Friday, November 21, 2014

Herbalife Dying - Part 1

We have to digress from Genting a bit given that this story is probably worth telling. We shall get back to Genting soon, hopefully the stock stays low! 

Ok, Herbalife, as most people would know, is an MLM scheme. MLM stand for multi-level marketing which is a legalized form of pyramid or ponzi scheme. We shall get into this in more detail later. Back to Herbalife. Herbalife sells some nutrition stuff by recruiting people to sell to their friends and their friends hopefully sell to even more friends. Herbalife claims that its products are healthy, very good for the body and apparently also help with weight management! What's more, the seller can make impressive passive income by become a distributor selling Herbalife products to others. It has operations all over the world, including Singapore and it has made huge monies. In recent years, revenue is close to USD 5 billion and net profit of USD 500 million. So this is no small fry!

Herbalife logo

Now MLM while disgusting, is quite legal. Many companies use MLM rather than traditional distribution (like via NTUC or internet) to sell stuff. In a ponzi scheme, which is illegal, there is no product involved. A person pays say $100 to join the ponzi scheme and benefits when he can recruit more downline (say 5 friends each pay $100 to their original upline friend). He takes a cut from his friends and if his friends recruit more people then he earns more. This obviously is unsustainable and hence outlawed in many countries when it became well known how the trickery works some 80 years ago.

However, MLM introduces a product (usually something qualitative with intangible benefits like health products, cosmetics etc) and if the value of the product exceeds 50% of the transaction, then it becomes legal! Now this makes things quite tricky because numbers can always be played around. Of course not all MLM are bad. Insurance works on the MLM concept and Tupperware was originally sold via MLM. But I would say that majority of MLM out there are dodgy and it is best to avoid them wholesale.

Ok, back to Herbalife.

The story begins when a famous hedge fund manager Bill Ackman uncovered the atrocities that Herbalife committed. Herbalife years ago started out selling to rich overweight people who can afford their overpriced health drinks but as it would, growth ran out. In order to continue growing, Herbalife in recent years started targeting low income and less educated sellers to help generate more earnings for their upline. The master salespeople dangled carrots of nutrition, weight loss, huge passive income and managed to con tons of these people. 

Here's how things work. A successful upline guy would usually invite a friend or two to one of Herbalife's health supplement party where they get to sample herbalife products. There will be lots of people at these parties but mostly already Herbalife people and everyone appears happy and chatty and it's easy to get sucked in and buy some of these overpriced stuff. Maybe like $200 for a week's worth. I believe in the a very short term, the product could have some visible health benefits, so people get hooked.

As time goes by, these people get persuaded to setup their own party or as Herbalife calls it: Nutrition Club to get more downline, sell more Herbalife products to their friends and earn passive income! Alas, most people cannot fork out $200 every week so 90% of these Nutrition Club owners see their life savings get sucked into buying inventories and inventories of Herbalife products. Some of these clubs become the neighbourhood childcare centre as the other low income mums and dads put their kids there while they go to work. There were sob stories of how families were ruined as they got conned into a promise of strong passive income for life but ended up broke with truckloads of unsold Herbalife inventories.

Due to some legalities around MLM, Herbalife cannot put up its logo and sell its products outright so Nutrition Clubs are not discernible from the outside. Usually, the interior is also pretty badly done up since most of these owners would not have money to invest in capex. The nice parties that they went to were akin to "mock" setups that doesn't represent most real nutrition clubs.

Supposedly a Herbalife Nutrition Club

In short, Herbalife was a con job, according to Bill Ackman, who uncovered most of these stuff in a 300+ page presentation a few months back. In fact he started shorting Herbalife about 2 years ago and repeatedly reported that it was a mega ponzi scheme waiting to blow up. However, given Herbalife's strong earnings growth, nobody believed him. Most unfortunate for Bill, another richer and more well known hedge fund manager Icahn bought Herbalife and squeezed up the stock price. Herbalife went from $40 to $80 and Bill Ackman lost a billion dollars at its peak. They went on TV and got into a vicious "gladiator fight show" with the media. It was bloody. 

Meanwhile Herbalife itself was feeling some heat from Bill and decided to launch its own fightback. It retorted some of Ackman's claim point by point in its investors' day presentation. Reading some of the slides reminded me of this famous Chinese story about a guy who duck a hole and buried some gold, but he was afraid that somebody might take it and hence he wrote,"there is no gold underneath this soil" and stuck it exactly where he buried the gold. Now if Herbalife is doing a legit business and making honest money, why does it need to make a big fuss over some hedge fund manager's claim?

Was it more than meets the eye? Stay tuned for Part 2!


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