GMI RATINGS: Here Are Some More Red Flags About Herbalife


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By Lev JanashviliHerbalife’s battle with its detractors is heating up. The consumer products company (NYSE: HLF) has lost about 60 per cent of its market value since April of 2012. Short interest in the stock, a gauge of investor pessimism, has increased by more than 500 per cent over the past year.

The latest data from ThomsonOne, published yesterday, places the short position in HLF at 26 million shares. In the meantime, Herbalife’s recent media coverage mainly focuses on whether the company more fully fits the definition of a Ponzi Scheme or merely a bad investment.

The company is fighting back. It has retained a law firm and a strategic advisor and scheduled an investor meeting in New York for January 10 to rebut the charges advanced by high-profile hedge fund managers, primarily Bill Ackman of Pershing Square Capital Management, L.P. and David Einhorn of Greenlight Capital.

Embattled but not alone, Herbalife has emerged as a tarnished icon of the multi-level marketing (MLM) industry, which also includes household names such as Avon Products, Tupperware Brands Corporation as well as smaller and private companies such as Nu Skin Enterprises, USANA Health Sciences, Inc. and Amway. While Ackman’s and Einhorn’s charges explicitly target Herbalife, they implicate the entire MLM industry. Not surprisingly, many of the MLM stocks have been trading in tandem.

GMI Ratings does not yet take a formal position on the ethics or legality of multi-level marketing, but we do encourage investors to remain mindful of basic ESG and accounting-related risks that may affect Herbalife’s performance. Specifically:

  • Co-occurrence of share repurchases and insider sales — Earlier this week, we included Herbalife in a list of 43 companies flagged for the co-occurrence of significant buybacks and insider sales. In our view, investors in these companies can reasonably pose the obvious question: If the repurchase truly reveals the management team’s conviction that the market undervalues the company’s stock, why would insiders sell stock at the same time? More importantly, why wouldn’t the insiders personally buy the shares?
  • Governance/Compensation Practices — Our ESG rating for Herbalife includes red flags for excessive executive compensation relative to peers, weak links between compensation and performance, a combined CEO/Chairman role, a classified board, and others.

  • Accounting Red Flags — Herbalife is flagged for “Cost of Goods Sold/Revenue”. Relatively low or declining cost of goods sold (COGS) is a primary indicator for possible expense recognition problems. If a company has much lower COGS per dollar of revenue than its peers or has experienced declining COGS in relation to sales, then one of two explanations must apply. Either the company operates more efficiently than its competitors, or it is excluding certain expenses from the COGS account. In particular, management may be misclassifying costs into other areas, such as SG&A. Alternatively, management may be capitalising costs that should be expensed as COGS.

The full report with a list of Herbalife’s ESG and forensic accounting risk metrics is available for download on the GMI Ratings website.


GMI Ratings is an independent provider of research and ratings on environmental, social, governance (ESG) and accounting-related risks affecting the performance of public companies. GMI Ratings is a registered investment adviser and is therefore subject to certain reporting requirements. Specifically, per our ethics policy, our analysts are precluded from engaging in any transactions involving any companies we follow. Our ratings and supporting research are intended to provide investors with an effective summary of ESG and forensic accounting factors that can and do impact issuer risk. They are not, however, intended for stand-alone use and should not be considered as simple Buy, Sell or Hold recommendations. We encourage investment professionals to regard these ratings as a specialised, proprietary input to be used in combination with existing fundamental analysis or other approaches and to help comply with the UN-PRI (United Nations Principles of Responsible Investing) and similar standards.

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