If you’re looking for a comeback stock to invest in, look no further than Herbalife Ltd. (NYSE:HLF). The company has endured criticism from one of the market’s most revered hedge fund managers. Perhaps any other company would have faltered, taking years to recover, if it could at all. However, there’s just something about Herbalife and its resiliency that is allowing it to do some chest pounding in the wake of accusations that could have brought it to its knees.
Wrong On This One
If you’ve followed the developments with Herbalife Ltd. (NYSE:HLF), you know that the hedge fund manager I am referring to is Bill Ackman. The founder of Pershing Square Capital Management announced in December that he was shorting Herbalife to the tune of $1 billion after deeming its business model to be a pyramid scheme.
Well, in a classic case of the chickens coming home to roost, Ackman’s trade is now working against him. Not only have government regulators not stepped in to back up his pyramid scheme claim about Herbalife Ltd. (NYSE:HLF), but investors are buying the company’s stock like crazy. The Securities and Exchange Commission’s enforcement division has opened an inquiry into Herbalife, according to The Wall Street Journal. However, nothing has come of it to date.
After Ackman’s pronouncement in December, the stock sold off sharply, closing one day at $26.06. However, now Herbalife is trading at the levels it enjoyed before Ackman’s pronouncement. In fact, it is closing in on its 52-week high of $56.39.
Catalysts for Herbalife
The most recent news that helped to propel the stock’s upward movement came on Tuesday when Herbalife Ltd. (NYSE:HLF) announced that it had hired PricewaterhouseCoopers (PwC) to audit its books. A scandal involving its previous auditor, KPMG, came earlier this year, forcing the accounting firm to quit.
Specifically, PwC will be reviewing Herbalife’s consolidated financial statements for the fiscal years ended Dec. 31, 2010, 2011, and 2012. It will also review the company’s condensed consolidated financial statements for the first quarter of 2013.
Quickly hiring a new auditor that will immediately begin re-auditing the company’s financial statement’s bodes well for Herbalife. On Tuesday, the day of the new auditor announcement, the volume of shares traded for Herbalife was exceptionally high. Its average daily volume is 2.8 million, but on Tuesday, it was 10.8 million.
Mother of All Short Squeezes
All of this has set the stage for Ackman to incur huge losses. He confidently boasted that he had shorted more than 20 million shares of Herbalife in December. Then entered Carl Icahn, who questioned what in the world Ackman was thinking. Never one to mince words, Icahn called Ackman’s position as helping the stock become “the mother of all short squeezes.” Icahn also backed up his confidence in the company with a trade. He
Also noteworthy is a finding by Bloomberg that Herbalife is the 11th most-shorted company in the Russell 1000 Index. Its average short interest is 3.1%.
Direct Selling as a Business Model
Ackman has not taken issue with Avon Products, Inc. (NYSE:AVP) and Nu Skin Enterprises, Inc. (NYSE:NUS), despite their business models also being based on direct selling. Key to the direct sales business is a company’s ability to attract sellers willing to work on commission. Avon and Nu Skin, like Herbalife, do not suffer from having a shortage of people eager to sell their products, and that has translated to increases in their sales.
Nu Skin is in the process of training and preparing its sales force for the launch of a weight management system that company officials think will be the largest product launch in its history. The company is very optimistic about the significant sales this product could generate and it considers it to be a game changer. So confident are execs that the 2013 guidance was significantly raised. The company projects second-quarter 2013 revenue will be in the $570 million to $580 million range.
Avon is the largest direct selling company in the world. In its case, its direct selling business model had run into problems over the past few quarters. However, as pointed out by a fellow Motley Fool blogger, the model has still proven advantageous to Avon. Those advantages include allowing the company to penetrate markets and reach remote communities without large capital investment, securing upside potential. As far as its sales reps are concerned, Avon is trying to motivate them by establishing stronger links between the hours they work and the compensation they receive.
It has taken steps to motivate customer representatives by establishing a stronger link between hours worked and compensation, while working to improve the customer experience through social media sites and mobile apps. It also eased concerns over its weak financial position with several refinancing activities, repaying $1.9 billion of debt and negotiating for more flexible covenants in the process.
When I reviewed Herbalife Ltd. (NYSE:HLF)’s total return to investors as researched by YCharts, and found that compared to its peers, its metrics were the worst. Herbalife is up 15.75% over the last year versus the S&P 500, whose return was up 31.95%. The total returns for its rivals Avon and Nu Skin, were up, too. Total returns for them to investors were 44.75% and 53.63%, respectively. Still, this does not seem to have stymied the stock’s performance.
Options Activity
To get a better idea of how optimistic investors and traders are about Herbalife, look no further than the options market. Interest is considerably high for the call contracts with strike prices of $52.50, $55, and $60 that expire in June. At the time of writing, the volume of contracts traded for these was about 8,100.
As noted by Born to Sell, call options are tradable securities that give the buyer of the call option the right to buy stock at the strike price before the expiration date. Likewise, the seller of a call option is obligated to sell stock at a certain price by a certain date if the buyer chooses to exercise his right.
Conclusion
Ackman’s allegation that Herbalife Ltd. (NYSE:HLF), the maker and seller of nutritional and weight-loss products, is a pyramid scheme is not new. The company has been trying to fend off such allegations for most of its existence. The reason for the allegation stems from its business model, which is based on the success of a global network of distributors.
As the dust continues to settle over Ackman’s trade, I see Herbalife Ltd. (NYSE:HLF)’s stock continuing to rise. So, as I said at the beginning of this post, buy this put upon stock now.
The article Does Ackman Want This Trade Back? originally appeared on Fool.com and is written by Tedra DeSue.
Tedra is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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