Someone Is Lying




So I recently had the privilege of sharing my views regarding some of my holdings on CNBC and boy was it quite the experience. Little nerve racking first time on live TV but it was an awesome experience and I look forward to doing it many more times. Investment Management will be my career and I look forward to the day of managing my own million dollar fund. While on CNBC I called Herbalife a pyramid scheme and I believe its intrinsic value is significantly lower then its 60 dollar plus current share price. So I thought it would be nice to provide some uncommon sense ( I've learned common sense isn't so common in the world anymore) as the controversy continues over its business heats up. For those of you who may not be aware, Herbalife’s business practices were being investigated by the Federal Trade Commission for over two years up until July 15th, 2016 in which a settlement was announced. Bill Ackman and Carl Icahn, two of the worlds top billionaire hedge fund managers have found themselves on opposite sides regarding the investigation and state of the company. Bill Ackman on the short side, and Carl Icahn on the long side. 
            Put simply, Herbalife’s business revolves around individuals signing up to be an independent distributor for the company with a goal of promoting and selling its products which include nutrition, weight-management, energy, fitness and personal care products throughout the world as well as trying to recruit new members for which you receive incentives for doing so. Here in lies the controversy regarding Herbalife and whether it operates as a pyramid scheme or not. As good as looking at all the numbers and the views of Bill Ackman and Carl Icahn are, I believe some of the most important information regarding the current true state of the company and what lies ahead comes from comparing and understanding the FTC’s investigation surrounding the settlement with Herbalife’s response and analysis to the settlement. Now from my knowledge settlements usually mean both sides have come to an agreement on common ground. But when we compare the remarks from the FTC and Herbalife, we get a very interesting story. In fact the analysis done by the FTC regarding the company is nearly the exact opposite conclusion that Herbalife claims it to be. Before we start jumping to conclusions let's let the facts and settlement do the talking. 

            Let's look at the concluding remarks from the FTC regarding the settlement:

“145. In sum, Defendants’ compensation structure incentivizes Distributors to purchase thousands of dollars of product to receive recruiting-based rewards and to recruit new participants who will do the same.
146. This results in the over-recruitment of participants and the over- supply of Defendants’ products and exacerbates participants’ difficulty in selling Herbalife products for a profit.
147. Participants in a business opportunity should have some reasonable prospect of earning profits from reselling products to customers. However, most Herbalife participants earn little or no profit, or even lose money, from retailing Herbalife products.
148. In the absence of a viable retail-based business opportunity, recruiting, rather than retail sales, is the natural focus of successful participants in Defendants’ business opportunity.
149. Thus, participants’ wholesale purchases from Herbalife are primarily a payment to participate in a business opportunity that rewards recruiting at the expense of retail sales.”(1)

Basically what these conclusions are saying is that Herbalife falsely promotes a well to do retail based opportunity and in actuality the majority of successful distributors within Herbalife primarily earned their income from recruiting and not from actual sales of the product. And  “Most Herbalife participants earn little or no profit, or even lose money, from retailing Herbalife products”! 

Here is another point provided by the FTC that I found particularly interesting:

“24. Defendants use videos to promote their business, making them available to Distributors through Herbalife’s websites, including myherbalife.com and video.herbalife.com. Defendants have at times also included videos in the starter packs that all new Distributors must purchase. Many of the videos are disseminated in both English and Spanish.
25. Defendants’ videos include representations that Distributors are likely to earn substantial income through Defendants’ business opportunity; images of expensive houses, luxury automobiles, and exotic vacations; and income testimonials.”(1)

Now I want you to read the FTC definition of a pyramid scheme:

“Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure. There are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales”.(2)

So what have we learned so far? The FTC considers a pyramid scheme as a business who's focus is  primarily based on recruiting, has a lack of retail sales for an actual product and a promise of large profits to consumers. All three things the FTC claimed Herbalife committed… Now for the best part.

FTC statement regarding Herbalife's business:

                "With this settlement, Herbalife has agreed to restructure its business, transforming it from an organization that pays its distributors based on their own wholesale purchases and those of their downlines, to one where compensation is calculated based upon verifiable retail sales.”

Why is that statement important? Here are the remarks from Herbalife’s press release regarding the settlement:

“While the Company believes that many of the allegations made by the FTC are factually incorrect, the Company believes settlement is in its best interest because the financial cost and distraction of protracted litigation would have been significant, and after more than two years of cooperating with the FTC’s investigation, the Company simply wanted to move forward”(4)

And this: 

"The FTC settlement is an acknowledgment that our business model is sound and underscores our confidence in our ability to move forward successfully, otherwise we would not have agreed to these terms."(4)

                            - Michael O. Johnson, 
                              Chairman & CEO, Herbalife


I mean talk about a complete contradiction…. Here we have the FTC concluding Herbalife had been at fault for numerous acts that clearly resemble those of a pyramid scheme and imposed new regulations and restrictions that will “restructure its business”. Meanwhile we have Herbalife basically saying the FTC is wrong, we disagree with them and the CEO claiming their “business model is sound"... How in the world is the business model sound when the FTC just imposed numerous restructuring regulations on the company and concluded Herbalife caused financial harm to countless consumers for misleading promotional and advertising activities, misleading income representations and numerous other misleadings and wrongdoings... 

One may ask well the FTC never called it a "pyramid scheme" so it can't be one.. I believe the FTC gave Herbalife a choice, agree to our terms and a large large fine ($200 million) and we won't publicly call you a "pyramid scheme" and give you a chance to restructure... I could be wrong but I don't see any other viable reason.

So I find the question becomes, who is lying, and who is telling the truth?.. Both can't be right. Either it's a pyramid scheme and with these new restrictions we will see Herbalife’s business drastically affected, or the FTC is completely wrong in their investigation and conclusion about Herbalife and these new regulations will not affect the company. 


One last final thought, there is quite the video circulating that I think is also something to consider when comparing remarks from each side and that involves the press conference of the FTC Chairwoman and a video released by Herbalife CEO Michael Johnson in response to the settlement…

Someone is lying..

-Anthony Bonsignore 





      (1)  Complaint for Permanent Injunction and Other Equitable Relief 
(3)  Statement of the Federal Trade Commission FTC v. Herbalife International of America, Inc.
(4)  Herbalife FTC Settlement Press Release 

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