David Einhorn Strikes Down Herbalife - For Now
Questions posed on an earnings conference call with Herbalife's (NYSE: HLF) management by famous value investor and noted short-seller David Einhorn have spooked HLF shareholders in a major way. The stock is in free-fall for a third straight day on Thursday, and the one-time high-flier is now down nearly 35% over the last 5 trading sessions.
After the dramatic sell-off, it is clear that HLF has become a victim of the famous Einhorn's dramatic sway on Wall Street. The term "victim" here, is of course, used loosely - frequently Einhorn is right about the companies he targets. Nevertheless, even the hint that the Greenlight Capital manager is sniffing around a company, or has initiated a short position, is enough to cause dramatic declines in stock prices.
This is primarily a result of his reputation as a damn sharp investor - one of the best in the world. Einhorn, who is 43, and looks maybe 21, began shorting Lehman Brothers stock more than a year before the once-venerable investment bank collapsed.
On the very day of this article, Thursday, May 3, shares of Einhorn-targeted Green Mountain Coffee Roasters (NASDAQ: GMCR) are down nearly 50% after a terrible earnings report and forward looking guidance. Einhorn presented his short thesis on GMCR last Fall at the Value Investing Congress in New York.
After today's massive plunge, GMCR is down more than 71% since Einhorn's October 17, 2011 presentation entitled "GAAP-uccino." The amount of money that the hedge fund manager has made for himself and his clients on this one position is unfathomable to most people - Greenlight has assets under management in excess of $5 billion, so GMCR was likely a relatively big position in terms of dollars.
Now it appears that Einhorn is looking to make money off of a plunge in Herbalife (NYSE: HLF) shares. The sell-off in the high-flying network marketing company began on Tuesday after Einhorn asked some potentially pointed questions on the company's conference call. In particular, Einhorn wanted to delve into the company's distribution system for its weight-loss shakes, fitness formulas, and energy boosters.
The gist of Einhorn's questioning focused on the perception that Herbalife is little more than a multilevel-marketing scheme. It is as yet unclear if Greenlight Capital has a short position in the stock. The hedge fund manager asked management for details about the hierarchy of supervisors, distributors, and consumers through which the company's products reached their end markets.
He then asked why the company had stopped providing figures categorizing its lower-end distributors as self-consumers, small retailers or potential sales leaders.
"I didn't view it as valuable information to the business or to the investors," replied CFO John DeSimone. He then told Einhorn that he'd be happy to email the breakout to him. "Our objective is to be completely transparent."
Einhorn replied, "That'll be helpful. Thanks — thanks so much, guys."
During the call, as soon as Einhorn started asking questions, the stock began to fall, closing Tuesday's trading session down 20%. Shares fell sharply again on Wednesday and have lost another 9% to $48.24 on Thursday. All in all, shares have lost nearly $20 since the conference call with Einhorn.
Perhaps the real testament to the money manager's sway is the fact that most analysts along with HLF management have subsequently called Einhorn's line of questioning "basic" and "elementary." In a statement, the company said that the Greenlight manager had "raised no new subjects or concerns. They were elementary questions usually asked by investors new to our industry. These are issues that have been thoroughly addressed before."
The company added, "Our business fundamentals are very strong and we are confident in our financials, our disclosures and our network marketing business method."
Many analysts are backing the company's assertions that Einhorn's questions were fairly straightforward and had been addressed numerous times before. On Thursday, HLF stepped up their defense and announced that they had struck a deal to buy back $427.9 million in shares, concluding the remainder of its previously-authorized $1 billion buyback program.
So what is the bottom line on HLF in the wake of the large sell-off? The fact is that the company does have a somewhat sketchy, multilevel-marketingesque business model. Many, many similar companies have very bad reputations.
At the same time, however, HLF has been around for 32 years, has been trading on the New York Stock Exchange since 2004, and has made a lot of money, both as a company, and for shareholders. Last year this company had over $3.4 billion in revenues and net income of $412.58 million.
Herbalife is growing like wildfire in international markets and this is driving sales and earnings momentum at the company. Analysts continue to like the stock which has been a high-flier in recent years. Timothy Ramey of D.A. Davidson & Co. called the the drop in the shares a "major buying opportunity" and reaffirmed his "buy" recommendation on HLF. He thinks the stock could hit $150.00 in the next five years.
The analyst called Einhorn's line of questioning basic, and said "I didn't hear anything on the call that would indicate anything other than this will continue to be a great growth stock."
At the very least, Einhorn's entrance onto the scene has caused significant volatility in HLF shares. For traders and investors this volatility presents opportunity. The stock has been very active in recent days and will likely continue to present trading opportunities in the coming week.
Given the major price dislocation, longer-term investors will likely have a chance to make money in this name - if they pick the right direction. By all accounts this is a very attractive stock, and it is still unclear if Einhorn actually has a short position in it. Herbalife has a 2.49% dividend yield at current levels and the stock is now trading at a forward P/E of 11.37 and a PEG ratio below 1. It looks very cheap.
Einhorn's reputation for sniffing out accounting problems and overvalued stocks, however, makes this situation fraught with danger. At the very least, long-term investors should wait for HLF to settle down before scooping up shares in the hope of a big rebound. After all, David Einhorn isn't always right, but he is right frequently enough, and dramatically enough, to make Wall Street sit-up and take notice.
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