Herbalife Slams Ackman on Twitter: Why That Could be Terrible for Shareholders

Embattled multilevel-marketing giant Herbalife has taken to social media to defend itself against hedge fund manager Bill Ackman. Dubbing him the "Worst of Wall Street," the tweet is part of the company's aggressive response to critics it accuses of running a smear campaign.

Herbalife has every right to defend itself against attacks it believes are baseless (Ackman and others have described the company as a pyramid scheme). However, the company's investors might wish to reconsider their stakes in the wake of this finding: Historically, companies that have aggressively gone after their short-selling skeptics have, more often than not, proven those critics right.

Attacking the shorts is a bad sign
"If you own shares in a company that declares war on short sellers, there is only one thing to do: sell your stake," The New York Times' Gretchen Morgenson wrote back in 2003. She continued:

That's the message in a new study by Owen A. Lamont, associate professor of finance at the University of Chicago's graduate school of business. ...The study, which covers 1977 to 2002, shows not only that the stocks of companies who try to thwart short sellers are generally overpriced, but also that short sellers are often dead right.

Lamont's study looked at the trailing performance of 270 companies that had been targeted by, and chose to respond to, short-selling campaigns. The responses varied in significance -- from accusing their critics of fraud, to suing the short-sellers, to making it difficult to borrow shares. Overall, the stocks of these combative companies underperformed the market by an average of more than 2% in each of the 12 months after the company's response.

Working to create a short squeeze is an even worse sign
Lamont found a difference in performance based on the actions the targeted companies took. Those that sought to reduce their float, impeding the ability of short-sellers to borrow their stock, did the worst -- underperforming the market by around 5% a month.

This is the strategy Herbalife appears to be employing. With large portions of the company held by just a handful of investors (Carl Icahn with nearly 17%, Bill Stiritz with more than 6%, and Richard Perry and George Soros each with about 5%) and the multilevel marketer engaged in an aggressive share repurchase program, Herbalife bulls have consistently argued that the company could be on the verge of a major short squeeze.

Lamont warns investors to stay away
But Lamont's research suggests investors would do well not to bet on such an outcome. "Wall Street wisdom suggests that high short interest stocks are good to own because they may rise due to a short squeeze," he wrote. "[But] the evidence shows that when firms take anti-shorting actions, their stock returns are extraordinarily low over the subsequent months and years."

Of course, there are a variety of possible explanations for this outcome, but one stands above the others: Often (though admittedly not always) those entities that were accused of fraud were, in fact, fraudulent, and were put at severe risk by the short-sellers working to expose their con. The companies that responded to their critics had the most to gain by such action, while those that were doing nothing wrong could simply go about their business, confident that things would work out in the long run.

To put it another way, when I see this picture on Herbalife's social media page, I am reminded of a famous Shakespeare quote: "The lady doth protest too much, methinks."

A better investment than Herbalife?
Give me five minutes and I'll show how you could own the best stock for 2014. Every year, The Motley Fool's chief investment officer hand-picks one stock with outstanding potential. But it's not just any run-of-the-mill company. It's a stock perfectly positioned to cash in on one of the upcoming year's most lucrative trends. Last year his pick skyrocketed 134%. And previous top picks have gained upwards of 908%, 1,252% and 1,303% over the subsequent years! Believe me, you don't want to miss what could be his biggest winner yet! Just click here to download your free copy of "The Motley Fool's Top Stock for 2014" today.

The article Herbalife Slams Ackman on Twitter: Why That Could be Terrible for Shareholders originally appeared on Fool.com.

Sam Mattera is short shares of Herbalife via put options. The Motley Fool recommends Twitter. The Motley Fool has the following options: long January 2016 $57 calls on Herbalife. 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.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story