MORNING BID – Herbalife and the options market

Jul 28, 2014 15:59 UTC

One of the market’s more well known short bets, Herbalife, reports earnings after the close on Monday. The company is most notable as the target of activist investor Bill Ackman, who has had plenty of choice words for the company and yet has not been able to make good on his short position just yet, despite his fervent belief it is defrauding investors and taking advantage of poor people.

That’s a hefty set of accusations for anyone to deal with, but the stock’s 25 percent one-day surge last week just after Ackman’s presentation turned into a big loser for folks who were betting on big declines by the end of last week.

Ackman, from what we’re aware of, has big positions in put options expiring in January – so it’s a long view he’s taken, and if he took it at the right time, it’s not necessarily a loser just yet. (The options rose in value for the first few months of this year, so it’s possible Ackman got out in time – given his presentations, though, he’s clearly got a position somewhere.)

If that’s the case, he’s currently losing money, and today’s earnings report – and subsequent activity – will be another test of his staying power. Now, he’s said he’s prepared to go to the ends of the earth for this short position, but there are limits to everything, and it’s worth looking at just what the bet is like right now.

There are huge, huge amounts of outstanding contracts in various put options expiring in January – about 220,000 contracts across a swathe of nine different strike prices, to say nothing of a bunch of other less popular strikes.

Most of these big positions are currently not profitable, and are actually worth less than what they’ve been worth over the last several months.

If Ackman did his buying in chunks, a good spot to examine is in the $50 put option contracts expiring in January – a bet the stock will fall below $50 by that time. There was a hell of a lot of volume in these options in January 2014 – on January 9, volume in the $50 strike contracts came to 25,000 contracts and on January 10 volume of 20,759 contracts.

On those days, the stock was trading around $81 a share, so if Ackman is behind these purchases, it means he thought that was an opportune time to buy those puts, which cost $7.25 and $7.45 on average that day, according to Thomson Reuters data.

If he doesn’t hold those options anymore, he may have sold them at a profit, but currently those options are a loser, and as long as the stock keeps rising, they will continue to erode in value.

Doing the math, it shakes out like this – at 25,000 contracts at $7.25 each (x 100 because each contract is 100 shares of stock), those would have cost $18.125 million. The other group would cost $15.465 million, for a total cost of about $33.6 million.

Right now, those options would be worth about $18.9 million, so that’s a 40 percent loss, and that’s just for the $50 strike, never mind all of the other strikes. This of course may not be his position, but whomever took these positions, be it one person or several, is not in a happy place.

What matters is this: Since the first day the $50 strikes expiring in January 2015 started trading (back in Oct 2013), this strike has never been worth less than it is now.

If he’s holding the options now that he bought at just about any time between Oct ’13 and now, he’s losing money. Of course, given these are options, he’s easily able to keep rolling down and buying another money and selling these, but eventually, if the stock doesn’t do what he wants, he’ll be losing a ton of money. He’s got a lot of money, but how much pain can he endure? That’s a real question.

Short Herbalife

Jul 23, 2014 22:09 UTC

The Herbalife saga continues. Yesterday, Bill Ackman made what he claimed would be the most important presentation of his career: a three-and-a-half-hour slideshow detailing how the company’s nutrition clubs prove it is a pyramid scheme. If you put “three-and-a-half hours” and “power point” together and guessed that many felt Ackman’s event failed to live up to the hype, you would be correct. David Gaffen spent most of the time during the presentation tracking the steady rise in Herbalife’s share price. At one point yesterday it was up 25 percent over where it had opened.

Herbalife’s statement on the presentation seized on this: “Once again, Bill Ackman has over-promised and under-delivered on his $1 billion bet against our company.” John Hempton at Bronte Capital (long a supporter on the Herbalife side) didn’t find Ackman that convincing. He says he too has done a lot of research on the company and its nutrition companies. “This is not a pyramid. There are plenty of real sales to real people … Its a lousy business but it is a business in which people have integrated their lives and their families,” he writes.

But there were plenty of people who were impressed with the substance of what Ackman presented. After the presentation, says Dan McCrum, “two of the biggest criticisms of the short case have been answered head on.” According to McCrum, Ackman did a good job of questioning whether Herbalife’s nutrition clubs are a part of its legitimate business (not just used to squeeze more money out of its distributors), and showing that using Herbalife’s system in this way is widespread.

Investor Whitney Tilson (who, to be fair, is also short Herbalife), says he came out of the presentation more confident — 12 percent more confident, to be precise. “I thought it was an outstanding presentation for regulators, because it gave them a roadmap for their investigations,” he told Stephen Foley. After giving the presentation a day to settle,Herb Greenberg finds Ackman’s presentation not only convincing, but “the kind of good you expect from someone who spent $50 million to fund the digging.”

The takeaway here is that most people’s just had their priors affirmed yesterday with regard to Herbalife. But maybe that was the point? Will Alden and Matt Goldstein atDealbook suggest that what Ackman might be looking for here is a lawsuit, which “would give his firm access to records at Herbalife that he might not otherwise be able to unearth.” This seems like the most logical explanation of Ackman’s behavior this week, says Matt Levine. Regulators can continue to ignore him — it would be somewhat embarrassing for them if Ackman turns out to be right. But “if Ackman and Herbalife end up in court, the court will just have to declare a winner. And allow lots of discovery.” — Shane Ferro

On to today’s links:

Making bank punishments arbitrary might make it harder for them to optimize doing bad things - Cathy O’Neil
Previously: why “we must deliberately set financial forest fires” at random - Steve Waldman

The death of the iPad - BI

Correlation Of The Day
The strange relationship between global warming denial and… speaking English - The Guardian

New Normal
Finance and politics are really boring - Annie Lowrey

Americans wouldn’t buy 1/3 pound burger because they thought quarter pounder had more beef - NYT Mag

70% of Twitter’s employees, and 79% of its leadership, are men - Circa

Gary Cohn wanted to let Charlie Gasparino know that if he can handle Charlie, he can handle a stiff drink - Charles Gasparino

Deutsche’s internal controls are part sensory deprivation chamber, part funhouse mirror - WSJ

“Smartphones don’t just increase the size of the internet by 2x or 3x, but more like 5x or 10x” - Benedict Evans

Financial Arcana
Dodd-Frank is finally paying off - Mike Konczal

Larry Summers on secular stagnation and the Ex-Im Bank - TNR
Why does Wall Street use a different kind of macroeconomic modeling than academia? - Noah Smith

Sovereign Debt Problems
A meeting with bondholders “had to be postponed, because the Argentineans said they could not get here in time” - Reuters

Revolving Door
Financial regulator named as the head of financial industry lobbying group - Reuters

The US Chamber of Commerce really doesn’t want money market reform to happen -Reuters

Discovering pyramids

Mar 25, 2014 21:17 UTC

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The hedge-fund equivalent of Stalingrad grinds on. Two weeks ago, the Federal Trade Commission launched a formal investigation into Herbalife, asking whether the company is set up as an illegal pyramid scheme — a process that could take 12-18 months. The move, which is “not an indication of wrongdoing”, nevertheless caused Herbalife’s stock to drop from more than $66 a share on March 10 to $53 today. On Saturday, with the stock at $49, Bloomberg reported that Bill Ackman is near breaking even on the $1 billion short he’s had against the company since December 2012. (Ackman was down as much as $500 million near the end of last year.)

New York Times article earlier this month laid out the way Ackman has taken to lobbying Washington to influence the outcome of this investigation. “So far, Mr. Ackman has persuaded four members of Congress, a New York State senator, a City Council member in Boston, the majority leader of the Nevada Senate and other elected officials in California to join the cause”, the NYT writes. Felix calls this move the Buffett Arbitrage. Ackman’s essentially betting his money on being able to influence legislation: “except that instead of trying to reduce the influence of money on politics [like Buffett], he’s trying to turn it into a trading mechanism”.

“There is a lot of confusion about what constitutes a pyramid scheme, and that confusion is largely the FTC’s fault”, writes Dan McCrum, who has a definitive series of posts on Herbalife over at Alphaville. The central question here is not whether Herbalife’s business model is structured like a pyramid, but whether it’s illegally structured like a pyramid. Herbalife’s products are sold through distributors, and the only real way to make money is for current distributors to recruit more distributors. Vikram Bath has a good overview of the subtle differences between a legal multi-level marketing company and an illegal pyramid scheme.

The most recent debate centers around “internal consumption”, or how much Herbalife product is consumed by Herbalife distributors rather than being sold to other customers. Ackman’s charge that Herbalife is a pyramid scheme comes from a paper by Peter Vander Nat, who defines a pyramid scheme as an organization from which “the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers”.

Herbalife, explains McCrum, argues that just because a company meets that criterion, that doesn’t make its business a pyramid scheme. The company says many of its “distributors” aren’t really distributors at all, but just signed up for the program to get the product at a discount, not to sell to other customers. Today it launched a website countering Ackman’s pyramid scheme claims.

John Hempton doesn’t necessarily think this is a problem. After speaking to many Herbalife distributors, many seem to be signed up only to get the discount, he writes. While they don’t intend on making sales, they are ardent consumers of the product. The solution for the FTC, he says, is just to go to as many Herbalife distributors as possible and ask whether, why, and how the distributors are consuming the product. – Shane Ferro

On to today’s links:

The economy is not doomed - Brad DeLong
There’s an economic component to smoking rates in the US - NYT

Behind the Music
To understand the pop music industry, you must understand Sweden - Whet Moser

Brain damage, digital competition, and oversaturation: Mark Cuban on why the NFL will implode in a decade - Mark Cuban

Why Box is going public: it needs the money - TechCrunch

The long-term unemployed aren’t lazy, they’re unlucky - Catherine Rampell

How widespread corruption is hobbling Cambodia’s economy - Adam Pasick

Easing Ain’t Easy
Fed governor Jeremy Stein’s tenuous theory driving the taper - Ryan Avent

“If your readers are losing IQ points reading your stuff, you are doing something wrong” - Ryan Chittum

ProPublica finds doctors taking research money and consulting fees from the same companies - Charles Ornstein and Ryann Grochowski Jones
The NLRB is cracking down on companies illegally classifying employees at temps - Harold Meyerson

Legitimately Good News
Solar energy is as cheap as conventional sources in Germany, Italy, and Spain - CleanTechnica

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MORNING BID – Puerto Rico in the spotlight

Mar 11, 2014 13:45 UTC

The market remains in a bit of a vacuum, with interesting activity focused on a few speculative investments that don’t necessarily suggest anything about the larger environment – though one could extrapolate from the interest in these myriad issues that the market is getting frothy, one way or another.

The island of Puerto Rico will sell about $3 billion in bonds to a varying group of investors on Tuesday, many of whom are likely not to be traditional municipal bond buyers. What’s interesting to see, as our muni team pointed out late Monday, is that the bonds appear set to sell at an 8-percent coupon, with yields somewhere in the mid-8s or high-8s. That’s nowhere near the 10-percent yield that some had expected. (Full Story)

What may be happening is a bit of fortuitous timing as the market had been in the midst of a half-way decent rally for a bit here and as investors clear the decks of some emerging-markets assets that have underperformed. The rest of the world has caught a bit of a cold here, it seems, so safer assets – and Puerto Rico qualifies on some bizarre level – will reap the rewards.

Some of it is also the buyers: Distressed debt funds and high-yield funds, along with hedge funds looking for fat yields and a bit less concerned about the implied risk that the junk-level sale suggests. The constant refrain one hears is that people would invest in somewhere other than the stock market but have nowhere to go. Well, there’s some nice beachfront property here.

Tuesday also promises the latest chapter in the saga of Bill Ackman vs. Herbalife HLF.N. This has so far not worked out all that well for Ackman, given the share increase in the last 12 months (admittedly, the stock has been weaker so far this year, losing about 18 percent). The hedge fund manager is expected to make a presentation that will include new allegations relating specifically to its operations in China, suggesting the company is violating laws in that country.

The Ackman thesis, essentially, is that Herbalife is a pyramid scheme, where only the first few investors are guaranteed to make money, though he has motivated opponents on the other side, including Carl Icahn, and of course, the company itself. As of Friday, about 18 percent of the company’s shares were being borrowed for short bets – a high figure – though it had been more than 20 percent a few months ago, according to Markit data.

Options action doesn’t really suggest much of a move for the rest of the week (at the money straddles put it at about 5 percent), suggesting people have, in part, grown weary of this battle, even as Ackman is reluctant to give it up.