The sharp decline in Herbalife’s stock price (NYSE:HLF) to multi-year lows and Pershing Square’s Bill Ackman gasconading his “psychological short” bet against the shares triggered mixed reactions from our readers.
Let’s touch on some history quickly before delving into the present. In 2016, Herbalife was ordered to pay $200 million as refunds to many of its distributors and drastically restructure its U.S. business operations, to settle FTC’s charges of “unfair and deceptive practices” against it. The FTC said that Herbalife promised a dream of financial freedom to its distributors/members, but the dream was an illusion as the vast majority of Herbalife distributors found they could make little or no money selling Herbalife products. The FTC also said it hoped the principles embodied in the settlement will set an example for for the multilevel marketing (“MLM”) industry more generally.
An MLM is a direct-selling business that uses people to sell their products/services to other people. Typically, people joining MLMs are told that they can make money in two ways. 1. by selling the MLM’s products/services and taking a cut of the sales. 2. by recruiting new distributors and earning bonuses/commissions when these new recruits buy or sell.
So, how do you differentiate an MLM from a pyramid company?
The FTC clearly defines that if the business pays the distribuotrs/members commissions based on sales to retail customers without requiring recruitment of new distributors, it is not a pyramid scheme. The other differentiation is that the MLMs should sell at least 70% of their goods to non-distributors or consumers outside the company, although tracking this diligently could be pretty tedious. On the other hand, pyramid schemes, rely on continuous recruitment of paying members, and selling a majority of products/services to the distributors.
Back then, activist investor Carl Icahn, commented on the Herbalife-FTC settlement in 2016, “The FTC settlement announced today, coming after a two-year investigation also concluded that Herbalife is not a pyramid scheme.” – This was refuted by the FTC chairwoman Edith Ramirez (at the time), who said “they were not determined not to have been a pyramid. That would be inaccurate.” She also said, “I do not endorse that statement. No.” – Later, Icahn exited his Herbalife position fully in May 2021, but made ~$1.3 billion from his long bet on HLF.
It should be noted that Ackman, who exited his short position in HLF in 2018, lost nearly $1 billion. In his comments on X.com, he gave vent to his longtime skepticism of Herbalife’s MLM structure, calling it one of the biggest pyramid schemes. He also expressed disappointment with the FTC for allowing it to operate after a $200 million settlement in 2016.
However, the stock’s sharp ~62% dive in the past twelve months is largely attributed to its weak financial results. Although revenues have grown from ~$4.4 billion in 2017 to ~$5.1 billion in 2023, expenses have increased in tandem, resulting in a sharp fall in operating income from ~$617 million to ~$356 million. The company is executing a transformation program to optimize cost efficacies. The program delivered ~$70 million of cost benefits in 2023 and is expected to produce at least $115 million of benefits in 2024. Besides, the guidance for flat revenues in 2024 vs. consensus for a ~1% growth, did not help matters much either.
Herbalife sees promise in its U.S. nutrition clubs that generated ~$900 million in retail business for 2023 (based on ~4.4 million unique customers, ~55 million transactions and average transaction amount of ~$16.50. The preferred customer conversion rates being as low as 1% in some clubs, Herbalife sees plenty of opportunity here vs. the ~10%+ conversion in its other multi-service clubs.
SA Quant system has a “Sell” rating on the stock, citing decelerating momentum and negative EPS revisions vs. other Consumer Staples stocks. SA analysts are neutral, while Wall Street appears more optimistic with a Buy rating.
Other publicly traded MLMs, include Tupperware Brands (TUP), and Nu Skin Enterprises(NUS). Both stocks are down 60%+ in the past year, not very different from HLF’s decline.