The financial battle over Herbalife slogs along as Bill Ackman and his firm, Pershing Square, settle in for the long haul in order to cash in on a $1 billion bet that the health drink company’s shares will tank. After Herbalife’s shares sank to just under $50 in March on the announcement of a Federal Trade Commission (FTC) investigation, the company’s shares now stand at $65.16. The short sale position taken by Pershing must be covered at some point and Ackman announced that 40 percent was covered last year with additional “put” or sale options subsequently acquired. The date for a final reckoning is unclear. If Ackman and Pershing are going to profit from the large bet against the fortunes of the health drink company, they will probably need some help from the FTC or significant negative results from company operations.
Ackman alleges that the health drink company is a pyramid scheme designed to separate lower and middle income participants from their money. A documentary produced by Pershing highlights the plight of several of them. The documentary notes the pressure placed on Herbalife “members” to purchase the product themselves in order to succeed. The company contends it offers a business opportunity for its members to grow a business using their sales techniques and products. With any direct sales organization offering financial incentives or commissions for recruitment, some amount of suspicion arises because the number of new members available at the bottom will eventually dwindle. For Herbalife, about half of its members who previously qualified for bonuses drop out each year. Ackman contends that the company induces women to put up their own funds to buy a substantial amount of the products in hopes of sales, and that a significant amount of the company’s revenues are ill gotten gains from women who will never be able to sell enough of the product to even cover their costs.
For its part, the company does not keep detailed records of the subsequent sales by members to know how the products are used. The president of Herbalife, Des Walsh, when questioned, appears to avoid the issue and expresses no real desire to change product tracking to confirm the identity of actual product end users. As most other companies around the globe want more and more data regarding customer identity and tastes, the health drink company appears to remain comfortable knowing less.
As the Herbalife financial battle slogs on, the FTC investigation rumbles forward as well. The finger pointing and accusations going back and forth have also resulted in Securities and Exchange Commission (SEC) investigations into the timing of certain events. The federal investigators are reportedly checking into Pershing tipping off other investors prior to negative information on the health drink company going public so the others might profit. While questions have been raised, no evidence of wrongdoing has turned up and Pershing denies any impermissible leaks. The federal investigators are also looking at the activities of the investment companies founded by George Soros and Carl Icahn, which acquired larger positions in Herbalife stock on the other side of Ackman’s bet.
The FTC does not have a strong track record of prosecuting pyramid schemes. The government agency has only leveled charges against five companies as running pyramid operations since 2001. In one bit of good news for Ackman and Pershing, the FBI is now investigating how Herbalife does business. In all likelihood, the Herbalife financial battle will continue to slog along as Ackman fires more ammo and the company fires back. Even if the company manages to rid itself of the FTC investigation, suspicions will continue until Herbalife is more forthcoming with information regarding who buys its products for actual use.
By William Costolo