The Herbalife billionaire’s square off…

Herbalife is a US listed company with a market value of $4 billion. It is fast becoming one of the most talked about stocks in the financial press as two high-profile, billionaire hedge fund managers – Daniel Loeb & Bill Ackman square off against each other with opposing positions. Someone must lose and it will be fascinating to see who is ultimately right and who is proved wrong.

Herbalife is a nutritional supplements company which sells its products through a network of circa 2.7 million independent distributors worldwide. These distributors then sell the products to customers. However, they are also incentivised to recruit other distributors, as they get commissions from products sold by these recruited distributors who, in return, are also motivated to scour for distributors, and so on. Sounds a bit like a pyramid selling scheme eh?

William Ackman – enjoying poker!

Enter William Ackman, the head of Pershing Square Capital Management, who has publicly and persistently claimed that Herbalife does in fact simply operates nothing but a pyramid scheme in which the distributors make more money from recruiting and on-selling products to distributors, rather than actually selling the company’s products to third-party customers. As such, he argues that the company should be shut down by the US Federal Trade Commission! Ackman is so convinced of the thesis that, back in December last year, he revealed that he had opened a large short position on the stock, widely reported to be worth around $1 billion.

David Einhorn of Greenlight Capital, who is most famous for breaking Allied Capital and shorting Lehman Brothers just before the GFC, also appears to share similar negative view on Herbalife’s business model, although it is not now known whether he has a position on the stock.

Dan Loeb

On the other hand, another well-known fund manager, Daniel Loeb of $9bn hedge fund Third Point, has taken the diametrically opposite view on the company, having recently built an 8% stake in Herbalife. Loeb was one of the best performing hedge fund managers in 2012, with one of his funds return a tub thumping 35% net of fees. Loeb’s view is also shared by the famed Wall Street investor and agitator, Carl Icahn, who also has reportedly gone long Herbalife stock and recently cleaned up to the tune of half a billion dollars in Netflix – buying the stock via Call options when it was trading around $55 compared with $180 now. In fact, Icahn engaged in a very public clash with Ackman on live TV, which has been the subject of much banter on the trading desks around the US. 

There is no doubting the entertainment value around the whole Herbalife saga but it is also interesting to look at the company’s financials – it currently has net debt of just $178 million, and free cash flows of approximately $450 million per annum. In other words, if it so desired, it can wipe its debt clean 2.5 times over with just a year of free cash flow. The company has also authorised a $1 billion stock repurchase program—a substantial de-equalisation program given its $4 billion market capitalisation.

Ackman better be right, as if he’s wrong, Loeb and Herbalife management will look to exact serious revenge on him through a short squeeze of epic proportions. With the look of the chart below it seems Loeb is presently winning this game of high stakes poker…