WASHINGTON, February 18, 2013 – A disturbing tale of stock manipulation and personal intrigue has been unfolding on Wall Street since early December of 2012. It was at that time that the founder and manager of “activist”* hedge fund Pershing Square Capital Management, Bill Ackman, went on public record to denounce weight and health management products company Herbalife (HLF) as an illegal pyramid scheme, declaring that the company should be shut down by the Federal government. Almost as an aside, he casually mentioned he’d shorted 20 million shares of Herbalife, fully expecting it would drop to zero in the reasonably near future.
The result of this purposely shocking announcement: Herbalife’s stock subsequently tanked, massively. According to AP, HLF “hit a low of $24.24 in late December as a result of Ackman’s allegations, their weakest level since July 2010. Shares have lost close to half their value since the end of April.”
Enter, stage right, fellow stock market buccaneer and Ackman arch enemy Carl Icahn. Also known for his “activist”* approach to investing, Icahn got into an on-air shouting match with Ackman on CNBC last month when Icahn questioned the latter’s motives for his Herbalife grandstanding. “Icahn branded Ackman a ‘liar,’ a ‘major loser’ and a ‘cry baby’; Ackman called Icahn a ‘bully’ who ‘takes advantage of people,’” observes investor and “Seeking Alpha” writer Craig Van Pelt, whose cool analysis of this flame war we’ll get to in a moment.
In the case of Herbalife, the bone of contention, as is often the case with direct-sales—aka multi-level marketing—oriented companies (Amway and Shaklee come to mind), is Ackman’s accusation that the company’s compensation of its sales force is essentially a thinly-disguised pyramid scheme that enriches big seller-managers at the top of the food chain to the detriment of the little guys purveying product at the bottom.
Candidly, while we tend to be vaguely suspicious of the evangelism we encounter when individuals approach us to buy products from the aforementioned companies, we find nothing particularly wrong with their compensation models, all things considered.
We’ve also been to in-home meetings where selling at all levels is described and pitched, and have invariably found each system to be transparent, always detailing how those who fully participate in the company program will invariably make more money than those who sell a little bit on the side. So, any extra pressure aside, it’s always up to you how much, if anything, you want to contribute to the enterprise in terms of effort. (That said, emphasis is always placed on the positive, as it is in any sales organization.)
But back to Herbalife. In addition to the antics of Ackman and Icahn, the Feds, via the FTC, may have been nosing about a bit in and around Herbalife’s business tent as well. But that, too, is actually old hat in multi-level marketing businesses. Amway and Shaklee, too, have occasionally had to deal with this kind of government meddling, not to mention the occasional, well-promoted lawsuits from aggrieved sales reps.
More to the point, the Ackman attack on Herbalife’s stock, while not unprecedented in the annals of Wall Street buccaneering, is yet another example of how the SEC fallen down on its job of protecting the markets and ensuring a fair shake for the small investor.
Here’s how the little guy gets hurt by the likes of Ackman: Mr. Investing Bigwig, publicly attacks company X as a squadron of thieving swine. Almost as an afterthought, Bigwig announces he’s shorted an enormous amount of Company X stock. What happens next? Terrified individual investors and small hedge funds holding X immediately race for the exits, iMessage their brokers, and dump their entire positions in the stock.
And then what happens? Company X immediately experiences a waterfall decline in price. Those little guys lose plenty of money as they panic-sell, while Bigwig chortles, lights an expensive Cuban cigar with a stray Benjamin, and begins to calculate the mega-profits he’s about to pocket as panicking suckers make his massive short bet more valuable by the second.
Enter Carl Icahn, ritually worshiped by CNBC’s talking heads but nonetheless a market manipulator himself. He’s just as adept as Ackman but who generally manages to successfully court the press, so they usually make him look good.
CNBC knew and knows there’s been no love lost between these two Wall Street swashbucklers. So it was not very surprising when Ackman and Icahn came to virtual blows during the late-January CNBC interview piece that pitted them against one another, with things getting down to their plug-ugly best during a heated exchange on the topic of Ackman’s Herbalife Deathstar short.
After that ratings-enhancing blowup, the situation smoldered beneath the surface until last week when Icahn once again appeared on CNBC. He made the dramatic announcement that he himself had purchased 14 million shares of Herbalife—nearly 13% of the company’s outstanding shares. Icahn’s long position was designed at least in part to neutralize Ackman’s short position, particularly since a third investor, Dan Loeb of Third Point LLC—yet another investment firm—had come on board to scoop up 9% of HLF’s shares.
Icahn was typically candid about his own motivations. While maintaining, as he usually does, that his new position in HLF was strictly an “investment,” Icahn also took aim at his real target, Ackman: “I’m not going to lie to you and say if he gets squeezed, I’m going to cry and do penance,” he stated flatly on CNBC. “The fact that I don’t like Ackman you can say is the strawberry on top of the ice cream.” In other words, this is a public duel without reference to 2nd Amendment rights.
Ackman promptly got hit in his investment shorts after Icahn’s announcement as the wily senior investor had planned. HLF blasted off roughly 10% to the upside after the Icahn announcement, as investors piled back in the stock, largely on the weight of his legendary—but uneven—reputation as an individual who brings out value in underperforming investments.
Thus, we arrive at the current state of 2013’s Ackman and Icahn Smackdown. The dizzying up and down moves of Herbalife’s now-captive stock are relatively predictable, given each day’s dueling headlines. But the game is becoming even more complex, potentially developing another front. Ackman owns a significant number of shares in JC Penney, believing that the shares of that struggling retailer are finally starting to come around.
But last week, a major New York legal firm decided to launch a legal attack on a key series of JC Penny (JCP) borrowings, an issue that, if pursued, could bring down this veteran retailer and mall anchor at the worst possible moment. The hot rumor—no confirmation at the moment—is that Icahn is behind this legal move, which could quickly pressure Ackman on another, unexpected front, weakening his resolve in both his HLF and JCP maneuvers.
At this point, it’s hard to tell exactly which one of these fat cats is the villain and which is the hero. Both are not what the Prudent Man would regard as upright examples of either prudent investing or good sportsmanship. Ackman, in particular, has much to answer for, given the obviously self-aggrandizing behavior during the rollout and justification of his massive short HLF position.
We confidently predict the Feds won’t do a thing about the current Herbalife flap, at least when it comes to the manipulation of the company’s stock. The FTC business model inquiry is likely to go nowhere any time soon and the SEC is unlikely to get involved as long as a sister agency is involved in one aspect of the case.
Is there a way to make money out of this kabuki theater exercise? Craig Van Pelt, cited earlier, seems to think there is, finding Ackman’s “bravado” to be “pathetic, incongruent, and irritating.” In opposition, he finds that Icahn’s involvement in HLF “suggested the prospects of a recapitalization or a going-private transaction. HLF shareholders should be delighted. Ackman should be horrified.”
Van Pelt notes that in defense of his short position, Ackman has merely “offered platitudes, not proof of a failing company…His major premise is 100% dependent upon regulators putting HLF out of business.”
As “HLF has been in business 32 years,” he continues, “[t]he suggestion of a 32 year FTC ‘coma’ [with regard to its sales accounting and business model] is simply absurd. The applicable statutory regulations are quite clear, they haven’t changed much over the years, and HLF has always maintained cadres of lawyers from the most powerful law firms to make certain that the Company was in compliance with all regulations.”
Practically speaking, writes Van Pelt, “it would appear that Pershing’s position is more than 80% of the market’s entire short.” Given HLF’s recently reported positive sales figures, plus the powers arrayed against Ackman’s (Pershing’s) short, he believes it’s far likelier that Herbalife could be “worth 103.93” in a leveraged buyout situation, not to mention the fact that the stock is worth more than its current price (~$73 per share) anyway.
An LBO, or something similar to it “would be catastrophic” for Ackman, making him “the victim of one of the greatest and most deadly short squeezes in history.” This leads Van Pelt to declare “I’m long HLF and I’ll stay long until Icahn makes his final move.”
But the game is still afoot. Dan Loeb recently revealed he’d recently sold off part of his Herbalife position. This may or may not have been an opportunistic reaction to Icahn’s recently announced long position, allowing Loeb to decrease a portion of his own position for a profit.
What would we do with HLF stock? Is there indeed an opportunity here? Short answer: we think there is. More thoughtful answer: While HLF has clearly become a news-driven trading vehicle stock, it may be quite some time before the company can be traded again on its merits.
Given that most of the relevant news on HLF is out, and given that the market itself will be prone to increasing volatility as the sequester issue in Washington reaches its crescendo, it may be most prudent right now for all but the most adventuresome investors to stay on the sidelines with regard to this stock. It’s up to you, of course. But the Prudent Man thinks there will be more than enough opportunity to lose money in the next three weeks or so. Why try your luck on a chancy roll of the dice?
Meanwhile, although it seems to be a thankless and hopeless task, we would once again urge the SEC to forget individual careerism, step up to the plate, and start getting serious once again about protecting the small investor by bringing back the original short-sale restrictions, eliminating the unfair advantages of high-frequency trading (HFT), banning dark pools and other methods whereby trading results in select areas are hidden from the average investor, and, above all, putting an end to the blatant, public manipulation of stock prices by well-heeled, unscrupulous investors and investment firms that inhabit that fabled 1% Club.
*Activist. Word frequently used by political journalists to provide cover for political Marxists; and by financial journalists to give cover to greedy, self-aggrandizing large investors and firms whose predatory tactics against publicly traded companies are usually obscured by their publicly proclaimed “Robin Hood” intentions.
Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He currently has a small face amount of bonds issued by Icahn Enterprises IEP but neither holds nor currently plans to hold HLF shares.
Any positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.
Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.
References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any ar500ticle under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.
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