In other news yesterday, reports in the Wall Street Journal and elsewhere indicated that the Securities and Exchange Commission had launched an investigation into Herbalife’s business practices.
Company officials laid out in exhaustive detail why they believe the assertions in Ackman’s report were either inaccurate or simply false. Ackman was not referred to by name in the presentation; rather, “Pershing Square,” the name of Ackman’s hedge fund, was used. Ackman has announced that his fund has taken a $1 billion negative position on Herbalife stock, leading to allegations by Herbalife officials that he is attempting to manipulate the stock price.
Herbalife is the world's third-biggest network marketing company, with 2011 net sales of $3.5 billion, according to Direct Selling News. It is the biggest such company devoted solely to nutrition (Avon and Amway are the two leaders).
Ackman’s argument revolves around a critique of Herbalife’s network selling model. Ackman asserted that Herbalife shows strong sales numbers primarily by inducing distributors to sign up still more distributors who buy products in the hopes of selling it on to others in an attempt to build their own sales organizations. Ackman also claimed that the company’s products are overpriced, and can only be sold at their existing price points by including the promise of potential network sales commissions.
Ackman further asserted that distributors drop out at high rates, and that Herbalife has a persistent need to find markets in new countries and new segments of existing markets that contain a pool of potential new distributors who have not already become jaded on the company’s business model.
The presentation included statements by Michael Johnson, Herbalife’s chairman and chief executive officer, Rich Goudis, chief operating officer, John DeSimone, chief financial officer, Vasilos Frankos, chief scientific officer and Des Walsh, president. The session also included presentations by a business information analyst and a business school professor.
Walsh: Ackman got it wrong
Walsh took the lead in debunking what he called misstatements about Herbalife’s operations. Indeed, his favorite phrase was, “the reality is.” Walsh said that distributors do not drop out at the rates asserted by Ackman, and of those who do drop out, 61% retain a positive image of the company. Walsh also said that many of the people the company calls "distributors" are in fact end users, and sign up for the role to get discounted product to use themselves.
While it is true that Herbalife is expanding into new markets worldwide, Walsh said that the majority of the company’s sales come from mature markets. If Ackman’s claims were true, he said, the opposite would the be case. Herbalife would have "burned through" these mature markets years ago, yet sales are still strong in the US, the oldest market of them all where the company started 32 years go, Walsh said.
Further, he said that Herbalife’s investment in R&D, the lack of which was cited by Ackman, is in line with other major nutiriton companies.
CFO John DeSimone argued that Herbalife is fully compliant with SEC-approved accounting practices. He also presented a comparison of Herbalife’s price points with those of other major nutrition brands, a comparison he said proves Herbalife’s prices are not out of line.
Possible legal action?
In many cases, Herbalife officials said Ackman’s report contained errors of fact. When asked at the end of the presentation whether the company was considering legal action against Pershing Square, Johnson said, “I can only say, on the advice of counsel, that we are going to look at every means available to protect this company’s reputation.”
Herbalife has been on a roller coaster ride recently; the company’s market troubles started with pointed questions by stock analyst David Einhorn in the company’s first-quarter earnings call in 2012 about how it compensates distributors. The company’s stock price tumbled from a 52-week high of $73 to a low of $24.24 in mid December following the Pershing Square report. On Wednesday, Daniel Loeb's Third Point LLC reported taking an 8.2% passive stake in the company, sparking a renaissance of sorts in the stock price, which closed Thursday at $39.24.