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Why Activist Investor Bill Ackman Is Wrong in His Short Position Against Herbalife

According to GuruFocus Real Time Picks, on Feb. 26, Carl Icahn (Trades, Portfolio) added Herbalife Ltd. (HLF), at an average price of $66.62 and currently holds 17 million shares of the stock, worth 0.01% of his portfolio. So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity when other hedge fund managers think it is a pyramid scheme and not a real business.

The Largest Network Marketing Companies in the World

Herbalife is a global nutrition company that sells weight management, meals and snacks, sports and fitness, energy and targeted nutritional products as well as personal care products. The company distributes and sells its products via a network of independent distributors, using the direct selling channel. The Asia Pacific region accounted for almost 30% of net sales; North America 20%; Europe, the Middle East & Africa 15%, South & Central America 17%; Mexico 12%; and China 6.8%.

The China Business

A few days ago, the New York Times published an article in which it detailed Bill Ackman (Trades, Portfolio)'s strategy pressure an investigation of Herbalife's distribution model which he calls a "pyramid scheme," where a company makes most of its money by recruiting distributors rather than selling products to real customers. Ackman has disclosed that his hedge fund, Pershing Square Capital Management, has sold short the company's shares. In November 2013, he admitted on Bloomberg TV that Pershing Square's open short position in Herbalife was "$400 million to $500 million." Ackman's latest attack on Herbalife is to discuss company documents obtained from a former employee about the business model in China.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 13.4x, trading at a discount compared to an average of 19.9x for the industry. To use another metric, its price-to-book ratio of 12x indicates a premium versus the industry average of 1.58x and the price-to-sales ratio of 1.5x is above the industry average of 0.9x. Two of three metrics indicate that the stock is relatively undervalued relative to its peers.

Earnings per share (EPS) increased heavily in the most recent quarter compared to the same quarter a year ago (15%). We include in the next graph the stock price because EPS often lead the stock price movement. As we can appreciate in the chart, the price performance makes the stock appealing with an upward trend over the last 10 years.


Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. With a ROE of 95.7% is well above the industry mean of 7.24% and GNC Holdings Inc. (GNC).

Final Comment

Herbalife's revenue growth has outpaced the industry average (19.8% versus 9.6%). I expect this trend to continue as well, as the significant earnings per share improvement registered in the last quarter. The stock price increased by almost 61% over the past year, which is really good for investors seeking capital appreciation. Hedge fund gurus Carl Icahn (Trades, Portfolio) and Daniel Loeb (Trades, Portfolio) have taken long positions in the stock.

On the other side, as we have analyzed earlier, Ackman after taking a $1 billion short position in shares and pressured regulators to investigate, is betting on a price drop. What should we do depends on following Mr. Icahn or Mr. Ackman. Because there's almost nothing about whether Herbalife is indeed a pyramid scheme, I would recommend investors to consider adding the stock for their long-term portfolios. The firm currently has a Zacks Rank #2 ( Buy).

Hedge fund gurus have also been active in the company in fourth quarter 2013. Gurus like Chuck Royce (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Jim Simons (Trades, Portfolio), Steven Cohen (Trades, Portfolio) and Richard Perry (Trades, Portfolio) have also invested in it.

Disclosure: Damian Illia holds no position in any stocks mentioned.

This article first appeared on GuruFocus.