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).
- not requiring an entry ("headhunting") fee;
- making product sales a precondition to receiving the performance bonus;
- requiring the buying back of excessive inventory; and
- requiring that products be sold to retail consumers.
BurnLounge 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:
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. 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.
As 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 simply incidental.
An observation on returns and inventory loading
The real response to Bill Ackman
Lead selling scams
The rules for Herbalife clubs
Full refunds and the change in short-thesis from “it's a pyramid in fact” to “it's a pyramid at law”
How big is Herbalife by sales - and comparisons to numbers of members
Herbalife: Who's Consuming All Those Shakes? And Why...
- On the ground investigative research into Herbalife's nutrition clubs suggests they're not what they seem.
- Club 100's quota system raises questions about the true nature of shake consumption.
- The motivation for sales in an MLM matters per recent rulings; that could be a factor in considering Herbalife's business.
(a). 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.
In 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.
(b). 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 thereafter.
China 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 me.
(c). 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.
(d). 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.
(e). 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 inventory loading...)
(f). 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 50% discount.
And 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.
Imagine 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.
And 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".
Roughly how big would your income be now? And from how many levels would you be collecting your income?
If 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.
At 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.
But 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.
This you are always entitled to - three levels deep.
After 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.
After 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.
The 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.
They do no sales - so they get no retail discount.
They 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.
They are unequivocally blocked on the "production bonus" so they get nothing there and
They 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.
So all they get is 5% of three levels down - which is likely to be trivial - probably less than $5000 a year.
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.