Herbalife could soon be breathing easier
Herbalife, which has survived multiple scrapes with regulators since the 1980s, is at a crossroads in its fight against investor William Ackman, who has long denounced the company as a fraud.
Shares of Herbalife (HLF) surged last week after the multilevel marketer of nutritional supplements announced it was in talks with the Federal Trade Commission to settle the agency's investigation into whether the company is a pyramid scheme. The probe started in 2014, two years after Ackman took a $1 billion short position in Herbalife's stock, meaning he was betting big that the shares will lose value.
The stock has given back some of those gains this week after Herbalife announced that it has miscalculated the growth rate of its members. In Friday afternoon trading, it was 5.3 percent higher, or $2.77, to $55.19.
Headquartered in the Cayman Islands, Herbalife has vehemently denied Ackman's claims and argued that the recent membership growth errors didn't have an impact on its earnings. It declined to comment for this story, as the FTC and Ackman's Pershing Square Capital Management also did.
Experts who follow the multilevel marketing industry are skeptical that Herbalife will face significant punishment. The company has said it wasn't sure how the FTC talks will end but noted they could lead to a "settlement which could include a monetary payment" among other things.
"Ackman's information about the company was right," said Tracy Coenen, a forensic accountant who has long been a multilevel marketing industry critic. "His investment theory was wrong. They are a pyramid scheme all day long, but the government (isn't) going to shut them down because our government agencies have taken the position very clearly that they are going to allow multilevel marketing to exist."
In determining whether Herbalife is a pyramid scheme, the FTC faces many challenges, such as the fact no federal rule defines what a pyramid scheme is, according to William Keep, dean of the School of Business at The College of New Jersey and an authority on multilevel marketing.
"The issue here is a resource issue as much as anything else," he said. "In cases where the defendant has chosen to fight the charges, they have often taken years to prosecute."
The FTC last year asked a federal court to shut down Vemma Nutritional Co. because it was allegedly operating a pyramid scheme, a case that Pershing Square says could serve as a model for prosecuting Herbalife. While similar to Herbalife, Vemma is a much smaller company, earning about $200 million in sales annually. Herbalife reported revenue of $4.5 billion in 2015.
Herbalife also has many fans among investors. Its shares have surged more than 75 percent over the past year, and Wall Street analysts expect the stock to rocket from around $55 now to $73 over the next year.
Ackman reportedly is losing money on his bet that Herbalife's stock will fall. And the company continues to post impressive growth rates. New members in the U.S. grew by 30.7 percent in the fourth quarter. While that was below the 70 percent Herbalife originally reported, it represents a sign of progress from the 1.8 percent gain seen in the third quarter, according to Meredith Adler, an analyst with Barclay's Capital.
"Although this is a big cut in the growth rate, we think most investors would have been pleased with 30.7% if it was the only number they had been given," wrote Adler in a note to clients. She has an "overweight" rating on the stock. Membership growth in "China also dropped markedly, to 3.2% from the prior 16.7%," Adler added. "This is disappointing, but we think the fact that the number is still positive is important."
The Direct Selling Association (DSA), a trade group, has long argued that the multilevel marketing industry can police itself. However, LegalShield, which provides legal protection to more than 1 million members in 49 states, recently quit the organization for failing to enforce its ethics standards. And Avon Products (AVP) left the DSA in 2014 because it said the organization's standards weren't strict enough. A DSA spokesperson didn't respond to a request for comment.