E Herbalife: Yes, Alice, There Is A Santa Claus

  • Just prior to the Herbalife (HLF) earnings there was an FTC Panel discussion on "Fraud Affects Every Community."
  • In the first FTC Fraud forum on 10/29, the SEC announced the formation of a new anti-pyramid scheme task force.
  • An announcement of a (likely) settlement in the Dana Bostick class-action provided merely some dead-cat bounce ahead of earnings.
  • Deterioration at AVON (AVP) further suggests that the MLM model is cannibalizing their business.
  • There are growing signs of community action against Herbalife and other MLM companies.

The Herbalife earnings release is behind us, and it wasn't pretty, though the eternally bullish John Hempton, he of "They are scumbags, but they're my scumbags," manages to find something to like. Then again, he also opined on Skype that night that the first acts of the new SEC anti-pyramid task force and the FTC's "Fraud Affects Every Community" road show would be to let Herbalife off the hook. Unlikely.

Meanwhile, the settlement in the Bostick class-action provided a little bit of dead-cat bounce on the day before earnings, but is now causing protests, including from LULAC (League of United Latin American Citizens), and could yet come unraveled, while another class action suit may be taking shape.

The company's inconsistent and presumptuous discussion of settlements with the FTC sound increasingly hollow, as Matt Stewart has argued here, where he points out four very different comments from the company about the likelihood of a settlement with the FTC. More recently, some have thought those statements were intended to press for a settlement in the Bostick class-action. Meanwhile CFO John DeSimone clarified in interviews that there was no new news in those reports, that they were merely reiterations of the company's position that they expect to be substantially exonerated.

Meanwhile, my interest in MLM in general and Herbalife (HLF) in particular, led me to send in the following question to the FTC panel on 10/29, about How Fraud Affects Communities (slightly edited):

I would like to ask the panel: Why can't FTC issue clearer guidelines about pyramid schemes? After all, prosecutable or not, every MLM is a pyramid scheme, because they all sacrifice retail to recruiting by design. The question of whether or not they are technically legal or illegal is of academic interest only to consumers. The fact is that in all cases the probabilities are hugely stacked against consumers. There is a reason why the SBA won't finance MLM-based business plans. What can be done to clear up the information, and make it more relevant to consumers?

In all, it pays to realize that what we are looking at is not so much a business problem, as it is a law enforcement problem, and thirty-five years of failure to enforce the anti-pyramid laws have resulted in people thinking MLM is a legitimate form of product distribution. At the same time this presumption of normalcy by a large group of people results in extreme abuses, and it seems Herbalife maybe the biggest target, in part because it is public, and Pershing Square took aim at it, but Vemma is bringing up the rear. Vemma's recruiting is increasingly causing mayhem in the millennial generation, and reports from college campuses are ugly, leading to bans on some campuses. It was already banned in Italy on a pyramid charge. This devastation is also coming to the attention of the FTC. 

The resistance to Herbalife has been organized slowly but surely, and it should be noted that LULAC president Brent Wilkes was on the FTC's panel on Fraud Affects Every Community. LULAC has been a prominent voice against the devastation that Herbalife has brought to the Hispanic community, and various other Hispanic organizations are joined in the fight. In New York City, City Council speaker Melissa Mark-Viverito, State Senator Adriano Espaillat, and Council members Julissa Ferrero and Annabel Palma have been vocal in supporting a probe by the AG. With Vemma, college presidents and disenchanted millennials can be counted on to be very vocal about their loss-making experiences, and file lots of complaints. I recently met a young economics student who is trying to make a movie about the whole MLM phenomenon, and Vemma was his biggest inspiration.

What the Earnings Release means

The Venezuelan problem is now fifty percent accounted for by shifting to the Sicad II rates, which is used in most other financial reports at the moment, at 50 Bolivars to the Dollar, and at least defensible for now, but still likely to have to be revisited as the deterioration in that country continues - the "street" exchange rates are more like 100 Bolivars to the Dollar, and there is no assurance Herbalife can actually repatriate moneys at the Sicad II rates. While John Hempton's analysis rationalizes that the YOY volume growth is not that bad, Matt Stewart dives deeper, and observes that the YOY rate of growth (recruiting trends) is negative in all markets except EMEA. And the marginal rate of growth is everything, for it tells us the growth trends, or in this case mostly shrinkage, a negative.

There were the usual objections on Twitter that the "saturation" theory is hard to prove, but the epidemiological model of Kay Herbert suggests otherwise, and John Hempton's look-back at growth in 2011, contrary to his intention, suggests indeed that we have seen the top. In short, with the underlying data suggesting long term deterioration, the revised outlook the management is offering for the full year and 2015 are likely optimistic, even aside from the almost binary possibilities on the regulatory front.

The outcomes there are likely between some kind of settlement that includes changes to the business model, likely to cause a slow death, or a criminal prosecution and a complete shutdown . Total exoneration seems a highly improbable outcome, resting on an assumption that American regulators are forever toothless. How all of this is reflected in the price is always a tricky argument, but ignoring it is not an option, and the 92% drop in earnings is an important warning, even if some of the adjustments are arguably of a "one time nature."

Community Action against HLF

Quite in line with my question to the FTC panel above, here is an example of grassroots action against Herbalife from Lawnsdale, IL, and there is more going on just like this. The FTC panel on 10/29 (for the full video see here) focuses on how communities are affected by fraud. The FTC is taking it on the road. Perhaps the most significant part of that news was the announcement of a new Pyramid Task Force at the SEC, perhaps the first sign of a change of course.

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Disclosure: The author has no position long or short, nor intends to open one in the near future.

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Old Time Investor 6 years ago Member's comment

Thanks Rogier, do you have any updates on this stock?

Danny Straus 6 years ago Member's comment

Great read!

John Fitch 6 years ago Member's comment

Great read Rogier. Interesting tidbit, Icahn's investment fund lost 5.3% in the third quarter. Icahn is Herbalife's biggest shareholder. Interested to see the share price if/when Icahn starts to pull out.