (HLF)' - Some wider common-sense questions.

December 2012, Bill Ackman overtly challenged 'Herbalife (HLF)' as the effectively-valueless (albeit legally-registered) publicly-traded, corporate front for an illegal pyramid scheme. At the same time, he declared that, after many months of rigorous research and analysis, he had engaged his Hedge Fund, Pershing Square Capital, in a $1.2 billion short-selling trade against 'Herbalife' which would be pursued to its inevitable conclusion, not only to make profits for his shareholders, but also in defence of his fellow citizens.

Three years later, as a direct result of Ackman's intervention (which, to his credit, has created rapidly-heightening public-consciousness in the USA), more than 1000 victims of the 'Herbalife' cultic racket are known to have come forward to file complaints with federal, and state, regulators and law enforcement agencies.

Bearing all the above in mind, the following letter (from 'Pershing Square Capital Management Holdings' to its shareholders, December 2015) was apparently written by Bill Ackman himself.

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http://www.gurufocus.com/news/377987/bill-ackman-comments-on-herbalife-short

Our thesis on HLF remains unchanged. We believe that Herbalife will ultimately be subject to regulatory action or will collapse because of fundamental deterioration in its business which relies on the continual recruitment of new victims. During the quarter, the potential for regulatory action increased while business fundamentals deteriorated.

From a regulatory perspective, we view the Complaint that the FTC filed on August 17th against Vemma Nutrition Company (“Vemma”), another MLM whose structure is similar to HLF’s, as a very positive development. The preliminary injunction issued against Vemma on September 18th is likely to make Vemma’s business totally unviable and provides a template for claims the FTC could bring against Herbalife.

On October 27th, New York State Senator Jeff Klein, working with Public Advocate Letitia James and a non-profit community group called Make The Road New York, released a critical report on Herbalife titled: "The American Scheme: Herbalife's Pyramid Shakedown". Based on its hidden camera investigations of more than 60 nutrition clubs located in New York City, the report concluded that Herbalife distributors are “running an illegal pyramid scheme.” The report was supported by data from 56 victims who individually lost as much as $100,000. On December 9th, Sen. Klein held a public roundtable to advance his campaign to stop Herbalife’s deceptive tactics. Senator Klein has proposed New York State legislation that would amend the New York State General Business Law to better protect New York State residents.

Despite predictions from Herbalife supporters that regulatory investigations would end during the quarter, they appear to have intensified. The company has now spent a total of $101 million defending itself, including $11.2 million in the quarter. Expenses related to “responding to governmental inquiries” increased from $5.8 million last quarter to $7.6 million this quarter which reflects the growing intensity of ongoing investigations. Assuming Herbalife is spending about $500 per hour on lawyers, $ 7.6 million represents 15,200 hours of legal time during the quarter, or 168 hours of legal time per day, seven days per week.

Herbalife’s fundamentals continued to decline during the quarter. Notably “total members” – perhaps Herbalife’s most important operating metric – declined from 4.1 million in the second quarter to 4.0 million in third quarter indicating that Herbalife churned through at least 500,000 members as the rate of member churn exceeded Herbalife’s ability to find new victims.3 On its conference call, the company also began using a new operating metric called ‘active members,’ suggesting that Herbalife concedes that a proportion – we expect, a large proportion – of its members are inactive. In our experience, companies that change the standards by which they measure themselves do so only when the old metric shows business deterioration that they would rather not disclose.

With respect to third quarter earnings, Herbalife posted weak revenues, but was able to reduce or defer certain expenses in order to generate earnings that exceeded analyst estimates. Among other questionable add-backs, Herbalife excludes regulatory and costs to “defend its business model” from its earnings estimates despite the fact that these expenses are likely to continue. On a consolidated basis, the company reported net sales of $1.1 billion, down 12% year-over-year, which was worse than Street expectations and below management guidance. The negative variance was largely attributable to foreign exchange headwinds. Similar to last quarter, China continues to be the key driver of Herbalife’s growth. While China’s year-over-year growth was 25%, Herbalife China revenues declined 5% when compared to the previous quarter.

Notably, HLF’s South Korean market continued to show substantial deterioration in the quarter. South Korea has been one of Herbalife’s largest markets and a significant driver of the company’s revenue and earnings growth. Over the last several years, South Korea has been Herbalife’s third or fourth largest market and one of its most profitable with approximately 56% contribution margins versus 43% for the rest of the company. Beginning a year ago, Herbalife Korea began to decline. This deterioration accelerated notably this quarter, down 39% versus last year on a constant-currency basis, and down 46% on an actual basis.

While management continues to blame the decline in Korea on “changes in the business model,” to us this looks like the classic “pop-and-drop” that is pervasive in pyramid schemes, a phrase that CEO Michael Johnson previously used to describe Herbalife’s rapid growth and inevitable decline in certain geographical regions. If one is looking for obvious evidence that Herbalife is a pyramid scheme, one need only look at the massive growth and rapid decline of Herbalife’s South Korea business and compare it with Unilever or another legitimate consumer packaged goods company.
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Yet, this recent Pershing document begs some wider common-sense questions:

• Why on Earth do Bill Ackman and his associates continue to employ (albeit occasionally) the thought-stopping jargon terms ('MLM', 'business,' etc.) to describe the demonstrably-criminal, blame the victim, cultic enterprises known as 'Herbalife', Vemma' etc. ?

• Why on Earth haven't Bill Ackman and his associates acted responsibly, come out and openly stated that 'Herbalife' is neither original nor unique, and clearly warned the public that 'Herbalife' is just one part of an ongoing criminogenic phenomenon of historic significance?

• In the past three years, why on Earth have the bosses of the 'Herbalife' cultic racket been allowed to  spend $101 millions stolen dollars obstructing justice in order to continue to commit related frauds?

• Since its instigation in 1989, exactly how many individuals in total have been churned through the so-called 'Herbalife MLM income opportunity?'

• What percentage of all these constantly-churning individuals have remained contractees of the so-called 'Herbalife MLM income opportunity' for more than one year, two years, three years, four years, five years, etc.?

• Exactly how many of all these transient contractees of the so-called 'Herbalife MLM income opportunity' have paid income tax on net-profits accruing from their temporary so-called 'MLM businesses?'

• Since the coining of the thought-stopping jargon term, 'Multi-Level Marketing,' by the instigators of  the 'Nutrilite'/ 'Mytinger and Casselberry' racket in the 1940s, exactly how many individuals in total have been churned through copy-cat so-called 'MLM income opportunities?'

• What percentage of all these constantly-churning individuals have remained contractees of any copy-cat so-called ' MLM income opportunity' for more than one year, two years, three years, four years, five years, etc.?'

• Exactly how many transient contractees of copy-cat so called 'MLM income opportunities' have paid income-tax on net-profits accruing from their temporary so-called 'MLM businesses?'

• Given that the withholding of key-information from people in order to take their money is fraud, what possible lawful reason could there be for the key-information contained in the answers to above six questions to have been withheld from the public and from regulators?

• Do the bosses of the 'Herbalife' cultic racket have any litigation/ legal expenses insurance for themselves or for their demonstrably-counterfeit 'direct selling' company?

• If the bosses of the 'Herbalife' cultic racket don't have any litigation/ legal expenses insurance for themselves and their demonstrably-counterfeit 'direct selling' company, why have they been unable to obtain it?

• Do the bosses of any 'MLM income opportunity' cultic racket have any litigation/ legal expenses insurance for themselves or for their demonstrably-counterfeit 'direct selling' companies?

• If the bosses of 'MLM income opportunity' cultic rackets don't have any litigation/ legal expenses insurance for themselves and their demonstrably-counterfeit 'direct selling' companies,  why have they been unable to obtain it?

• Other than its instigators, in whose financial interests has it been for the pernicious, thought-stopping, totalitarian/ totalistic Utopian fairy story entitled, 'Multi Level Marketing Income Opportunity,' to have been allowed to continue to be peddled to countless millions of vulnerable people, without any rigorous official challenge to its authenticity?

David Brear (copyright 2015)