The core bear case for Herbalife is that these distributors are deceived - and that there are not huge numbers of real sales - and that the bulk of the sales are to people who are buying it for the business opportunity rather than to consume the product in its own right.
Indeed for this to be a pyramid at law the company needs to be selling the majority of its product to distributors who are not buying this for deliberate personal consumption but rather for the business opportunity.
If the majority of sales are to people who are not active distributors there is simply no way that this is a pyramid. A reasonable summary of the pre-Burn Lounge law from an anti-Herbalife slant is given by Dan McCrum at the FT.
Even he would concede that if a majority of sales were to people who were not active distributors with a valid distribution contract then Herbalife is not a pyramid scheme.
There are several steps to the argument.
Size of Herbalife sales
A large number of people on Wall Street have positions on Herbalife without having thought clearly about its size. It doesn't appear much in their social circles so it must be small.
Bill Ackman sneers at them when they say their competitor is McDonalds.
Each packet contains 15 fifty gram meal replacements (see the label above). So if it were all meal replacement there would be 896.2 million meals replaced per quarter.
That would be 3584.7 million meals annually.
Not all of this is meal replacement though. My guess [explained above] is that only 58 percent of sales are meal replacement.
That would suggestion 2079.1 million actual meals annually.
Mr Ackman sneers when the company compares itself to McDonalds. But hey - I want to.
Here is the comparison: based on number of meals served Herbalife is about 8 percent of the size of McDonalds. [For comparison Herbalife is about 5 percent of the market cap of McDonalds. It does not make sense to compare revenue because McDonalds has a lot of franchise revenue - but it is - for completeness - roughly 18 percent of the revenue of McDonalds.]
Herbalife sales per distributor
This number is increased considerably from when Mr Ackman did his original presentation. The 2011 annual report listed 2.7 million independent distributors.
(b). The majority of Herbalife product is consumed by people who are not distributors or
I think we can reject hypothesis (a) very easily. The company generates huge amounts of cash and was buying back stock rapidly before Bill Ackman came along without blowing the debt out unreasonably. [They have bought even larger amounts more stock since Bill Ackman and the net debt has now risen sharply.] They would not have had the cash to buy back stock if the revenue numbers were falsified.
And I think we can reject (c) above pretty easily too. I have spent considerable time looking for the inventory and I can't find it. It is not on Ebay or Craigs list (as per this post). Besides you can now return it for a full refund - so having unsold inventory sitting in the garage is stupid and unlikely.
So we are left with the middle choice - the majority of Herbalife product is consumed by people who are not distributors.
Corrections and amplifications:
There are two amendments that need to be made to this post. The first is that I got the volume points wrong.
Here is a Herbalife label with volume points:
The 550 gram packet is 23.95 volume points. The 750 gram packet is 32.75 volume points. This would make my comparison less extreme and serves to undermine the argument above.
However the labels (and considerable practice) suggest that the way that this is consumed is mixed with skim milk and some fruit and blended - with the dose being 25 grams not 50 grams.
Putting those things together the calculations are more extreme, not less extreme than in the article above. [My guess - there are more than 15 million consumers who consume reasonable amounts of Herbalife product - meaning more than weekly.]
Bluntly there is too much Herbalife sold for a majority of sales to be internal to the distributor base. The sales must be external.
These numbers are utterly consistent with this press release (link) from Herbalife which suggests that 80 percent of sales are outside the network. In which case the FTC will go away.