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Herbalife Ltd. (HLF): A Bull Versus Bear Tug Of War

 January 07, 2013 02:33 PM

(By Rich Bieglmeier) Herbalife Ltd. (HLF) has been in the middle of an intriguing tug-of-war between famous short-seller Bill Ackman and HLF bull Robert Chapman. Ackman says the network marketing company that sells weight management, nutritional supplement, energy, sports and fitness, and personal care products worldwide are nothing more than a "pyramid scheme." The shorter boasts that Herbalife if the best short idea he has "ever seen." In an address outlining his thesis, Ackman boldly claimed his price target is zero and that he will give 100% of his profit from an "enormous" short to charity. iStock reviewed Ackman's 334 page presentation, so you don't have to.

[Related -Herbalife Ltd. (HLF) Q3 Earnings Preview: What To Watch?]

This is the CliffsNotes' version: Herbalife has no competitive advantage, inflates its price, makes more money from recruiting new sales people than actual sales, but uses "discounts' essentially to hide the fact, uses deceptive promises of income potential to lure new dreamers, spends little to nothing on advertising, actually harms most recruiters financially, and is running out of attractive countries for expansion for "pop and drops" to enhance revenue.

The presentation notes that many lawsuits have found judges flirting with labeling HLF a "pyramid scheme," and a court in Denmark stated, "Herbalife is in breach of Articles 91, 4 and 99 of the Act regarding market practises and consumer protection because it has established, managed or promoted a pyramid scheme, whereby the consumer or a business stands to make money which is more likely the result of introducing new consumers or businesses into the scheme than from the sale or use of products. The court orders cessation of this breach and thus of the Herbalife pyramid scheme whereby a consumer or an business stands to make money which is more likely the result of introducing new consumers or businesses into the scheme than from the sale or use of products."

[Related -How To Invest Like Bill Ackman]

Chapman and HLF management feel Chapman's call is "market manipulation" and that earnings and revisions will prove Ackman's claims are false and crush his short. In a letter to his investors, Chapman wrote that HLF has $100 potential and that Ackman's presentation and timing are admissions that the FTC will not deem Herbalife a pyramid scheme and shut the company down. Besides, he says 80% of HLF's sales are international and beyond the FTC's reach.

With equal bravado, Chapman's letter stated, "Despite beguiling and specious reasoning, Ackman will fail to influence/cause a material regulator response or a HLF distributor exodus. Consequently, he will suffer a merciless short squeeze, catalyzed and augmented by a fast and furious combination of HLF share count shrinkage (buyback) and excellent operating performance (beat and raise dynamic.)" He even hints that HLF could self-tender and take the company private.

HLF will have an investor's day on Thursday where management will offer "a detailed rebuttal of Ackman's claims. Chapman does a little of his own defense and analysis offering, "Herbalife will produce over $725mm of earnings before interest, depreciation, and amortization (EBITDA) this year." Adding, "Think of HLF's gushing cash flow this way – HLF is printing EBITDA of over $2mm/day." Using the S&P 500's EBITDA of 8, deducting debt and adding cash back in, and Chapman says HLF is worth $50.46 per share – more than 38% upside.

Last week, Wall Street seemed to take Chapman's side and accumulated more than $130 million – 3.27% of market cap – during the New Year shortened trading week.

Only one of these two men can be right. iStock would suspect that this week's investor conference could shake things up and cause a short-term spike. The HLF chart shows upside to $45. Aggressive investors might consider adding call options. For example, the January $32.50 call options last traded at $5, putting the breakeven point at $37.50, one dollar more than HLF's price as we type.

Herbalife Ltd. (HLF) price has been sensitive to which side is tugging the rope. With management stepping up to make its pitch this week, the rope is likely to move towards bulls this week. 



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