This morning we learned that Dan Loeb is long nutritional supplement company Herbalife, and now we know why.
Loeb hashed out his thesis in his latest letter to investors — his hedge fund, Third Point is up 21.2 per cent for 2012, and 9.2 per cent for Q4, by the way — and said that fellow hedge fund manager Bill Ackman’s short against the company is “preposterous.”
After going over Herbalife’s awesome stats ($29.87 billion in sales with 20-50 per cent growth each year since 2004). Loeb gets to the heart of why the company is not a pyramid scheme, as Ackman has said.
From the letter:
The pyramid scheme is a serious accusation that we have studied with our advisors. We don’t believe it has merit. The short thesis rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for three decades and will shortly awaken (at the behest of a hedge fund short seller) to shut down the company. We find this to be preposterous.
He goes on to say that the FTC’s regulatory framework makes it possible for multi-level marketing companies to conduct business legally. Not only that, but he adds that while Ackman’s presentation was “lengthy” there was “little new ‘news’ in the presentation” or evidence to show that Herbalife had crossed into breaking the law.
… even the short seller conceded that the FTC was not looking at Herbalife’s practices. In our experience, expert regulators like those at the FTC do not respond to sudden pressure from a hedge fund whistleblower by acceding blindly to their demands. Finally, even if there were some regulator intervention, we are comforted by the fact that 80 per cent of Herbalife’s revenues come from overseas.
Here’s how it ends:
So we return to our compounder thesis, available at an attractive discount, probably for a limited time only. We believe that continued strong operating performance combined with disciplined capital return could easily send the stock back towards its April highs. Let’s not forget: the business itself is performing well. Volume, revenue and earnings are all growing double digits and the balance sheet is largely unlevered. Management has a history of returning 100 per cent of net income to shareholders in the form of dividends and buybacks. If management were to deploy its existing $950 million buyback authorization in the $40-45 range (only taking leverage to approximately 1.5x), we estimate that run-rate EPS for 2013 could be $5.50-5.70 using the reduced share count. Applying a modest 10-12x earnings multiple suggests Herbalife’s shares are worth $55-$68, offering 40-70 per cent upside from here and making the company a compelling long investment for Third Point. Given that the Company has historically traded more in the 12-14x range (and traded at 16-20x earnings through much of 2011 and early 2012), the opportunity for the Company to tell its side of the story tomorrow at its Analyst Day in New York, and the significant short interest, we believe shares could even trade well above our current price target.
This is very similar to another Herbalife long, John Hempton, who has made the same argument. Yes, there are some business model issues, but the FTC is not going to act on them on the behest of a billionaire hedge funder.