Herbalife Swings and Misses in Rebuttal


If the stock market's reaction is any indication, supplements seller Herbalife did less to help its public image than did hedge fund operator Daniel Loeb's decision to go long on the stock. At least after he took a large 8.2% stake in the stock, the market sent its shares soaring. When Herbalife addressed the accusations against it that it was a pyramid scheme, the stock fell more than 3%. Maybe management needs to let others do the talking for them.

Pershing Square Capital's Bill Ackman threw a high and tight pitch at Herbalife's head, and the supplement maker should have responded with a presentation yesterday (if not sooner) that would've knocked the ball out of the park. Instead, they opted for the safety of a bunt that still leaves investors wondering if it can make it in the big leagues.

Safety in numbers
Most multi-level marketing organizations have had the charge of "pyramid scheme" hurled at them at one time or another, save perhaps more venerable names like Tupperware and Avon Products. But USANA Health Sciences, Medifast, Mannatech, Blyth, and Pre-Paid Legal have pretty much all had their organizations challenged as modern-day chain letters (Pre-Paid was even accused of being akin to Bernie Madoff, with the result being the Tupperware of legal services is now a privately held company).

That the group has largely survived intact with some even advancing after the tumult bodes well that Herbalife will also get beyond this episode, but that seems to be its biggest defense it offered up: Everyone else is doing it, so they're honest brokers, too. Even the Girl Scouts essentially run an MLM operation, they said, and no one criticizes them.

The story goes on and on
Management did say that Ackman mischaracterized its business, and while his critique of labeling everyone a "distributor" may hold water, the rest of his attack falls short of reality. Of course, for his part the hedge fund operator also accused Herbalife of distorting his presentation and leaving many of the biggest questions unanswered, including alleged "overstatements and inaccuracies" in the company's earnings statement for distributors that ignores the fact 93% of them have no gross earnings. Ackman will be making his own rebuttal soon.

And therein lies the risk for Herbalife. It should have responded to the charges right away, just like it did when everyone got nervous after David Einhorn appeared on an earnings conference call early last year and asked a lot of questions. Management was forthright and transparent in its answers and subsequent actions to create more openness.

After Ackman's bean ball, however, the company left the charges hanging out in the open for a good month or more, and then gave what I thought was a tepid response. Calling its nutrition centers places where people can get hugs along with a healthy drink -- "the world needs more hugs," its president said -- is hardly a suitable response to the rough and tumble of the marketplace. By dragging the process out, it keeps questions about the company's viability and efficacy front and center in the minds of investors.

It doesn't help that the SEC has launched yet another investigation into its operations, either. While the third inquiry is unlikely to find anything more amiss than the prior two did, it's another chink in its armor and means doubts will linger on.

Learning to choose your battles
There's an old political adage that says, "Never pick a fight with someone who buys ink by the barrel," meaning you shouldn't argue with the media because they can go after you all day long. In the Internet age, when bytes are more plentiful than ink, it's still a good maxim that many should abide by and one Herbalife should heed.

Another aphorism is "the best revenge is living well." If Herbalife is more than just a multi-level marketing pyramid scam, then the truth will out and its results will speak for themselves. As a short-seller, Ackman saying he believed the stock would go to zero was simply a bit of grandstanding, playing his book to help his short position. He might very well believe it will collapse, but the durability of those that have gone before in similar circumstances suggests it won't. By keeping the story in the headlines over extended periods of time only serves to help his profits and does nothing to help investors who've stood by the supplements seller.

Multi-level marketing companies do suffer from the inherent power of math: There are only so many people they can get to sell their products, and then no more. When the distributor is also the customer, they are an end user, as Herbalife says, but it's not building the long-term relationship that was promised -- and it will strike out in the end.

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The article Herbalife Swings and Misses in Rebuttal originally appeared on Fool.com.

Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of Tupperware Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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