Saturday, January 12, 2013

Hedge Fund Manager Ackman Goes in the Ring Against Herbalife

In recent investing news, I have been following the kerfluffle between hedge fund manager Bill Ackman (who I'll admit I had never heard of before, but I don't follow hedge funds) and Herbalife, a corporation that sells weight loss shakes and business opportunities to sell weight loss shakes (I'll admit, while I don't know exact details about this company, I am familiar with their business model and have studied it extensively).

Back in December, Ackman made a presentation to some investors where he laid out his case that Herbalife is running an illegal pyramid scheme and will be shut down by the FTC.  As part of this he announced that he had taken a short position of $1 billion with a price target of $0.  In other words, he doesn't have any intention of covering his short because he beliefs the company will be shut down by the FTC.  Herbalife has responded to this presentation with their own during they recent investor phone call. Depending on which side you are on, the news seems to indicate that this response was either a slam dunk or an airball.

In a nutshell, Ackman's presentation goes over the funny math that Herbalife uses, which, in their estimation, shows that Herbalife distributors make more money from recruitment than they do from retail sales of their product.  I have gone through their presentation, and I find their logical argument rather impressive.  But there were some numerical errors that I found along the way.  So let me go through those.

First, on slide 10 and 11 of the presentation linked to above, it compares Herbalife to other consumer product companies like Church & Dwight, Energizer, and Clorox (as a disclaimer, I own Clorox stock and have for about 12 years).  The problem I have with this comparison can be easily seen on the slide 11, is that all of these companies have several brands that span the spectrum of consumer buys: cleaning products, food, clothing, cosmetics, etc. I was familiar with almost all of the brands, even if I didn't know what the parent company name was (Church & Dwight has Arm&Hammer, Nair, Trojan, and Xtra).

One of the things that Ackman brings up is even though all four of these companies are similar in size and in the consumer products brand, Herbalife is a relative unknown. I can think of two reasons for this.  1) Herbalife primarily sells a narrow segment of the consumer products market, namely health and wellness products and advertises by word of mouth (this is a segment that I don't use much products in so am not very familiar with) and 2) although similar size to the other three, Herbalife sales are primarily international.  So, I thought I would test these hypothesis.  Since all four are publically traded the information I need is right there in their filings to the SEC.

 Below is the information that I gleaned from the SEC EDGAR site of filings. Dollars are in millions. I looked at the last quarterly report available for each company.

Revenue Largest Segment Largest Segment % Revenue US Revenue US revenue %
Herbalife $1017 Weight Loss/Nutrition 91.0% $203 20.0%
Church & Dwight $725 Household Products 61.9% $530 73.1%
Energizer $1124 Personal Care 59.9% $579 51.5%
Clorox $1338 Cleaning 45.6% $1035 77.4%

In a nutshell, my two hypothesis are correct.  Herbalife is more concentrated in sales in a single segment than any of the other three.  And Herbalife relies on International sales far more than any of the other companies. Neither of these is inherently bad, it just shows that Ackman's comparison wasn't the best comparison. Whether or not there actually are more similar companies to compare it to, I don't know, I'll leave that to his paid researchers to figure out.

Second, slide 12 identifies Herbalife as a $2 billion brand that no one has heard of. Ackman explains how he comes up with this number, 29% of total product then adjusting for shipping costs and Herbalife's revenue/discount reporting.  I just use the 29% and look at their total sales and come up with $853 million.  So, less than $1 billion brand.  Furthermore, as shown above, most of these other brands probably have 50%-75% of their sales in the US, while Herbalife only has 20%, so their Formula 1 shake is only a $170 million brand in the US.

Third, slide 14 shows that Herbalife sells more powder drink mix.  Except does it really.  They sell more $ wise.  He doesn't include the premixed liquids, although I will all together since Herbalife doesn't offer it and my guess is if they did then their powder sales would decrease and liquid sales increase. I didn't bother to look up the actual amounts for the other brands but assumed that Ensure and Slimfast had 60% sales in the US and GNC had 90%.

Sales Adjusted for US
Herbalife (Ackman) $1800 $360
Herbalife (mine) $853 $171
Ensure $700 $420
Slimfast $600 $360
Leanshake $50 $45

This is more evidence why Herbalife is relatively unknown.  No matter which numbers you believe, Herbalife isn't the most popular weight loss shake.  But lets look at these numbers in another way. How many servings of each are actually sold? Ackman gives us the information needed on slide 16.

Sales Cost per Serving # Servings US Servings
Herbalife (Ackman) $1800 $2.87 627 125
Ensure $700 $1.03 680 408
Slimfast $600 $1.04 577 346
Leanshake $50 $1.74 29 26

Sales and servings are in millions and it looks like Herbalife has an even smaller market share on a serving basis than before.  So to answer the question, why is Herbalife a relative unknown in the US? Because for every 1 person drinking their shake, there are 6.25 people drinking these other three brands.  This isn't even all of the brands available. A quick look on the internet found that Walmart has a weight loss shake - the Equate brand which is cheaper than any of the ones that Ackman lists (disclosure, I also own stock in Walmart and have for 6 years).  I doubt I could easily find sales of this brand shake, but it is possible that it and many others are a significant player on the weight loss shake market.

Fourth, slide 21 states that Herbalife products are commodities and lists several competing brands.  This in and of itself isn't enough for me to say that Herbalife is a commodity as opposed to a premium product like they claim.  So, I compared the nutrition label for the above Walmart weight loss shake to the Herbalife shake.  Guess what I found? Yep, basically identical (when the powder is mixed with 8 oz nonfat milk). Herbalife has less fat and more protein, and a few of the nutrients are different. Walmart has a full day supply of Vitamin C and Vitamin E while Herbalife only has 25%.  Comparing the ingredients, Herbalife has soy protein (accounting for the extra protein) and that is about it.  So, unless you want to pay a hefty premium (up to $2 a serving) for that extra 7 grams of protein, you would be just as well off buying the Walmart brand.  And after looking at this, I can agree with Ackman that Herbalife is not a premium product, just a premium price.

That is about all of the problems, that I see.  I think Bill Ackman could have made a stronger case by comparing with more appropriate companies.  That being said, Herbalife has responded and there are some issues I have with how they play with the numbers.

In response to Ackman, Herbalife touted the information from a customer survey they had done by Lieberman Research Worldwide (another company I have never heard of, but there isn't any reason for me to necessarily).  During an interview on CNBC, the CEO implies that 90% of their product is sold to people outside of the distributor network.  On the other hand, the 3rd Quarter conference call that Herbalife had and is referenced in the report linked above states that 90% of customers are outside of the distributor network.  These are two very different things.  So are one, both, or neither of them correct?

Let's do some more looking.  We know that this survey was conducted in the US so we'll try to confine ourselves to that market.  However, much of the information in the quarterly report for Herbalife is for the North American market.  Fortunately for us, Mexico is not part of that reporting and the numbers for North America are only a few percent higher than for the US by itself (i.e. $209 million revenue vs. $202 million).  That being said, I'll use North America as a proxy. $ figures are in the millions.

Net sales $209
Monthly Active Sales Leaders 67,826
Total Distributors 372,000
Retail Sales $332
Distributor Allowance $158

So, here is the first bit of information.  The Active Sales Leaders qualify to buy product at a 50% discount. All other distributors can only buy at a 25%, 35% or 42% discount.  Retail sales is the recommended retail sales price and distributor allowance is the discounted amount of retail sales.  So net sales is then retail sales minus distributor allowance plus shipping charges.  The first thing that can be seen is that a significant amount of sales is from active sales leaders (this would be expected).  To determine exactly how much, I'll just assume there is only two discounts 50% and 25%. Using a little algebra this equates to 90% by Active Sales Leaders and 10% by the rest (so it follows the Peter Principle).

Getting back to the Lieberman report for a minute.  They found 5.5 million customers from the past 3 month period, over 90% were not in the distributor network, and 2/3 were likely to buy again. With only 372,000 distributors total in North America, if there are 5.5 million customers, then of course 90% are outside of the distributor network.

Next I'll assume that all of the non active distributors (305,000) are only in it for personal consumption, this is somewhat implied in the Herbalife filings. 10% of $332 million is $33.2 million in retail product sales over a 3 month period.  Divide this by the distributors and you have $109/ quarter or $36/mo. This is equivalent to a single 750 g bottle of the Formula 1 shake powder (30 servings).  Herbalife recommends 1 serving a day for weight maintenance and 2 servings a day for weight loss.  So, none of these distributors are using the product for weight loss, or there are a significant number of them that don't use the product regularly, or (considering Herbalife sells several products) using some algebra again 25% use $100 per month (Herbalife recommended), 20% use $39 per month (one bottle), 25 percent use $39 per quarter, and 30% use $39 per year.

So, if people are becoming distributors just for personal consumption, they certainly aren't consuming a whole lot.

Next we have the 68,000 active Sales Leaders who are buying $300 million retail (for $150 million) each three months.  And there are roughly 5.1 million customers that are buying from these distributors if all of the numbers are correct.  To begin, that is 75 customers per distributor (which is 3 times the amount from the Herbalife plan - slide 58), however, it amounts to only $1470 per month in retail (which is a little more than half of what the Herbalife plan shows of $2500/month).  So at a minimum, the standard sales pitch of the opportunity should be updated to reflect what is actually happening, of course, it is kind of hard to get someone to buy in to finding 75 regular customers.  If you figure there is one hour spent per quarter on each customer, plus meetings and other Herbalife related stuff, you have a full time job!

If there are 5.1 million real customers, what are they buying?  Let's assume that the 68,000 distributors also have a personal use of $100 retail per month (as recommended by Herbalife), that leaves $280 million being purchased by the customers - $55 per quarter.  So, that translate to two of the smaller bottles per quarter (not per month per quarter).  In other words, the customers aren't using it for weight loss or maintenance. Which means if these are the real customers of Herbalife, then Herbalife doesn't understand how its products are being used by the public. To answer the other statement from Herbalife, Sales Leaders are buying $20million per quarter for personal use (if they are using $100 per month) and all other distributors are buying $33 million per quarter for personal use.  Which means that the distributor network accounts for at least 16% of all sales, so no 90% of Herbalife product is not sold outside of the distributor network.  If it is, then the distributors themselves don't believe in the product enough to use it.

The last funny bit of numbers that I wanted to look at is one of the "X has more A than M, B than N, C, than P..." So I used the USDA food information database to find out what is in each of the items listed on the Formula 1 sales page.

Formula 1 Mango Banana Chicken Broccoli Yogurt Beans
Calories 180 124 105 127 15 103 237
Protein (g) 17 2 1 17 1 10 15
Fat (g) 1 1 0 6 0 0 1
Carbohydrate (g) 26 31 27 0 3 14 43
Sugar (g) 23 28 14 0 1 14 1
Fiber (g) 3 3 3 0 1 0 10
Calcium (mg) 250 23 6 7 21 366 80
Vitamin A (mcg) 210 112 4 6 14 4 0
Vitamin C (mg) 18 75 10 0 39.2 2 0
Iron (mg) 1.05 0.33 0.31 0.77 0.32 0.17 2.97

Let's go through the claims one at a time.  "More Vitamin A than a Mango." Yes, but I never thought of mangoes as a Vitamin A food, compared to carrots, it only has half as much Vitamin A.  And a mango will give you all of the Vitamin C that you need for a day.

"More Vitamin C than a Banana." Again, when did bananas become a vitamin C food?  Yes, the statement is true, but since we already got almost 4 times the vitamin C from the mango, it is moot. "More protein than a chicken thigh." Well, depends on the size of the chicken thigh, I found them to be equal.  Besides as mentioned above, this is soy protein compared to animal protein.  Is there a difference, I don't know, ask a nutritionist.

"More fiber than 1/2 cup of broccoli." Yes, but the same as a mango or a banana.  Besides, broccoli has so little calories you could eat two cups of it and have more fiber than Formula 1. "More calcium than 6 oz of yogurt." Not from what I found, but then again, I don't know what yogurt they are using as their baseline. Yogurt also has a sizeable amount of protein.

"More iron than 1/2 cup of beans." Again, not from what I found, but I don't know what beans they are talking about there are lots of different kinds of beans (I used black beans, because I eat them). Beans also have almost as much protein as the Formula 1.

If you added all of these foods together you would get 711 calories. This is a decent sized meal.  However to compare it I also adjusted them down to 180 calories.

Formula 1 All Foods Adjusted Foods
Calories 180 711 180
Protein (g) 17 46 12
Fat (g) 1 8 2
Carbohydrate (g) 26 118 30
Sugar (g) 23 58 15
Fiber (g) 3 17 4
Calcium (mg) 250 503 127
Vitamin A (mcg) 210 140 35
Vitamin C (mg) 18 126.2 32
Iron (mg) 1.05 4.87 1.23

Looking at this there is less protein, sugar, calcium, and Vitamin A.  Other than Vitamin A, all other nutrients could be equalized or better by simply adjusting the proportions of each food and get the same nutrition as a shake.  The vitamin A can be taken care of by adding carrots to the mix.  In other words, there is nothing special about the Formula 1 shake that can't be found by limiting your portion size of common foods. Personally, I happen to like eating a variety of foods which is part of the reason I am not into the shake meal fad.

Overall, I think the Herbalife business model sucks for distributors.  Sure Herbalife makes a lot of money from it, and as long as they can continue to get 1 million or more new people to sign up each year, this could go on forever.  All of the MLMs have proven that there is a ready and willing market of potential distributors willing to sign up for the next thing.  So, I find a bet for Herbalife going to $0 a long shot.  Add to this that there has been little enforcement of the FTC regulations for pyramid schemes over the last 30 years.  The MLM industry has jumped into the lobbying game with both feet and it has profited them nicely.  So relying on the FTC to shut down Herbalife is also a longshot.

On the other hand, I have to go back to the business model.  It sucks for distributors.  The information on the internet has exploded in the last 10 years.  Analysis of the Herbalife business model (or any MLM for that matter) with actual numbers, not the rosy picture they paint for themselves of the ideal model, looks dismal for not just the average distributor, but up to 99% of all participants.  Using Herbalife's North America numbers, 372,000 distributors, while only 68,000 are actively selling. If 99% are losing money after all expenses are accounted for, then 3720 sales leaders (5% active sellers) are making money. This matches what Ackman shows on slide 74. While it has lasted for 30 years, I can't see it lasting for another 30 years based on the information available. Which means I wouldn't bet on Herbalife going up significantly.  In conclusion, I believe the information that has been presented thus far probably limits where Herbalife is going to trade in the future (barring any action by the SEC or FTC), somewhere between $25 and $50.


  1. Hey, that's some good analysis here.

    On one hand, I agree with you about US sales being low in comparison with the other companies. However, I wouldn't fault Ackman's comparison without bringing better comparisions of your own to the table. Maybe he did the best he could. I've heard of all 5 of Energizer's brands that Ackman highlighted. Even if Herbalife's US revenue is less than half of all those brands, you'd think you'd still have heard of one of them. On the other hand, as Ackman notes, they do no product advertising.

    The most notable thing is that Herbalife corrected his saying that 90% of the product is sold outside the network to saying that 90% of distributors buy it for self consumption (he made this correction on CNBC - In other words, he went from make a big statement about distributors making retail sales to the complete opposite, not retailing the product at all. This sounds like an admission to me that Herbalife is a pyramid scheme (when you combine it with what the FTC says about more than half of sales needing to be outside the network). This is another great article about how if retail sales aren't made outside the network, all the money flows through the network essentially a pyramid scheme:

    Since 90% of the distributors buy it for self-consumption, it isn't reaching the public. I don't know how these work with the Lieberman report, but since I haven't seen the Lieberman published along with the methodology I don't recognize it. Also often these companies are contracted by the company as an agent to prove what the company wants to prove. They'll massage the stats as necessary.

    The "X has more A than M, B than N, C, than P..." is something that is common in MLM marketing. I covered a ViSalus video that does the same thing here: This YouTube video does an even better job than I did with a spreadsheet -

    One thing that is worth noting is that the people that are betting on Herbalife don't bring any information to the table to contradict Ackman or show that Herbalife is legal. Instead they are simply traders who see one guy with a massive short and realize there's an opportunity to manipulate the market with a short squeeze. The fact that the company is Herbalife is insignificant to them. It could be Pocket Lint, Inc. as long as the balance sheet shows what it shows.

  2. If 90% of distributors are only buying for personal consumption, then about half of the distributors making commissions shouldn't be. This makes the numbers look even worse. If on the other hand he is saying that 90% of distributors ALSO use the product personally, then some small adjustment should be made (I assumed 100% of distributors use at least some product).