Herbalife: Ackman Is Down To His Last Round Of Ammunition

Recently, Matt Stewart wrote a Seeking Alpha article titled "Ackman Still on Side of the 'Angels' Despite Mark to Market Loss."

Mr. Stewart could very well be correct. But, Pershing Square does not have a single investor who cares whether or not Ackman is "on the side of the angels". They are all Rod Tidwell (Cuba Gooding) screaming "Show me the money!" at Jerry Maguire (Tom Cruise). That's all the clients care about. They have no interest in their investment managers becoming social activists with their money.

Having tried almost everything and failed, Ackman is down to his last round of ammunition.

But first, here is a partial list of Ackman's attempts to attack Herbalife (HLF) and drive the stock down. So far, none have been successful:

1. Presenting a 342 slide presentation and making it public, trying to scare off Herbalife customers and sales people, enlisting other shorts and attracting regulators. Instead, there is no indication of any damage to the enthusiasm of its distributors or the size of its distribution network, sales/customers seem to be doing just fine; instead of more shorts, he attracted high-powered investors on the other side of the trade, who sensed a great short-squeeze opportunity, and, beyond an initial recognition of the allegations, there is no indication of any follow up by any regulatory agency.

2. An ongoing high-profile campaign trying to do more of the same, including his recent presentation at the Robin Hood conference. So far, there are no high-profile investors on Ackman's side of the trade.

3. Supporting Hispanic activists to attract regulatory or government action by painting Herbalife as a racist company that victimizes poor Hispanics.

Ackman

• Apparently, Ackman got the Congressional Hispanic Caucus to write a letter to the FTC, but to date there has been no follow-up activity. In fact, if you go to the Congressional Hispanic Conference website and do a search for "Herbalife", you get no results. It doesn't seem to be a serious matter to the Caucus.


• So far, Ackman has several geographically disparate small groups of local activists making speeches but otherwise achieving very little. For the most part, the groups are having press conferences during which they make totally unsupported allegations, then call for an investigation. One example is from Illinois.

Herbalife

• On the other side, in September, 2013, Herbalife was honored by The Hispanic Heritage Foundation as part of their 26th Annual Hispanic Heritage Awards. The event was held at the Kennedy Center in Washington.


• This quote (part of the article linked above) from Antonio Tijerino, President and CEO of the Hispanic Heritage Foundation, is notable: "We are proud to partner with Herbalife in carrying on the rich tradition of the Hispanic Heritage Awards," commented Antonio Tijerino, President and CEO of the Hispanic Heritage Foundation. "Herbalife is an exceptional match with the mission of the Hispanic Heritage Foundation as we celebrate the significant contributions made by Hispanic leaders throughout the country. We are especially thrilled to have Herbalife host the Inspira Award, which recognizes the entrepreneurial spirit and vision of Hispanic leaders that have impacted history in America and the world. Not only does Herbalife support the Hispanic community, Herbalife also inspires the entrepreneurial spirit of thousands of individual members of the Hispanic population across America."

4. Threatening PricewaterhouseCoopers with a 52 page letter warning them about all the things that might happen to them if they didn't brand Herbalife a pyramid scheme. This is a link to the entire letter. The audit was completed recently and, as appropriate, PwC paid absolutely no attention to Ackman. Ackman's response was that PwC had no responsibility to brand Herbalife a pyramid scheme and their audit wasn't important to his short case. In other words: Ackman's effort at intimidation was a total failure.

5. Trying to drive the stock down by using his (rapidly tarnishing) reputation to make outlandish and sensational public commentary (stock going to zero, end of the earth, etc).

6. Accusing hedge funds and individuals on the other side of the trade with illegal activities, disclosure, stock trading, etc. One example: Ackman goes after Soros. There is no indication that any regulatory agency responded to those allegations in any way.

7. Making ridiculous claims, such as HLF products are overpriced as a reason the FTC should investigate. Tongue in cheek: The FTC responded by saying they would get to Herbalife products as soon as they finished investigating Starbucks (SBUX) for selling the most expensive cup of coffee in the country and multiple branded pharmaceutical companies for selling overpriced products compared to generic equivalents.

8. Succeeding in getting the SEC, FTC or any other government agency to investigate. In response to Ackman's demands, all the agencies responded -- as they had to -- with the equivalent of, "We'll look into it," but there has been no follow-up by any of them.

9. Using the Belgian court decision that branded Herbalife a pyramid scheme as proof-positive for his investment thesis. Then after the Appellate Court reversed the decision, he said it didn't matter as U.S. law is different. By the way, if you read the decision carefully you'll see that it is, depending on your perspective, a complete and total rejection of the Plaintiff's claims or a total vindication of Herbalife. Also, the Appellate Judge wrote a comprehensive discussion about product sales to end users vs. distributors for their own consumption. One of Ackman's major accusations against Herbalife is related to that issue. I urge you to read the decision, as it fully supports Herbalife.

The shorts are just about out of ammunition. But they have one last shot.

They need to get a Senator or Congressman to help them. To that end, Ackman has hired two high-powered Washington, DC lobbying firms and spent $138,000 through November, 2013. He and his lobbyists are working hard to "encourage" Washington politicians to pressure the SEC and/or the FTC to investigate Herbalife.

My perspective: Ackman and Pershing Square have little chance to win their battle against Herbalife in Washington. Here's why:

Herbalife has home field advantage in Washington.

When Pershing and Ackman first attacked Herbalife, the company was caught totally off guard. Ackman is a very successful and focused hedge fund manager, operating with the help of sophisticated Wall Street trading, publicizing and promoting techniques. The Sohn Conference last December was the launching pad for the Wall Street equivalent of the U.S. military's "Shock and Awe" attack on Iraq in 2003. Herbalife tried to fight back but the reality was that Michael Johnson, as smart, tough and competitive as he is, was no match for Ackman on the latter's home field. Herbalife survived the Ackman attack -- not because the company won the Wall Street war but because Ackman lost it. Ackman lost the Wall Street war on his home field because everything he tried to do -- as above -- was wrong or a failure.

Washington is Herbalife's home court and Pershing/Ackman are novices there. Here is a repeat link to the OpenSecrets.org link that reports it all. Until 2013, Pershing had never spent anything on lobbying in Washington. They spent $138,000 year-to-date. Herbalife, and their trade associations -- like almost every large company and trade association in every industry -- has been working the Washington scene for decades. Against Ackman's initial foray with 2 lobbying firms and $138,000, Herbalife is using 5 lobbying firms and has spent $1,340,000 year to date, almost 10X as much as Pershing Square. And, Herbalife has its own internal lobbying staff. And their trade association spends even more. Pershing is competing as a AA League rookie in the minor leagues against highly experienced Hall of Fame players in the Big Leagues. And, before the Bears try to use Herbalife's lobbying as an indication the company is trying to hide something, what Herbalife does is pretty much Standard Operating Procedure for every large company and every large industry in the country. I have heard, second hand, that there were 14,000 registered lobbyists in Washington as of 2009. Herbalife isn't doing anything special compared to other companies.

Of course, whether or not Herbalife is a pyramid scheme is, at best, a technical question and subject to legal nuance and interpretation. And the Herbalife business model has survived government investigations in the past. If Herbalife neatly fit into a clear definition of "pyramid scheme", Pershing Square might have a chance, even if they were outspent. But the pyramid scheme question is answered in shades of gray, and in that area, Pershing's lobbying has almost no chance to succeed.

Regulatory Agencies 101

Ackman acts and talks as if his Herbalife analysis and allegations are shocking and never-before understood by regulatory agencies. He speaks as if the FTC should sit at his feet and appreciate the education he will freely give them about how to define an illegal pyramid scheme (Herbalife) and distinguish it from a legitimate multi-level marketing business. He makes wild public comments trying to convince the SEC that he recognizes securities fraud better than they do. He's the new kid on the block for all of that, and he is trying to tell all the experienced hands that he knows more than they know. It all sounds pretty arrogant to me.

In my experience, regulatory agencies do not take kindly to public efforts to coerce them into doing anything. They don't take kindly to outsiders with almost no experience or background telling them they don't understand the laws regarding industries they are charged with regulating. And they especially don't take kindly to those efforts when the protagonist has a massive self-interest in getting them to do his bidding.

You can be certain that the FTC and Herbalife and their multi-level marketing trade organization are in touch and collaborating on a routine basis, and have been doing that for years. It is almost routine that any large company and industry will be in continual communications with their regulators, if for nothing else than to make sure that everyone understands and is playing by the ever changing rules. There is absolutely no reason the FTC should listen to Ackman's supposedly shocking new revelations about Herbalife; from the FTC perspective, they've been there and done that long before Ackman showed up on the scene and will be there and doing that long after he leaves.

As a result, I don't think the regulators are going to do anything about Herbalife unless pushed into it by powerful Congressmen. And, as detailed below, I think that's highly unlikely, too.

Politics 101

Herbalife has reported they have more than 500,000 distributors. Add to that Herbalife's customers and employees of their suppliers. On average, that is around 1,000 - 1,500 people friendly to Herbalife in every Congressional District in the country. Most of them do -- or can -- vote, and all have long email lists. Put plainly and simply: I can't picture a single Representative or Senator willing to antagonize any of his constituents by supporting a billionaire hedge-fund manager who is clearly "out to get" the company -- and in the process kill the constituents' jobs. The company simply has far too many friends at the grass roots level. There is no winning scenario for a politician to risk antagonizing thousands of constituents by supporting Ackman. Every politician has too much to lose and very little to gain.

In fact, about the only potential political gain is to create a new source of campaign contributions. Consider Chuck Schumer, Democratic Senator from New York. He gets most of his campaign money from Wall Street and related law firms. And, although a Democrat, he has been one of the Senate's main champions of Wall Street interests. But supporting a single hedge fund manager whose interests are directly in opposition to tens of thousands of Schumer's grass-roots constituents is different from supporting an esoteric tax break no one at the grass roots understands or cares about. Even Schumer will not be on Ackman's side against Herbalife.

Add to that the fact that there must be public disclosure of all campaign contributions and lobbying efforts, and no one in Congress or the Administration will support Ackman.

Ackman's Regulatory Risk - The SEC

While Ackman has been busy trying to convince the SEC that Herbalife and everyone on the other side of his trade is somehow or other breaking SEC rules, he may himself be at risk of violating SEC rules. Have you ever heard of a "Pump and Dump"? It's when a brokerage firm or other entity works hard promoting a stock it already owns, and as soon as it drives the price up it sells its own position without announcing it. Ackman has been pounding on Herbalife for a long time. If he were successful, and then all of a sudden covered his short, he would be doing the equivalent of a "Pump and Dump" from the short side. I believe he put himself at potential regulatory risk when he said, a week or two ago, "This is not a trade for me. We're going to take this, as I say, to the end of the earth." He has all but promised the public he will never cover his short. It seems to me that if he covers without pre-announcement, he will have done the equivalent of a "Reverse Pump and Dump". You should understand that this is a speculation on my part. Although I have some experience with SEC regulations, I am not an attorney.

Investment Conclusion

Pershing Square and Ackman are out of ammunition. They have all but lost the war, and each day the stock goes up makes them get more bloody.

And, of course, if Herbalife is successful at any effort to shrink its shares outstanding, that will be the nail in Pershing Square's coffin.

Final Thoughts

Ackman made the initial Sohn Conference presentation on Wednesday, December 19, 2012. Prior to the conference, Herbalife stock had been trading in the $43-$45 range. Three trading days after Ackman's presentation, on Christmas Eve, December 24, 2012, the stock hit an inter-day low of $24.24. Since that intra-day low, the stock has gone straight up, closing at $78.75 exactly one year later, Christmas Eve, December 24, 2013. That's a one year gain of about $54/share, or +213%. Considering larger company stocks, Herbalife's one year gain is highly unusual, to say the least.

I spent my professional life in the investment management business. This may be the worst short I've ever seen from a high-profile otherwise successful hedge fund manager. None I know or ever worked with would have stuck with the Herbalife short for so long, regardless of how certain he was that he was right. Eventually, everyone knows you can't fight the tape. You cover, keep your eyes open, and come back to short another day if it seems appropriate at the time.

Ackman has suffered the worst fate possible for a professional money manager: he has become a laughing-stock in the industry and among his peers.

And he seems to have lost professional perspective on his investment:

• His "end of the earth" comment has given him no flexibility at all as events continue to unfold. He has taken a binary all-right or all-wrong approach to Herbalife, when any professional money manager understands the need for flexibility as events unfold.


• His derision of those on the opposite side of the trade is incomprehensible. From the NY Times Dealbook column immediately after the Robin Hood Conference: "He also lashed out at investors who held long positions in the company, describing them as being 80-year-old billionaires. Some of the company's biggest shareholders include Carl C. Icahn (who is 77), Mr. Stiritz (79) and George Soros (83)." I respect the investment acumen of anyone who's made a billion dollars, and I can't understand why age would have anything to do with their ability to disagree with Ackman's investment judgment.

Outstanding investors are hard-headed and analytical. They never marry a stock or investment idea. They recognize they are in a batting average business and cut their losses quickly. They never let their personalities get in the way of their judgment. Instead, Ackman has managed his Herbalife short using emotion, hubris and arrogance. That is a formula for failure.

Source: Herbalife: Ackman Is Down To His Last Round Of Ammunition

Disclosure: I am long HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: I may add to my long position at any time. I have no plans to sell in the next 72 hours.

This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.