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Opportunity’s ‘Call’-ing in Herbalife

'Reverse Einhorn Effect' offers intrepid option players big upside


On April 30, nutritional supplement distributor Herbalife (NYSE:HLF) reported vibrant earnings that easily bested Wall Street expectations.

The company said it saw a higher-than-expected first-quarter profit of $108.2 million, or 88 cents per share, compared with $88.7 million, or 71 cents per share, the prior year. Herbalife also said revenue rose 21% to $964.2 million. Analysts were anticipating earnings of 81 cents a share on revenue of $892.9 million.

The only sour note in the announcement was Herbalife’s forecast second-quarter earnings, which it said likely would come in slightly below estimates.

The following day, Herbalife shares were sold off hard after Greenlight Capital hedge-fund manager David Einhorn asked some very pointed questions about the company’s financials during the earnings conference call. The stock fell more than 20% that day, and trading actually was halted twice while the NYSE sorted out the heavy order volume.

Einhorn’s specific questions pertained to how Herbalife quantifies distributors, consumers and other clients. Einhorn also asked the company why it stopped disclosing the percentage breakdown among its distributors. The questions brought up concerns about how Herbalife quantifies its business, and that brought out the sellers in droves.

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The chart here shows the dramatic plunge in the shares due largely to the Einhorn’s questioning of the company. The “Einhorn effect,” as it has come to be known, is indeed powerful, because when Mr. Einhorn asks questions, companies tremble.

The latest victim of the Einhorn effect is Martin Marrieta Materials (NYSE:MLM), which plunged more than 10% on May 16 after Mr. Einhorn’s comments during the Sohn Investment Conference in New York City. Past victims of Einhorn’s keen wit include now-defunct Lehman Brothers, St. Joe (NYSE:JOE) and of course, trader favorite Green Mountain Coffee Roasters (NASDAQ:GMCR). All wilted under the focus of Einhorn’s lens, and all sold off on his respective bearish calls.

Now, however, there might be a reverse Einhorn effect in play. In fact, it has come to a point now where what Einhorn doesn’t ask is news. In the case of Herbalife, the stock rose 17% the day Einhorn didn’t list it as one of his least favorite stocks.

For options players, the tumult in Herbalife shares represents both a cautionary tale, and a tale of potential opportunity. Cautionary, as it shows how fast a stock can crater when it’s followed by Einhorn. Opportunity, as it shows that even when Einhorn stays silent — perhaps especially when he’s silent — the shares can spike significantly higher.

I think the more important thing here is that Einhorn’s recent silence on HLF means his initial conference call questions were more clarification-type inquiries than anything else. That means that in retrospect, investors were too quick to dump HLF based on those questions.

In the case of Herbalife, one needs to look at the fundamentals, which despite the noise from the share price, haven’t changed at all since the company reported those robust earnings. Herbalife still has great growth prospects, and the company continues expanding its operations in growth markets such as Latin America and China.

In fact, based on the strength of its earnings, strong growth prospects and the “Reverse Einhorn Effect,” bullish options players might want to look at the slightly out-of-the-money HLF Jun 2012 45.00 call for a quick trade. That option expires on June 15, so if you want to have a little more time to let things play out, then a good alternative is the HLF Jul 2012 47.50 call.

As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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