New York - Herbalife executives defended their business on
Thursday as a "legitimate company" with customers outside the network
of people who sign up to sell its nutrition products, stepping up the defense
against pyramid scheme accusations by short seller Bill Ackman.
The hedge fund operator, who has placed a huge bet that
Herbalife stock will fall, has argued that the company is an unsustainable
scheme because distributors earn more than 10 times as much from recruitment as
they do by selling company products.
Ackman's Pershing Square, which has spent months researching
the company, has also promised to fire off more specifics. For his $11bn fund,
the $1bn short position is a key holding.
Herbalife has quickly transformed from a somewhat obscure
purveyor of weight-loss products into a battleground for the biggest names in
the hedge fund industry. Third Point's Dan Loeb has taken the other side of
Ackman's trade, calling his thesis "preposterous" and predicting a
sharp rise in the stock.
Loeb reached out to Herbalife through a third party and met
with Chief Executive Michael Johnson one time within the past few weeks,
Herbalife President Des Walsh said in an interview. He did not provide details
of the meeting.
The feud brings to a head rumblings that started in May,
when star hedge fund manager David Einhorn of Greenlight Capital asked questions about corporate disclosure on
a conference call, putting the shares under severe pressure. (Einhorn has
declined to say whether he took a position in the stock).
At a meeting with investors and analysts in New York,
Herbalife executives said 31% of its US orders in 2012 were shipped to
customers who were not Herbalife distributors, and an outside researcher hired
by the company said 92% of Herbalife's customer base was not part of the
company's distributor base.
Herbalife operates on a multilevel marketing structure, where
distributors not only make money for their own sales, but also for sales by
people they recruit to become distributors themselves. Chief Financial Officer
John DiSimone said on Thursday that all payments to distributors are based on
sales, not rewards for recruiting.
Also, in 32 years as a company, only one court, in Belgium,
has found that Herbalife is a pyramid scheme, and Herbalife planned to appeal
that ruling, Herbalife President Des Walsh said at the investor meeting.
Herbalife shares were down about 4% at $38.41 on Thursday on
the New York Stock Exchange after rising as high as $42.99 during the day.
Ackman, who oversees some $11bn in assets at Pershing Square
Capital Management, said December 19 he was betting against Herbalife. A day
later, he delivered a three-hour presentation, using more than 300 Powerpoint
slides to back his position.
During the presentation, Herbalife management disputed many
of Ackman's assertions and also repeated that they would have answered his questions
about the company if he had contacted them before his presentation.
Ninety-two percent of the growth at Herbalife comes from
markets the company entered more than 10 years ago, Walsh said, trying to
counter allegations that there is a "pop-and-drop" factor with sales
jumping when the company gets into a market and then falling off.
He also said that there are no minimum purchases required by
distributors, denouncing so-called "pay to play" allegations.
Walsh said that as far as the company is concerned, it has
dealt with the substance of Ackman's argument. The company, which has hired the
law firm of Boies, Schiller & Flexner in the matter, has not yet decided if
it will pursue legal action against Ackman.
"We are reviewing all our options," he said.
Yet just minutes after the company's presentation ended,
Ackman's hedge fund claimed Herbalife did not answer Pershing Square's points
as it said it would.
"The company distorted, mischaracterised, and outright
ignored large portions of our presentation," Ackman said in a statement.
One analyst who was at the presentation said that Herbalife
did not present much new information, but did respond well to Ackman's attack.
"I think they did a good job of helping people
understand what a pyramid scheme is and why it is not one," D.A. Davidson
analyst Timothy Ramey said. He has a "buy" rating on the stock.
Battle of the hedge fund stars
Having two hedge funds, even big and prominent ones like
Pershing Square and Third Point, on the opposite side of a trade is not
unusual. Greenlight's Einhorn once found himself on opposite sides of a trade
with investor Bruce Berkowitz when Einhorn called land developer St. Joe's
overvalued and began shorting it, while Berkowitz had a long position and tried
to shake up management to improve performance.
But what makes this showdown unique is the one-on-one
quality of the battle pitting two of the industry's biggest stars against one
The battle lines are being drawn, with each man commanding a
loyal following of investors and a brash self-confidence to take on some of the
financial world's most sacred cows.
"This will be a battle of firepower," said David
Tawil, who runs hedge fund Maglan Capital.
Amid all the interest on both sides, SunGard's Astec
Analytics said Thursday that the cost of borrowing Herbalife shares to sell short
rose two percentage points just in the last day, a substantial move.
Herbalife shares closed at $42.84 on December 18, the day
before Ackman disclosed that he had shorted the stock.
The shares fell as low as $26.06 in subsequent days, but
have recovered most of their losses as investors questioned whether the Federal
Trade Commission would take any action against Herbalife, as Ackman wanted.
Separately, the US Securities and Exchange Commission's
enforcement division has opened an investigation into Herbalife, a source
familiar with the matter said.
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