I just heard that Ackman has shorted $HLF (Herbalife) – a company that I hadn’t heard about until today. He will publish his short thesis tomorrow, So, since I’m such an Ackman fan (OK, Bill Ackman is my God), I thought I’d take a crack at his short thesis. Remember, it’s a reading from pure cold over the course of half an hour. I am an amateur. If I am even remotely close to what Ackman is thinking, I award myself one point.
Herbalife Ltd. is a global network marketing company that sells weight management, nutritional supplements, energy, sports and fitness products and personal care products through a network of approximately 2.7 million independent distributors, except in China, where the Company sells its products through retail stores.
The company has gross profit margins of 80% – higher than MSFT (Microsoft). Just how is this possible? If something seems to be too good to be true, then it probably is.
HLF seems to sell its products through distributors -think Amway. Typing amway and herbalife into Google reveals the second hit as “Corporate Frauds Watch: Herbalife, Amway are like twins out to cheat people”. Oh. So, they sell overpriced goods to a distributor, who then has to try to sell them on. The site elaborates:
If you are lured by the commission, then the trap is ready. You will realise only later after purchasing products worth Rs. one hundred thousand or more that it is virtually impossible to sell these products. By that time it would be too late. Now you start advertising in the same way to attract people’s attention.
This is a game that can only be played for so long. As you “burn through” your distributors, you exhaust the demand for your product. It’s not repeat business: you cannot sell to someone who already has more inventory than they could possibly sell themselves.
You can see signs of the business model becoming more-and-more saturated if you look at inventory turnover (turnover divided by inventory). For 2008, inventory turnover was 17.6, and declined monotonically to 13.9 for 2011. It is more worrying when you look at the quarterly trends. For 3 m/e 30-Sep-2011, inventory turnover was 4.03. A year later, 3 m/e 30-Sep-2012, inventory turnover had reduced significantly to 3.25
I’m sure Ackman’s thesis will be far more thorough.