is a very long post. I have done a lot of work on Herbalife that
should be made public – and I am travelling on several long-haul
plane journeys which gave me time to splice it all together. [Now in New York via London and the Middle East.]
are Herbalife groups all around the world and they reflect the
character of the community they are in.
I want to start you in Israel in a mostly Arab (though mixed) town.
It could be Nazareth (but it isn't). There are mixed clubs throughout
Israel. I am assured there are non-mixed clubs too but we have not
been to them. For example there are clubs in Rahat
(the largest Bedouin
city in Israel).
colleague - who took the notes from this visit - promised the
relevant people that he would not reveal their secrets - so I am not
going to tell you the particular town and I have changed the name of
the people at the club. [The Arab womens' names I have chosen are to
the best of my knowledge appropriate alternatives. If I have that bit
of the culture wrong I apologise.]
club is managed by Asriyah, who is a belly dance teacher. The members
meet every (almost) every evening and have a similar process:
Drink the shake (the food) – which costs around 12 shekel.
Drink a Herbalife tea.
Drink water with Aloe Vera.
this order differs from Herbalife clubs in countries I have visited
where the tea or water comes first.
whole meal costs 18 shekel (USD4.70) which is cheap
to the meal replaced. The club saves members money. [The meal being
cheap relative to the meal replaced applies in most markets I have
seen but not in China.]
sharp weight loss a member might have ten of these meals a week,
adding another meal per day. Long time customers often drop to five
meal replacements per week - which is usually sufficient to keep the
they drink the aloe water, there is a discussion “managed” by
colleague arrived late (when they were drinking the water and joined
in). Asriyah asked each member to tell a bit about himself or herself
and their progress.
was Lubabah – who is religious and works in a bank – she has been
a member for 6 months and has lost 18 kg. She brought in another 10
members (her friends), all similar background. Each one lost between
7 – 18 kg, and they also measure the diameter loss (they total
around 100 cm).
Asriyah knows all the numbers and is constantly motivating them.
people come with bad habits (they hardly drink water - and instead
drink Coca Cola, they eat a lot of carbs and do no sports).
all have fast results with (relatively) small effort (they are not
doing the tough sports, just the specific diet and some exercise).
was also a priest, who lost 12 kg and has claimed that he tried
sports, but ended up eating pita bread with chocolate so did not lose
weight. He measures weight loss and muscle gain.
was an Arab woman who lost 21 kg, so brought her daughter was well.
told us that she never hears any good words from her husband – it
is all about serving him and how fat she was. For the first time in
her life she feels “like a million dollars” and is much happier.
has 5 Ethiopian customers – one lost 27 kg and is getting great
feedback from her kids, and some other requests from her husband (she
smiled and everyone clapped).
could continue with these – my colleague heard 30 members. The
common theme was the amazing results, the understanding of proper
eating habits which some did not have, and the positive feeling due
to the change. The average “duration” of the customers is over 6
months, and some were there for 2 years.
knows each customer’s data by heart, and is the motivator – she
WhatsApp'ed them a few times a day and asks to show her what they ate
– they all “complain” but love her and feel they that at last
someone cares about them.
woman who served my colleague water has 8 customers and is “in
process” of opening up her own club, but is still being “mentored”
by Nuwwarrah (an upline member). The organization recommends having
at least 10 customers before one opens a club. [The organisation in
this context is the organisation run by a very senior distributor
rather than the company – but of that I could not be sure.]
this finished (each one got his/her chance to talk), they all have a
fitness session – some indoor (the Arab women) and some out in the
park. Exercise was some kind of belly dancing. It does not look too
hard to us, yet one must remember that some have not done ANY workout
is pretty obvious this is working really well.
The clear results of the program – they really lose weight and
The emotional support – this is the reason why one needs clubs –
for the support – just like we see running teams. People do this
better in a group than alone.
Social. They become very close friends. The atmosphere was very open,
and they get a chance to discuss their weakness (fat, loss of
control) with no shame, because everyone has a similar problem.
is like the alcoholic groups or parents that meet for child
treatments (e.g. ADD).
are other aspects too.
Importance. For some of these people, this is the first and only time
they are “recognized”. Some described a life where no one sees
them – they are there to serve, are not attractive and have very
low self-esteem. It is not easy for “normal” successful people to
understand this aspect – they take it as a given, yet fat people
suffer from low esteem from an early age – they become used to
being laughed at.
distributors are not allowed to make medical claims as a matter of
company policy - but in discussion with club members medical claims
were made. There are some real medical improvements that are a
consequence of this diet, and the lives of some have improved a lot.
Diabetic treatment was minimized, and many other examples were given.
colleague was skeptical about the extent of medical claims. Whatever:
losing weight (per-se) rather than Herbalife products really does
have some major effects.
the way I have met (not at this club) people who claim that Herbalife
cures arthritis - and that is clearly false - but losing 20 kg
reduces strain on joints.
makes around 15K shekels a month on this activity, which means she
can stop her other work – it is a substantial motivation. However
when asked what motivates her, you can see that it is the feeling of
doing good to others, gaining a large number of friends (she
considers ALL members as friends) and the contribution to others she
has. It was the same response from up-line supervisors. They enjoy
what they do, believe they have a great cause and results, gain many
friends (“it is the people – that is what we enjoy”) and make a
proper living. Some of the up-line supervisors make roughly 100K
shekel/month (good money indeed given their prior circumstances).
However they have a large number of clubs beneath them.
have visited 17 different Herbalife distributors in 7 countries
including China. There are commonalities: the product is sold by
creating and maintaining a sense of community and results and health
claims are ubiquitous. Several friends have visited clubs in still
other countries - and reported back similarlu.
are lots of consumers who have built the club into their lifestyle.
Sure they pay more than protein shakes are worth - but they get more
than protein shakes. They get a community, friends and the support
needed to get results.
is what the facts on the ground look like. They do not bear any
Ackman's long presentation.
There are clubs catering to police officers in Miami, clubs run in
Asian communities in Sydney, clubs which are Moslem social meetings
in Malaysia, strangely different social-groups in China [which I will
discuss below] and clubs in beer-bar-brothels on the beach in
Cambodia and Thailand where local poor people sell diet shakes to
overweight German sexpats [no I am not kidding and I will detail one
of those later in this note too].
in every case the club sells real product in an ethical manner.
is in my opinion a highly ethical company. This is completely in
contrast to the received opinion on Wall Street. It does good
business in a fine manner and it has many years of growth ahead of
it. [Incidentally I think the growth is a near certainty too – and
explain my reasons below.]
is the stock in the portfolio I am most proud to own. It is also the
stock about whose long-term prospects I am most bullish.
was a surprise to me
learn a lot of things being a facts-on-the-ground driven professional
investor. The world is a complicated place and businesses work in
ways that you do not expect.
Herbalife has surprised me more than any company I have studied in
the last decade.
Bill Ackman made his original presentation I
am utterly convinced by everything in Bill Ackman’s presentation
except the final conclusion – that Herbalife’s stock will
collapse. I took a long position on Christmas Eve. I suspect that
Herbalife is so profitable and so powerful they will see Mr Ackman’s
attack off – and the easiest way to do that is to buy back stock
(and make the stock go up). Mr Ackman has given them the incentive to
return their huge (but tainted) profits to shareholders (and I plan
to be a recipient shareholder).
to my shame I even got on CNBC and called management "scumbags".
you had told me that a business whose business model was persuading
people to sell diet shakes and other potions to their friends at
approximately 1.3-1.5 times fair retail price was an ethical, high
quality business I would have told you that you were insane.
had preconceptions driven by ideology. An ideology that might be
described as ivory-tower liberal.
I don't care what your ideological preconceptions tell you. If the
facts on the ground tell you that you are wrong then you are wrong.
And it doesn't matter who you are either. You could be Warren
Buffett, David Einhorn, Bill Ackman or my mother (all of whom are
usually right) but if the facts on the ground disagree with your
ideologically driven preconceptions then you are wrong.
Ackman's thesis is utterly wrong - and the morality that surrounds
his thesis is also misguided.
is a long post however to go through all of his arguments in detail.
I guess it is the basis of a book on the Herbalife saga. Someone will
write that book (it won't be me) but whilst the issue is still live I
want to write the first draft of history.
Herbalife debate thus far
Herbalife debate comes almost entirely from the presentations of one
man: Bill Ackman. Mr Ackman has made four three hour presentations -
and the story has changed somewhat over those presentations.
before any Ackman presentation there was a single set of poisonous
questions by David Einhorn on a Herbalife conference call.
is the transcript
but it takes some explaining to understand why these questions were
Question: 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: So, David, we have a 70% custom rule which is basically
says that 70% of all products sold to consumers or actually consume
my distributors for their own personal use. So obviously what we’ve
seen with nutrition clubs is that we now have visibility for the
first time to our customers. We know that we reported on this call
for the first time the number of commercial clubs around the world,
which is in excessive of 30,000, so that has given us feasibility to
the tremendous amount of products that are being sold directly to the
consumers and we see that as a growing trend in our business.
So, what is the percentage that actually sold to consumers that are
So, we don't have an exact percentage David because we don't have
visibility to that level of detail.
Do you have an approximation?
So well again going back to our 70%, where we believe is that it is
that 70% or potentially in excess of that.
Okay. What is the incentive for supervisor to sign somebody up to
become a distributor as opposed to – if they’re just going to
consume for themselves as opposed to just selling them the product
for the markup. How does the distributor – how does the supervisor
come out better?
Sure. So, I think there are two reasons for that. So, we know from
our business today that many of our future supervisors and business
builders come in as customers and then they become distributors. So,
the benefit from a supervisor is the ability for greater retention of
that customer/distributor because they are now earning a 25%
discount. The second issue is that it preserves linage. So obviously,
if I sign you up David as a distributor, my hope and my expectation
is that based on the tremendous product result that you’re going to
achieve that you’ll have friends and families go to you and say,
gosh David you look great, what do you want. You’re going to
respond to them, I’m on Herbalife, and that will encourage you to
say, wow maybe this is a business opportunity I could be interested
in. So, the benefit for me as your supervisor is one, the discount
that you would get and that for my greater likelihood of retaining,
it was a permanent customer and secondly, the hope that at some
stage, you will decide to do the business and therefore that you are
already in my lineage and is part of my group.
Right. But just trying to understand this clearly, if I sell to a
customer, I bought it - I'm a supervisor, I buy at a 50% discount, I
sell to a customer, I make 50 points, if he pays the full price. If
he signs up with a distributor and buys it himself, he gets a 25%
discount and I get seven points as a royalty. Is that how it works?
No, you would get the other 25%.
I will get 20% plus the 7%.
So, unless you're on royalty, you would simply (inaudible) in the
difference. So, you are in a 50% discount, you are selling at a 25%
discount, and so the difference between the two is your profit on
Right, so if he signs up with a distributor and buys it for himself
from Herbalife, I still get the 25%.
That is correct.
OK. Good. One last question, when you had your previous 10-K, you
disclosed three groups of distributors at the low-end. You called 29%
self consumers, 57% small retailers, and 14% potential sales leaders
and then that disclosure did not repeat in the subsequent 10-K. So, I
got two questions, first of all how do you track that and how do you
characterize and know which ones are which? And second, why did you
stop disclosing that in the last 10-K? Is that something that you
stopped tracking or just stopped disclosing?
Hi, this is John. The criteria for grouping distributors into
different classes was based off of their volume purchases and we are
making assumptions that people below of certain volume. While doing
the business, they were buying soft consumption and I don’t
remember the exact amounts, but I can get it to you after the call,
as how we delineated between the three classes. And one the reason
that we took out of the 10k is a change in CFO from which to me I
didn’t view it is valuable information to the business or to the
investors. However, we can easily provide the exact same breakout
going forward if you would like [indiscernible] into our investors.
Again, I don’t remember the exact delineation between the three
classes, but I can certainly get it to you. Our objective is to be
completely transparent, so."
is a reason this questioning is so poisonous. In Queens (where Mr
Einhorn went to visit clubs) it is almost impossible to find someone
in a club who has not signed a distribution agreement.
you ask them why they signed a distribution agreement they will tell
you it is so they can get the product at a 25 percent discount when
they consume it at home (mostly rarely). Most of it is consumed in
the club. That said – my quick look around Queens suggested that
just about everyone has signed a distribution agreement. [This is not
true in other parts of the world – but as far as I know Mr Einhorn
had not visited clubs outside the five boroughs of New York.]
there are court cases on what defines a “pyramid scheme”. And if
you take the court-cases decided before the Einhorn questions
literally it turns out to be very difficult for Herbalife.
case has been decided since (the appeal on Burn Lounge) which makes
life considerably easier for Herbalife. However that decision
post-dated the Einhorn questions.
Einhorn asked his question much MLM law hinged on two 1970s cases on
what constitutes a legal or illegal multi-level marketing scheme. The
FTC tried to close Koscot Interplanatory (an MLM selling cosmetics)
and Amway. They succeeded on the former and lost on the latter. The
Amway rule created safe harbours through which the entire MLM
industry tries to operate [or in some cases in my view cosmetically
pretends to operate].
basic facts of Koscot look like a pyramid/ponzi to a casual observer:
The sales person - called a "beauty advisor" puchases
products from her sponsor (who may be a supervisor or director) at a
40 percent discount, for sale to the consuming public. The beauty
advisor receives a refund bonus from her sponsor each month, based on
the total retail volume ordered during the month. Entrant qualifies
by investing $10 for a starter kit.
The supervisor purchases products from the company at a 55 percent
discount for distribution to his beauty advisors and direct sales to
the consuming public. The supervisor receives a special commission
for each new supervisor order he creates, $500 or 25 percent of the
$2000 paid for the initial order. An entrant qualifies as a
supervisor in any one of these ways:
By investing $2000 immediately;
By purchasing $5400 in Koscot cosmetics (at retail value) from his
By selling a portion of the required $5400 volume through his
organization and purchasing the balance in one lump sum.
The director purchases products from the company at a 65 percent
discount for distribution to his direct distributors (supervisors and
beauty advisors) and for direct sales to the consuming public. The
director is entitled to a 10 percent special commission on all of his
supervisor's purchases. He receives $500 for each supervisor order
that he sells. The director sponsoring a new director is also
entitled to a 65 percent commission ($1,950) on the $3,000 additional
inventory which the new director is required to purchase. An entrant
qualifies as a director by: a) becoming a supervisor, purchasing the
additional $3000 director inventory and selling a new supervisor
order in order to replace himself in his sponsoring director's
organization; or b) by initially investing $5000 and becoming known
as an apprentice director until he fulfills all the necessary
positions are described more fully to the prospective investors at
'Opportunity Meeting' held weekly in various locations across the
country. At such a meeting, a movie is shown and speeches are made
which concentrate upon the unlimited potential to earn large sums of
money in a relatively short time by recruiting others into the Koscot
program. In most instances, the opportunity meeting will closely
follow the script provided by respondents as found in the
distributor's training manual. This meeting is run in such a manner
as to excite those attending and to induce them into making an
emotional decision to invest in the program.
would be pretty hard not to determine this was a pyramid. Indeed the
court suggested this was “inherently deceptive and fraudulent”
and the Federal Trade Commission [the relevant government body] has
the power to regulate “deceptive” and “unfair” practices -
thus giving the FTC power to close Koscot. This has been taken ever
since as giving the FTC considerable power to regulate multi-level
however got off. The Wikipedia page on the Amway case is here:
has avoided the abuses of pyramid schemes by:
requiring an entry ("headhunting") fee;
product sales a precondition to receiving the performance bonus;
the buying back of excessive inventory; and
that products be sold to retail consumers.
also found that "Amway is not in business to sell
distributorships and is not a pyramid distribution scheme."
the opinion section of the ruling the Commissioner stated:
other Amway rules serve to prevent inventory loading and encourage
the sale of Amway products to consumers. The "70 percent rule"
provides that "[every] distributor must sell at wholesale and/or
retail at least 70% of the total amount of products he bought during
a given month in order to receive the Performance Bonus due on all
products bought…." This rule prevents the accumulation of
inventory at any level. The "10 customer" rule states that
"[i]n order to obtain the right to earn Performance Bonuses on
the volume of products sold by him to his sponsored distributors
during a given month, a sponsoring distributor must make not less
than one sale at retail to each of ten different customers that month
and produce proof of such sales to his sponsor and Direct
Distributor." This rule makes retail selling an essential part
of being a distributor. The ALJ found that the buyback rule, the
70-percent rule, and the ten-customer rule are enforced, and that
they serve to prevent inventory loading and encourage retailing.
F.T.C. 618: Opinion, page 716
if you sell washing powder to someone and they consume some if
themselves that is okay (internal consumption is okay) but when the
consumer is consuming it all internally (and it is a lot) it is good
prima-facie evidence they were stuck with it and hence a pyramid.
court/judgements wanted to work out the difference between forced and
unforced internal consumption and came up with this 70 percent rule.
If 70 percent of the
product is sold external to the network it must be real.
The Amway case also required buy-back of excess inventory (although
it allowed it to be bought back with a discount-restocking fee) and
it required there be a number of external customers who
clubs in Queens do not obviously meet this criteria.
They work by being alcoholics anonymous for fat Hispanic people. You
go there and
it is the social support network that gets you to stick to the diet.
Almost everyone “signs up” as a distributor. Almost all sales are
thus internal to the network.
my casual observation suggests that many sales are real sales. People
who are signed up as distributors (but with no intention of selling
stuff) regularly come in and buy product from other distributors.
of the clubs I visited asked for my name when I bought shakes - and
the club manager explained that he took it because there was a “ten
customer rule” but compliance with this was the exception rather
than the norm - and many of the club managers were probably
illiterate - so compliance was impossible. [Running a Herbalife club,
sometimes successfully, is a job taken by more than a few illiterate
the Herbalife clubs in Queens were your guide (and they were for much
of the New York Hedge Fund community) then even though the
consumption was real consumption by repeat customers then
Herbalife had a problem with the Amway safe harbour. Consumption was
is evidence that the Queens clubs were unusual. I have seen clubs
where almost all the consumption is by people who are not members. In
China almost all consumption is by people who have not signed up as
distributors (and the distributor qualification is hard). But the
Queens clubs were visible in New York - and they are a very common
form of club.
whole issue of the 70 percent rule and the Queens clubs was made
irrelevant by the Federal Court decision in the BurnLounge case.
was a pyramid scheme selling music burning services and shut by the
FTC. Much (probably the vast majority) of the consumption was
internal - and hence an appeals court got do decide on internal
consumption issues during the entire and intense Herbalife debate.
and Arnold cite a passage from an FTC advisory letter, Exhibit 3 at
trial, to argue that proof of internal consumption does not establish
that BurnLounge was a pyramid. Read in its entirety, the relevant
passage of the letter is consistent with the district court’s
analysis. The relevant passage reads:
has been made of the personal, or internal, consumption issue in
recent years. In fact, the amount of internal consumption in any
multi-level compensation business does not determine whether or not
the FTC will consider the plan a pyramid scheme. The critical
question for the FTC is whether the revenues that primarily support
the commissions paid to all participants are generated from purchases
of goods and services that are not simply incidental to the purchase
of the right to participate in a money-making venture.
discussed above, the rewards BurnLounge paid to Moguls were primarily
in return for selling the right to participate in the money-making
venture—the Mogul program. The merchandise in the packages was
the court decided on that. Bluntly internal consumption is perfectly
acceptable provided: "commissions paid to all participants are
generated from purchases of goods and services that are not simply
incidental to the purchase of the right to participate in a
Herbalife clubs in Queens clearly meet this test. The consumption
witnessed there - just like the consumption in the club in Israel -
was for the purposes of losing weight and for the purposes of the
social community that surrounded the club. The customers were not
there for the right to participate in a money-making venture.
poison in David Einhorn's questions has evaporated, over-ruled by the
judges' decision in BurnLounge.
the Einhorn questions and the Ackman (Pershing Square) presentation
David Einhorn asked his poisonous questions on the Herbalife
conference call there was considerable speculation about what was Mr
Einhorn's position in Herbalife and what other venemous material he
Einhorn clearly fed this speculation. He was expected to present at
the Ira Sohn conference (a high-profile hedge fund event in New York)
and the rumour was that he was going to present on an MLM. MLM
usually stands for multi-level marketing scheme - and hence everyone
assumed he was going to present on Herbalife.
he presented on Martin Marietta - ticker MLM - and - on the day of
the presentation Herbalife shares appreciated sharply. The story is
told in Deal
Herbalife short-story exploded to the front page in late December
2012 when Bill Ackman (Pershing Square Capital) presented a massive
short presentation over three hours. The presentation is still on the
was done in as high a profile way as possible.
Ira Sohn Conference is a charity event originally in New York and
heavily Jewish - but now global and less obviously Jewish. The most
famous hedge fund managers in the world give a “best ideas”
presentation for an audience that pays many thousands of dollars per
conference is where David Einhorn presented his famous Lehman
presentation (that was widely credited as being a precipitator of
called a “special” Ira Sohn conference (with a $25 million
donation to the charity) and presented for three hours on Herbalife.
core analysis is that Formula 1 [Herbalife's key protein shake
product] is just another version of commodity protein-powder (just
like many other brands) but they sell at premiums to those other
brands. They are commodities as per this slide:
Mr Ackman goes further - and says that there is no real reason to buy
that ultimately (according to Mr Ackman) the reason why Herbalife
sells so much product is that it is all about the “business
opportunity”. To quote Mr Ackman's conclusion:
Ackman then goes on for about 50 slides sampling huge amounts of “get
rich” literature from recruiting distributors which pretty
convincingly shows that some
distributors make unrealistic claims. This
literature does not come from the company,
however many of the distributors making unrealistic claims are senior
in the chain.
are some things in this presentation that are flat-out-silly. For
example Shane Dineen (a Texan analyst who seemed to have carriage of
the stock for Pershing Square) asked rhetorically at one point if we
knew whether there was a single legitimate end-consumer of Herbalife
anywhere in the world.
is clearly and patently wrong. But Bill Ackman described Shane
Dineen's part of the presentation as being the result of a year's
Dineen's suggestion that it is possible that there are no legitimate
consumers of Herbalife is flat-out-inconsistent with the amount of
research Bill Ackman has claimed to have done. It is dead
to find legitimate consumers - and and they will proudly show you the
before and after photos. You may not like the cult-like behaviour of
many Herbalife consumers - but many will sell you on the product and
they are not
distributors. [This is a company where the customers who often have
not signed a distribution agreement are rabid believers.]
- either Pershing Square (Bill Ackman's fund)
did not do as much
work as they said or they are trying hard to fit into a pre-ordained
clearly states that most the sales are internal to the network and
that the break-up (which the company made in response to David
Einhorn) between “real” distributors and “discount purchasers”
is phoney. He notes that there are easily available Herbalife
products online (on Ebay) at a 35 percent discount - and hence it is
insane to become a distributor for a 25 percent discount.
Pershing Square argues that it is a pyramid in
fact and a pyramid
fact that you meet plenty of people who become distributors for a 25
percent discount is not deemed worthy of attention here. They do it
because they are members of a weight loss club (alcoholics anonymous
for fat people) but as Mr Ackman does not see the community he does
not see this as sane.]
- Bill Ackman wants to argue there is not sufficient real consumption
- in other words there is an endless chain of recruitment and
He quotes FTC guidance on inventory loading in this slide:
Ackman also tries to refute the refund test in Amway:
also has slides that point out that in some countries (e.g. El
Salvador) there is no return policy. He also finds an affidavit of a
customer who “threw out” $5000 worth of Herbalife. [There is now
a return policy in El Salvador - but there may not have been when Mr
Ackman wrote his slides.]
Ackman's allegation is that the refund is much
less generous than Amway - and that it is almost impossible to claim
(too many onerous audit requirements) and therefore this must be an
inventory loading pyramid.
will get back to the refund rules later because the company amended
them seemingly in response to the Ackman presentation.
observation on returns and inventory loading
was on returns I found the first clear chink in Bill Ackman’s
presentation. Herbalife is vast (calculations below but about 6.6
percent of the size of McDonalds globally in terms of numbers of
meals served). If there is really a lot of “inventory loading”
there must be huge amounts of inventory somewhere looking for a home.
would expect to find it on Craigs List and Ebay - in other words
where people sell unwanted product - and if the volumes were as Bill
Ackman suggests then it would be sold in distress on these formats.
is not. It is almost non-existent on Craigs List and never sold at a
sharp discount. There are lots of sellers on Ebay - but they all sell
it with a “buy-it-now” price at a 35 percent discount and
they have been selling it for years.
you try to find out who the sellers are they will not tell you.
is a typical example - the sale of two tins of Formula 1 - free
shipping in the USA:
seller (“Zoomherbal”) has over 11 thousand bits of feedback and
has sold this item almost 4000 times. They have probably sold 20
thousand Herbalife items. Selling 20 plus thousand items suggests
that selling Herbalife products on Ebay is a business for
is breaching the rules of Herbalife because Herbalife does not like
people selling online as it undermines the business of the existing
35 percent discount means that the distributor is almost certainly a
fairly high-level distributor and buys it (say) a 50 percent discount
- so they can do this and make money.
have extensively looked on Ebay (and in various countries) but I
cannot find any being sold in distress.
conclusion: inventory loading does not happen.
real response to Bill Ackman
Ackman asked (rhetorically) why you would buy overpriced protein
shakes at full price (or even a 25 percent discount) when cheaper
stuff is available online and in supermarkets.
does this many times
answer is obvious. The
product is not the protein shake. It is the community support for
diet. In other words
it is the club in Israel with the belly-dance fitness instructor, or
the cafe (in Queens) or the Dance Club (in Malaysia) or the boot camp
in Sydney or whatever. It is not substantially different to the
question as to why would I buy a $10 drink at a bar when I can buy
the same drink for $1 and drink it at home? Of course context
product Herbalife sells is the MLM - it is the community. It is the
acknowledging that is the fundamental error in Mr Ackman’s
when he analyses the product as a "commodity" he misses the
point. Someone once asked me if what Herbalife sold was hugs. Yes,
and in some cases literally. I suspect it is the biggest hug seller
in the world. When I look the distributors become genuine friends
with their customers. They care about their customers. That is the
power and enthusiasm that this company provides.
new thing in Ackman’s Herbalife presentation (and where the taint
against Herbalife is hard to make go away) is the prevalence of lead
in the network. Here Mr Ackman is on stronger ground.
most offensive of these was a guy by the name of Shawn Dahl who had a
business called “Income at home”. As the inventory loading thesis
(which was the original core short-thesis) disappeared the stories
about Shawn Dahl grew louder.
is a reasonable press story here (probably sourced from people
associated with Bill Ackman):
probably sent over 2 billion scam emails in the 2010-2012 - you were
told about a woman who earned 7-10 thousand per month working from
home. At my hedge fund we have a few email accounts we collect scam
emails in (for the reason of finding stocks to short). We saw
hundreds of “work from home” emails.
emails and the first click did not identify Herbalife - but I gather
that is where they led you. To get into the business opportunity you
needed to buy leads, websites and other services from Dahl. The
amounts of money fleeced by people who purchased these services were
large and it was not difficult to find people who had been hurt by
the lead sellers.
were numerous stories in the press about the damage caused by lead
sellers and there were three big lead sellers in the organization.
The three big alleged lead sellers were Shawn Dahl, John Peterson and
of those (Dahl, Peterson) were highly active. Doran Andry was a lead
seller back in Mark Hughes day - and was and remains a very senior
distributor (Chairmans Club) until this day. However he was
successfully sued for fraud by some hurt distributors a decade ago
and settled. To my knowledge he has not sold leads since. [All Ackman
examples involving Doran Andry are over a decade old.]
implemented a rule change in March 2013 (about three months after the
Ackman presentation) such that anyone who sold leads was disqualified
as a Herbalife distributor and lost their downline. Dahl and Peterson
severed links with the company. Doran Andry remains silent (but still
presumably collects checks from his downline). Dahl went to Nutrie
another MLM (not very successfully it seems) and you can find his
twitter feed here:
Peterson shot himself in the roof of the mouth (to a surprising
amount of press coverage).
the company banned lead sellers it said that it would have a low
single-digit negative effect on sales. You can’t see it in the
sales numbers during the following three quarters. However sales have
been weak now for three quarters and some shorts have blamed the weak
sales on this change. [I do not think so - and I have a demonstrable
explanation of the weak sales below.]
rules for Herbalife clubs
Pershing Square's presentation much is made on the seemingly perverse
rules for setting up Herbalife clubs and how dowdy they all seem.
Here are photos he has of clubs (and which do not seem unfair for
clubs in low income areas).
experience is that in poorer areas clubs look like this. In richer
areas they can look more like this one (which is in Delaware and
in both cases there is no signage and the purpose of the club is
indicates the following and seems to indicate that (a) it is entirely
consistent with the rules of Herbalife and (b) that it is nefarious:
company has been fairly clear why it is like that. The explanation is
that for a MLM it is important for distributors to protect
the second sale.
(famously) opened stores (under Andrea Jung as CEO) and it
was a disaster.
The issue is that if a woman knocking on doors gets a woman to buy
Avon she will likely get a further sale out of it later. Indeed the
job of an Avon lady is to build up a book of repeat customers - and
the job of a Herbalife distributor is similarly to build up a book of
if the customer can buy it from a store that
undermines the direct selling model.
[You can't get a second sale if the customer can easily go
protect the business of their distributors the company prohibits
anyone from opening a store that is identifiable as a Herbalife store
(except to people in enough know to recognise the colours), or to
sell it online (which is why the Ebay people I have approached are
said - the store rules have been a source of short-conspiracy thesis
ever since. The rules are clearly to protect the business of existing
distributors but if you do not understand the underlying business
rationalle the rules look perverse. The company has - in my
observation - made consistent moves entirely to protect the business
of existing distributors – and many seemingly perverse company
moves can be understood only in that context.
Ackman’s later presentations
Ackman has followed up his original presentations with several more.
is a documentary interviewing several Herbalife victims. It turns out
that every victim was a victim of Shawn Dahl and the money they lost
substantially went to Shawn Dahl rather than to Herbalife. Shawn
Dahl's downline was (at most) a low single-digit percentage of
is a study arguing Herbalife’s (fast growing) business in China is
illegal under Chinese law.
is an area where I feel quite qualified to comment. In China I
visited three Herbalife distributors, two in Beijing without
permission from the company and without giving the company advance
notice and one in Dongguan with guidance from the company. I
travelled with a translator quite expert in the relevant Chinese
rules (the translator had previously spent some time sceptically
researching Nu Skin's rather dodgy China operations). [My China notes
refunds and the change in short-thesis from “it's a pyramid in
fact” to “it's a pyramid at law”
response to the original short-thesis was to (a) ban lead-sellers as
discussed, and (b) implement the “gold standard” for refunds
which offers a full 100 percent refund including
for all sellers on unopened product and for opened starter kits. The
refund rules are in the top of all boxes sold by Herbalife and in the
US are sent in English and Spanish.
was to prove that inventory loading did not happen and it could not
be a pyramid in the sense originally described by Bill Ackman.
have been some quibbles about this refund. It does not include
postage paid by the customer in receiving the product and several
people have tried to argue that this is a major profit centre for the
company. [This postage is not paid in a large proportion of
non-American-non-Chinese sales - as these are field sales - discussed
below.] However you count it though the refund is more generous than
required under the Amway safe-harbour provision - and the evidence is
that it is honoured scrupulously on the ground.
a result there was a change in the short-thesis from it's
a pyramid in fact
(proven by inventory loading and having to recruit more victims to
buy more inventory) to it's a pyramid
because all the customers are insiders - that is members of the club
- and that all sales are to people who are legally signed up as
other words Bill Ackman retreated to David Einhorn’s original (and
company has always denied that a majority of sales are to people who
have signed up as a distributor but (until very recently) they did
not give definitive data and even that data came from a commissioned
survey and not from their own distributors. As stated compliance with
distributor rules about how the distributors should report sales to
external customers is thin (in part because many of the distributors
company press release that gave the critical data out is here:
release is several years late and vague - and as stated the source of
the data was Herbalife-sponsored surveys of its U.S. customers and
Members that were undertaken by the market research firms Lieberman
Research Worldwide and The Nielsen Company, B.V. This
looked rather thin and the fact they needed to rely on third-party
research data rather than their own extensive (Oracle) based system
tells you that compliance by their distributors is far from total.
[In visiting various distributors I can assure you I have seen the
full-range from utter compliance to total disregard of the 70 percent
the 70 percent rule now looks like it is unnecessary because the
BurnLounge case made it clear that the question was really whether
the purchases are not merely incidental to the business
big is Herbalife by sales - and comparisons to numbers of members
Herbalife quotes its quarterly numbers it quotes them in dollars and
also in “volume points”. Volume points are how status (hence
commission) in the Herbalife structure is determined. All products
(except the business starter kit) have a certain number of volume
points attached and that number is independent of the price of the
product or which country it is sold in. [The business starter kit has
no volume points attached because payment to the upline for selling
business starter kits would clearly be a “recruiting reward” as
per the above-mentioned Koscot case.]
tin of Formula 1 is the same number of “volume points” in every
country in the world.
did the calculation in the second quarter of 2014. Volume points have
shrunk somewhat since then (and I will explain why below). But this
gives a reasonable scale for the business.
volume points were 1.43 billion for the quarter. This is the highest
rate ever - but annualizes at 5.72 billion.
percent of sales are Formula 1 [a number that comes from the Bill
Ackman slide above].
suggests that annual Formula 1 sales are 1.83 billion volume points
are 750 gram tins of Formula 1 [the tin comes in two sizes - the
other being 550 grams].
suggested meal (and the ones that I have been served in clubs) is a
25 gram scoop of Formula 1 blended with skim milk. [If you do not
want to use milk use more Formula 1 but taste is compromised.]
suggests that a tin contains 30 “meals” or enough for a month.
[This is consistent with Herbalife user blogs…]
is not quite a meal equals a volume point - but a meal is 1.08 volume
suggests that annual
Formula 1 meals sold is about 1.7 billion or 4.6 million per day.
is an astounding number. McDonalds famously serves about 70 million
meals per day - so it is 6.6% the size of McDonalds in terms of meals
served. Moreover there are 3.7 million distributors but only 340
thousand sales leaders.
ALL the distributors had one meal per day every
day of the year
then you still would not account for volume.
many distributors are lapsed or have very low volumes. So in order
for it to be majority sold to Herbalife distributors [and hence be a
“pyramid at law” there have to be a vast number of distributors
who consume multiple meals per day of Herbalife. Alternatively they
must have enormous stockpiles in their garages.]
who allegedly consume multiple meals a day
calculation I make above – showing that to be a pyramid most the
distributors need to consume multiple meals a day has – to some
extent – become the short case.
this is what Bill Ackman alleged in one of his later presentations
that focuses on “Club 100”. I think implausibly the short-selling
crowd came up with the idea that the distributors were consuming
seven plus meals per day.
100 - an introduction
is a kind of nice (and rather glitzy) video about clubs put out by
the company - and it turns out that about half the clubs are Club 100
members [visible in logos on the wall and the like]. Club 100 is
clearly a big thing.
also have training programs, and it is through the training programs
that shorts have alleged that people eat up to seven Herbalife meals
a day for reasons entirely concerned with the business
opportunity. These training
programs have become the means by which shorts think Herbalife fails
on the test defined in the Burn Lounge case.
am not making this up.
need only look at a SeekingAlpha article by Christine Richards.
Christine Richards is a former journalist who worked for a
hedge-fund-research shop called The Indago Group. She is also the
hagiographer of Bill Ackman.
Richard has since left the Indago to start her own firm (Orion
Research). By repute (though I suspect it is not true) it was her who
planted the Einhorn questions.
is the Christine
(which had a surprisingly negative effect on the stock). I quote it
nearly in full because it is the entirety of Bill Ackman’s new
thesis (and the now 650 comments on the article tell you the ardour
at with which all this stuff is debated):
Who's Consuming All Those Shakes? And Why...
the ground investigative research into Herbalife's nutrition clubs
suggests they're not what they seem.
100's quota system raises questions about the true nature of shake
motivation for sales in an MLM matters per recent rulings; that
could be a factor in considering Herbalife's business.
the truth behind Herbalife's Nutrition Club business? If you read
Reuters article, based on interviews the reporters did with people
they encountered at ten Nutrition Clubs, you probably came away
believing these Clubs are a force for good in the Hispanic community.
I think the reporters were deceived by what they saw and heard, and I
base this statement on several years of researching these Clubs, not
just in the U.S. and Puerto Rico, but Mexico, Colombia, Venezuela and
Brazil. Walk into an Herbalife Nutrition Club and you enter into a
charade created by an elaborate and cynical "training"
system that turns distributors and their family members and friends
into conscripted consumers. Let me explain how I came to that
started visiting Herbalife Nutrition Clubs in 2011 as part of a
project on behalf of a number of hedge fund managers who were trying
to determine whether Herbalife Ltd. (NYSE:HLF)
was a legitimate business or, as some critics alleged, a pyramid
scheme: an unsustainable and illegal business model in which
participants make money primarily by enrolling new participants in
help answer this question, I decided to take a close look at
Herbalife's Nutrition Club network, which was (and still is) fueling
the company's growth. These Clubs, which serve single portions of the
company's products such as its Formula One protein shake, were
popular with a surprising demographic in the U.S.: Hispanic
immigrants in low-income neighborhoods.
started my research by visiting the Corona neighborhood of Queens,
mapping out the Clubs surrounding Junction Boulevard and Roosevelt
Avenue. Many were hidden away in undesirable retail locations, down
alleys and in the basement level of strip malls, with shabby looking
storefronts and interiors hidden by green curtains. A handful,
however, were more prominent and had signs (in Spanish) that
expressed boundless optimism: "A Beautiful Life," "A
Better World," etc. But one thing I knew for sure was that there
were far too many of these Clubs to make any economic sense: I found
26 within a few blocks of the Junction Boulevard subway stop.
after, I started visiting Nutrition Clubs with hedge fund clients.
Herbalife was under no particular scrutiny then, which was a good
thing, because we certainly didn't blend in at the largely
Ecuadorean-run Clubs we were visiting: a middle-aged white woman,
with a notebook and a printed Google map of the neighborhood, and a
hedge fund analyst, invariably "dressed down" in baseball
cap and extraordinarily expensive loafers. [John's note: baseball cap
and loafers sounds very like David Einhorn but I have been told that it probably is not.] We stood out like two
Jehovah's Witnesses canvassing the neighborhood - and that was before
we opened our mouths. On one of my first visits with an analyst, I
warned him that my high school Spanish was a bit rusty and asked if
he spoke any. Alas, he replied that he had studied Latin in school.
our visits, we identified ourselves as analysts seeking to better
understand the operations of this publicly traded company. I think
most people suspected we were from Herbalife's compliance department,
checking to see whether they were following the company's endless and
often bizarre rules: no Herbalife signs visible from the street, all
doors and windows covered to prevent visibility into the Club, no
"Open" or "Closed" signs, no selling full
containers of products, etc. (These rules alone raised serious doubts
in my mind about how a distributor could hope to succeed.)
people we met in the Clubs were without exception friendly and
tolerant of the communication barrier. They believed Herbalife was
transforming their lives from paid-under-the-table kitchen help and
construction workers into full-fledged achievers of the American
Dream. They talked about Nutrition Clubs as a route to the
prestigious and lucrative Herbalife "President's Team." I
left every Club I visited hoping that somehow this business would
work out for them.
people dismiss the harm done by pyramid schemes, downplaying it with
comparisons to companies that sell us things that aren't very good
for us: cigarettes and liquor, fast food and lottery tickets, etc.
But this is a spurious comparison. Nobody who smokes thinks it's good
for them and nobody who buys a lottery ticket thinks the odds are in
deceptive business opportunities reshape lives around lies, making
deep inroads into a person's psyche, changing whom they interact with
and whom they shut out, how they spend their waking hours, and how
they dream about and build for their future. Robert Fitzpatrick, an
expert in analyzing business opportunity fraud, had concluded that
Herbalife's business was based on deception long before I began my
research. He summed it up in an email he sent me: "Herbalife has
entered the fabric of Main Street. It has tampered with the souls of
millions of people."
what was Herbalife doing with these souls in this hardworking,
immigrant community in Queens? Was it delivering on its promise of a
better life for the people who attended and ran these Clubs? If so,
there was something extraordinary at work here: a company that had
found a way to engage those at the bottom of the economic ladder,
people confronted with daily hardships most Americans can only
imagine, and through its products and business opportunity was
steering them toward better health and financial security.
some, Herbalife clearly hadn't delivered on this promise, as
evidenced by the dozens of shuttered or moribund Nutrition Clubs I
saw, testaments to someone's failed dream - and to my suspicion that
these Clubs were a place for disillusioned (and broke) Herbalife
distributors to dump the product they'd been forced to buy in their
pursuit of the "business opportunity."
I also found active Clubs and watched as people came through the
door, handed over $5, and drank servings of the products. I watched
Club operators record each person's name and proudly explain that
these customers came each and every day - they were frequently
described as "socios" (the Spanish word for partner) in
this grand Herbalife vision of health and financial freedom. Yet,
there was always a hint of staging to these interactions. More than
once I asked a person visiting a Club if he or she worked there or
was an Herbalife distributor, and the answer, from a person with a
limited English vocabulary, was jarring: "No. I just come here
to consume." Consume?
morning I visited a number of Clubs with a well-known hedge fund
manager -- a positive sign that interest in our research was
trickling upward. Hedge fund types tend to be health and body
conscious and while most were curious to see the products,
they baulked at actually consuming them. "You can never be too
careful about what you put into your body." This meant that when
the host's back was turned, I frequently switched the cups and ended
up drinking both servings. But, on this day, my companion was 100%
into the research; he gamely consumed at every club and complimented
the host on the preparation. Among the Clubs we visited was one
enthusiastically staffed by a husband and wife team, who phoned their
high school-age son to come and translate. All three were
distributors and had put the family savings, plus money borrowed from
relatives, into the Club.
our final stop, we climbed a creaky flight of stairs to the second
floor where -- expecting to find a locked door or a deserted Club --
we entered a tiny room in which about a dozen men in bulky hoodies
and heavy work boots sat silently on folding chairs, eyes fixed
straight ahead, Formula One shakes in hand. These men were vaguely
familiar, the faces one glimpses hauling debris out of buildings
undergoing renovations, bussing dishes in the kitchens of
restaurants, and flying through treacherous Manhattan traffic on
rickety bicycles, delivering food. They certainly weren't overweight
and didn't appear to have the luxury of the time or money required to
consume expensive nutritional shakes in a Club. But nevertheless,
here they were, doing what Herbalife claimed so many in the Hispanic
community loved to do: gather in a social setting to enjoy good
host had a bright - though slightly bemused - smile for us. Everyone
else could have been waiting for a bus; oblivious to a cartoon
blasting in Spanish on an overhead TV, the men ignored one another
and avoided eye contact with us.
every seat taken, we had to stand, drinking our third Formula One
shake, Aloe Water and Herbal Tea of the morning, a good 40 to 50
fluid ounces each into our research. A few minutes later, in search
of the bathroom, we were directed into a large adjoining room where,
the host explained, the group held regular training meetings. It was
empty, lights out, but he assured us that it filled up twice a week
with all of the distributors in the neighborhood who were learning
our way back down the stairs, I asked my companion if he thought
people were really there because they wanted to drink a Formula One
what were they doing?
claims that Nutrition Club visitors are genuine customers seeking
better health and are drawn to the Clubs because they lack the
economic resources to buy an entire container of Formula One, so
instead they're paying a few dollars a day to consume single portions
of the products. These consumers prove that Herbalife is not a
pyramid scheme, according to the company, because, after all, if the
sales in Nutrition Clubs are to real customers, then the commissions
Herbalife pays on the purchase of those products to the distributors
operating the Clubs are linked primarily to retail sales, not to
recruitment and qualification.
these men grudgingly consuming shakes in a tiny Club in Queens
examples of the customers that proved Herbalife was not a pyramid
answer only became clear later, when I was hired full-time to study
Herbalife by another hedge fund manager, Bill Ackman, whom I met as a
reporter covering his short position on a bond insurance company
called MBIA. That was a seven-year story, and you can read a book
about it here.
MBIA, which insured bonds backed by risky mortgages and magically
turned them into triple-A-rated securities in the run-up to the 2008
credit crisis, was a company that, like Herbalife, one might argue
was in the too-good-to-be-true business.
after I began work for Ackman, I came across the first "Club
100" Nutrition Club on the Internet. The group, also known by
its Spanish name "Club Cien," appeared to make up a vast
network of Herbalife Nutrition Clubs in the Hispanic community in the
U.S. and across Latin America. I found a Yahoo message board used by
Club 100 members in Venezuela describing the rules for visiting an
Herbalife Nutrition Club.
ran parts of the text through Google Translate and out spilled a
cryptic and clunky description of how a person visiting a Club is
supposed to act:
MAJOR GROUPS OF 5 PEOPLE BY CLUB TO VISIT."
THE USE OF UNAUTHORIZED PHOTO CAMERAS."
TALKING TO CONSUMERS CLUB, UNLESS YOU ASK THE HOST."
BE VIEWED ONLY CLUBS THAT ARE 25 AND MORE ACTIVE IN THE SYSTEM
CERTIFICATION WITH SEALS."
THE RULE: ALWAYS GOOD ATTITUDE: SILENT, KIND, ASSIGN CONSUMERS
CHAIRS. IF TESTIMONY TO HELP AND GIVE WHAT YOU ASK, SEEK TO AVOID
SPECIFIC PRODUCTS OR FLAVORS , WITH QUESTIONS TO AVOID HOST STOP OR
WHILE STUDENTS ARE RESPONDING TO CONSUMERS."
when are real customers told to remain silent and instructed not to
ask for certain flavors? But, if the people visiting Nutrition Clubs
weren't real customers, who were they?
find out, we hired freelance reporters and private investigators to
visit Club 100 Clubs in major cities in the U.S. and Puerto Rico,
then in Mexico, Colombia, Venezuela and Brazil. There was a great
deal of secrecy surrounding Club 100's business methods. We were
often told that only those who signed up with Herbalife through Club
100 were allowed to know how the plan operated. Even those already
enrolled in the group were kept in the dark about much of its
operation and were told they would be informed about the next phase
only after completing the current phase. We signed up and joined Club
100 agreeing to do exactly what we were told was necessary to
succeed. Our investigators uncovered a business that turns those
seeking to open Nutrition Clubs - along with family members and
friends helping them pursue their dream - into conscripted consumers
by forcing aspiring Club owners through a series of tasks: touring
Clubs and paying to consume at each one, working for free in an
upline distributor's Club while being required to consume on the job,
and practicing making hundreds of shakes, which family members are
required to buy and consume. Trainees also are required to create a
story or testimonial about the benefits of the products on their
health and to tell this story numerous times to potential recruits in
order to graduate. Only those who complete all these tasks, which are
tracked and verified by upline distributors on an official form, are
certified to open their own Clubs.
promised rewards are enticing. Those who follow Club 100's rules are
told they will reach the President's Team where they can expect to
earn hundreds of thousands of dollars a year for the rest of their
lives. Herbalife's own data suggests that fewer than 1-in-10,000
distributors will reach the President's Team - but these nearly
impossible odds are rarely if ever disclosed to recruits.
Herbalife trainers (i.e. recruiters) play on desperation and
disappointment. In the U.S. we recorded training sessions where
messages like the following were directed at undocumented workers for
whom the American Dream had proved elusive:
you take it (the certification course), you'll get good consequences.
If you leave it, I don't know how life will go for you, because how
long have you been in this country? 10? 15? 20 years? Another 5, 10
or 20 years will go by and you'll continue in the same spot. Because
if in another 5 or 10 years you haven't achieved what you expected in
this country, you're not going to achieve it."
July 22, 2014, as part of Bill Ackman's presentation on Herbalife
entitled "The Big Lie," I detailed our findings about Club
100. While investors appear to have mostly ignored our findings - on
the company's second quarter earnings conference call a few days
later, not a single analyst asked about Club 100 - I believe it is
key to understanding the character of Herbalife's business, and,
ultimately to forecasting the company's fate.
aggressively sells its "business opportunity" - but
requires lots of coerced consuming to access it. Our team's months of
research in the U.S., Puerto Rico, Mexico, Colombia and Venezuela
showed that a distributor diligently attempting the certification
process - the first step in Club 100's complex and secretive plan -
would consume or cause other people to consume about 632 shakes over
a three-month period. Here's how:
are expected to work out of an upline distributor's Club. As part
of this unpaid internship, they are expected to consume as often
as twice a day - AM and PM shifts.
are required to go on tours of eight Nutrition Clubs and to pay
for and consume at each Club.
are often expected to consume at classes and other mandatory
events. Let's assume a trainee attends three weekly events for 12
are required to make 100 shakes as part of the mandatory shake
training requirement. Distributors are likely to offer free
samples (which they pay for) or cajole friends and family members
to come into the Club to pay for and consume these practice
are required to take a test proving they can invite one paying
consumer into a Club every half hour for four hours
are expected to recruit 10 individuals who will act as regular
attendees of an upline distributor's Club for one month.
actual numbers vary quite a bit because there is plenty of room for
trainers to impose inconsistent and repetitive requirements, but I
believe these estimates are realistic.
averages out to seven shakes every single day for every single
recruit (632 / 90 days), which adds up to millions of shakes
annually! Again, if all this consumption was legitimate, Herbalife
would be a reputable and impressive business. But it's not - it's
part of a nefarious plan to bring low-income distributors (and their
friends and family) into Clubs to share the cost of admission to this
deceptively promoted American Dream.
claim that the motivation of these customers doesn't matter -
consumption is consumption. But the courts and regulators see it
the beginning of this Wall Street battle, the Direct Selling
Association, which represents Herbalife and other MLMs, has pointed
reporters and analysts interested in evaluating whether Herbalife is
a pyramid scheme to a 2004 advisory letter issued by the FTC on the
question of distributor consumption, which states: "Much has
been made of the personal, or internal, consumption issue in recent
years. In fact, the amount of internal consumption in any multi-level
compensation business does not determine whether or not the FTC will
consider the plan a pyramid scheme."
has leaned heavily on this letter and, in fact, the company now calls
its distributors "members."
on June 2, 2014, an appeals panel upheld a decision that BurnLounge,
an MLM that sold downloadable music, was a pyramid scheme. BurnLounge
had appealed an earlier ruling, in part, by citing the 2004 letter
and arguing that its distributors should be considered customers. The
court rejected the argument and pointed back to the 2004 letter,
stressing that the relevant passage on internal consumption must be
read in its entirety: "The critical question for the FTC is
whether the revenues that primarily support the commissions paid to
all participants are generated from purchases of goods and services
that are not simply incidental to the purchase of the right to
participate in a money-making venture."
other words, motivation does, in fact, matter. Regulators and courts
want to know why people are consuming a product. Are they consuming
it because they like it and would choose it over other products based
on price, quality, brand, the overall experience, etc.? Or, is the
real motivation behind the purchase of a product "the right to
participate in a money-making venture"?
Club 100 system is fiendishly clever. It ensnares countless people
all over the world in Herbalife's web, drains them of their time and
money and, best of all (from Herbalife's point of view), results in a
great deal of consumption of Herbalife's products, which makes it
much harder for regulators to detect and shut down this sophisticated
pyramid scheme. Finally, it is clear why we don't see very much
Herbalife product stacked in garages or dumped on eBay, and why so
little is returned to the company. Most of the product is indeed
consumed, but not, as Herbalife would have you believe, by real
customers but rather by those pursuing quotas established by the
company's top distributors for people they deceive into pursuing a
false promise of the American Dream.
out by language and cultural barriers, by suspicion that we were
compliance officers or immigration officials posing as Wall Street
researchers, and, most importantly, by a system that created its own
illusion, it would be three years before I understood it. Now,
thinking back on that morning in Queens, I understand why the men
crowded into that second-story Nutrition Club in Queens appeared to
be such unconvincing customers - it's because they weren't
real customers. Instead, they were spending money they couldn't spare
to drink a shake they probably didn't like to lose fat they didn't
have in order to pursue (or help a friend or family member pursue) a
"certification" for a "business opportunity" that
doesn't exist for the overwhelming majority of people. They weren't
customers in any traditional sense of the word; rather, they were
paying the price of admission to a fraudulently promoted business,
one shake at a time.
Richard is the President of Orion Research LLC, which does
investigative research for investors. She is a former reporter with
Bloomberg News and Dow Jones and the author of Confidence
Game: How Bill Ackman Called Wall Street's Bluff (Wiley,
2010). Pershing Square Capital Management, which
has a short position on Herbalife, is a client of Orion Research LLC.
The author has no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. The author wrote
this article themselves, and it expresses their own opinions. The
author has no business relationship with any company whose stock is
mentioned in this article.
disclosure: The author does not take positions in companies she
researches. Pershing Square Capital Management, which has a short
position on Herbalife, is a client of Orion Research LLC.
idea that there are a huge number of people paying to drink 5-7 plus
protein shakes a day is - in my opinion - ludicrous. I challenge you
to do that (as you would almost certainly throw up). It is also
deeply contrary to what I saw on the ground. I saw real and regular
I don't know how to react here... Christine Richard can't speak their language,
wants to ignore what they tell her when asked directly, spend three
years researching and came to the conclusion that literally millions
of people drink enough Herbalife shakes to throw up on a daily basis
because they have been fooled into believing it is a route to
illusion here – and it has been repeated to me by other shorts –
is that there is a fraud here that has taken in millions of people
who are uneducated but we – white-middle-class liberals – can see
right through it no matter what these people say.
is the line of someone who sees facts-on-the-ground that differ from
their thesis and distorts those facts to come up with a new thesis.
Latino correspondent in Miami was so offended by this he started
sending me pictures of clubs in Little Havana. Here goes.
club in question is run by the guy on the left’s wife [i.e. the
wife of the senior policeman]. The club has about 280 visitors a day
(which makes it an acceptable business) about 40 of whom are
uniformed cops. The club also has a cycling group associated with it.
Ray [the guy on the right] told me it was an alternative to the
policeman’s sedentary with doughnuts diet.
- with real consumer doing a shake a day - is the model on the
ground. It is a repeated pattern, easy to find.
with middle class customers are rarer – but they are generally
entirely in poverty struck neighbourhoods reflect their community.
The clubs in Queens are a fairly gruesome affair. You
need about 60 visitors a day to make minimum wage and the clubs get
50-70. You can easily find people who work long hours for less than
you talk to these people they think it better than working in a
fast-food joint. They socialize with their friends, they think they
are doing well, often they have young kids playing in the back of the
club. The more middle class the area the larger the clubs tend to be
(but some clubs in Malaysia are huge). The club above (with the
police) is apparently 240-280 visitors a day - which winds up being
far better than minimum wage. The cops believe in the business
opportunity - without stating that they will get rich from it.
However as most hedge fund types have visited only Queens (if they
have visited any) they see only the gruesome.
marketing schemes in China are illegal. Direct selling organisations
are not. The differences are subtle [is Avon a direct seller, or a
multi-level marketer?]. But the origin of the difference is not
subtle. In China hierarchical structures involving lots of people not
under the direct control of the Party are illegal. Strangely Bill
Ackman's China presentation presented the Chinese MLM laws as about
consumer protection whereas they are about Party protection. [If
consumer protection were so important why are most Chinese correctly
convinced their food chain is compromised?]
I visited Herbalife distributors in Beijing without permission from
the company, sent my notes - including some concerns - to the company
and some large shareholders - and then with permission of the company
went to visit distributors in Dongguan (in the Pearl River Delta).
The Dongguan visit was on the same day as my visit to Hanergy in
distributors I was taken to in Dongguan were particularly successful
(the most successful in the area) but apart from that the features
were mostly unchanged between Beijing and the South.
are my contemporaneous notes of my trip to two distributors in outer
The price point for a Herbalife diet plan is a about 2X America. This
fits with my observation that everything is overpriced in China and
the currency is just flat wrong - but it is kind of disconcerting.
America Herbalife meals are cheaper than the meals they replace. A $5
stop at a club to drink all three (aloe drink, tea, shake) is cheaper
than getting equivalently full at Burger King. That is emphatically
not true in China - where the meals are maybe 5X as expensive as the
meals they replace and if you are middle income white-collar in
Beijing then the expense of a two meal per day replacement diet is
large compared to income. And if you are blue collar working class in
Beijing it is 100 percent of income. This means that the product is
not for the working class in China and it limits its size.
should note that this was the thing about the Beijing stores I found
most upsetting. In American as in Israel and in most other markets
Herbalife is cheaper than the meal it replaces. Bill Ackman (falsely)
describes it as expensive and ripping off the poor. But Herbalife
clubs - rather than a gym and personal trainer - are the way the poor
get in shape. And it is a very cheap way.
in China limits that market. Herbalife is necessarily a middle income
The second observation is that the clubs are quite different from the
Mexico/USA clubs even though the people there thought the model came
from Mexico. In the Mexico/USA clubs you walk through the door and
drink "all three". It is a sit-around-and-chat model. The
clubs are pseudo cafes - but you swap coffee for diet products. In
this case none of the three clubs would sell me a single shake.
Indeed it was very difficult to get them to sell me anything at all.
What they wanted to do - and it seems to be standard - is that they
measure your fat and other body measurements (standard
electro-conductivity scales) and then put you on a diet plan. The
diet plan is 7 days - but they then try to renew you for 90 days and
then - presumably at a lower intensity - for a longer time
- for the record - is a photo of me getting measured up for a diet
plan (which you might unkindly note that I need).
this is the club which actually says Nutrition Club in English...
[This club is about 15 kilometres from central Beijing.]
is still a daily consumption model - but there was less direct
oversight of the daily consumption. The idea of buying a cannister of
diet shake was sort of foreign to them. I did so though and I paid
full retail - 550gram cannister for 329 Yuan (52 USD). This is a $26
retail price normally. And they were deeply reluctant to sell it to
Both clubs were well appointed. The name Herbalife did not appear on
the door (as per usual) and the staff were flat-out good looking.
Young, groovy well dressed. This is contrast with the Hispanic clubs
in New York where the owners are usually poverty struck by New York
standards. These people would not look out of place in middle class
Sydney - and indeed would be considered good looking.
We asked how many customers they had. Both said 40 – and at the
time I was not sure I believed them. [I should note that 40 turns out
to be a magic number – and I probably do believe them in
retrospect.] In the time we were there (Sunday, good weather) a
couple of customers came through both shops but did not stop around.
There was almost no inventory at the stores. They told us that the
ordering process is that the customers have a number - and they order
online. The product is delivered direct to the customer and the
company has a warehouse in the major cities so it is next day
delivery. The lack of inventory is kind of important because if this
is the model it is 100% safe against being called a pyramid under US
law (as the sales are clearly to end customers and there is no
cannot stress how important this is. There is no inventory anywhere
in the chain that is not a company owned warehouse in China. The
company is completely immune to a pyramid allegation in China - and
if this were the model in the US there would be no possible
allegation either. The Ackman assertion that the entire global
business is a pyramid is falsified by this fact. The fastest growing
part of it has no pyramid features at all.
At one stage we asked how much you [the distributor] got when a
customer placed an order - and it seemed to be between 15 and 30
percent of the sale. [They showed us a remuneration scale I did not
understand - but strangely all the distributor cuts seemed below the
US. For instance they told us the cheapest a distributor can buy it
is 30% discount - but outside China a sales leader can buy it at a
later discovered that the direct selling rules in China limit the
retail margin to 30 percent - but everywhere outside China the
retailers doing serious volume (i.e. greater than about $4000 worth
per year) buy the product at a 50 percent discount. The company does
a few things which seem to circumvent this rule - and it pays other
commissions for "activities".
second club we saw was in a Greenland development. Greenland is a
particularly delusional listed Chinese property developer.
building was five years old and probably about half vacant. The
downstairs was never tenanted and was falling apart. Here are few
was a typical downstairs tenancy.
most heavily vacant buildings in China doors featured heavy duty
bicycle locks. [I have seen hundreds of such locks...]
there was an occupied section and the "club" was in a small
room on the fifth floor. Again there was limited signage on the door
- but your chance of finding this club from the street was
there were customers who visited whilst I was there.
this was a not a club where people sat down and had shakes and
chatted. Instead the club clearly organised exercise activities. For
example it took people hiking in the hills outside Beijing. In China
this is an entirely saleable proposition... there are no hiking clubs
in Beijing - and clubs per-se are very hard to organise within Party
were pictures of activities on the walls. The Dongguan club I went to
had pictures of going to the beach - which looked very attractive and
was about 70 km away. A bus would be hired. The company paid for
these activities (supplementing the 30 percent retail commission that
was paid) and senior distributors are paid more. You could - if you
were aggressive about it - construe these payments as breaking the
direct selling law in China. But I do not think that would be the
organisation is extremely
how these activities are organised - because I think they are the
main selling point - but they are also the point at which the club
gets together large numbers of people (and hence runs the risk of
offending the Party). The Dongguan club (and the management in
Dongguan who I met) told me they had to ensure that all activities
were limited to 40 people - a number which did not offend the Party.
It was clear that any and all rules about gathering of people were
the rules they were most keen to observe.
both Beijing clubs we visited claimed they had 40 members. 40 members
was a number that was repeated in Donnguan - and seems to be the
limit of the number that you can take on one of your activities. We
did the maths and with 40 members you make quite a good living in
China relative the alternatives available. [The people who ran the
second club had previously been hair clippers and talked about life
Dongguan club differed from the Beijing clubs in a couple of
respects. Firstly it was more successful - and the person claimed
about 130 members - but told us that he never organised a group of
more than 40. [It was the most successful club around and the company
chose it for us.] Moreover it used to be in a cafe - so it had a bar
at which people could and did sit around drinking shakes. This is not
like clubs in other countries though - the number of people who drank
shakes there would never have exceeded half a dozen. The shakes were
mostly drunk at home. The owner told us the bar was not installed by
him but the previous tenant at the shop.
club however would accept deliveries on behalf of its customers - and
these were placed in lockers at the club. The customer's name was
written on them. The distributor held no inventory.
are the lockers...
here, inside the locker is customer product with their name on it.
This product was opened - and the customer came in irregularly and
had a shake with the owner and/or some friends.
a summary - the business in China is not in the long-run as
attractive as the business in say Israel - because it is much harder
to provide the social aspect and a sense of community in a country
where large gatherings tend to raise the ire of authorities. But the
market is huge (there are millions of overweight people - the victims
of having four grandparents per grandkid). And there is plenty of
it is also - because it is relatively expensive - not a product for
the very poor in China. This probably eliminates half or more of the
potential market in China.
of the more controversial things about Herbalife is the remuneration
structure which makes a few distributors very rich and can remunerate
a distributor down an endless chain of recruits. In other words if A
recruits B recruits C recruits D recruits E all the way down to Z it
is almost inconceiveable that A has anything to do with Z - but A is
(sometimes) entitled to a proportion of purchases by Z or even
purchases by Z's customers.
endless remuneration scheme is tied to get-rich claims by some
distributors and is argued by Ackman and his supporters to be
evidence that this is a pyramid scheme designed to enrich the people
at the very top.
- and I have proved comprehensively - the key Ackman researchers did
not understand the remuneration scheme.
posed a question and gave people about ten days to answer it. This
was the question.
you were the very first Herbalife distributor and you recruited three
people and they - eventually and through their downline - recruited
the millions of people who now consume and/or distribute Herbalife.
also presume you did nothing else for the rest of your career. You
just sat there and collected the "recruitment rewards" or
the "royalty checks".
how big would your income be now? And from how many levels would you
be collecting your income?
nobody except some distributors who read my blog got the answer. [The
distributors were fast and accurate.] Cristine Richards - Ackman's
key researcher - was comprehensively
Here is the answer I gave:
you are a base level distributor you buy the product at a discount of
up to 42 percent. You sell it at retail. You make a margin.
some point you become a sales leader. A sales leader is entitled to
buy it at up to 50 percent discount. You can NEVER buy the product at
a higher discount than 50 percent.
the sales leader is entitled to a royalty. The royalty is paid three
levels deep. A recruits B recruits C recruits D recruits E then A is
entitled to 5% of BCD but not E's sales. B is entititled to 5% of CDE
sales. That way 15 percent more is paid out.
you are always entitled to - three levels deep.
that there is a "production bonus". These are up to 7% of
sales based on your level. However if someone in your down-line earns
2% production bonus then you are only entitled to 5%. And when your
down-line is long and successful enough the entire 7% will be earned
below you. You will be blocked and receive no income.
that and if you are senior enough you may receive the Mark Hughes
Bonus - typically 1% of all sales paid infinitely deep in the sales
structure. However if someone in the Chairman's Club is below you
(and this happens) then you get blocked on that too. So you will
receive no Mark Hughes bonus.
person I describe could never be in the Chairman's Club (to do that
you need 5 people below you to make a certain level) but someone who
was very early and has done almost no recruiting will almost entirely
be blocked on the Chairman's Club as well.
lets calculate the answer...
do no sales - so they get no retail discount.
have people three levels below them - so they receive 5% of their
production - but their immediate network is either senior and doing
few sales or sclerotic). This is the only income they get - and it is
5% of three levels.
are unequivocally blocked on the "production bonus" so they
get nothing there and
are not Chairman's Club or above because they recruited only three
people - and if the recruited more they would be blocked for most of
it anyway just because the very early guys have all been blocked out
unless they kept growing their network.
all they get is 5% of three levels down - which is likely to be
trivial - probably less than $5000 a year.
the 50% plus the 15% plus the 7% plus the 1% is the famous 73% payout
ratio. It all gets paid - just not to the foundation recruiter. In
fact it gets paid to people they recruited, people who worked hard to
build networks and make more sales.
is worth examining how you qualify for the senior levels in the sales
become a sales leader you need to sell 4000 volume points (roughly
$4000 worth at retail) in a year. After that you become entitled to
organizational volume - volume from your three-sales-leader deep
a regular customer replaces 400 meals a year and consumes 600 volume
points then you should be able to do this on about 7 regular
stay a sales leader you need to requalify every February.
are about 350,000 sales leaders globally and a little over half
requalify. The average sales leader does many times the required
volume. [The number of sales leaders being recruited is currently
falling but the retention rate for sales leaders is rising. The
reasons for this trend are discussed below.]
make Presidents Team and be entitled to production bonus is fairly
simple - but it looks awful hard to do. You need to get 200,0000
volume points per month for three consecutive months in your
"organization" - that is three sales leaders deep. In other
words three layers deep you need to be replacing somewhat over
100,000 meals per month - and that would require say 2000 people on a
could not be done by inventory loading because you need to do it for
three consecutive months. The fact that anyone qualifies as a
President's team member suggests the core Ackman thesis is wrong.
However there are between 1-4 qualifications globally per month.
Quite a few people have met this - and people are building new and
sustained organisations fairly regularly.
are many dans in the Presidents Team - and to reach the highest dan
(and get the maximum production bonus) you need to be doing 1 million
volume points per month in your organisation.
become Chairmans' Club you need five separate Presidents' Team
members below you (I am not sure what level of the Presidents' Team
they need to be). This can't be done without bringing huge training
and infrastructure to your Presidents' Team aspirants. It seems
extraordinarily difficult to qualify as a Chairmans' Club member but
most years 1-2 people make it. When I have met these people they are
as organised and competent as the senior sales staff at say Oracle.
There is a high degree of professionalism required to do this.
is one level above that - so rare it is almost theoretical. That is
"Founders Circle". To become Founders Circle you need ten
Presidents' Team members of the highest dan in ten entirely separate
downlines below you. To my knowledge only four people have ever
achieved this. If there is a new ascension once a decade I would be
remuneration system is - in my opinion - a work of genius. The senior
staff have to build huge organisations below them and do huge amounts
of mentoring to succeed. And then they have to continue to do it or
their income tails off to zero fairly rapidly. If they do not keep
working their downline eventually has people rise to their level and
they are blocked from receiving income. Herbalife senior
positions are a golden-treadmill - where people wind up working huge
hours to maintain their network and to make sure they are not
compensation plan and the ability to know - this is a perfect stock
make this compensation plan work the company has and requires a very
comprehensive (Oracle) computer system. Moreover distributors have
access to their part of the system - so if you are a Presidents' Club
member you can see everything in your downline. You can see how much
they are ordering, their address, the repeat orders, who they have
is a necessary part of running a Presidents' club organization. The
senior distributor sees a sales leader whose sales are rapidly
increasing they can find out why - and spread the good word. If a
sales leader's sales are dropping off you can call in for some
mentoring. This is all done by a typical Presidents' Club member.
Presidents' Club member will also tell you accurately what is
happening in their downline. They are not company insiders - they are
independent contractors. And they will tell you how hard they work
and how many people are in their downline and what gets people to
sell and what does not because they are keen to recruit you and get
you to do the same.
you talk to six or seven independent senior distributors you can get
a very accurate idea of what is going on in the company in real time.
is a company where what would normally be "inside information"
is legally and freely available for anyone who wants to talk with a
bunch of distributors. It is the rare case of a company in which you
genuinely can know the important details of sales and profits.
rewards work. It is amazing to me that most of Wall Street has taken
some interest in the Herbalife debate but very few people have done
this sort of detailed work.
I talk below (and I will talk below) about what is going on with
sales and the change in the marketing plan - it is an area in which I
can know. I may be "speculating" but it is very informed
speculation. I have talked with enough distributors to know the basic
trends. These distributors do not cover the whole company (I am not
that well connected) but they cover a wide sample. For the moment all
I am going to say is that this looks like a fantastic stock and about
to get rapidly better.
of Herbalife distributors
distributors vary according to the culture they are in. It could not
be any other way – this is a distributed sales model
where local entrepreneurs work out what works in their community.
The model Wall Street
is most familiar with is the “cafe-style” distributorship in
Queens. These are very poorly equipped generally – often poorly lit
and decorated. They reflect what it is like living as minimum wage
workers in greater New York (for an affluent Wall-Streeter they are
The (relatively grim)
Queens clubs however are far from the only model.
China model that I saw at all three distributors
I visited in China was one where you had a fitness assessment, weight
loss goals and the product was sent to you at home for consumption.
The only meetings were group outings limited to 40 people. The 40
person limit was driven by Party rules which Herbalife complies with.
The Arab model (which
I gather is repeated in Abu Dhabi and a few other places) is a
group-hug model. The club is held in someone's very cheap space but
includes group discussion and group exercise. [There are clubs in Abu
Dhabi – but I did not get to visit them when I passed through. It
has become a hobby to visit clubs in strange locations.]
One of the strangest
models I know exists on the coast of Thailand and Cambodia. I mention
it only because Bill Ackman made a big thing in one of his
presentations about how Herbalife had gone to Cambodia and hence was
“targeting” the poorest people in the world. This has also become
of the SeekingAlpha hit pieces. It amazes me however that
Pershing Square has strong views on Herbalife in Cambodia without
going to look.
So let's look for
him. These clubs on the coast of Thailand and Cambodia exist in the
major sex-tourism destinations – places where men go and drink beer
under the shade of some awning and are fawned on by younger women who
want them to buy “lady-drinks” from which they get a commission.
They will also go home with client if they pay a “bar-fine”.
Venues that are “beer
bars” in the afternoon are sometimes Herbalife clubs in the
morning, with older women running the club. The customers are
overweight German and Australian expats [sexpats
in the jargon]. You can find some of these clubs online complete
with before-and-after photos of formerly fat Europeans sexpats. I
won't do it for you – but just pick your sex-tourism hotspot and
google it with the words “nutrition club”. I only raise this so
bluntly because it is a clear and unequivocal place where Bill Ackman
was wrong. There are real customers. And they are not the poorest
people in the world. [Besides, when the community that Herbalife is
in is a sex-tourism community why should you be surprised that some
entrepreneurial local distributor has targeted sex tourists?]
There are Herbalife
clubs attached to Yoga studios. Think middle-aged housewives wanting
to lose some weight and get some flexibility. They buy a little shake
as well. More generally there are large fitness clubs which sell
Herbalife. A fairly good example is in Sydney – it is called
24FitClub. The model here
is often that there is a free fitness meeting in a park (usually on a
Sunday morning). The fitness events also sign people up as Herbalife
customers – and when you pay for Herbalife you are paying for the
fitness event and the commodity shake. This clearly answers
the short-seller question as to why people pay more than market for a
commodity. [It is that they are not buying a commodity.]
Some of these clubs –
particularly in Malaysia – are very large indeed (a thousand
members has been quoted to me in one instance). There are clubs that
meet in the park that have hundreds of members – and they also meet
for fitness dances in gymnasiums (rented for the occasion). This
works very well in places where women (Muslim) have a social
restriction on dancing and the distinction between dancing and
fitness exercises is blurred. They become Muslim dating clubs. [There
are videos of such clubs on YouTube if you are interested.]
In every one of these
cases protein shakes are being sold with “community” and in
every case real customers exist. These
clubs are a direct answer to the Ackman question – asked many times
– as to why
would anyone buy overpriced protein shakes at full price (or even a
25 percent discount) when cheaper stuff is available online and in
supermarkets? The answer: you get more when you buy it from a
noted above, there is one point where Bill Ackman seems to have some
legitimate points – the former presence of lead-sellers in
Herbalife's distributor base. In almost every multi-level marketing
plan there are people who will sell “tools” to help you identify
customers. These tools are usually something like a list of leads for
people who have responded positively to a work from home business
opportunity or the like. The “lead sellers” invariably sell the
same lead many times.
offers a refund on their products. As noted, the refund is now
far-in-excess of Amway safe-harbour requirements. It has been
increased to a full refund including
lead-sellers do not offer a refund.
people have paid $20 per lead. The money doesn't go to Herbalife –
it goes to the lead-seller. There are plenty of examples of people
who have been ripped off by lead-sellers at all
MLMs. Indeed given the defences in the Amway safe-harbour (which is a
90 percent refund) the main way you can lose substantial money in a
“goods” MLM is to lead-sellers. [Note that BurnLounge – which
has been found to be a pyramid – sold music burning services –
and it is very hard to argue that these are not consumed when
delivered and refunds were not offered.]
early on in the Herbalife saga (early 2013) the company banned any
lead-sellers from the organisation. [You were fired as a distributor
if you were found to be selling leads.] I have not tested this
hypothesis by finding someone who sells leads and seeing if they get
fired – but Shawn Dahl and other lead-sellers left Herbalife. The
company announced at the time that it would have a “low-single-digit
negative effect on sales”. Truly if you look through the quarterly
sales you can't see it. This was the first (of many) changes in the
distribution rules that have had a negative – albeit temporary –
effect on sales growth.
have visited many
Herbalife distributors – and I cannot find “victims”. One
Hispanic President's Club member I spoke to said he knew no Hispanic
“victims”. His customers ran communities – rather than being
solo-operators who thought they could just sell stuff from home.
sales (and Mexico)
back to the 1970s when the Amway decision was made. Payments over the
phone were difficult – not everyone had a credit card. Deliveries
of small parcels to millions of individual customers were impossible.
These were the days before Amazon and ubiquitous parcel delivery.
those days – and it is the environment that permeates the Amway
decision – the distributors took very large deliveries (half a
garage full) and they in turn made deliveries to their customers and
even small distributors. Most end sales were made “in the field”.
of course left the possibility that the distributor would be left
with a huge amount of inventory and could really only make money by
persuading other people to similarly take a huge amount of inventory.
It was in to this environment that the Amway safe-harbour rules were
designed. Provided the company could convince that there were real
customers (the 70 percent external rule) and that you could not get
stuck with inventory (a 90 percent refund rule) then you were safe
against a pyramid accusation.
1970s conditions no longer exist in America. UPS and credit cards are
ubiquitous and it is entirely possible to make deliveries directly to
end customers (as they do in China) and also to accept small payments
from end customers.
very recently there were not widely available payment mechanisms in
many developing countries. [Smart-phones have to some extent changed
that.] To this day accurate and timely delivery of small parcels is
of Herbalife's distributors still live in countries with difficult
delivery systems – and a few years ago Herbalife had never made a
direct sale to more than a million of its distributors. Instead these
distributors simply purchased from other distributors. Sales
from other distributors are called “field sales”.
field sale is a legitimate way of distributing product in countries
with poor distribution networks – and indeed they were
once common in the USA.
they come with several difficulties for Herbalife. I will illustrate
difficulty is that field sales make it relatively easy to subvert the
distributor networks... Cristine Richard in her article about “field
sales” quotes a problem from several years ago in Mexico.
was happening is, in markets or in states where we did not have
distribution points, very entrepreneurial distributors were driving a
pickup truck to a distribution center, picking up product and then
selling to people that were not in their organization. (Bank of
America Securities Consumer Conference, March 12, 2009)
This means real
customer were buying real product but they were doing it in a way
that circumvents the standard distributor network. Herbalife goes
to extraordinary extents to protect distributor businesses (for
example it will not allow online sales). The purpose of this (as
described above) is to protect a distributor's “second sale”.
Herbalife will ban distributors for behaving like this – and this
disrupts sales and selling. If there were no field sales this would
field sales can be used to game the promotion rules at Herbalife. To
become a Chairman's Club member you need to get five distributors
below you of a certain level of President's Club. This matters
because when you do so you block the Chairman's Club member above you
for part of the royalty – and so getting a fifth President's Club
member below you matters.
To game sales just
shift-them around a little – and do some compensation of the person
you shifted from. It is tricky but can be done in a field-sales
environment whereas it cannot be done in a direct delivery
There was an incident
in Argentina a few years ago where this happened. There was an
ascension to the Chairman's Club (thus shifting around considerable
royalty entitlement) and this ascension was disputed and then
reversed. To say this caused ructions in the distributor network
is understating it. People did not trust each other any more. [I
gather from discussions that this was not the only such incident –
but I cannot vouch for others...]
is a final problem with field sales – and this is particularly
evident in Mexico. If all the sales are field sales Herbalife has far
less control of and ownership over its network than is desirable. In
Mexico there are three senior distributors who have built a network
of distributors that cross the country. This network of distributors
can do same-day deliveries to most of Mexico – which is darn useful
– but alas comes at a cost to the company which is that they have
ceded most the power to the distributors. Herbalife does not have a
personal point of contact with their customers.
the widespread availability of payment networks in the developing
world (via smart-phones) has allowed Herbalife to fix this –
getting much more detailed information on its network and gaining
control over its distribution. This is a substantial strengthening of
Herbalife's business – but it comes at some short term cost. The
short term costs (described in more detail below) are evident in the
accounts for the last few quarters.
the rule change banning lead-sellers did not have an appreciable
effect on sales, other rule changes have. They
are – in my well-supported view – the reason why sales have been
weak at the moment.
rule-changes are superficially a response to Ackman. Specifically the
company has insisted that multiple orders are placed (over time) to
qualify as a sales leader (the key distribution level).
the past you could qualify for a sales leader with a single large
order of 4000 volume points (about $4000) or with several orders
(totalling 5000 volume points) placed over a year. The large order
was called a “success builder order” and was a key exhibit in the
claim that the company was a pyramid scheme. After all –
encouraging people to buy large amounts that they can't sell is a key
feature of pyramid schemes and is the feature that the Amway rules
were designed to ameliorate.
the company changed this so that the only way that you could qualify
as a sales leader was with multiple orders spread over some time. If
you can't sell the first order of say $1000 then it is unlikely you
will be stupid enough to make another $1000 order.
pyramid scheme would make this change – but Herbalife has rolled it
out over the world. They started in Russia and some parts of Eastern
Europe and the Middle East (test markets) but have now rolled this
out globally. [The Club in Israel described at the beginning of this
post operated under the new rules.]
rule change is a very
effective defence to the Ackman claims – a pyramid scheme simply
would not do this.
And when talking the company presents this as one of the reasons why
the scheme needs to be rolled out.
I think this is only part of the story.
second part of the story is that involves cleaning up field sales.
You cannot enforce a multiple-order rule if the orders are field
sales and the upline distributors just fulfil the order. They could –
of course – take a single order and enter it in the computer system
as multiple orders.
the company made a very important change – one that will change the
nature of the company for decades. It now insists that orders to
qualify as a sales leader (the key distributor level) are placed with
the company directly – and not via field sales.
the United States this is almost no change. In Mexico it is huge. For
the first time Herbalife will have a direct relationship with all of
their key distributors.
it work however is hard. The company needs to get their own delivery
network up to the standard of the warehouse network owned by the
senior Mexican distributors. They have had to rapidly get something
like 1200 company controlled and company stocked distribution points
in Mexico. They did this effectively and quickly. [This is a company
that really can execute – it is – on the ground – one of the
best management teams I have ever seen.]
dramatically strengthens their business.
it has very notable negative short-term effects on sales. For a start
slower first orders just – well – slowed down sales. There is no
surprise there. This effect was visible in every
jurisdiction and in jurisdictions where it was trialled some time ago
[notably Eastern Europe] sales have bounced back.
do I know they have bounced back?
some distributors in those areas have shared their data with me. This
is one of those things about researching this stock. Because the
distributors are independent contractors with good data you can get
very accurate data from them. You
the move away from field sales – particularly in Mexico - have
resulted in the upline distributors destocking their warehouses and
the company stocking their own. This will result in temporarily lower
sales (as the distributors destock) and a permanent increase in
inventory (as the company warehouses get filled). Cash flow effects
are negative and
it was these cash flow effects that were most visible during the
fourth quarter of 2014.
After those results were released the shorts (including Bill Ackman)
were crowing about falling cash flow. [See this
SeekingAlpha article for an example.]
real sales effect of the rule change
senior distributors don't just sit around and gather their checks. If
they did they would shortly get blocked in the distribution chain.
They are active sales people building distribution chains. In Mexico
that meant many things including building warehouses.
the main thing that senior distributors do is they mentor downline
distributors. If you spend any time with a senior distributor you
will see this in action.
they get a new sales leader there is a lot of training involved. It
is – frankly – a waste of their time if the new sales leader
drops out quickly. If the new sales leader seeks a refund of product
it is doubly a waste of their time as they do not get paid at all.
key determinant of upline income is how many of their downline builds
communities around them – how many build sustainable (albeit often
you talk to distributors you find that their key determinant of
success is a retention rate. Most people who join Herbalife drop out.
Most sales leaders fail to build successful businesses. [This is true
for all diet products – I do not think Herbalife is unusual here.]
I have seen senior distributors for whom over 90 percent of sales are
to repeat customers. There are enormous numbers of new customers –
but the total sales to new customers do not add up to much. It is the
retained customers that account for almost everything.
distributors with repeating business are valuable and the core of
their income. New customers are only really worth something to the
extent they produce repeat business.
here is the rub. In the markets Herbalife tested with the requirement
as a sales leader the retention rate was higher. Quite a bit higher.
And the upline distributors spent much more of their (limited) time
training people who were successfully building repeat businesses. And
this had a sort of snowball effect on sales. The first effect of the
rule change was that sales fell.
that they grew. And then they started to grow at an accelerating
rate. Distributors qualified under the new rule are (a) much more
likely to produce repeated sales and (b) much more likely to recruit
people who in turn produce repeat sales. The distributors are
profoundly happy with the rule change – and they are seeing their
income rise. The income-to-effort ratio is also changing favourably.
do I know? Well distributors have the data. I said that above.
is simply wonderful as a shareholder or potential shareholder. There
is currently some weakness in Herbalife sales. Herbalife has guided
for increasing sales in the second half of this year. If
the trends here follow the test markets those increases are
Better – if the trends follow the test markets then not only will
sales and earnings accelerate, they will accelerate at an
is the trick. If the test markets are a guide (and I believe they
are) then that record will be repeated, but this time the earnings
will accelerate. Big
numbers are possible.
I don't think anyone other than the wildest bulls expect accelerating
growth from here – but that is a distinct possibility.
something close to 20,000 words that is long enough. I will be
getting off the plane shortly anyway. So here is a good place to
we have however is a short-case built on arguments that do
not fit the facts-on-the-ground.
the ground this is an ethical company that does good things and
builds huge and sustaining communities around its products.
it is doing rational things that are short-term earnings negative but
will strengthen the business and set the company up for not only
growing earnings but accelerating underlying sales (and hence
earnings) over the next few years.
is focussed on shareholders. Their execution is excellent (see the
build out in Mexico).
there is a 30 plus percent short interest in the stock.
the starting price-earnings ratio is modest – considerably under
the market average.
isn't a better stock in my portfolio. It will eventually go well over
$200 [even without short-covering]. The stock is indecently cheap
now. And the company is of the highest quality.
PS. There has been two amendments to this post.
In the original I suggested that the biography that Ms. Richard wrote of Bill Ackman and his MBIA short was a "paid" biography. I have been reliably informed by someone with links to the publisher that it was not. The suggestion has been removed.
The second amendment is that the person who asserted to me that Cristine Richard planted the David Einhorn question is less than sure about this and I have mostly removed the assertion.
Finally a few people have questioned why I called David Einhorn's questions "poisonous". Well at a trivial level an instant and substantial drop in the stock price suggested many people agreed.
But more generally (a) the company answered them very badly and (b) I am not sure there was any way they could answer them well. In that sense they were - at least to public perceptions of the company "poisonous". Once asked public perception was going to change.
The questions were not unfair though. "When did you stop beating your wife?" is the classic unfair question because it pre-assumes the nasty facts. David did not pre-assume the nasty fact in that way. But I think they did pre-assume an interpretation of the law - an interpretation since made irrelevant by BurnLounge.
One more correction - Anthony Powell, not Peterson was the distributor who left over lead-selling - along with Shawn Dahl.