Is David Einhorn Going to Short Herbalife’s Stock?

May 1, 2012
J. Webster
Comments Off on Is David Einhorn Going to Short Herbalife’s Stock?

Herbalife’s (HLF) stock is tanking perhaps in large part because David Einhorn is asking some questions on their earnings call about 10K disclosures related to distributors and might be going short the stock.

This is not the person you want investigating your company for any reason. The famed short seller and Poker player bites and doesn’t let go like a dog and his bone. He is most famous for shorting shares of Lehman Brothers, FirstSolar, Green Mountain….and the list goes on.

CNBC’s John Melloy with the news on Twitter.

Again, you just don’t want David Einhorn asking any questions about your company. He once wrote a book, Fooling Some of the People All of the Time: A Long, Short Story, about shorting Allied Capital – he saw that their accounting was corrupt and went short for years and years. If he sees something wrong in your books he will chomp down.

The Wall Street Journal has the transcript of the David Einhorn questions here.

(Q – David Einhorn): I got a couple of questions for you. First is, how much of the sales that you’d make in terms of final sales are sold outside the network and how much are consumed within the distributor base?

(A): So, David, we have a 70% custom rule which is basically says that 70% of all products sold to consumers or actually consume my distributors for their own personal use. So obviously what we’ve seen with nutrition clubs is that we now have visibility for the first time to our customers. We know that we reported on this call for the first time the number of commercial clubs around the world, which is in excessive of 30,000, so that has given us feasibility to the tremendous amount of products that are being sold directly to the consumers and we see that as a growing trend in our business.

(Q – David Einhorn): So, what is the percentage that actually sold to consumers that are not distributors?

(A): So, we don’t have an exact percentage David because we don’t have visibility to that level of detail.

(Q – David Einhorn): Do you have an approximation?

(A): So well again going back to our 70%, where we believe is that it is that 70% or potentially in excess of that.

(Q – David Einhorn): Okay. What is the incentive for supervisor to sign somebody up to become a distributor as opposed to – if they’re just going to consume for themselves as opposed to just selling them the product for the markup. How does the distributor – how does the supervisor come out better?

(A): Sure.

(A): So, I think there are two reasons for that. So, we know from our business today that many of our future supervisors and business builders come in as customers and then they become distributors. So, the benefit from a supervisor is the ability for greater retention of that customer/distributor because they are now earning a 25% discount. The second issue is that it preserves linage. So obviously, if I sign you up David as a distributor, my hope and my expectation is that based on the tremendous product result that you’re going to achieve that you’ll have friends and families go to you and say, gosh David you look great, what do you want. You’re going to respond to them, I’m on Herbalife, and that will encourage you to say, wow maybe this is a business opportunity I could be interested in. So, the benefit for me as your supervisor is one, the discount that you would get and that for my greater likelihood of retaining, it was a permanent customer and secondly, the hope that at some stage, you will decide to do the business and therefore that you are already in my lineage and is part of my group.

(Q – David Einhorn): Right. But just trying to understand this clearly, if I sell to a customer, I bought it – I’m a supervisor, I buy at a 50% discount, I sell to a customer, I make 50 points, if he pays the full price. If he signs up with a distributor and buys it himself, he gets a 25% discount and I get seven points as a royalty. Is that how it works?

(A): No, you would get the other 25%.

(Q – David Einhorn): I will get 20% plus the 7%.

(A): So, unless you’re are on royalty you would simply are in the difference. So, you are in a 50% discount, you are selling at a 25% discount, and so the difference between the two is your profit on that sale.

(Q – David Einhorn): Right. So if he signs up with a distributor and buys it for himself from Herbalife, I still get the 25%.

(A): That is correct.

(Q – David Einhorn): Okay. Good. One last question, when you had your previous 10-K, you disclosed three groups of distributors at the low-end. You called 29% self consumers, 57% small retailers, and 14% potential sales leaders and then that disclosure did not repeat in the subsequent 10-K. So, I got two questions, first of all how do you track that and how do you characterize and know which ones are which? And second, why did you stop disclosing that in the last 10-K? Is that something that you stopped tracking or just stopped disclosing?

(A – John Desimone): David, hi, this is John. The criteria for grouping distributors into different classes was based off of their volume purchases and we are making assumptions that people below of certain volume. While doing the business, they were buying soft consumption and I don’t remember the exact amounts, but I can get it to you after the call, as how we delineated between the three classes.

And one the reason that we took out of the 10k is a change in CFO from which to me I didn’t view it is valuable information to the business or to the investors. However, we can easily provide the exact same breakout going forward if you would like [indiscernible] into our investors. Again, I don’t remember the exact delineation between the three classes, but I can certainly get it to you. Our objective is to be completely transparent, so.

(Q – David Einhorn): Thanks [indiscernible], I appreciate that sort of follow up, that will be helpful.

(A): Thanks.

(Q – David Einhorn): Thank you so much guys.

To me, if you’re business model has even the faint hint of a pyramid scheme or some kind of tiered payout system for distributors, it seems a little too mysterious. Einhorn isn’t showing all his cards but I think he’s got something up his sleeve. Careful Herbalife, you’re going up against a wise one.

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