Over the past three decades, Herbalife Ltd. (NYSE:HLF) has been one of the fastest growing multilevel-marketing companies. However, it has recently been attacked by Bill Ackman, one of the most famous hedge fund activist investors. With a $0 target price for Herbalife, Ackman considered this to be the highest conviction that he had ever had about any of his investments. In contrast, Dan Loeb, another famous hedge fund manager, viewed Herbalife as an investment opportunity. He has purchased 8.9 million shares, which accounts for 8.2% of the company’s total shares outstanding.
A Bear Case
Bill Ackman presented his 324-slide thesis on Herbalife in the recent Ira Sohn conference. In his presentation, he tackled all aspects of the business practice and the company’s core products. Historically, Herbalife enjoyed tremendous revenue growth for more than 30 years. Sales have significantly increased from only $2 million in 1980 to $4.4 billion in 2011. That worked out to a remarkable 29% annualized growth. Ackman pointed out that the high growth was unusual in comparison with the growth of other big consumer and household businesses, including Energizer Holdings, Inc. (NYSE:ENR) and Church & Dwight Co., Inc. (NYSE:CHD). Both of these companies have their histories dated back to the 19th century. Energizer generated LTM revenue of $4.6 billion, while this number for Church & Dwight was $2.8 billion. However with only 30 years in business, Herbalife’s LTM revenue has reached nearly $3.9 billion. Moreover, while Energizer and Church & Dwight had their gross margins of only 46.8% and 43.9%, respectively, Herbalife had a questionably high gross margin of 80%.
In addition, Bill Ackman also questioned why many commodity products of Herbalife were sold at high prices even without any advertisements. It was because a business opportunity was bundled with the company’s products. He also stated that Herbalife had the highest payout in comparison with other multilevel-marketing companies, including Nu Skin Enterprises, Inc.(NYSE:NUS) and Medifast, Inc. (NYSE:MED). While Nu Skin and Medifast paid out 80% and 31% in commissions, respectively, to their top 1% distributors, Herbalife’s payout rate was 88%. Many investors might argue with Bill Ackman that if it were a Ponzi scheme, how it could have been expanding for the last 30 years? The reason, Ackman pointed out, was because Herbalife just kept entering new countries.
A Bull Case
Dan Loeb, on the other hand, has been bullish about Herbalife. His fund, Third Point, has taken advantage of the recent significant drop in Herbalife’s share price after Bill Ackman’s analysis. Dan Loeb described Herbalife as a “classic compounder.” He wrote in the fourth quarter letter to shareholders: “a well-managed company that sustains consistent top-line growth, has a leading market position, and steadily increases margins, earnings per share and free cash flow while demonstrating shareholder-friendly behavior.” Dan Loeb pointed out that Herbalife had been growing its revenue at double-digit rate and expanding margins for the last 8 years. With the free cash flow generated, the management has de-levered the company’s balance sheet and reduced the number of shares outstanding by 25%.