As he usually does, Michael Lewis stole the show in 2014. During the promotion of his book Flash Boys he made some fairly controversial claims that the U.S. stock market is “Rigged”, and while he was primarily referring to high frequency trading, many non-pros failed to make the distinction between their broker screwing them as opposed to some computer in Jersey City. Over the past 15 years, investors have had their share of reasons to be skeptical of those selling them securities. From Internet IPOs rolled out with strong buys and sky high price targets in the late 1990s, to securitized mortgage securities in the Aughts. “Rigged” has a lot of different meanings to investors who have been burned by the Wall Street machine, but for those of us who accept the embedded arb-able inefficiencies that do and will always exist, it’s hard not to highlight situations that seem so obviously manipulated.
Herbalife (HLF) is a clear example. Someone somewhere is manipulating the stock. This has been a story that has been clearly overshadowed by two large investors who have made the exact opposite directional bet on the viability of the company’s business model and the prospects for the stock. Without accusing any parties specifically, HLF stock has looked rigged from time to time. Back in April, I nearly fell off my chair (MorningWord 4/29/14-HLF: I Didn’t Choose the Herbalife, It Chose Me) when the company announced the suspension of their dividend (following the prior issuance in early February of a $1.15 billion convertible note) using both source of funds to buy back their own stock. It is my opinion that the company wanted to squeeze the sizable short position (Pershing Square’s Bill Ackman) and cause him to cover. The year-to-date chart of HLF below shows the period of relative calm during May and June when it appeared the company was buying back stock hand over fist:
It’s an understatement that the stock has been volatile over the last month. The stock had a sharp decline in front of Ackman’s July 22nd marathon presentation that was supposed to offer the knockout punch and demonstrate that HLF is a pyramid scheme (it didn’t). The short squeeze that ensued was epic, sending the shares up 25% in one day, but in many ways it felt like the company’s last gasp. Since the Q2 report last week, which registered the first earnings miss for HLF since 2008, the stock has declined 25%. Just yesterday, HLF stopped on a dime at $50, a long-term psychological support level:
While Ackman’s claim is that HLF’s business model is against the law, and that their books are rigged, I can’t help but watch the stock and think that there are also claims to be made that those trading the stock have also been playing games.
Yesterday I closed most of a bearish position (here) as the headline risk and the high short interest make the potential for a sharp snapback on the slightest bit of good news. Often times you will hear traders say things like if you didn’t cover your short yesterday, it is like you re-shorted at the closing level. So if you ask me, would I short it here?? Well, it’s all a matter of conviction. Bill Ackman clearly has it, and the single largest line of listed open interest in the options is the Jan15 7o puts (70,000, believed to be Ackman) with an untold amount of over-the-counter put options. So $50 is going to be a battle ground level for a bit. Until it isn’t.
Is it a good press on short side here? No, but this story is a bit of an adult swim anyways and if Ackman’s work finally encourages serious investigation by the Feds, then the stock is likely to see lower lows, and the largest shareholders like Carl Icahn may be forced to lighten up (if he already hasn’t).