Herbalife, A Countdown Until May

People enjoy facts, so I will try to limit opinion. In this article I will state facts about Herbalife (NYSE:HLF) and point to why the stock will likely decline. I have read several of the articles here on Herbalife, and I believe there is a lot of misinformation floating around about recent occurrences with the company.

As most of us know, the FTC recently reached an agreement with Herbalife and it was spun many ways, both as a positive and a negative. More recently,Herbalife held an earnings call and beat 2nd quarter earnings and raised full year 2016 guidance. I can hear the bulls screaming “Yes.”

The problem with this is that the FTC settlement was essentially broken into two parts. The first part, laid out in sections II-XII in the FTC settlement, was effective immediately. It mostly deals with banning misleading recruiting claims and installing a compliance officer.

The second part, laid out in section I of the FTC settlement, includes the requirement that 80 percent of end sales must end up in a consumers hands in order for the distributor(s) to be compensated. This part is not effective for 10 months(see page 29 of the FTC settlement linked above.) Being that the settlement is dated 7/15/16, Herbalife has until 5/15/17 to come into compliance.

On Herbalife’s 2nd quarter Earnings Call, they repeatedly tried to claim that the FTC settlement was going to be beneficial to Herbalife’s business practice, and that some of the changes would be implemented before the settlement requires. Among the changes they will make ahead of schedule are the classification of consumers as either distributors or preferred customers and the implementation of an app for distributors to input receipts so that distributors can practice and familiarize themselves with the system when the rules come into effect in May. However, what they are not implementing early is the rule that 80% of product must end up in a customer’s hand for the distributors to be compensated, claiming “the compensation programming is what takes the most time,” even though they did not mention any changes to the compensation tiers.

Thus, the upwards revision to full year 2016 guidance does not allow for inference into how the 80% rule will effect Herbalife’s business, even though they tried to spin it otherwise in their 2nd Quarter conference call.

Next, I will address one of the most prudent of the bull arguments for the future of Herbalife, which is that the FTC settlement only effects North America, which only accounts for 22% of Herbalife’s net sales. While this may be true, it will have a greater effect on Herbalife’s overall earnings, as pointed out on pages 43-44 of Pershing Square Capital’s Presentation.

This bull case assumes that no further action will be taken against Herbalife in other countries. This is very naive. Pershing Square Capital is the only reason why the FTC investigated Herbalife in the first place. Pershing Square Capital claims:

The FTC complaint and settlement provide a roadmap for regulators in 90 other countries around the world to enforce similar requirements. We intend to work with these regulators to ensure that no future victims are harmed whether in the U.S. or otherwise.

If another country opens an investigation into Herbalife, it would be a huge negative catalyst for the stock.

To be a good detective, you always have to follow the money. Only one insider transaction has taken place since the “record setting quarter” earnings call. The SVP/ Managing director of North America, a very relevant executive to this story, exercised all the options she owned on 10,000 shares and then liquidated not just those 10,000 shares but the additional 4,143 shares she owned, bringing her total vested interest to zero. Interestingly, she did this over 3 transactions in 5 days. When you’re selling stock to buy a house, you know how much money you need and sell accordingly. This executive was liquidating her entire position.

Herbalife can try to spin this as a positive as much as they want. Eventually the numbers will speak. I wouldn’t want to be long Herbalife come May 2017.

Article source: SeekingAlpha.com