Bill Ackman Lays Out Herbalife Short Case

Shares of Herbalife HLF plunged on Wednesday after it was reported that hedge fund manager Bill Ackman had bet against the company's stock. Following that report, on Thursday, Ackman appeared at a special Ira Sohn investment event and laid out his thesis as to why he had sold short shares of Herbalife. Ackman started by noting the rapid pace of Herbalife's expansion, stating that, given the industry it operates in, Herbalife had grown at an amazing pace. He noted the curious fact that, despite the fact that Herbalife's product name was relatively well known, not many people had actually heard of any of their products. Ackman noted that the company spends almost no money advertising its individual products, instead Herbalife advertises only its brand name -- in Ackman's mind, for the purpose of boosting recruitment. Ackman then analyzed the company's various products, noting that they were largely commodities, and extremely overpriced ones at that. Most notably, Herbalife has few if any patents, which he said is strange for a company that claims to have such revolutionary products. Ackman also noted the company's tactics to create an air of credibility. In conference calls and business materials, Herbalife frequently makes references to its UCLA ties, claiming that it donates significant funds to the university for research and development. In reality, the company has only given UCLA about $1.5 million -- a paltry amount. Further, Ackman referenced the company's conflicting statements on research and development, playing a video of the company's CEO telling CNBC's Jim Cramer that they spent a lot of money on research and development. Ackman contrasted that claim with the company's SEC filings, which indicate that the company spends almost nothing on R&D. Ultimately, Ackman's criticism of the company came down to his allegation that the company was fundamentally a pyramid scheme. Herbalife, like many other companies, operates as a “multi-level marketing” company or MLM. In an MLM, products are sold by “independent distributors” who are compensated both for selling the company's products and for recruiting new independent distributors. Regulatory agencies allow MLM companies to exist, but place a careful restriction on them: To avoid a pyramid scheme designation, more than 50 percent of an MLM distributor's income must come from retail sales, rather than recruiting other distributors. Ackman argued that, in order to get around this designation, Herbalife placed ridiculously high suggested retail prices on its products. It then accounted for these products at their full suggested retail price, even though, in reality, these products were sold at a heavy discount, if at all. Following Ackman, Pershing Square analyst Shane Dinneen explained the intricacies of Herbalife's recruiting scheme. Dinneen broke down exactly how recruiting is rewarded and compensated for. At the time of writing, Pershing Square is still detailing its case against Herbalife. Check Benzinga for future updates. Shares of Herbalife traded lower during Pershing's presentation, falling about four percent to near $35.76.