MorningWord 11/14/14: $HLF – I Didn’t Choose The Herbalife, It Chose Me

by Dan November 14, 2014 9:44 am • Commentary

Despite Herbailfe (HLF) being cut in half in 2014, losing more than $3 billion in market cap from the all time highs made in January, the story is far from over.  Today we should be getting 13F filings from large holders. Carl Icahn, HLF’s largest holder who controls five of 13 board seats, has been reported as recently as September  that he has not sold a share. But it will be interesting to see if he has adjusted his stake in the time since as the stock is likely getting very near his average price from late 2012.

While I don’t have dog in this hunt I find the story fascinating. Carl Icahn’s investment of 17,000,000 shares (and who knows what else he had in options) was worth $1.4 billion on Jan 8th of this year but as of last night’s close only worth $643 million.  While Bill Ackman, the largest short and likely a good bit of the stock’s 42% short interest, was nearly blown-out in early January but is now seeing some of his put strikes come back into play. He could be in the driver’s seat now as there good news for the company has been few and far between lately.

Just this morning, Reuters reported that one of the 8 non-Icahn controlled board members is in hot water:

Prosecutors in Brazil charged current Herbalife board member Pedro Cardoso with money laundering in 2008 for allegedly participating in an embezzlement scheme a decade earlier that siphoned 26.7 million Brazilian reais ($10.4 million) from the state government in Espirito Santo.

While this is has little to no effect on HLF as a company it has ovbious reputational risk among the investment community. It is important to note that Cardoso has been on the board since early 2009, soon after the alleged offense, and has the second longest tenure of outside directors on the board.   Will Icahn push for another seat??

I suspect that all that talk about taking the company private in 2013 was just talk. The company has spent more than $1 billion buying back their stock with every ounce of free cashflow in 2014.  As we have mentioned in the past (MorningWord 11/4/14: $HLF’s Sudden Weight Loss), for large institutional investors who would be inclined to take a bullish view on the company, a far better way to express this view would be buying the convertible debt that was issued in February that trades at 75 cents on the dollar.


The convert has a far better recovery rate than the equity if Ackman is proven right that the company is a Pyramid scheme and will be shut down by regulators.  Obviously that is a very low probability and would be the largest fraud in the public investment arena since the days of Enron and Worldcom. Betting for those types of outcomes is generally not a profitable strategy for retail investors.  So the stock remains a no touch except for those with a high risk tolerance because the lower the stock goes the more dangerous it becomes.

If the FTC were to come out and give the company a slap on the wrist, I suspect Ackman would have to cover and would create one of the most epic short squeezes known to man.  Rival hedge funds would have a field day bidding up the shares to inflict max pain on Ackman.

However there are a whole host of continued negative outcomes that don’t include the company being shut down or even getting a slap on the wrist. They would continue to significantly curtail their earnings power. Growth has already come to a halt, from 33% earnings growth in 2013, to an expected 9% this year and a 6% decline next, as sales growth is expected to be low single digits for the next 2 years.

So when I revisit this story today because of the news of the board member and the potential for some sort of acknowledgement of large holders reducing their stakes in their impending 13F releases I still see a very binary story with massive moves towards zero or back towards highs possible over time. Options market makers expect the same with an expected $9 (or about 23% move) in either direction by Jan 2nd weekly expiration (with the stock at $37.85 the Jan2 weekly straddle is offered at about $9, the Jan2nd weekly 37.50 call and put).

We play this stock from time to time and may do so again. It’s an amazing story to watch.