Monday, March 24, 2014

Herbalife internal consumption: a comment

The debate on Herbalife has come back to the issue of internal consumption - that is how much of Herbalife's product is consumed by their own distribution network rather than external customers.

Peter Vander Nat - an economist for the FTC - has written a paper which gives Herbalife bears a lot of succour. He doesn't much like internal consumption. If Peter Vander Nat's paper is decisive then Herbalife will have a very tough time with regulators.

Dan McCrum - one of two consistently anti-Herbalife journalists - harps on about internal consumption as being the hallmark of a pyramid scheme. Here is yet another article.

And the most ardent Herbalife bull (and I am an ardent bull) must admit that a multi-level-marketing scheme where all the consumption is by people in the pyramid gives you pause. You have to ask where are the real customers? And if there are no real customers then surely it is a pyramid as a matter of fact (if not a matter of law). And pyramid schemes will eventually collapse on their own - they don't need the FTC to bring them down - even if government action speeds up the process. [And that is an important point - if the Ackman thesis on Herbalife is correct the government action doesn't change the end result - just the speed at which that result happens.]

But it is also clear that not all internal consumption is problematic. I have no problem with a young woman signing up as an Avon lady so she can buy cosmetics at a discount. I am sure plenty do. And if she takes half an hour putting on make-up in preparation for Saturday night - isn't that real consumption?

And I have spoken to several Herbalife customers and they are mostly signed up as distributors and they do not intend to sell product. They are signed up simply to get the 25 percent discount. Some even bulk up their orders between a few of them to get 35 percent discounts - but they still intend on making no retail sales except to themselves as a "buying club". Indeed when I went to the Herbalife in Queens I spoke to several people who were real customers and were proud of the weight that they had lost being repeat customers over many months. They were buying Herbalife at full freight from one distributor (the owner of the nutrition shop) and were themselves Herbalife distributors to buy product at a discount at home. These people never sold Herbalife except maybe a little to family members. But they still purchased Herbalife independent of their own distribution arrangement and clearly and publicly consumed it.

I should (overriding my bullishness) explore this - a crux issue in the Herbalife debate neutrally. I expect bears to comment - and I figure this will wind up being more than one post. So lets give an example of clearly bad internal-consumption and an example of clearly-good internal consumption. I am not saying whether either of these examples predominate or even exist within the Herbalife network - but just outlining what might be a very bad position for Herbalife or a very good position for Herbalife.

Whether the examples exist or predominate is a fact to be checked on the ground - not a theory to be hypothesized. The FTC I hope will check the facts on the ground rather than pontificate on theory.

But then I suspect the FTC will be better than many a Wall-Streeter. There are many people who have an opinion on Herbalife without doing their own research - and instead they borrow "facts" from convenient parties. Bill Ackman claims to have done a lot of research. I have done a fair bit and wound up at a diametrically opposed position. I don't expect you to take either of our claims seriously without doing your own research. We both have vested interests.

This post doesn't do the research for you. It outlines a process by which you can do it for yourself. There is very big money to be made here - Herbalife in the conception of the bears goes to zero. I think it goes well over $100 and probably eventually closer to $200.

This is a place where if you do the research you can know - and you can make a lot of money. But you also need to worry about the FTC deciding arbitrarily and - like much of Wall Street - not doing the research. [And that is a worry you need to have whether you are a bull or a bear. Arbitrary government decisions happen and they are not pretty.]

Anyway lets start with two examples:

Example A: Clearly bad internal consumption

If you are a Herbalife "Senior Consultant" you can get a 42% discount on your product if you place a single order of 1000 volume points. That 42% discount applies that month only. This is described in this video from a couple of very senior Herbalife distributors (the critical bit starts at 5:20):

This clearly encourages people to place one order - a "success builder order". And it is a pretty big order. A pack of Herbalife Formula 1 - the key diet shake product - is about 24 volume points - so the order would need to be over 40 packs of Formula 1 - each pack being 750 grams. With discounts the order is still around a $1000.

Now you could imagine a situation where an unscrupulous upstream distributor encourages someone to place such an order - explaining to them that this large order will make their margins 7 percent better (42 percent discount rather than 35 percent) and that 7 percent means that when they sell it to the throngs of waiting customers they will make more money.

And you could of course imagine that our hapless victim doesn't find the throngs of waiting customers - and is left with something like 30 kg of unsold (and in my opinion unpalatable) protein shakes and doesn't want to throw them out and so internally (ie self) consumes.

A "meal replacement" is roughly 60 grams - so our poor person either throws out their shakes, stores it indefinitely, starts selling it on EBAY or Craigs List in distress, or starts drinking very regular meal-replacement shakes. 30kg is 500 meals so they could self-consume this quite reasonably in two years.

But they may feel victimized. This would be bad internal consumption - inventory loading based on fraudulent business opportunities.

There are several defences to say this does not exist. Herbalife has a refund program for unopened Herbalife product sold to distributors - and the refund option lasts a full year. The refund does not include postage (so our victim will be out of pocket). Moreover the victim may not be aware they are entitled to a refund - and their upline will actively discourage them taking a refund as the upline will docked volume points. Moreover I have seen companies that overcharge for postage (postage as a profit center), and I have seen companies where it is almost impossible to cancel a contract or get a refund even if you are legally entitled. I have also seen companies where it is impossible to find details on the refund even when it clearly exists. So the facts of the refund need to be tested on the ground.

Whether these people exist or even predominate in the network is - of course - determined by facts on the ground. This post does not check the facts on the ground. It is thinking about things rather than actually doing those things.

Example B: Clearly acceptable internal-consumption

Very early in my Herbalife travels I met a Hispanic guy in a Herbalife club. He had been a customer for about twenty months. He had lost about 50 pounds and he would say to you with sincerity that Herbalife saved his life. He was signed up as a distributor.

He was sitting in a Herbalife club drinking a shake which he paid $5 for. This was the same price I paid for it - that is retail. This was real consumption - and he was not in the Herbalife club to participate in a scheme - rather he was there to chat with his friends and drink protein shakes.

My distributor had a job - and he had no intention of making a living selling Herbalife. His photo was on the wall of the Herbalife club as a success story - with gold-stars next to his name as he met weight targets.

Most breakfasts he came to this club on the way to work. He did it to chat with friends and the proprietor (who had become a friend if he wasn't a friend already). He was however a distributor as well - originally so he could buy the product for home consumption at a 25 percent discount though he had (being a true-believer in the product) sold some to product to friends and relatives. However that is incidental. Almost all the product he purchased he consumed himself.

But he is also clearly a real consumer - and he had come to the store maybe 200 times to consume and each time he had paid the same price a retail customer pays. His cumulative payments were over $1000. Over time I would expect him to spend a fair bit more than that.

This is technically self-consumption. This is product sold to an internal distributor - but it is very difficult indeed to argue it is problematic and Peter Vander Nat's assertions about the wrongs of self-consumption are clearly off the mark in this case.

The fact that this is an "internal sale" doesn't make the consumption any less real.

It has a characteristic that is important though - it is repeat business. Anywhere you see repeat business it is very hard to argue the customer is a victim. People get ripped off regularly - but they seldom go back to the same source to get ripped off again.

Perhaps the right question to ask is not the David Einhorn question of how much of the sales are to customers outside the base but how much of the sales are to repeat customers - and how often do they repeat. Repeat purchases by individuals are not consistent with inventory loading fraud even if the repeat purchases are internally consumed.

If the sales are to repeat customers then almost all of Bill Ackman's arguments fall apart.


Checking the facts on the ground

I know some people out there plan on actually doing due diligence. Here is a plan...

You could go and find a bunch of Herbalife distributors. Its not hard to do.

Get out an Android phone in any Hispanic-rich area. Ask it to navigate you to Herbalife distributors and start asking questions when you find them or do not find them. I did this starting at Avondale Arizona and took this screenshot. A similar screenshot in Corona New York is laced with Herbalife distributors.

If two days of legwork throws up a lot of people who may be internal consumption (they are signed up as distributors but drink the product) but that most of that internal consumption looks like my bad example then short the stock and send your detailed evidence to the FTC. [Send it to me too... I like knowing when I am wrong.]

If however the internal consumption looks like good internal consumption (repeat customers mostly) then Bill Ackman is wrong and it should be easy enough to convince the FTC that this is a real business and Ackman should be ignored.

I have met several customers who are true believers. They really believe Herbalife saved their life and it is a wonderful product - and they are mostly right. The cult-of-weight-loss shakes works for them. Herbalife has saved their life.

Herbalife's best defence is to get testimonies from more than 100 of them and send those testimonies to the FTC - or better get their customers to send the testimonies to the FTC. Before and after photos are good. If they get 1000 plus of these they win. After all 1000 plus people who have been in the meal-replacement game long enough to lose 50 pounds is good evidence of intended, deliberate personal consumption - and it shouldn't matter a jot whether the people are signed up as distributors. [Someone who actually loses 50 pounds is a real customer of a weight loss club no matter whether they work there or not...]

Short circuit this process:

There is a simple way of short-circuiting this process. You can for a few hundred dollars and some pain work out whether Herbalife is a pyramid scheme. Herbalife will hate me for saying this because it imposes costs on them.

The solution: sign up as a Herbalife distributor. Place a success builder order. See if all the information needed to get a refund is available easily available.

Try and get your refund.

If it is easy to get and they do not gouge you on postage then it simply cannot be an inventory loading scheme as-per-Ackman. For this to be a pyramid scheme you have to have literally millions of distributors stuck with unwanted inventory.

If the company offers and honours refunds to failed distributors then the idea that the whole scheme works by selling inventory to failed distributors is ludicrous.

If you do this take your position in the stock, send your information to the SEC and wait to profit.

Oh, and send it to me too. Always interested.

One for the observant

People who read my posts obsessively (and there are a few of you) may notice that in the screenshot above there is a Herbalife distributor in Botany Street Bondi Junction. Bondi Junction is not in Arizona, it is in Australia and it is where Bronte Capital has its offices. Its in there because I marked it in my personal Google maps.

The Herbalife distributor in that screenshot is United Online Business Systems - which isn't any old Herbalife distributor. It is the Australian arm of Shawn Dahl's distribution business. Shawn Dahl is the most infamous scummy Herbalife distributor - the one that sold leads and false business plans and is the centerpiece of most of Bill Ackman's examples. There is a very good story in the Verge about Shawn Dahl's business and Shawn Dahl was the first distributor Bill Ackman outlined when he started writing up the business of distributors.

It is kind of ironic that the iconic scummy Herbalife distributor is the closest Herbalife distributor to my office.

Shawn Dahl is no longer a Herbalife distributor. Herbalife kicked him out of their network. I could find no trace of his Australian office. [Fair point to Bill Ackman though: it took Bill Ackman before Herbalife got rid of Shawn Dahl. They should not have waited that long.]

Criticism where criticism is due

I don't normally criticize the press - but here I am getting a touch annoyed. The FT have written dozens of stories on Herbalife. The FT has journalists in dozens of countries. I am critical of Wall Street (myself included) for thinking about things but not actually doing those things. [I have spent a lifetime thinking about things without actually doing those things.]

I am double-critical of news organizations who report without leaving their desk and without checking the facts on the ground. But who - like me - are very good at theorizing.

The FT is uniquely placed to bring some rationality to this debate. One day they could send a journalist to a distributor in six or seven different jurisdictions. May I suggest (a) Corona New York, (b) Los Angeles, (c) Mexico City, (d) Kuala Lumpur, (e) anywhere in China, (f) Australia. KL is probably Herbalife's strongest market - so that is an important inclusion.

After doing this the FT will be able to answer definitively whether there are large numbers of real customers globally and those customers voluntarily consume the shakes because they want to consume the shakes, or whether the customers are just suckered distributors as per Bill Ackman.

It is however work - probably a day work for six journalists. But it is a great story - and real facts are the reason you buy the financial press.

I have done this mostly myself. However nobody will believe me because I have a financial interest in the results. Its time for the press to reassert itself as a conflict free arbiter of real data. For that I will gladly pay the several hundred dollars a year for the FT's strangely coloured pages.


PS. Dan McCrum - who seems to write most of the FTs stories on Herbalife - lives in London. London is strangely devoid of Herbalife clubs. I tried to find one to visit with Dan in London and flat-out could not. Herbalife in the UK ranks very low on Google Trends - and My Herbalife - which is the search you would do for the Herbalife distributor portal - barely ranks at all. Dan's location makes it very hard for him to do the checking on the ground his stories warrant. If there is criticism of Dan's work ethic it isn't meant. It is criticism only of location.


Unknown said...

I have recently begun to wonder if the FT is as independent as you presume. e.g. is it beyond the realm of possibility that journos are on the take?

John Hempton said...

I think it is vanishingly unlikely the journalists at the FT are on the take.

I have spoken with Dan McCrum and found him honest and competent. I disagree with him - and I wish he would get in a plane and start visiting Herbalife clubs.

But I would bet a lot of money at short odds on his honesty. That is a safe bet.


Phillip M. said...

few questions -

1 - how can even a minority of people who sign up to become a true distributor ever have a reasonable chance of achieving retail sales when Herbalife will allow that customer to sign up and receive a discount on the product themselves? Wouldn't this suggest that a vast majority of compensation comes from the distributor's down-line? (And I believe you need to be a supervisor to be paid commission on down-line purchases. So someone starting out would really need to upfront inventory load to get to that level).

2 - You speak of legit retail sales from nutrition clubs. By Herbalife's own definition, you paid for a daily pass to a private club and not an actual herbalife drink. It might be semantics but it is too quickly to be completely legit and count as retail sales. Herbalife structures this for 2 reasons - 1 - so clubs are not regulated as restaurants an 2 - so they don't break agreements with their distributors that there will be ZERO retail outlets which sell Herbalife products. If they deem nutrition club sales as retail sales, they are breaking their own agreement with distributors.

3 - in regards to repeat customers, Herbalife says that a vast majority of distributors sign up just for the discount. How come turnover in the low level has been reported to be 80+% per annum if you were to believe in the notion of repeat customers?

In my opinion, there is undoubtedly something structurally wrong about this business. It might not be taken down, but there is fragility in the pyramid structure. Any simple change to compensation structure takes this down quickly.

John Hempton said...


In question 1. If the Herbalife upline gets remuneration from downline sales even if it is internal distribution he has an incentive to encourage internal distribution. He will tell you you are losing weight. He will measure you. All good - that is what you are paying for.

But alas he will also discourage you from claiming a refund if you are entitled.

His incentive system is neither consistent nor inconsistent with pyramid. Facts on the ground please.

2. The semantics here are food laws... but you walk in you get a shake - you are a customer. Pretty clearly I was. Try it one day.

3. All diets have 80 plus percent drop out rates. But if most of the sales are to the 20% and the 20% stay customers for years then these are real repeat sales.

Again facts-on-the-ground. If you walk into clubs though most the poeple you see are the return customers. The one-off customers disappear. So my sample may be somewhat biased.

But in my sample there are LOTS of repeat customers doing lots of sales.

I presume there are also lots of people - a vast majority in the data - who do not stick to the diet.

No surprise there.

Unknown said...

I should have clarified the reporting on HLF is not my gripe with the FT. The example I am thinking of is at a minimum reverse broking.... This pretty much defines the Lex column.

Generalenthu said...

I am not sure if you have seen this (, but it is incorrect to say that Vander Nat sees personal consumption as problematic. He might be personally not OK with that definition, but that is not how he interprets the law.

There is some additional context on why the personal consumption language has crept into some consent decrees, but this is largely FUD propagated by the shorts.

Anonymous said...

Good article, but I do have 1 issue. You can't get mad at the Post or the FT for constantly running negative articles about the company. I think everyone would agree that the company is shady about literally every aspect of their business. Reporters generally spin dog shit to be bullish no matter what (hi CNBC and equity analysts), but nobody complains when stocks rise. can't have a double standard like that.

Also 1000 "success" stories could merely be a placebo effect or because the shakes have no nutritional value but take up space in your stomach making you feel full. the quickest way to lose weight (imo) is not eating. This last part is just speculation on my part

Jason K said...

Isn't it a bit self fulfilling conducting this type of research at herbalife clubs? You wouldn't expect people who have been ripped off or unhappy with their herbalife experience to show up and pay an admission fee at one of these clubs.

Proving that some legitimate customers exist is not equivalent to proving the majority of sales are to legitimate customers in my opinion.

Even if the 80% of customers turning over each year are simply dropping out as they would in any diet doesn't that significantly weaken the business case for herbalife? I wouldn't want to own a business where I can only count 20% of my customers in the last year as recurring (especially in this case where the whole pitch is based on herbalife bring a superior weight loss alternatives to other diets and products).

P.s I struggle to take much comfort from the anecdotal evidence of a few club members that herbalife is some sort of weight loss panacea. As heart warming as those stories may be I don't think there is much scientific evidence out there to support the efficacy of herbalife over GNC or any other equivalent (and cheaper) competitor products.

Unknown said...

John Connor -- what are you suggesting about the Lex team here at the FT?


Anonymous said...

John: The BULLS I know, long ago, visited nutrition clubs, talked to users, bought retail products, signed up as distributors, tried to inventory load, tried to return products, and analyzed the compensation scheme. Some even commissioned large scale surveys to measure brand awareness, consumption, and distributor intent. This is basic due diligence and took about one month! And this is why they're BULLS.

The BEARS I know simply regurgitate Ackman's presentations and haven't shown a single independent data point or evidence. Read Whitney Tilson's comments as an example. They are just jumping on the band-wagon and trying to drive the stock lower.

I think the FTC will recommend some changes (more disclosure on earning levels, less volume requirements, etc.) and use Herbalife as an example to reform the industry. And then the company will continue to print $9 in EPS in 2015 after buying back a ton of stock, and the stock price will be a lot higher than it is today.

Thank you for your post.

Anonymous said...

I might be wrong but Herbalife appears to be straddling the line between a weight watchers type phenomenon and a more traditional sports supplement factory (with associated muscle magazines and advertisements).

I was curious of the actual cost of these drinks compared to shakes I make myself.

I was surprised how bad they are and using the Formula 1 brand as an example, the nutritional value and ingredients put into each shake are horrible.

Each serve is 26 g, of that 9 g is protein (soy), 9 g is sugar (fructose), and 3 g is fiber. The fiber in this case appears to be in the form of cellulose powder. All of those components are about as bad as you can get in a meal replacement (MRP). It should not be difficult to find soy protein for $10 a kilo in bulk from farms in Australia. It is a rotation crop used to diversify and regenerate sugarcane land. The fructose is also incredibly cheap and herbalife should be buying it for less than a dollar a kilo from corn growers in the states. Cellulose is a bit more expensive due to the need to breakdown the lignocellulose but it is still very cheap (and cheaper still if it is just lignocellulose). There are additional costs for the flavouring but essentially the bulk costs are the protein/carbohydrate/fiber costs.

Each Formula 1 bottle (780 g) total contains ~30 servings (26 g per). That is 9 x 30 = 270 g protein ($2.70 @ $10/kg), 9 x 30 = 270 g fructose ($0.27 @ $1/kg), and 3 x 30 = 90 g cellulose ($0.18 @ $2/kg). If you want to also include the flavouring then you are looking at 2 x 30 = 60 g flavoring ($0.05 @ $25/kg retail [cheaper in bulk]).

Grand total of $3.20 per bottle. Just looking at ebay, these bottles sell for between $40 and $95. I'm not sure what the 42 % distributor price is but the margins look ridiculous considering the product being sold.

The model looks exactly like the model used in bodybuilding magazines from the 50s to the 90s. Protein shakes and MRPs with ancillary products to promote additional targeted healthfulness.

I think Bill Ackman is smart and trying to attack the herbalife brand, which is particularly troubling for a company relying on it's reputation to sell incredibly cheap and nasty product as an upper market good. He hasn't started investing in telenovelas yet but he will eventually realise his error.

If you are interested, look at EAS, they were a supplement company from the 90s. They sold ridiculously overpriced supplements that did nothing but tasted good. The price they charged ($150/kg) was insane. Eventually the market caught up and ate heavily into their market share. They still do OK because the market also grew very healthily but I just don't see herbalife having the same luck.

Letitride2 said...

John, What are the ingredients in a shake and how many are there?

John Hempton said...

The ingredients in a shake are Soy Protein Isolate and a few other things to get you to drink it (notably flavours).

The most important special ingredient however is the community group to get you to drink it. That is Herbalife's real model.


VandalsStoleMyHandle said...

I don't know the ins and outs, but a few things are clear: the FTC's rules are very poorly drafted and ambiguous. So a lot depends on which way the political and bureaucratic winds blow, which seems too risky to hang much of an investment thesis on.

I come here because I'm a fan of the blog and your thinking, so take that as given. However, the issue I have with this analysis is that it seems overly emotive. All this talk about saving lives comes across as shrill. After all, we're talking about bog-standard denatured protein drinks, not some new wonder drug. When you talk about Herbalife clubs saving these peoples' lives, rational discussion gets crowded out. What next, are we to infer that if Ackman succeeds, he'll have blood on his hands?!

HLF management come across as fairly shady, but that's OK. Buy the stock, fine; pecunia non olet. But singing HLF's praises in overly emotive terms crosses the line from analysis to spruiking, in my opinion.

Anonymous said...

Herbalife now pays for shipping on products returned to them. That is, there is literally no reason for a distributor to be 'stuck' with excess inventory.

From the most recent quarterly call on 2/19/14 (CEO speaking):

"We have an industry leading inventory return policy. Upon resigning, the member is entitled to a 100% refund on all products returned that are unopened and that had been purchased in the prior 12 months. We even pay for the cost of shipping on these returned products.

Equally important, these gold standard policies are not only in the member rulebook, as they have always been for many years, but now all new members are required to acknowledge that they are aware of these consumer protections before they even join us.

Additionally, a brochure containing our gold standard protections, as well as a hotline for reporting issues, is now included in every order beginning this week".

It seems to me that the litany of changes that HLF has made to its U.S. business practices over the past 12 months has enabled them to get ahead of many of the changes that the FTC is/was likely to ask them to make.

foobar said...

Why do you believe that going to a nutrition club is an accurate sample?

It seems likely to me that doing that is subject to both survivorship bias and selection bias.

Put another way it is not obvious that the people who go to nutrition clubs are representative of distributors as a whole.

rafaminos said...

Considering the fact that herbalife products have a 2-year expiration date (see :, massive inventories at the distributors would imply fire sales of the products which John has shown to be wrong (
That means that 1) either there are no inventories and the products are consumed or 2) refunds are possible and the entire inventory is with Herbalife
In either case, the company is not a pyramid scheme.
Considering the financial results, 1 would seem more plausible.

Phillip M. said...

Thanks for the reply Mr Hempton -

I just can't figure out a way to the math work. As an example, according to Herbalife's 2012 Statement of Average Gross Compensation for the US, of the 494k distributors, only 30%, or 143k, had a down-line. The rest, 351k, were presumably just in the scheme to be able to buy the product at a discount...

However, in 2012, Herbalife had $908M USD in N. American revenues. To be conservative, if you assumed that all of these revs were generated by distributors with a down-line and that 30% ($272M USD) of these revenues were paid out as commissions to them, it would only equate to an average monthly GROSS compensation of $158 dollars per person with a downline. Obviously this number is drastically reduced when you a) factor in that the 351k distributors with no down-line who obviously contributed to revs and b) realize that these distributor numbers are static and as of Dec 31st, 2012 and do not include all of the distributors who left throughout the year.

I personally have not seen anything which convinces me that actual meaningful retail sales exist.

Phillip M. said...

Facts on the Ground

Anonymous said...

Another thought provoking piece.

However, this issue cannot be removed by empirical evidence or "research on the ground". The issue is purely one of defining a legal test. Research will simply confirm or deny one view of the test, but not substantiate the legitimacy of the test in the first place. Confidence on both the bull and bear side of the argument based on rational empirical investigation is admirable, but misplaced.

Let me demonstrate. Lets say that product sales are almost exclusively for distributor consumption (which I believe empirical research confirms - yes I am relying on other people's footwork here). The company itself acknowledges this. Lets also say that much of these sales are for "bad" consumption - i.e. wasted or not actually consumed. Lets say further, that these "bad" sales were even as a result of inducement from potential financial rewards, rather than intention to consume.

Now, such a "worst case scenario" finding would fall a foul of the "Burnlounge" decision since, the sales would not have been made but for the inducement of financial reward. But, the scenario does not matter much to the tradition FTC published option set in 2002 where "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." This is because even in this scenario, participants still obtain monetary benefits from the sale of shakes to the "bad" distributors", not from any fees or other recruitment revenues. In other words, "failed" and potentially "misleadingly induced" distributors don't matter, if they still bought shakes rather than payed some kind or fee or toll, because the shakes are real products which could have been consumed by real people (themselves as internal consumers or external ones). It doesn't matter that they never were (in the worst case scenario).

The legal test is entirely unclear and unsettled. It has not been put in statute, it has not been authoratively set out by the Supreme Court. There is absolutely no way, even through empirical research and common sense to judge where the legal line or a "pyramid scheme" will be drawn. It is a speculative bet. Regardless or whether the bull or bears eventually prevail, neither position will vindicate their prior analysis. Arguments can me made in favour of what the legal test should be, and a position can be taken accordingly, but that is all. Those arguments are mostly a mater of analysis of legal precedent and principle - of which I have seen some, but limited discourse. Perhaps this is because there really is no persuasive way to predict what the test legal WILL be, even if there are some interesting practical argument as to what it SHOULD be.

Anonymous said...

Let me disclaim this comment that I have not researched the specifics of Herbalife. I'm looking at this case from a policy background. Quite simply, the FTC is unlikely to shut down a business that is not already obviously failing.

Those who are in-depth researching rules, regulation, and precedents in such matter need to reevaluate their line of thinking. The FTC will find a way to justify whatever course they wish to take (i.e. one that will make them look like they're "Doing Something" and also generate the least complaints). Most likely they'll come up with some measures that Herbalife must follow that have de minimis impact on the business and allow the politicians involved to claim victory for "standing up to big businesses and for the little guy" in press releases. The alternative is an endless, ugly fight that everyone (i.e. the politicians attacking the company) loses in. Someone on Sen. Markey's staff knows that Republicans may retake the senate this fall and would love nothing more than to hold ethics hearings on "liberal MA Senator using government regulators to shut down American businesses in cahoots with Wall Street billionaire". A negotiated consent decree in the next couple months takes that off the table and lets Markey et al "win" without exposing them to downside risk.

That said, if Herbalife is going to collapse anyway that's immaterial and the FTC will happily hasten that demise. The bears have to believe the company is going to start failing significantly independently of any investigation in the near future to be justified in their position.

Matt Stewart said...


Your common sense "on the ground" observations may make sense to you but that is not how the law works in the USA.

Your analysis is also simplistic and perhaps naive too. For an intelligent guy, you seem to be missing entirely what the Herbalife Marketing Plan is designed to do. What is the central incentive that gets created? What is the central behavior followed by Plan participants? Do you really think it is "personal consumption"?

Finally...your Success Builder order is an illegal anti-trust violation. See Koscot and Holiday Magic cases. Herbalife cannot charge its distributors "inventory loading" price points to encourage up front purchases...this is illegal. Once you take away this perverse incentive, how much inventory will participants actually buy?

Are you still clinging to your idea that Herbalife is like AA for fat people? Or does it occur to you why this business has no appeal in London, UK?

On the bright last you are now starting to question yourself...Ackman is right on this story. He will be avenged just like MBIA.

Anonymous said...


Is the secret sauce in the Herbalife model the "hug" obese people get from their upline sponsor every day


A perverse incentive system that sponsors and endless chain of new recruits and is, therefore, a pyramid scheme?

Frankly...your channel checks/on the ground observations seem painfully naive.

I have no doubt you could also find evidence of prostitution or underaged smoking, but they would still be illegal discoveries.

Herbalife is illegal because of its compensation system - not legitimate because you can find a bunch of gordos who drink Formula 1.

When you figure out why the comp plan is illegal you will understand why Ackman is corrrect.

zukaloo said...

If the London FT journalist would like to contact the Herbalife office in the UK 0845 0560606 they would be delighted to let you see the hundreds of thriving clubs we have in the UK, where our customer bases are massive. I have a wellness club, and as well as having a very large customer base, I also consume the products because they are brilliant. I have a choice, I have been around for 12 years, long ago qualifying for maximum discount, so all the products I buy are to fill the very big demand.

Finally, as distributors, we are bound by a very rigorous code of ethics, and our wellness centres are visited by corporate to ensure we run our businesses to the letter of the law. So please do drop by, I would be delighted.

Anonymous said...

John - I'm persuaded by your thesis as to the domestic market. But, what about China? Ackman's latest is a purported analysis of Chinese law. China is a big chunk of HLF's growth story.

Do you have a view? You're a lot closer to China than we are, do you have an insight into how China will view HLF?

Anonymous said...

Internal consumption seems to be a silly measure. Then you would have to consider Costco to be a pyramid scheme too because customers consume most of what they buy. Perhaps Herbalife just needs to call such people "gold customers" rather than "distributors".

Anonymous said...

Hi John,

I'm a big fan of the blog and always enjoy hearing about your investments and opinions.

However, I do find it disappointing that you've only decided to start this leg work only AFTER the stock has dropped significantly and AFTER the FTC has opened an investigation.

I would be sincerely disappointed if I was an investor in your fund.

No position/opinion in HLF

Owner said...

Herbalife has redefined a non- sponsoring distributor as a customer. Time will tell how many of these people will buy, as they lack the profit incentive. However, giving even a 50% "discount" to something priced 3X other products is still an overpriced product, and the social aspect will be thereby tested in isolation, rather than coupled with the profit incentive. My bet is much lower sales. The question is also what action to take for the 30+ years of coupled incentives.

The FTC and SEC have clear guidance based on case history:, which says, in part, "Not all multilevel marketing plans are legitimate. If the money you make is based on your sales to the public, it may be a legitimate multilevel marketing plan. If the money you make is based on the number of people you recruit and your sales to them, it’s not. It’s a pyramid scheme. Pyramid schemes are illegal, and the vast majority of participants lose money." and the SEC,, "No demonstrated revenue from retail sales. Ask to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the MLM company generates revenue from selling its products or services to people outside the program." Both regulators are clear that little to no retail sales equals an illegal pyramid.

An even more significant issue is one that is extremely under-reported, the profit made by high level distributors OUTSIDE of Herbalife, the so-called "lead generation" and other "tools," such as tickets for various meetings, books, CDs, voice mail, website access, etc. These profits often FAR exceed the money made from the MLM AND keep most distributors from having a net profit. Here's an example of a company that is an even larger scam than Herbalife:

Let's create a healthier and wealthier world together. said...

From the Herbalife Honors event this week:
One of HLF’s new BoD Dr Richard Carmona said he is totally amazed at what HLF is doing. He knows first hand HLF products are excellent and that HLF is… “A distribution network for PUBLIC HEALTH worldwide.” This is something Carmona wanted to achieve as 17th US Surgeon General, but was unable to implement a sustainable working model like HLF has in place. He understands distributors bring valuable content and products to people which create a “sustainable” healthy and active lifestyle.

Michael O. Johnson said HLF is fighting a technical argument – that HLF is a pyramid scheme. But, HLF will win this argument because HLF sells products and has an excellent product return policy.

Unknown said...

For Mr Paul Murphy

Your former colleagues at the Telegraph published a story on Sina on the 30th of Jan. This was commissioned research.

The FT perpetuated misleading information in The Lex on the 3rd of Feb re the fall in Weibo users which I note now is corrected.
Given you were sloppy in fact checking (and I concede the mistake was easy to make but you did have 5 days to check and especially as Sina reported a record 860,000 tweets for the first minute of Chinese new year on the 31st of Jan it should have set off an alarm bell) it simply makes me wonder in the instances where the Lex view comes from discussions with the sell and buyside communities if you conduct deep enough independent research or just end up perpetuating a one sided perspective. The FT has a high standing. It should get out of its chair and kick the tyres more often.

But for a paper that can confuse Mario Monti with Mario Draghi I guess anything is possible.

Anonymous said...

John: You say "The FTC and SEC have clear guidance based on case history . . . Both regulators are clear that little to no retail sales equals an illegal pyramid."

Neither the FTC nor SEC have the authority to decide the standard for what is or isn't a pyramid scheme. Both organizations regularly overreach beyond the limits of their regulatory authority; when they attempt to actually *do* anything with those promulgated standards, they're routinely rejected by the Courts. The standard is whether product is consumed by "ultimate users."

Let me hammer this home further: If the FTC or SEC wanted to make a rule determining what is or isn't a pyramid scheme, they would have to draft that rule in a public process, and publish the rule publicly for comments, before deciding whether to put it into effect. It would then enter something called the Code of Federal Regulations and become subject to judicial scrutiny.

There is no section of the CFR giving a definition of Pyramid scheme. That's because neither the FTC or SEC has made a rule. The FTC or SEC's comments on their website are not the law, and do not accurately predict either case outcomes or the agencies' own behavior.

If you want an example of this, consider the SEC's attempt to regulate "business brokers" as registered broker/dealers. The SEC continues to claim that business brokers must register, and their website says this. *Every* attempt to enforce that theory has been rejected by the Courts as regulatory overreaching, but the SEC hasn't changed its website.

If you disagree and think the FTC or SEC's web pages on pyramid schemes accurately describe the law, I challenge anyone to find any court case in which those definitions were applied and where the outcome would have been different if the court had applied the "ultimate users" test.

Anonymous said...

Oops - I thought the comment from "Owner" was from John. Sorry about that John. So my comment is a response to him, not you.

John Hempton said...

Dear Anonymous above - can you riddle me this...

Why is it that shorts insist on calling the Herbalife buyers Gordos?

Are they even aware that proportionately Herbalife's biggest market is Malaysia?


And I don't even want to go near the racism here.


VandalsStoleMyHandle said...

There are 30-odd comments above, of which a reasonable number would appear to be substantive, and that's what you choose to focus on...X called Y a bad name?!

Anonymous said...

John - I have no position in HLF, but you talked to ONE PERSON in a nutrition club. Give me a break. That's not "proof" of anything. Have you tried ordering as a distributor and getting a refund? If not, why? Have you asked yourself why HLF does not want to do anything substantive to enforce its 70% rulle?

And why are you now just asking these questions an entire year after going on CNBC proclaiming your long position??? It seems you are te one - not Ackman - who has failed to do his due diligence. Good luck to you, but the FTC will shut this company down eventually IMO.

Jeff said...

I am just trying to figure out why an "investor" would choose to invest in a company that, by his own admission, is shady & manipulative in its dealings, and generates all of its revenue selling a single junky, overpriced product.

Whether or not the FTC takes action, is that a sustainable business model? If Herbalife is really just selling a weight loss club - then why not just open a bunch of weight loss clubs? Why shroud it in mystery and uplines and downlines and manipulative compensation schemes and ever changing return polices, and etc. etc.?

I do not know whether HLF is a pyramid scheme in a technical sense -- I could see the FTC making either decision. But I do know that for a company selling protein shakes and/or weight loss meetings, there is way, way, too much intentional complexity here for it to all be above the line. It does not past the bullshit test.

And if we can agree that there is a considerable amount of "below the line" activity -- how can you guess at how deep it all goes? How can you reliably speculate on how many cockroaches are in the kitchen? I don't think any amount of on the ground research is going to tell you that.

We shall see, though. (Neither long not short here -- I think this is a great one for the too hard pile.) -

Anonymous said...

I happened to pick up this post through Google. Such a pleasure to read a well thought out, clearly articulated, measured piece on Herbalife (or, frankly, on anything),with full discolsure on where you stand. Apart form the style, I thought the content accuratley highlighted (for the first time in materials I read about Herbalife) the fallacy of treating "internal consumption" as a 100% bad phenomenon. Thanks for writing this, and lots of luck in your investments (I have a small long position in HLF, but nothing to write home about).

Stocks DD said...


Good luck selling this version to regulators! It is what it is.
Regulators will find the truth.

"And I have spoken to several Herbalife customers and they are mostly signed up as distributors and they do not intend to sell product. They are signed up simply to get the 25 percent discount. Some even bulk up their orders between a few of them to get 35 percent discounts - but they still intend on making no retail sales except to themselves as a "buying club". Indeed when I went to the Herbalife in Queens I spoke to several people who were real customers and were proud of the weight that they had lost being repeat customers over many months. "

vimax canada said...

Dear Anonymous above - can you riddle me this...

Why is it that shorts insist on calling the Herbalife buyers Gordos?

Are they even aware that proportionately Herbalife's biggest market is Malaysia?

agen judi online said...

There are 30-odd comments above, of which a reasonable number would appear to be substantive, and that's what you choose to focus on...X called Y a bad name?!

herbalife reviews said...

I think it is vanishingly unlikely the journalists at the FT are on the take.

I have spoken with Dan McCrum and found him honest and competent. I disagree with him - and I wish he would get in a plane and start visiting Herbalife clubs.

But I would bet a lot of money at short odds on his honesty. That is a safe bet.

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