Federal investigators and the FBI are looking into claims that activist hedge fund manager Bill Ackman hired cronies to send Herbalife Ltd. (NYSE:HLF) stock lower as his fund held a $1 billion short position in the shares, according to the Wall Street Journal.
HLF stock was rallying Friday on the news, trading as much as 14% higher. If the Feds can prove someone illegally manipulated HLF stock by intentionally and deliberately making false statements about the company to affect its stock price, heads will roll.
And the thought is that Herbalife stock will look a heckuva lot more attractive to many investors, too.
However, even if the probe turns up evidence of market manipulation, I think HLF stock is a dog. If you own it, do yourself a favor and sell on today’s uptick.
Fundamental Problems With Herbalife Ltd.
Ackman, the vociferous manager of Pershing Square Capital Management LP, an activist hedge fund, has loudly asserted that the HLF stock has been doomed for years. In late 2012, he argued that the nutritional supplements company was a pyramid scheme via a flamboyant 342-page slideshow, giving HLF stock a $0 price target.
Ackman’s fundamental thesis is that Herbalife’s top brass take home all the dough by signing up salespeople, most of whom produce sales for the company but can’t actually make any real money themselves. He considers such a business model unsustainable.
The jury is still out on those claims, and with investigators now shifting their attention to people tied to Ackman, who knows what to believe?
Luckily, investors don’t even need to know whether Herbalife is a pyramid scheme to reach a verdict on HLF stock: It’s a strong, strong sell.
Let’s pretend for a minute that the whole Ackman-Herbalife feud doesn’t exist and take a look at the cold, hard numbers.
Over the course of just four years, Herbalife’s long-term debt increased tenfold, soaring from $173 million in 2010 to $1.7 billion in 2014. This rapid leveraging — unwise in and of itself — also sent interest expenses through the roof. What was just a $6 million cost in 2010 morphed into a $79 million expense four years later. Not insignificant for a company with net income of $308 million in 2014.
Even without the constant pyramid scheme accusations, it’d be no wonder why the HLF stock price — even after today’s gain — is off 35% in the last year.
So where did all this debt come from, you might ask? And more importantly, where is the money going?
The debt is simply the result of bond issuances. As for what HLF is doing with the money, the theory is that Herbalife is buoying itself with stock buybacks:
“In 2014, Herbalife repurchased 19.7 million shares of HLF on the open market at a cost of $1.26 billion, or an average of $64.25 per share. This was after HLF repurchased 6.1 million shares in 2013 at an average price of $49.08 per share.”
As my colleague Matt Thalman notes, the depressed HLF stock price — just under $38 at the time this article was written — means that Herbalife “was essentially lighting money on fire by purchasing overpriced stock across 2014 while financing it with billions of dollars in debt.”
Bottom Line
With a multiyear streak of decelerating sales growth and revenues expected to actually decline in 2015, it doesn’t really matter what the Ackman probe turns up. HLF stock is a sell on its own merits, and today’s bounce presents the perfect opportunity.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.
