MorningWord 11/4/14: $HLF’s Sudden Weight Loss

by Dan November 4, 2014 9:39 am • Commentary

Herbalife (HLF) is down 14% this morning after the company issued their second consecutive earnings miss and guided down the current quarter eps and sales estimate (Per Bloomberg: Sees 4Q adj EPS $1.30-$1.40, est. $1.69; sees 4Q sales down 5%-8%, est. up 8%).  At the moment, the decline is slightly shy of  the options market’s 15% implied move, but inline with the average over the last 4 quarters.  However, it’s early, and this story feels like it is crashing under its own weight.

To refresh, activist shareholder Bill Ackman contends that the the company is a pyramid scheme, and will be shut down by the Feds, and has put his money where his mouth is to the tune of more than $1 billion, possibly a large part of the stock’s 43% short interest.  On the other side of the trade is activist shareholder Carl Icahn, who is the single largest shareholder with 18.5% of the shares outstanding and controls 5 out of 13 board seats.  For a guy like Carl Icahn, who has had such great success sniffing out under-appreciated assets or poorly run companies of which value can be unlocked, this investment sticks out like a sore thumb where it appears value has been massively inflated and those running the company may be pulling a fast one.

I have no dog in this hunt, but it seemed fairly obvious to be me that the company was losing its grip when in late April they suspended their dividend and decided to use that cash to buy back more shares.  This occurred just 2 months after the company issued a $1.15 billion convertible bond to fund an accelerated share buyback when the shares were significantly higher than current levels.

It appears that the company has run out of levers to pull to squeeze shorts.  With increased regulator scrutiny, the company’s results have taken a turn for the worse.  There is likely a correlation there.  Herbalife has been forced to clean up its predatory marketing practices over the past 6 months (including practices like the century club that Ackman has detailed), which has likely hurt sales overall.

It seems fairly apparent to this little ol’ trader that HLF at the very least is a ‘no-touch” and could trade lower than here even if the FTC does not shut down the company. The company levered up to buy back stock to fight Ackman, but in the process has hampered its cash flow flexibility going forward.  That comes at a time when the business itself might remain under pressure even on a settlement with the FTC, depending on how stringent the FTC’s terms are for “amending” Herbalife’s business, sales, and marketing.

I would also add that for those who were looking for long exposure, the convert due 2019 which has traded as low as 74 cents on the dollar back in Sept (closing 89 yesterday) is likely a far better own than the stock given the fact that Ackman thinks the equity is a ZERO and the convert has a much higher recovery rate.

For me this story likely comes down to a binary outcome.  Will the FTC shut them down as a pyramid? Or as has been rumored, will the company settle and introduce significant changes to their business model?  I certainly have no idea what will happen, but given the stock’s year to date performance, down more than 40%, it seems that both scenarios are bad.

I would suggest that no matter the outcome there is another potential negative catalyst before anything is resolved – Carl Icahn selling his stake and leaving the board.  If this were to happen and his people were to decide that the company is not as cheap as originally thought, or that the business model is not as pristine as originally presented, it would be lights out for this stock.  Aside from the FTC giving the company a clean slate or shutting them down, in my mind this is the other sort of binary outcome for the stock which could happen on no news.

Back on September 16th I wrote a post on Herbalife (Whale Hunting in HLF…Call Me Ishmael) which was a response to Ackman’s comment (directed at Icahn) at CNBC’s Delivering Alpha Conference in July:

“It’s not about winning,” Ackman said on Herbalife. “I would love to find a way to get Carl out of this stock.”

If I were Ackman, I would propose a transaction to Icahn.

Buy all 17,000,000 million shares that Icahn owns, at a big discount to current levels, but above his average price, effectively covering a portion of his short and get Icahn’s representatives off of the board.


This sort of proposal creates an incremental buyer, something Icahn would sorely need of if he is to ever exit his position. A buyer which, at the moment, does not appear to exist.

Icahn’s board representation should have him knowing a lot more than Ackman’s lobbyists as to the likelihood of a settlement with the FTC, as has been rumored.  So the question that I don’t have the answer to is this:  if talks with FTC take a turn away from settlement and if it appears that increased regulation would materially alter the company’s business prospects, would Icahn exit the long position, and can he in the open market given his board representation? 

This is not a stock that looks at all attractive, even down 14% on the day nearing the 52 week lows.