Messrs. Ackman and Icahn are locked in a very public battle of wills over the value of Herbalife Ltd. Mr. Ackman has taken approximately $1 billion or about 20% short position in Herbalife, while Mr. Icahn has countered with 13% long stake in the company. The two investors have dueled out the arguments on CNBC for half an hour in January. Meanwhile, the company’s stock price has fluctuated from a closing high of $72.69 to a closing low of $26.06 over the past year. The stock closed at $36.79 on February 22.
Mr. Icahn’s newly-acquired large equity position makes him a legal insider according to Securities and Exchange Act of 1934, since he now owns more than 10% of the common stock. Going forward, Mr. Icahn will need to report every transaction in Herbalife shares within two business days to the SEC (Section 10a). Mr. Icahn will also be subject to other restrictions on insiders such as Sections 10-b (no short swings profits within 6 months)
Based on simple valuation metrics, the stock price seems attractive. Nevertheless, in my academic research (with Professor Amiyatosh Purnanandam), I have found that when insiders and shorts disagree about the valuation of the company, it is usually the case that the insiders win and shorts lose. More specifically, insiders tend to win and shorts tend to lose, if shorts increase their short interest while insiders are increasing their long positions. Similarly, insiders tend to win and shorts tend to lose, if shorts cover their short positions while insiders are selling the stock.
Shorts also win sometimes. In general, shorts tend to win if their transactions agree with those of insiders. Hence, shorts tend to win if they trade in the same direction as insiders. Shorts also win if they trade in the absence of any insider trading.
While we do not know how Herbalife Ltd. controversy will shake out, it is instructive to take a look at what Herbalife insiders have been doing. Recent SEC filings show that Herbalife officers and directors have bought $3.8 million worth of shares while they sold $67 million in shares. So far, this favors the short position.
However, most of these insider sales have mostly occurred early before the Ackman-Icahn controversy, at an average price of $61.80. To get a clearer picture, I focused on post May 2012, after the prices started dropping significantly. Since October 2012, insider purchasing is actually running ahead. Insiders have purchased $3.8 million worth of shares while they have sold only $1.7 million of shares. The sharp turnaround from insiders selling to insider buying suggests that at least some insiders consider recent low stock prices attractive. This tends to favor the longs.
We will watch and see how this interesting battle shakes out.