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No, Bronte Capital Didn’t Debunk Ackman’s Herbalife Ltd. (HLF) Thesis

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Herbalife Ltd. (NYSE:HLF)Shares of multi-level marketing giant Herbalife Ltd. (NYSE:HLF) surged over 6% on Monday after Bronte Capital’s John Hempton claimed to have debunked Ackman’s thesis in a blog post.

Unfortunately, Hempton did nothing of the such. His argument against Ackman’s thesis is built on a faulty premise, and he fails to disprove the claim that Herbalife Ltd. (NYSE:HLF) is a pyramid scheme.

Hempton: why Herbalife is not a pyramid scheme

Hempton’s argument comes down to one simple claim: there aren’t enough Herbalife products being sold on Craigslist or eBay Inc (NASDAQ:EBAY).

According to Hempton, if one accepts Ackman’s claim — that Herbalife Ltd. (NYSE:HLF) is a pyramid scheme — then:

  1. Failed distributors should be sitting on thousands of tons of unsold Herbalife products
  2. These failed distributors should dump the unsold products on the secondary market
  3. Craigslist and eBay are good representations of the secondary market
  4. Picking any local Craigslist or eBay at random should reveals tons of failed Herbalife distributors selling the product at a steep discount

Hempton then proceeds to check France’s eBay and LA’s Craigslist, and concludes that there aren’t enough fire sales for his liking.

Problems with Hempton’s argument

Of course, there are numerous problems with Hempton’s test.

For starters, while I think Ackman would agree that failed Herbalife distributors are sitting on thousands of tons of unsold product, it’s too big of an assumption to claim that all the distributors would sell the unsold product on the secondary market.

Sure, that’s exactly what a smart investor like Hempton would do. But the typical Herbalife Ltd. (NYSE:HLF) distributor lacks Hempton’s business acumen (otherwise they wouldn’t be a Herbalife distributor in the first place).

It’s possible that the unused Herablife product is getting tossed in the trash, given away, or still sitting on the shelves of the failed distributors.

Moreover, it’s a big leap to assume that Craigslist and eBay are accurate representations of the Herbalife secondary market, or that any one of these sites chosen at random is a good sample.

In the US, Herbalife’s distributor base is disproportionately composed of Latinos (over 60% in 2007), and internationally, the reception to Herbalife has been quite varied. Belgium, France’s neighbor to the north, found Herbalife to be a pyramid scheme, and outlawed the company in late 2011.

Photos of Herbalife Ltd. (NYSE:HLF) nutrition clubs in the US show signs written in Spanish. Why then would one turn to english-based Craigslist?

Lastly, even if one accepts that every Craigslist and eBay is an accurate representation of the secondary market, Hempton makes no attempt to figure out what the right threshold is.

In other words, if Hempton’s test is valid, there should be some magical threshold, of which a number above said threshold indicates that the company in question is a pyramid scheme. For example, if Herbalife is a pyramid scheme, one would expect to find 10 Herbalife products for sale on LA’s Craigslist on a given day.

But Hempton provides no such number. (He finds five apparently failed Herbalife distributors in Chicago, but seems to dismiss that number as too small given the size of the city.) Ultimately, he concludes that there just isn’t enough online evidence to suit his liking.

The existence of any online discounts is a strike against Herbalife

Hempton does not dispute Ackman’s original notion — that Herbalife Ltd. (NYSE:HLF) products can be purchased online at a steep discount. In fact, he finds evidence to support it, pointing to a particular eBay seller who has a history of offering Herbalife products at a 35% discount.

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