Brushing off the criticism that has plagued his position for the last eight months, Ackman provides a detailed argument as to why Herbalife Ltd. (NYSE:HLF) shares are set to collapse.
"The probability of...regulatory intervention has increased materially"
As I've said before, if Herbalife shares are going to $0 (Ackman's price target) it will be due to regulatory action. If the company is, as Ackman claims, running a pyramid scheme, the SEC or FTC could shut the firm down, seize its assets, and wipe out its shareholders.
In the letter, Ackman writes that he has reason to believe that the probability of forthcoming regulatory action is likely, but does not say why, writing that "we are not at liberty to disclose the nature of these developments." He does, however, put a timetable on the possibility of such action. Earlier in the year, the FTC shut down Fortune Hi-Tech Marketing, a multi-level marketer deemed a pyramid scheme by regulators.
Ackman notes that it took two years for the FTC to shut down the company, after a lengthy investigation process. Yet, he believes that any action taken against Herbalife Ltd. (NYSE:HLF) (should it take place) would occur far sooner given the heightened scrutiny surrounding the company.
Ackman first accused Herbalife of being a pyramid scheme last December, exactly eight months ago. In another year, it will be 19 months -- just short of two years. Therefore, if regulators are going to act more swiftly against Herbalife than they did against Fortune Hi-Tech, investors could expect a regulatory event within a year.
A confidence game
Ackman also argues that Herbalife Ltd. (NYSE:HLF) as a company is very dependent on the confidence of its distributors. As roughly 90% of new Herbalife distributors give up at the end of one year, the company has to recruit some 2 million new distributors every year to keep its business going.
Moreover, existing distributors have to continue buying thousands of dollars worth of product each year in order to qualify for referral bonuses. Therefore, confidence in the company's product and the firm's business opportunity are of the utmost importance.
Since Ackman's attacks, Herbalife Ltd. (NYSE:HLF) has adopted new policies that make life harder for its distributors. Some top distributors, like Shawn Dahl and Anthony Powell, have defected.
At the same time, there are questions surrounding the quality of Herbalife's products. A former Herbalife employee has come forward alleging that the company has, in the past, violated safety regulations in the manufacturing of its products.
The MLM industry in the crosshairs
If Ackman is ultimately proven right and Herbalife is shut down, it should reverberate through the entire multi-level marketing space. Most of the big MLM firms, like Amway, are private, but others, like USANA Health Sciences, Inc. (NYSE:USNA) and Nu Skin Enterprises, Inc. (NYSE:NUS), are publicly traded.
While Herbalife has had a good year (shares have nearly doubled in 2013), both USANA Health Sciences, Inc. (NYSE:USNA) and Nu Skin Enterprises, Inc. (NYSE:NUS) have outperformed it, each rising more than 130%.
As I've written in the past, criticism against the MLM business model is widespread, and yet most of the big name companies have persisted, untouched by the US government. But shutting down Herbalife Ltd. (NYSE:HLF), one of the biggest companies in the sector, would send a message that the regulatory environment has changed.