“Shorting” a stock is a tactic used when you believe a stock is overvalued and is likely to go down in the future. Essentially, you borrow shares from your broker and sell them at the current price. Then, in the future, once the price of the stock has fallen, you buy them back and return them.
For example:
You think ABC Widget Co.'s stock, currently trading at 50, is due to fall. You sell 100 borrowed shares for 5000.00. Then in two weeks, ABC’s stock value has fallen to 40.00 per share, and you buy 100 shares at 4000.00. You’ve pocketed 1000.00 on the transaction.
The danger of course is that you could get caught in a situation where ABC’s shares soar, and the broker calls for his shares back. Then you must buy the shares at the current price. So, if ABC went up to 60.00 per share, then you’d have to pay 6000.00, for a net loss of 1000.00
In addition to what Wargamer says, there are a number of activist investors who, rather than looking for companies with solid fundamentals who they think will go up in value, look for companies which they think are severely overvalued, defrauding investors, misstating earnings, or engaging in other tomfoolery. These investors take short positions on those companies and then publish their findings hoping to drive the price down and also get other people looking into their accusations.
Yeah, do not get the stock market. I just can’t wrap my head around YOU selling SOMEONE ELSE’S property. How is that not theft? You pay back the loan with something that has less value. If you borrow something you sort of have an ethical obligation not to fuck around with it before giving it back.
The more I read about this guy Ackman, the less I like about him.
I am no fan of MLMs, including Herbalife, as they invariably waste a lot of people’s time and money. But I’m also not a fan of devious and greedy hedge fund managers. And it seems like Ackman’s strategy here is to take a massive short position and then make it pay off by actively trying to crush the company.
At any rate, it does seem clear that Ackman’s presentation was a lot more impressive to people who don’t know anything about Herbalife specifically and just have a general dislike of all MLM schemes than it was to professionals whose business it is to analyze these things. See also: Why Bill Ackman is targeting Herbalife
If I borrow a hundred dollars from you, spend it on some stock, and then the country experiences massive inflation causing the value of the dollar to decrease, and then I sell the stock for $500 and give you your hundred bucks back (with interest), have I done something wrong?
When people loan money, they hope the value of that money doesn’t go down too much before they get it back. When people borrow money, they hope money gets cheaper to acquire because that makes paying it back easier.
A short sale in the stock market is no different. The short seller borrows some shares of stock, spends them on some currency (dollars) and then hopes it will be cheaper to acquire the shares in the future to pay them back (with interest).
Everybody involved in this transaction is a willing participant.
Petty interesting stuff, for those who are interested in this type of thing.
I’m not sure if that’s true. My understanding is that brokerage firms can use shares owned by margin accountholders to back shorts.
One thing I never got clear is who gets to vote in shareholder elections. It would seem that there should end up being more official shareholders than actual shares.
Ackman could still be right and win in the end. But I think two things are clear:
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[li]A lot of Very Smart People have seen all he has to say and are willing to bet hundreds of millions of dollars that he is wrong.[/li][li]To this point, he is himself hundreds of millions in the red on this venture.[/li][/ul]
Broader point is that what can seem “epic” and convincing to the lay person can sometimes have less to it than meets the eye.
And to my earlier point about Ackman’s sleazy tactics:
I hadn’t seen this before, so this is my first look at all this. I know nothing about Ackmann, and his actions seem a bit sleazy to me. However, I look at that independently from the content of the presentation.
I will note my own personal uneasiness with MLMs - the practice seems to be flirting with pyramid schemes. Legally, they are permissable if there is more revenue generated by product sales than by commissions, i.e. you sell more actual product than recruit people to work for you. Practically, there is a lot of manipulation to hide pyramid schemes.
Reading this presentation is highly remeniscent of our lengthy thread here on Lyoness. Very similar descriptions of obfuscation to hide the real revenue stream.
I read through the entire powerpoint. I was unable to play the webcast. Overall, I found it convincing. He takes multiple routes to justify the argument that Herbalife is a pyramid scheme, and I kept finding them convincing. Okay, some of the deep financial stuff late in the presentation started getting over my head, but there were several lines I found well-supported.
Unfortunately, this doesn’t seem to be as convincing to other market analysts or the FTC.
Wait, if evaluated against what it claims itself is, it would be a failure? The fact that it is successful at being something else does not protect against the fact that it is misrepresenting itself to it’s customers.
I read through his rebuttal argument. To respond to a few of his points:
There seems to be some confusion here over how the term “brand” is being used. Ackmann is making a distinction between the distributor (i.e. Herbalife) and the products (e.g. Formula 1, Niteworks, etc). Slide 11 compares Herblife against Church & Dwight Co, Inc., for instance. and lists “Key Brands” as Arm & Hammer Baking Soda, Xtra, Nair, Trojan Condoms. It lists Energizer Holdings, Inc against Herbalife, and then lists brands as Energizer batteries, Schick, Playtex, Edge Shaving Gel, Bonana Boat suntan lotion. Perhaps Ackmann is misusing the word “brand”, but his comparison is not quite what Timothy Ramey is criticizing. If you look at slide 12 (the one Ramey cites) the brands listed include Oreo, Charmin, Crest, Gerber, Palmolive, Betty Crocker, Listerine, Clorox, and “Formula 1 Healthy Meal”. Which of those “brands” is not a household name?
I suppose it is a fair criticism that the overall product “brand” is well known even if the names of the actual products are not.
Ackmann addresses this, though, by pointing out that Herbalife spends “de minimus” dollars on product advertising. That’s not his description, that is taken from HerbaLife’s own responses to the SEC concerning their financials. From the powerpoint, page 25:
There is Herbalife using “brand” in the same specific manner to refer to the products, not the company.
And look, there is Herbalife stating right there in the clear their promotions are aimed at recruiting distributors, not selling products. Shouldn’t that be a giant red flag?
It might be a fair criticism that Ackmann uses 2.2 times the normal serving size. He states in his fine print that he is trying to compare apples to apples with respect to comparing Formula 1 versus equivalent products from other companies (Ensure, Slim-Fast, etc). He chose to use a 200 calorie serving size for Formula 1. The problem is that number of calories may not be the correct unit of comparison for this purpose.
For example, Ensure is typically a higher calorie product than Slim-Fast – I know, because I have looked at their labels, and their purposes are different. Slim-Fast is a “weight loss” product, and is aimed at limiting calories. Ensure is a “nutrition supplement” and is sometimes used as food replacement for those who are unable to eat regular food. The cannister cites seems to be 250 calories per serving, and I’ve seen a version as high as 350 calories per serving marketed for those meal replacement situations. So using a calorie count as a basis of comparison seems inappropriate to me. A more appropriate method is to look at typical serving sizes for each product, i.e. 1 shake or whatever.
However, I dispute the second half of Ramey’s rebuttal. The “retail” price he uses is Herbalife’s recommended retail price. It is the dollar amount that Herbalife assumes each product costs for the basis of all their financial calculations, and a large part of the basis of their claims that they have higher revenue from product sales than from recruiting. It is very fair to use that number as the basis for price comparison between products.
Besides, Ackmann also includes examples of two other products (multivitamin and Niteworks L-argenine), both of which also show considerable markups.
And even if you include the customers who become distributors just for the discount, $1.09 per serving is not the low end, it’s the middle range, higher than $1.04 for Slim-Fast, 1.03 for Ensure, and .88 for Gen-Soy Shake. It’s only less than GNC Total Lean Lean Shake at $1.74 per serving.
I’ll grant that brand name plays a role in product choice. Ackmann’s choice of the word “commodity” may again be somewhat incorrect. However, the point Ackmann was trying to make with that word is that Herbalife does not create unique products that nobody else sells, something protected by a patent for instance. Think of name brand drugs and the period before the generics can be sold. Rather, they make a “health shake” that has equivalents from many other companies; they make a multivitamin that is not substantially different than many other brands; they make an L-argenine supplement that is no different than many other L-argenine supplements available. These are items with equivalents from other brands, like cola. Maybe you like Coke, maybe you like Pepsi, maybe you will buy generic “cola”, but they’re all colas, and there are plenty to choose from. Actually, colas probably have more distinction than Herbalife’s products do - they actually have taste variance.
This is irrelevant. Herbalife claims to customers that “We’re doing research around the clock in this company” and “Since 2003, we’ve increased our research and development expenditures dramatically to advance the product-development process.” Except the Herbalife 2011 Annual Report states, “For all periods presented, research and development costs were expensed as incurred and were not material.” That’s right, their own financial statements indicate they have minimal research expenditures. From the Herbalife 2004 Prospectus: “The Company’s research and development is primarily performed by outside consultants and is less than $2 million per year.” So it does not matter if R&D is trying to develop the neatest new innovation, or just trying to come up with a better formulation for multivitamin or a better tasting shake product, it’s R&D as being used by Herbalife and as being used by Ackmann, and Herbalife states they don’t spend much on it.
They are misrepresenting themselves in their marketing versus their financial statements.
If you look at the materials, there are 4 levels of “distributor” below the Supervisor level. Those 4 levels make up the 82.3% referred to above. They are called collectively “Non-Sales Leaders”, as opposed to the “Sales Leaders” that are collectively the groups from Superviser and above.
Distributor: 25% discount
Senior Consultant: 35% or 42% discount on retail, 7% or 17% on wholesale (driven by number of Volume Points sold, requires 500 in one month)
Success Builder: 42% discount (for 1000 VP orders)
Qualified Producer: 42% retail profit, 7% or 17% wholesale profit (2500 VP in 1 to 3 months)
Different places in the presentation, Ackmann makes different points. However, to get the designations above “Distributor”, you have to be selling more product than just purchasing for yourself to get the discount. ($500 in sales in 1 month, minimum.)
Later in the presentation, Ackmann defends the position that most of the Non-Sales Leaders are failed distributors rather than mere consumers. He bases this argument on the fact that there is high turnover in these categories, and that sales from these Non-Sales Leaders down their supply chain are counted as retail income even though they are sales of product to downstream distributors. He points out the bookkeeping that Herbalife uses to justify their claims, and explains why he feels it is obfuscatory bookkeeping.
By the way, the FTC defines how much “internal consumption” (i.e. using the products yourself rather than selling it outside the company) is acceptable, yet Herbalife does not track this at all. Guess what: “Distributors” that just join to get the discount count as “internal consumption” as far as the FTC is concerned. So it does matter, if Herbalife is trying to defend that it is not a Pyramid Scheme.
Oh, and in case you wish to know, Ackmann eventually states that he uses a conservative number of 30% for his purposes in estimating the amount of product that is bought by members rather than sold outside the network.
Wait, Ramey just confirmed this is a sign of a pyramid scheme.
The sustainability of buying product to maintain status and then selling it at substantial discount on E-Bay is a fair argument - if everybody did it, it would undercut the legitimate sales. Except if the bulk of income is really derived from
royalties, then it can still be economically viable for a mid-level sales leader to buy his way in. There is an actual example where real dollar values were obtained from a lawsuit that demonstrates it.
Furthermore, part of Ackermann’s argument is that the sustained success of Herbalife is due to their continued expansion into more and more markets, keeping the pyramid base growing to mask the losses. There’s a lot more in the presentation that this rebuttal is ignoring. I just don’t think I can summarize it here.
The basic disagreement here is whether Non-Sales-Leaders in the three levels above basic Distributor are in it just for the discounts, or are trying to make money at it.
I don’t find his rebuttals convincing, and think Ackmann has put a lot more into it than the rebuttals did.
If the business model is based on revenue from product sales, then you are correct. If the business model is based on revenue from recruiting distrubutors who pay for the privilege of recruiting more distributors, then the business case will go to zero when there are no more people to recruit.
Yes, that is a correct assessment. His claim is that they are playing games with the numbers and misrepresenting actual costs, actual revenue, and actual retail sales income, and that an accurate assessment will show that they earn more from recruiting than from product sales.
Multi Level Marketing is a practice that can be done in a sustained manner, but it is also a fundamental element of a pyramid scheme. Ackmann’s arguments are that Herbalife is dramatically misleading on how it actually works, that the real finances do not match the claims, and that the longevity of success is because Herbalife has been perpetually moving into new markets - new countries, now finding new ways to reach out to lower socio-economic groups. It hasn’t hit bottom yet, because Herbalife keeps digging deeper.
All MLMs spend minimal dollars on advertising. That business model does not rely on corporate advertising, but relies on the distributors to pump the products.
As above, the company recruits distributors, the distributors sell the product. I don’t see any problem with this at all.
New people keep being born.
[I should note that you’ve made many good points. I didn’t address it until now because it was a long post with a lot of content.]
Thanks for posting the followup. What it shows is that Ackman is not a great hedge fund manager and that he did not accurately predict how people respond to Herbalife. It doesn’t make him wrong in his analysis of the company.
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Well, there’s advertising, and false advertising. I’m not saying Herbalife falls legally into false advertising, but your original statement was that Herbalife was failing to be what it claims it is.
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Though they usually rely on distributors to pump distributorships.
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When more revenue comes from signing up distributors than actual product sales, that crosses the line to illegal pyramid schemes. Focusing on getting more distributors rather than making distributors successful sellers seems to be focusing on the illegal pyramid scheme rather than the legal product distribution plan.
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There is that. There are also new countries to invade.
True. There’s an old saying “the market can remain irrational for longer than you can remain solvent”.
I don’t think it’s as black and white as that. Herbalife emphasizes one aspect when it’s really relying on another.
If Ford advertises that their cars are “the best cars on the market”, they don’t mean that they’re better than Lexuses, and if you expose Ford as a scam by proving that they’re not. That was just advertising hyperbole. As long as the cars are good value for the money they should do OK.
And the products too. The point here is that you can’t make something out of the fact that Herbalife has vitually no spending advertising their products, since they have a business model that explicitly rejects this approach in favor of an alternative form of marketing.
We’re taling about their “promotions” not their revenue.
Legally, the claim they are a pyramid scheme cannot be measured by their promotions. It can be measured by their revenues. But if one wished to make a claim regarding them being a pyramid scheme, one could look at a pattern of traits, and include promotions as one part of the pattern. I think the pattern is indicative.
I will concede that the MLM marketing plan does not focus on advertising through billboards, TV spots, etc, and relies on grassroots, in-person awareness raising. I think there is still a point regarding the fact that they are primarily marketing the Herbalife brand rather than any actual products. McDonalds may focus on the McDonalds brand, but they still talk about Big Macs.
Considering that Herbalife’s stock has appreciated about 60% since Ackerman started his campaign last December, it would appear that the market disagrees with him and he lost a substantial amount on the short position he put on.
Of course, with all that, I’m not investing any money in Herbalife stock either …
BTW, Ackman is also playing the Race Card, in harping on the fact that many of the Herbalife distributors are lower income Hispanics. He managed to get some Hispanic activist group interested.
