If you have no financial stake, the story of Herbalife (HLF) this year has been fun to follow in many ways. The fact that Bill Ackman of Pershing Square declared a massive short position in the stock was not, in and of itself, a huge surprise. Mr Ackman has established large short positions before and has been no shrinking violet when it comes to informing the public of them. What was unusual was that Ackman vowed to give any profit from the trade to charity.
His crusade against HLF was, he said, born of a belief that Herbalife was essentially running a pyramid scheme that effectively preyed upon the underprivileged. It could be that Ackman’s motives are pure, but I have a natural tendency to be a little cynical when a billionaire hedge fund manager tells me he is establishing and publicly declaring a position as some kind of civic duty.
His accusations could well have some degree of veracity. I have met several people involved with Herbalife. All of them were sellers rather than buyers of the supplements, and all of them tried to sell me on becoming a distributor rather than trying to sell me any product. Of course anecdotal evidence proves nothing, but this is enough to ensure that I personally wouldn’t invest in HLF, at least not for the long term.
As a short term trade, however, buying HLF has been very profitable for some this year. The stock is up over 187% from the lows at the end of last year.
The problem is that it is hard to escape the feeling that a lot of this upward pressure on the stock is, like the big drop a year ago as Pershing sold, not a product of the fundamentals and outlook for the company, but rather of a battle of Wall Street egos. Ackman has upset a lot of people. I have worked in dealing rooms and can tell you that when one of your own, who has benefitted from the cutthroat world of trading, starts to accuse everybody else of some lack of moral fiber, it can be a little galling.
I am sure that to many people, all that Ackman is pointing out is that HLF is a modern American company, where the majority of the money made goes to the upper echelons of management. You can debate all day whether this is justified or not, but it is nothing novel. Now, as evidenced last week, every time Mr. Ackman opens his mouth, the market punishes him. He repeated the accusations of a pyramid scheme then, and offered more evidence to support his case. The stock jumped around 6%.
My problem here is that it looks to me that both sides of this argument are selling something questionable.
To me, the biggest worry about Herbalife is that they have, to date, refused to release any evidence of the percentage of their product that is retailed rather than sold as inventory to new distributors. It seems that numbers are a little confused, as HLF claims that many people who sign on as distributors are actually “discount buyers”.
There is also evidence that MLM as a business model is faltering, even if there is a legitimate end market for their products. A glance at a chart published by long term vocal critic of MLM, William Keep at Seeking Alpha and reproduced here shows that the direct sales industry in general may be approaching a tipping point. Sales have gone down while the number of sales people has continued to climb, a set of circumstances that is unsustainable for too long.
It could be, then, that Ackman was in many ways right to short HLF, but the result reminds us all of an uncomfortable truth. When trading or investing, it is quite possible to be right and still get hosed. There is no doubt in my mind that Bill Gross was “right” when he claimed in 2011 that Treasuries were going to turn and end a 30 year bull market, it’s just that it didn’t happen in 2011. Apple (AAPL) still had a massive market share and phenomenal growth when its shares were trading at around $700… I could go on and on.
In addition to the possibility that this was the old “right trade, wrong time” problem, Ackman may have another, more significant issue. By going public with his huge short position, then portraying it as a selfless crusade, he made many people feel that their intelligence was being questioned. If this really was a moral crusade, then why sell the stock short at all? As I said, Mr. Ackman’s suspicions about HLF could be true and his concern genuine, but voicing them once a substantial position has been established and started to go wrong smelled too much like the time honored Wall Street tradition of talking one’s own book.
Once the position was established and publicized, the actual profit or loss on the trade became less important in the grand scheme of things than the effect it would have on the reputation of Bill Ackman, and therefore of Pershing Square. Donating any potential profit from a disastrous trade is not really that big of a deal; rescuing the reputation of the fund from the effects of that trade is.
Am I sounding too cynical, especially in this Holiday season? Maybe, but when trading becomes about more than simply profit or loss, I cannot run away fast enough. Whether it is stocks whose adherents display an almost religious faith, regardless of profitability or prospects, or an indication once a trade has gone wrong that making money wasn’t the motivation, I am afraid the cynic in me takes over.
If pushed, I would, because of doubts about HLF’s ability to continue growing, favor a short position in the stock, but until the battle of egos ends, my best advice would be to watch the HLF story unfold and enjoy the spectacle without any financial interest.