What’s Ackman’s Herbalife game?

By Felix Salmon
December 31, 2012

Bill Ackman sure knows how to make a splash: his presentation laying out his Herbalife short is rapidly approaching 3 million pageviews on Business Insider, plus many more from his own website. What’s more, it has already made him a lot of money: even with Herbalife stock up more than 12% today, at about $33 per share, it’s safe to assume that Ackman put on his short at between $45 and $50. If John Hempton is right and the short is on the order of $1 billion, then that means Ackman has made more than $300 million in the past couple of weeks.

And as Michelle Celarier notes, that $300 million is going to come in very handy when Ackman puts together his year-end report, not to mention if and when he ever tries to take Pershing Square public. As of the end of September, his fund was down for the year; Herbalife should change that.

Celarier also notes that Ackman’s broadside was carefully timed: it not only came just before year-end, but also came during a Herbalife “quiet period”, during which the company’s retaliatory arsenal is temporarily depleted.

The amount of sheer theater surrounding Ackman’s short — he literally presented his idea from a stage, and followed up his presentation with a big round of media appearances — makes it clear that the presentation itself is part of the trade. Ackman’s an activist investor, who tries to make money by changing the state of the world, and in this case it’s very clear what change he wants to see: he’d like the US government to prosecute Herbalife for being a pyramid scheme.

Ackman says that he has a price target of zero on Herbalife stock, which is extremely aggressive given that this is a company which makes a lot of money every year. The only way that Herbalife goes to zero is if it gets prosecuted for being a pyramid scheme. But there’s no evidence that a prosecution is forthcoming: after all, Herbalife has been around for 32 years, and the FTC has done nothing so far.

Ackman, when asked, says that the purpose of the theater is to bring the “facts about Herbalife” to the attention of people who would otherwise be duped by its sales pitch: if those people knew the truth, he says, they would never sign up with the company. But there’s basically zero overlap between the kind of people who read 334-page slideshows, on the one hand, and the kind of people who dream of getting rich selling Herbalife products, on the other.

The vast majority of Ackman’s presentation is devoted to an attempt to prove that Herbalife is a pyramid scheme. That’s hard: the distinction between an illegal pyramid scheme, on the one hand, and a legitimate multi-level marketing scheme, on the other, is largely in the eyes of the beholder. All of these things look pretty skeevy from the outside, but that doesn’t make them illegal, and people like Kid Dynamite are doing a good job of chipping away at many of the key bits of Ackman’s presentation.

That’s the bit which doesn’t add up, for me. Ackman has a pretty good short thesis on Herbalife even if it’s a legal MLM operation: he thinks it’s running out of markets and demographics to exploit. But he buries that short thesis inside hundreds of pages of heavy-handed argument on the pyramid-scheme front, and claims loudly that he thinks that Herbalife is going all the way to zero.

The problem is that he doesn’t ever spell out his argument, and explain why he thinks it’s probable that Herbalife is going to zero. After all, in order for that to happen, you need a lot of things to break Ackman’s way:

  1. Ackman has to be right about Herbalife being an illegal pyramid scheme
  2. The FTC has to be persuaded that Ackman is right about Herbalife being an illegal pyramid scheme
  3. The FTC has to then make the decision to prosecute Herbalife
  4. The FTC then needs to win its prosecution against Herbalife
  5. The FTC victory over Herbalife needs to be so decisive that the stock goes all the way to zero.

No matter what probabilities you put on each of these events, the chances of them all happening can’t be particularly high. And the initial one — the determination of whether or not Ackman is right about the pyramid-scheme thing — is not even all that important: you can put that probability at 100%, and you still don’t have a compelling case that Herbalife is going to zero.

All of which makes the Ackman presentation look to me like it’s a lamb dressed up as a lion, and that Celarier might well be right: Ackman could just have been trying to engineer the biggest possible year-end drop rather than genuinely betting on the demise of the entire company. It wouldn’t surprise me in the slightest to see this story go nowhere in 2013, with both Ackman and Herbalife quietly dropping the matter rather than continuing to fight for no good reason. Ackman has made a lot of money on this trade already: it’s not clear that he has any particular need to kill Herbalife as a whole.

The question, of course, is the degree to which Ackman has now covered his shorts, and the degree to which he’s still betting on substantial further declines. It could even be that today’s rise was caused by Ackman taking profits on his trade. After all, it’s always nice to be able to cash such things in, rather than just see them on paper.

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