Tuesday, July 23, 2013

It was the night before Christmas... falsifying Bill Ackman's Herbalife thesis

It was few days before Christmas and Sahm Adrangi (from Kerrisdale Capital) pinged me (on Google Voice) asking if I had an opinion on Herbalife.

I responded: "why bother? Crowded short."

I knew a little about Herbalife. It was a multi-level-marketing scheme (MLM) selling mostly weight loss products. This was a scheme where instead of buying weight loss products from a grocer or a specialist shop I purchased them from a friend. And the friend could make money two ways - either by selling product to me or recruiting me to sell product to other people.

I have long held a distaste for MLMs seeing how Amway used to behave in Western Sydney. Amway sold overpriced crap to distributors who were a collection of no-hopers and recovering drug dealers. (Contra: I also knew a very successful Avon lady... and she convinced me that MLMs sometimes sold useful products well.)

That said, Sahm just told me to listen to the Bill Ackman presentation. Sahm is crazy-smart so if he tells me to listen to something I listen.

Anyway, I unfurled myself on the couch at work for three hours of (Bill's) self indulgence.

Bill Ackman's thesis about Herbalife is that it is a pyramid scheme, hence

(a) illegal,
(b) unsustainable, or
(c) both illegal and unsustainable.

He has several key slides to support this thesis...

First he makes out that people don't really know what Herbalife is. He uses comparable companies being Church & Dwight, Energizer and Clorox.

I confess to knowing few Herbalife products - so this was modestly convincing.

He then - using that piece of rhetoric asserts that Formula 1 is the only $2 billion brand that "nobody has ever heard of".

So far, so good. He does not assert the sales are not real though (because they are). Indeed he acknowledges the company is real and that the gross margins are superior.

Through a process of elimination he shows that the gross margins are not a result of superior product (its a commodity), superior technology (they do not have any), superior R&D (they don't do any) or any of half a dozen other reasons you might have superior margins.

After that he asserts (and then tries to prove) that the gross margin and indeed the whole business comes about because it is a pyramid scheme.

He uses an old Federal Trade Commission (FTC) definition of a pyramid scheme - and it is the definition which we will go with because this determines whether Herbalife is illegal (in the US anyway) and the FTC definition overlaps with what would commonly collapse as a pyramid anyway.

Here is the slide defining a pyramid scheme.

This legal definition is the core to the whole Herbalife story - so I will write it out:

If an organization sells goods or services to the public and the participants in the organization obtain monetary benefits from (1) recruiting new members and (2) selling the organization's goods and services to consumers, the organization is deemed a pyramid scheme if the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers. [Emphasis as per Bill Ackman...]

In summary: real sales to consumers is kosher. Sales to distributors (and not to end consumers) are not kosher. A little of the latter is OK (the distributors do need to have some stock). A lot of the latter is not.

The critical question is how much are sales to consumers.

And here the question arises: what is a sale to a consumer versus a sale to a distributor. After all if a distributor buys the product for their own use they are considered a consumer. If the distributor buys it to sell it (and they are stuck with it) then they are a failed distributor. End consumption is what matters here.

Slide 119 asks this question fairly directly:

To quote:

How much product purchased by Herbalife distributors is actually resold to Retail Customers?

The next slide repeats the now infamous David Einhorn question on a conference call (the one that caused the stock to drop 20 percent). It is a question that Herbalife answered very badly...

Again I will quote because it is critical:

Question #1 from David Einhorn: "First 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?"
Answer: We don't track this number and do not believe it is relevant to the business or investors.
The full text of the Einhorn question and answer session is at the end of this post...

Bill Ackman does not state it - but the question was asked on 2 May 2012.

Anyway this is a terrible answer and left Herbalife open to the Ackman attack because a surprisingly large proportion of the sales are not to externals but to people who are signed up as distributors. Self consumption by distributors is a critical issue and the company said they did not track it.

Three weeks later Herbalife was in damage repair mode - trying to distance themselves from this answer. Ackman puts up several slides dealing with this - a typical one is repeated below...

Again - for completeness I will put up the Ackman highlighted sections...

"...the attempt of Herbalife 101 was to break the distributors into single and multilevel. Why? Because A, it is truly single, and B, nobody questions single-level, knowing that most people who are in single-level aren't in it to make a lot of money. They are in it for part time or it self-consumption. If you go back to the old Avon model, before they were multilevel, right, self consumption, not even an issue. It is not covered on the FTC's website. It is expected."
And later...
I think it has been misrepresented as the product needs to be consumed outside the network, which it does not. A, the FTC said it does not. But B, wehn you think of the 82% of people at single-level, which is, again, that is all they are, it is not even a consideration as a challenge to the model.
Essentially the company eventually answered David Einhorn by asserting that the single level distributors are basically self-consumers - and hence part of the consumption set rather than part of the distributor set.

And this is the critical question. If the single level distributors are distributors without end sales then this is a pyramid. If the single level distributors are really consumers then this is not a pyramid, is legal and probably sustainable.

The company clearly has some explaining to do. What they are asserting is that millions of people sign a 48 thousand word distribution agreement, pay a $55 fee to become a distributor and buy product then just consume it themselves anyway. Bill Ackman clearly thinks this is BS.

The company asserts they do this because if they sign up as a distributor they get a 25 percent discount. It makes their personal consumption cheaper.

Bill Ackman then asks the following (possibly rhetorical) question:

Again to quote:

Why would anyone pay $55 to get a 25% discount when Herbalife products are widely available online for discounts of more than 35%?

Ackman answers this question with the following slide:

Bluntly - and this is the critical step in his argument that "We Believe the Majority of Herbalife's So-Called "Discount Buyers" are, in Fact, Failed Distributors" [punctuation in Ackman original].

About this time Sahm Adrangi pinged me again. It was one of those classic Sahm Adrangi observations - super-smart but I don't think how smart he realized it was.

He said that Ackman's assertion is really funny. He was imagining billions of dollars worth of Formula 1 diet supplements sitting on people's shelves or in their garages unsold. They sell almost two billion dollars worth of Formula 1 per year - on my count roughly 120 thousand metric tonnes per year. Most of that is sold to "distributors" who may or may not be "discount buyers". If they are - as Bill Ackman asserts - "failed distributors" then maybe 50 thousand tonnes of this stuff are building up on shelves and in garages every year.

If that 50 thousand tonne per annum build up is real then Bill Ackman is right.

And if that 50 thousand tonne per annum build up is not real then Bill Ackman is wrong. He is falsified. The whole Bill Ackman thesis falls apart.

We at Bronte are really into our epistemology. We seek things that can falsify our thesis - and if our thesis does not conform to reality then it does not matter who we are (Bill Ackman or Richard Feynman) and it does not matter how smart we are, we are wrong. Indeed here is Richard Feynman explaining process...

Indeed this video (and you really should watch it - visitors by email should go to the blog) lays it out.

You make a guess. You calculate the implications of the guess. If those implications do not square with observation then the guess is wrong.

Ackman made a guess - the guess is that the "so called discount buyers are in fact failed distributors".

The guess implies that there is a 50 thousand tonne per annum build up of Formula 1 on shelves and in garages of failed distributors.

If that calculation does not conform to reality then Bill Ackman is wrong (and it does not matter who he is, how smart he is or how beautiful the thesis)...

Our attempts to observe the 50 thousand tonnes per annum build up...

At Bronte our version of investing nirvana is when we can find theses on which you can make or lose a lot of money. And then peculiarly we can design simple falsifiable tests. Sahm Adrangi (bless his brilliant soul) provided us our test...

Go find (or fail to find) that 50 thousand tonnes per annum build up...

To start I asked some Herbalife distributors (found via the internet) what their stockpile was.

The answers were so small that they could not possibly account for the necessary build up.

But I guess those are the successful distributors as they can be found via the internet.

So I tried to think like a failed distributor.

If I was a failed distributor I might have $2000 worth of this getting old on my shelf. I might (reasonably) want to recover some money. So I would sell it.

Where? Craigs List or Ebay.

If I found lots of desperate distributors - failed ones - selling it on Ebay then Bill Ackman is probably right. If there are no such people then Bill Ackman is wrong. Simple test. And I can do it for any city or country in the world from my desk at home. For example I could use a proxy server and log into Ebay in France and test there. Which is what I did.

Anyway here is an example - Craigs List, Chicago, complete Herbalife listing...

It is a grand total of six people, five of whom present as small time failed customer/distributors and one of whom is trolling for business as a continuing distributor. The small-time distributors have some opened product (as in I started this diet and it was not for me).

I have done this test for many cities - and I simply have not found the level of distress. However if you go to a city with a large Hispanic population you find a lot of adverts. Los Angeles has many but almost all of them are continuing distributors wanting to sell products. This is a typical advert:

This person has been advertising on Craigs List for some time.

There are also adverts pitching that if you "sign up with me" you can have a permanent 25 percent off your Herbalife products...

In other words they are pitching precisely the offer that Bill Ackman (rhetorically) thinks is implausible.

So far I have found nothing like the level of distress that would be implied if Bill Ackman's thesis is correct.

So I looked at Ebay. Linked is a typical seller... the seller has sold well over 2000 Herbalife items, all with a minimum price (typically a 35 percent discount to retail) and over a multi-year period. They often detail their use-by dates - and those use-by dates change over time (suggesting that the product was purchased at dates that also changed over time).

When you try to communicate with one of these sellers you work out the truth. They are higher-level distributors. They buy the stuff effectively at a 50 percent discount (or 42 percent discount) and sell it at a 35 percent discount and thus make a profit. They are not failed distributors. Instead they are discounters gaming the system by trying to capture the bulk of the profits of the chain.

I looked and looked. Honestly I did. And I could find no evidence of large sales at distress - the sort of sales that would happen if there were 50 thousand tonnes per year build up of unsold inventory in the hands of "failed distributors".

And so we have it. Bill Ackman had a thesis. I calculated the implications of that thesis (distress selling on Ebay and Craigs List). This observation did not accord with reality.

Therefore Bill Ackman is wrong. And it does not matter how beautiful Bill Ackman is, how smart he is, how rich he is, or whatever. He is still wrong. And there isn't any room for argument about it.


PS. Bill Ackman being wrong does not make the stock a great buy. Indeed Bill Ackman being wrong does not tell me the truth. I can't find the truth with any certainty. I can only falsify ... I have a series of theses about the truth but they are subject of other posts...

There could be one of hundreds of other things wrong with the company (and hopefully those are testable things).

But we can be certain of one thing: Herbalife is not a pyramid scheme in the sense promoted by Bill Ackman. We can take the 300 page Bill Ackman presentation and throw it out. Falsified...

And any journalist (Michelle Celarier) who continues to take Bill Ackman seriously on this issue has disconnected from reality.


Appendix - the full text of the Einhorn question and answer session

David Einhorn
I've got a couple of questions for you. First is how much of the sales that you make in terms of final sales are sold outside the network and how much are consumed within the distributor base?

Desmond Walsh
So, David, we have a 70% customer rule, which effectively says that 70% of all products is sold to consumers or actually consumed by 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. You know that we reported on this call for the first time, the number of commercial clubs around the world, which is in excess of 30,000. So that has given us visibility 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.

David Einhorn
So what is the percentage that is actually sold to consumers that are not distributors?

Desmond Walsh
So we don't have an exact percentage, David, because we don't have visibility to that level of detail.

David Einhorn
Do you have an approximation?

Desmond Walsh
So well, again going back to our 70% rule, we believe that it's at 70% or potentially in excess of that.

David Einhorn
Okay. What is the incentive for a supervisor to sign somebody up to become a distributor as opposed to -- if they're just going to consume it for themselves, as opposed to just selling them the product for the markup? How does the supervisor come out better?

Desmond Walsh
Sure. So I think there's 2 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 a greater retention of that customer/distributor because they are now earning a 25% discount. The second issue is that it preserves lineage. So obviously, if I sign you up, David, as a distributor, my hope and expectation is that based on the tremendous product result that you're going to achieve, that you will have friends and families go to you and say, gosh, David you look great, what are you on? You're going to respond and say I'm 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 would get and therefore, my greater likelihood of retaining you as 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.

David Einhorn
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 and make 50 points if he pays the full price. If he signs up as a distributor and buys it himself, he gets a 25% discount and I get 7 points as a royalty, is that how it works?

Desmond Walsh
No. You will get the other 25%.

David Einhorn
I'll get the 25% plus the 7.

Desmond Walsh
So unless you're earning royalties, you would simply earn the difference. So you're in a 50% discount, you're selling at a 25% discount. And so the difference between the 2 is your profit on that sale.

David Einhorn
Right. So if he signs up as a distributor and buys it for himself from Herbalife, I still get the 25%?

Desmond Walsh
That is correct.

David Einhorn
Okay, good. One last question. When you had your previous 10-K, you disclosed 3 groups of distributors at the low end. You called 29% self consumers, 57% smaller retailers and 14% potential Sales Leaders. And then that disclosure did not repeat in the subsequent 10-K. So I've got 2 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've stopped tracking or just stopped disclosing?

John G. DeSimone
This is John. The criteria for grouping distributors into different classes was based off of their volume purchases. And we make assumptions that people below are a certain volume weren't doing the business, they were buying self consumption. And I don't remember the exact amounts but I can get it to you after the call. It's how we delineated between the 3 classes. One of the reasons we took it out of the 10-K is a change in CFO for which to me, I didn't view it as valuable information to the business or to the investors. However, we can easily provide the exact same breakout going forward if you like. I could email it to you and to our investors. Again, I don't remember the exact delineation between the 3 classes but I can certainly get it to you. Our objective is to be completely transparent.


Anonymous said...

I don't have a dog in this fight, but I will try to think like a failed distributor and answer your question (and my wife is a failed NS distributor, so I can cheat a bit). I would not sell it. I'm too busy (read too lazy). I would let the stuff accumulate in my basement, in my garage, in the pantry. If I had company I would give some away. When it got really old I would either pour it down the drain or throw it away.

Anonymous said...

I should add that selling HLF stuff online, especially at a loss, is an admission that one made a bad decision, and who can do that? Just like bad stocks, who among us can admit they made a mistake?
That's why my wife had boxes of NutraSkin stuff sitting around for years - to do anything else was just too painful to think about.

uair01 said...

It is a well known sociological technique to analyze the contents of garbage cans. You could try this. Why not call your local gagbage dump and ask if they see big loads of unused Herbalife? Or ask your local garbage-person if they see it often?

CrimeBustersNow said...

John: Herbalife is a pyramid scheme.

There are three types of individuals supporting $HLF. First, and probably the majority; individuals who have bought into the $HLF brainwashing, unable to understand and identify pyramid/Ponzi schemes. Second, those who know very well it is a pyramid scheme; their motives in denying the fact; simply that they profit from the confusion. Third those backing Herbalife who claim they have no financial interest in supporting $HLF; their motives are more diverse and less comprehendible. But $HLF is a pyramid scheme; a pseudo corporation that is fraudulently representing itself as a lucrative “Businesses Opportunity.”

David Thornton

I notice than all All comments must be approved by the blog author. It will be interesting to see if this is posted.

Anonymous said...

Agreed with above - you are probably underestimating the laziness of a failed distributor and overestimating their sophistication. Plenty of people still aren't sophisticated enough to know to sell something on Ebay, and more still wouldn't be motivated by the prospect of recouping minimal losses. You are inherently dealing with a lower sophistication population anyway when talking about low end HLF distributors, so I wouldn't be surprised to not see "evidence of distress" online. It's a nice bit of critical thinking and research, but you give yourself too much credit on this one, IMO.

Anonymous said...

Why wouldn't the failed distributors just sell it back to the company?


CurmudgeonlyTroll said...

If it's a pyramid, shouldn't be too hard to sign up a significant fraction of the money-losers in a class action lawsuit.

There's a deep pocket and a supposed fraud that cost people a lot of money.

If they can't do that, if at least a few lawyers haven't already sniffed it out and done some cases, then it can't be a very good case.

Al said...

Like most of the other commentators, I view this argument as being low powered. The test rests upon the soundness of the notion that unsellable inventory will be puked out at distress prices.

Note that most Ebay sellers offer a 35% discount + free shipping. That begs the question of why non-failed distibutors, i.e. actually consumers, pay an upfront fee for a 25% discount of the same product.

Dan McGlinchey Emerging Growth Equities said...

John, love the logical procession of your report here and have always enjoyed your blog posts. However, have you done any tax analysis on a "failed distributor" writing off "unsold inventory" against earned income? There may be a real cash arbitrage there that explains some of the Ackman thesis.

Dan McGlinchey Emerging Growth Equities said...

John, wonderful logical progession throughout your report. and have always enjoyed your blog posts. Question I have: is there a meaningful tax arbitrage ie. "failed distributor" - collects his product discount and writes off unsold versus earned income from other sources?

CrocodileChuck said...

Excellent Karl Popper Test.



Peter Flaherty said...

Rubbish John. Not enough rigour.

I am a distributor. I signed up 6 years ago to get the cheaper product. I did not know I could otherwise get it cheaper, call be silly. I bought about $500 worth, used half and through the rest out.

There is no reason why you wouldn't just throw $500 worth of crappy product away.

I admitted I was wrong. I didn't want the hassle of recovering a hundred bucks or more. I have several items that have some value to someone's but usually just through it away. Too much effort.

Have you seem trash on local council collection days?

How may "failed distributors" like me need to through out their own "$500" every year?

Note that most distributors don't bulk store product, you only order what you need. So you'd have to be a lot stupider than stupid me to have $2,000 in stock lying around.

Seriously, compute that. What's the answer. I bet its entirely plausible that this is what is happening. That doesn't mean that Ackman is right - it just means your falsification test is wrong. It doesn't falsify the way you would wish it to.

Great post though, I enjoyed it.

Anonymous said...

Could you please post your calculation showing how USD $2B of Formula 1 equates to 120,000 tonnes?

Anonymous said...

Who cares what Ackman or what you think, the people who know nothing about this business model or products should stick to their rat race jobs or go try open a restaurant and see how hard work it is, most people have no idea about the time energy & focus and determination it takes to build any business !
long on hlf at 35 thanks Bill for an opportunity and thanks hlf U got some products and lost 23 pounds and feel fricking great !

Sambo said...

I'm sure that last before/after picture is just a woman when she is pregnant and then not pregnant.

Disclosure: long HLF calls, 2015 $25 and $30s - 3 bagger so far. Come on Bill - give me another one.


Anonymous said...

Simply one of the best posts on any blog in recent memory, highly entertaining and rigorous dissection of the story. This is why finance is so interesting, and it's just a shame that the proper stories so rarely come to light. More like this please!

Would say that the thesis needs further experimentation to falsify - usually the first problem in science (bad design or more often very sloppy procedure). Even if they're only discount buyers who end up with excess product surely the issue remains?

On a related note, Soros was also obsessed with Popper's falsification in his convulted attempt to join the ranks of the intellectuals. Generally, as a macro player myself, such clean theses are harder to test well in macro space (rates/fx) because there is more noise and I find you require a longer term view and stronger stomach for P&L volatility that the business and many in it do not share.

Thanks again

Anonymous said...

Does Bernie Ecclestone know that Herbalife is using the name Formula 1?


Anonymous said...

Everything on ebay sells at a 35% discount: jeans, toys, electronics, movies, etc.

There are too many risks like slow shipping, inconvenience, fraud, used sold as new, poor packaging, misleading picture, incorrect description, stale, expired, fake, mislabled import, etc.

I laugh at Ackman's ebay comparison he clearly doesn't understand the ebay marketplace.

abee crombie said...

Nice post. I do think you are missing a big part of Ackmans short, which is to publicize the short into trying to get 'distributors' to drop the brand, and thus cause a self fulling cycle that benefits the shorts.

I guess he is still waiting. But I'll give it to him, he was short Ambac for years before it finally blew up. http://factsaboutherbalife.com/

Activist investing to a new level!

PS . At least he wasnt short Tesla!

Tony Apostolides said...

I would like to share my experience from a man, who was my professor (Kostas Christopoulos) in economics and finance in Economics University of Athens, back in 2005..and set up a pyramid with high interest rates per month (even higher for those who brought more clients-victims) depending on the capital you had trusted to the MAN..

His target was the savings of the cleaning personnel of the university, the maintenance stuff and even some students (I guess the less clever ones). Later on I imagine he extended to any kind of believer, who seek easy money..The business went well for couple of years, the pyramid kept widening its base and the payment of the interest gradually faded and changed from monthly basis to biannual and then to none at all.

To make a long story short, I believe the Herbalife case, as any story who reminds us of a pyramid by the first look, it's actually a pyramid OR a potential pyramid.. IF THE ORIGINAL PRODUCT IS SOLD WAY OVER THE COST (more than 200%), creating the profit margin that gradually shrinks as we move down the pyramid. In our example the 50% discount at some point and then 35% I think.
In contrast to a normal business that sells its product with a 20-40% profit, leaving space to only large distributors to claim a piece from the pie and to the others (maybe small or part time distributors) no space at all, due to increased fixed costs, scaled economies etc..

-sorry for the long sheet!

P.S. The MAN is still in jail I think or maybe under the Greek law, is free spending the 15 million euros he embezzled in 2 years and carefully laundered using numerous off shores.
(original article in Greek - http://news.kathimerini.gr/4dcgi/news/economyepix_2Kath/edition?fdate=09/09/2005
google translated link in english -

njs said...


What about the hypothesis that pyramid schemes can profit off of failure.

I remember as a kid going to an Amway presentation and got the whole 9 yards that anyone who has been to one of these is familiar with (nice car parked out front, one sales person who is insanely successful, etc). Luckily, for myself, my father had educated me about the insanity and drear of MLM companies.

I had a friend who, against the advice of a bunch of us there, bought the scheme hook line and sinker. He became a distributor and convinced his friends and family to buy the product (a phone service), which a bunch of them did. When I talked to one of the people who bought from him they said they knew the product was crap (and in fact had kept their old phone service), but they were doing it out of pity for my friend. Needless to say the whole thing ended in a year and he ended up joining the Navy, but in that time I'm sure the company made a ton of money off of his failure.

I guess I don't disagree with your assessment that Ackman's thesis is wrong, but I still think that Herbalife is a pyramid scheme. That doesn't mean they aren't selling their product though. Eventually they will have pillaged and burned enough friends and family to come tumbling down. When is anybody's guess.

Robert Mae said...

This is nowhere near as alluring as the crime being perpetrated on Fannie and Freddie. Get to it, John, my interest is waning.

mokwit said...

Have you considered that the high level distributors selling on ebay bought the product to qualify that month for the commissions generated by their downline - it is worthwhile for a distributor with a big network to do this - he likely has to sell on ebay because product for downline is ordered direct by the downline so he can't sell the product direct to them maybe. He is not selling at a price that gives him a viable profit margin he is offloading unwanted inventory at just enough of a discount to entice buyers on ebay. Selling retail size to multiple end users as a high level distributor makes no sense and is not the best returning strategy - building and motivating the downline is (- selling his own seminars and motivational products is even better and maybe the real business for some/many/all).

Secondly have you considered how awkward it is to send back product - you likely have to physically deliver it back to their warehouse maybe at HQ (maybe can ship) and likely have to fill in forms etc - many small failed distributors in addition to not wanting to admit failure also would be of the level where they don't have the motivation/time off work to do it - especially if small amounts.

mokwit said...

With MLM one of the criteria for it not being a 'pyramid' as per 'Golden Products' and 'Holiday Magic' is the fact that there is a fixed retail price and purchase discount is the same for everybody at a certain level- but more discount at the top levels less at lower levels - profit comes from distributor discount not product markup.

In MLM there is just enough margin at the lowest level to maybe make part time selling of retail look worthwhile - especially repeat consumables to friends. With the old true pyramids I think you also had a class of priveleged ditributors (maybe volume based)and eventually with each level selling at a markup there would be a level of buyer who to make a profit would have to sell at a price that was not viable - i.e too high vs prices in the shops so no end consumers who would buy - that is where the pyramid stopped with last buyer as bagholder and no buy back.

C said...

John, I don't believe you have successfully invalidated the hypothesis because your test doesn't have the capacity to observe all the variables. We are talking far less accuracy than Heisenberg's uncertainty where there's a trade-off between position and momentum; in this case, the uncertainty being that we can't ascertain the amount of product disposed of by failed or active distributors, even with your thorough research; nor can we observe the amount of product sold to end consumers (perhaps why HLF don't state).

For all companies selling weightloss shakes the used by date works in the same way as planned obsolesence, the supplements require people to conform to a regime, albeit, many don't. Indeed, I have thrown out more protein powder than I wish to remember... In addition, I have seen HLF products stocked up in wardrobes of friends and relatives high up in the hierarchy. The difference with HLF products is that as part of the structure you don't buy when you need it because as a distributor you have to buy monthly (I believe), whereas, if you want protein powder you visit your local supplement shop. Arguably HLF products are thrown out at a higher rate than say GNC or BSC because the latter are bought at the consumer's discretion, and the former based on a minimum volume.

Assuming the goods will be sold online is assuming actor rationality, similarly, assuming visibility on unused HLF product is like asking a fat man if he has been sticking to his diet, arguably his shopping list will not correspond to his answer.

Full clarity on this I think is unattainable, HLF is a wilderness of mirrors.

Anonymous said...

Selling would be to admit to failure for most of these people, who; may have failed on the business as well as the diet!

Anonymous said...

@Curmudgeonly Troll - you can't find these consumers willing to form a class action suit because they only lose a few hundred dollars at a time.

Anonymous said...

As quite a few people pointed out, your analysis is flawed since you picked out only one way of detecting a failed distributor. By your own process, you failed.

That said, I do believe that your previous posts on HLF offered a much better thesis - i.e. that the product HLF sells is not the diet powder (which is a commodity), but the social network (whic is not).

The powder is just an excuse - and it can be well dropped down the sink or whatever, just to keep the social network.

So failed distributors may not matter, since they can knowingly keep in the game for reasons othes than acquiring the powder & money from that.

Then Ackman thesis is falsified much earlier - i.e. he misunderstands what is being sold.

Of course, it still leaves the question of whether HLF technically is or isn't pyramid scheme, and to show it isn't you'd probably have to show in court that the "side-benefits" are worth a lot to the customers.

Anonymous said...

The test that you had designed is also subject to falsification...

Your implicit assumption "majority of failed distributors will wish to liquidate their product online" has (prima facie) been falsified by people leaving comments...

Tom said...

Your scientific rigor falls apart on a simple lapse of logic. Since Herbalife products are non-durable, the evidence of widespread distributor failure would be huge volumes going into the trash, not building up. The trouble with Ackman's case is that this has been going on for a long time with no evidence that anyone wants to interpret the pyramid ban as applying to Herbalife. Nonetheless the company is potentially vulnerable to a sudden change of mind on that somewhere.

Anonymous said...

I worry about this post because I think you are doing it out of some feeling of intellectual superiority over Bill Ackman. I too read his paper over Christmas and unlike you, I was mighty impressed with his thoroughness and the expense he incurred to prove his case. However, you have won the argument because you saw a cash rich company which could afford to buy back stock and kill the shorts. That has happened. You have made money. Move on. Hubris is a dangerous thing.

Anonymous said...

Your analysis overlooks the issue of the discounted retail sale. Distributors can buy product at a 25%, 35%, 42% and 50% discount. If they turn around and sell the same product for that same discount, the only parties making profit on that sale are the upline distributors -- the markup has already been made.

When there is a greater incentive towards recruiting (because a distributor always profits off downline purchases but does not necessarily profit off their own purchases for retail) the scheme moves into the pyramid scheme territory.

TL;DR: There doesn't need to be a fire sale on products to indicate that Herbalife rewards recruiting unrelated retail sales, a discount at purchase price demonstrates this.

Anonymous said...

Wouldn't you think that Ackman could have - at the very least, found at least 1000 HLF distributors to illustrate his point? For crying out loud, he shorted $1 billion of the stock! Given all of your assumptions finding 1000 failed distributors to show the world should be easy. Show us how much each one of them lost. It wasn't done because it can't be done.

Shorts explain why, when surveyed, 87% of FORMER Distributors would recommend Herbalife products to friends and family, and 63% of former Distributors would recommend becoming an Herbalife Distributor.
Go to slide 47 here to see my reference... http://bit.ly/12WKL8E

As far as the laws being broken - the FTC has NOT been asleep. In fact, they recently closed down a MLM company without any press pressure or Ackman, etc...

Anonymous said...

Fascinating post.

But the ultimate question is not whether Herbalife truly is a pyramid scheme or not...

...but whether the FTC thinks it is. Falsify that.

Good ideas in any case.

Anonymous said...

John - really well written (as always).

However, the conclusion ("We can take the 300 page Bill Ackman presentation and throw it out. Falsified..." seems premature, under-developed and based on emotion.

For example, the 50kt pa seems plausible to me given it is not sitting in 10 or 20 basements but rather is being distributed and redistributed...and redistributed...and redistributed...amongst millions of people worldwide.

It seems plausible to me that 5kg of product is sitting in 10m basements/garages across the globe.

John Hempton said...

5kg is personal consumption. My cumulative personal consumption of protein weight loss shakes is about that since January. 20 pounds lighter.

The volume of GNC maybe half Herbalife and nobody doubts that it is consumed...

Wexboy said...

John - another take on this idea might provide some interesting/alternative feedback:

Advertise (on Craigslist etc.) that you want to BUY (large amounts of) Herbalife products, and see who/how much actually comes out of the woodwork...

Anonymous said...

Hey, try looking on ebay.com for herbalife. 4000 results. CraigsList? WTF?

Anonymous said...

Having an obsession with epistemology can lead to problems of its own. There are somethings that we don't know and can't know and as an investor you are better off accepting that, putting it into the "too hard basket" and moving on to other opportunities.

The pyramid definition turns on one fact - does the business generate sufficient sales to people who buy the product for the purpose of consumption to pay the recruiting based rewards. I don't know that drawing "logical" conclusions from isolated observations (e.g. is there an inventory pile up)provides any certainty in answering this question.

Although I hold no position in HLF and have no idea if it is or isn't a legitimate MLM I am personally suspicious of the fact that management do not publish or (as they have claimed) do not track the information required to form any sort of reasonable view on this issue. It appears they haven't even attempted to focus the argument on this point or made any effort to collect that sort of information if they do not have it already.

Anonymous said...

What are the chances of 2 top executives of one company die mysteriously within about 10 years apart ?

looks like the health is not so good !

Anonymous said...

Now a year later the share price is collapsing, so was Ackman so wrong?

Anonymous said...

This is terrible analysis masquerading as scientific method. You didn't find your assumed buildup of Herbalife product in one or two possible channels and you claim that means you've proved Ackman's thesis "false"? Did you check the storage unit of every hoodwinked believer who doesn't have room to shelf boxes of diet powder in his dwelling? Did you check every municipal dump for the expired product that the more pragmatic among the suckers would have thrown away?

As of yesterday's close, HLF is down 48% from its close on the day you posted this article. That doesn't prove Ackman's thesis (though it sure supports it), but it does prove your epistemology is horrendous. Talk about starting with a conclusion in mind and fitting the facts to your end.

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