Sunday, August 17, 2014

My sincere best wishes to Bill Ackman: Fannie Mae and Freddie Mac edition

Bill Ackman is suing the Federal Government over the Fannie Mae and Freddie Mac bailout terms.

It is clear that the US Government will make a profit over that bailout and yet they are still suspending payment on Fannie Mae and Freddie Mac preferred securities. These securities are potentially money good.

Long-time readers know that I purchased a lot of these securities from 0.7c to 2 cents in the dollar - and I wrote a ten part blog series on this purchase. 100 cents in the dollar would be quite fine.

Bill is late to the trade - but in all sincerity I wish him well.


For the record here is my ten part series on Fannie and Freddie. I have cross checked the numbers that I guessed - some are high, some are low - but in the end it is roughly a wash. [Defaults are higher than I would have guessed, severity lower for instance...]

Part 1, Part II, Part III, Part IV, Part V, Part VI, Part VII, Part VIII, Part IX, Part X.

The series took a while because I broke my collarbone in the middle of it.

Friday, August 15, 2014

Australia is different

Advice to a new Australian:
Australia is different.
Our housing prices never go down.
Never ever.
And you have got to believe that.
Otherwise you will have nothing to talk about at dinner parties.

Wednesday, August 13, 2014

Valeant Pharmaceuticals part XI: Less luscious lips

I find it increasingly difficult to work out Valeant's revenue numbers and their implications. Simple maths keeps bringing out astounding factoids. Again I  am harping back to the sale of the Facial Injectables/Aesthetics franchise to Galderma. Again I am quoting Michael Pearson (the CEO) on the conference call:

On the aesthetics side, we recently sold certain facial injectable products to Galderma for approximately $1.4 billion, for a gain of over $300 million. We are pleased to report that under Valeant's ownership, we accelerated the sales performance of the Medicis aesthetics assets through Q1 of this year compared to the performance under previous Medicis ownership. In April, we announced our offer for Allergan and publicly stated that we would be divesting these aesthetics products. 
As expected, the aesthetics business deteriorated in Q2. The physicians were confused as to what products we wanted them to buy: our legacy Medicis products or our soon-to-have Allergan products. The uncertain status of our MVP Program also created concern for the doctors. Our reps and management were focused on pleasing their new owners and holding back sales until they worked for the new company, and our competitors were discounting heavily and is proportionately trying to take a temporary share to demonstrate weakness in our business.  
As a result, our sales dropped approximately 40% in Q2. Fortunately, these assets are now safely in Galderma's hands, and we can now focus on the rest of our business.
Okay, so what we are being told is that the Facial Injectables business had sales growth all the way through Q1 of 2014 - and presumably was also doing pretty well in the second quarter until Valeant announced that they were buying Allergan.

Then presumably they fell off further when they announced that they were selling the unit to Nestle/Galderma.

There is only one problem here: dates.

The (unsolicited) offer for Allergan almost a quarter of the way through the quarter. The deal selling the fillers business was announced two thirds of the way through the quarter.

If you assume the drop happened over these announcements the actual drop had to be enormous - well over fifty percent.

I see two possibilities.

(a) the procedures didn't happen, or

(b) the procedures happened but using some other company's fillers.

And for (a) to be true the doctors had to forgo the income and throughout America and Canada - women will have more wrinkles and less luscious lips because they suddenly stopped using Restylane, Perlane and Emervel injectable cosmetic treatments - and all because of the machinations in Corporate America.

And for (b) to be true doctors need to know and care who is the provider of the injectables they use. This seems unlikely because the websites (typical example linked) are labelled Medicis not Valeant and have been for some time.

Valeant states that the competitors discounted during the quarter. However the main competitor is Juvederm owned by Allergan - and they reported revenue growth driven by unit volume. There is no indication of discounting.

Oh the amazing power of the deal.


Monday, August 11, 2014

Valeant Pharmaceuticals Part X: a follow up on the sale of facial injectables

This is part ten of a long series on Valeant Pharmaceuticals - a major company in the speciality pharmaceutical space - and one that has cumulatively undertaken many billions in acquisitions.

The series was prompted by their biggest attempted acquisition to date - an unsolicited and ultimately hostile bid for Allergan - the maker of Botox.

If you have not been following you can review the series here: Part IPart IIPart IIIPart IIIaPart IVPart VPart VIPart VIIPart VIII and Part IX.


In my last post on Valeant Pharmaceuticals I observed that the company had blamed its earnings miss on the sale of its Facial Injectables business to Galderma. Specifically they stated that [Valeant] had built into our previous guidance $230 million of revenue and $0.50 per share cash EPS for the second half of the year from the (now sold) injectables business.

I calculated that there were 340 million shares outstanding and so for six months they were forgoing 170 million of earnings by selling that business. This is 340 million annualized and the business was sold for $1400 million. 

This meant the business was sold at roughly 4 times earnings.

Michael Pearson stated on the conference call that were able to "realize the full value for these products" and so I thought there must be an error. After all Michael Pearson [the CEO of Valeant] is a clever and rational man and he would not sell at so low a price.

The post-tax and fees sales price is considerably lower than $1400 million - and so the sale looks even more insane. The 10-Q declares that there were $50 million in selling costs associated with the asset:

Divestiture of Filler and Toxin Assets
On July 10, 2014, the Company sold all rights to Restylane®, Perlane®, Emervel®, Sculptra®, and Dysport® owned or held by the Company to Galderma for approximately $1.4 billion in cash. The assets were included primarily in the Company's Developed Markets segment. The carrying values of the assets sold, which includes $622.6 million of intangible assets, $16.1 million of inventory, and a $403.1 million allocation of goodwill, were classified within Assets held for sale in the consolidated balance sheet as of June 30, 2014. In addition, the royalty obligation on sales of Sculptra® owed to Galderma of $27.1 million was classified as a Liability held for sale in the consolidated balance sheet as of June 30, 2014. The costs to sell for this divestiture of approximately $50 million will be recognized in the third quarter of 2014. As this divestiture does not represent a strategic shift that has, or will have, a major effect on operations and financial results, a discontinued operations presentation was not appropriate"

And slide 165 of this presentation assumes that $170 million in tax will also be paid on the divestiture. The net proceeds were thus $1180 million and the implied price earnings ratio for the sale was 3.5 times.


This observation of mine caused a stir - because the guidance does not look plausible.

I guess several people have asked either analysts or the company because explanations are coming out.

JPMorgan - in a note dated 6 August 2014 gave an explanation. I quote:

Management provided additional clarity on aesthetic injectables divestment. 
The EPS impact from the divestiture of Valeant’s injectable franchise has been a key point of controversy since 2Q results last week. Although the injectable franchise generated $280mm in sales in 2013, Valeant had doubled its sales force on these products in January and forecasted sales to increase to $400mm in 2014 (largely back half-weighted as the sales force ramped). Further, Valeant opted to retain much of its sales infrastructure after the divestiture and, as a result, incremental margins on 2H divested revenues were extremely high.
The key explanation - highlighted - is that Valeant opted to retain much of its sales infrastructure after the divestiture. If this is true then the earnings effect of lost sales would be particularly high.

It would be a good explanation. The only problem is that this explanation is in radical disagreement with statements by the management of Valeant. 

In the press release announcing the closure of the sale (dated 10 July 2014) Michael Pearson stated:
Humberto Antunes , CEO of Galderma, has embraced our commercial team and I know he will continue our efforts to build strong relationships with the healthcare leaders in this industry.
It sure sounds like the sales force went with Galderma with the products in direct contradiction of the JPMorgan broker article.

This impression is further enhanced in by Valeant's conference call where they blame a dramatic intra-quarter fall in the sales of Facial Injectable product on the sale. To quote:

As expected, the aesthetics business deteriorated in Q2. The physicians were confused as to what products we wanted them to buy: our legacy Medicis products or our soon-to-have Allergan products. The uncertain status of our MVP Program also created concern for the doctors. Our reps and management were focused on pleasing their new owners and holding back sales until they worked for the new company, and our competitors were discounting heavily and disproportionately trying to take a temporary share to demonstrate weakness in our business. 
As a result, our sales dropped approximately 40% in Q2. Fortunately, these assets are now safely in Galderma's hands, and we can now focus on the rest of our business.
You see (as per the highlighted section) the injectables sales force were holding back sales, focused on pleasing their new owners. Which of course implied they had new owners.

Galderma's management are also clear that most of the sales infrastructure went with the products to Galderma. Galderma's press release states:
At Galderma people come first. We are thrilled to take on board the experienced teams from Valeant Aesthetics and, more than ever, our intent is to preserve the quality of the long-lasting relationship built with doctors. 

The JPMorgan note quoted above explicitly states that the sales force stayed with Valeant. Michael Pearson however has repeatedly stated the sales infrastructure went with the new owners.

Just for kicks I have examined many profiles on - checking the movement with functions with the asset sale. It is pretty clear - the sales infrastructure went with the asset.

Analysts make mistakes (I do regularly).

I gave an early draft of this blog post to Chris Schott, Jessica Fye, Wendy Lin and Dana Flanders (the JPMorgan analysts) and expected them to come out with an explanation consistent with the statements of Valeant and Galderma management (or for that matter consistent with easily obtained data on LinkedIn).

I will print that explanation when it is forwarded to me. But without further explanation the guidance provided by Valeant continues to make no sense. And the implication is devastating. Either Valeant is just making up its guidance numbers or they sold a growing business at under four times earnings.


Saturday, August 9, 2014

Bill Ackman's new best friend: Vladimir Putin

People with better knowledge of the details of Russia's sanctions seem to think that most Herbalife product will still get through - so Herbalife is not going to miss because of Russian sanctions. Further comment on the moral point of this post in the post-script.

The news of the day is that Vladimir Putin has banned the import of Western food into Russia.

Whilst nobody has said it yet this is almost certainly negative for Herbalife. Herbalife has a business in Russia and to the best of my knowledge has no manufacturing in Russia. Its not huge - Europe, Middle East and Africa is less than a sixth of Herbalife globally - and Russia is likely a very small part of that.

However I would be surprised if the EMEA segment did not shrink next quarter.

There are of course in Russia a bunch of distributors who have built businesses in Russia distributing protein shakes, running clubs and fitness businesses and the like. Their businesses will now fail - and it will not be the fault of Herbalife.

The miss will be of great benefit to Bill Ackman who is short this non-pyramid scheme and - at least on this trade - needs all the help he can get.

Bill Ackman will get some cheer from his new best friend Vladimir.

Sometimes the cards land right for a fund manager.


There are big problems closing a successful and honest direct selling organization. Many people have built legitimate businesses selling the product. Vladimir has no moral scruples but Herbalife (despite their reputation) do.

Herbalife has distributors in Venezuela who have built successful businesses there. There are now very strict currency controls in place - Herbalife sells product into Venezuela but can't get the money out. The currency they do have devalues fast. If they buy any property with the money its likely to get nationalized.

As a shareholder I wish that Herbalife would simply stop sending their product to Venezuela. Anything they send there is frankly lost.

However Herbalife feels integrated with their distributors - and responsible for them. To abandon a country is (morally) hard for a direct selling organization and Herbalife has a hard time doing it.

Vladimir Putin not so much.


What Bill Ackman wants the FTC to do in America is destroy the business of tens of thousands of people.

I will let you judge the morality of that.


Post script. When I started on Herbalife I believed every word Bill Ackman said - and I told the world so. But I was happy to own Herbalife for the bounce.

I have since become convinced that Bill Ackman is wrong on every substantive point. This is not a pyramid scheme - instead there are millions (maybe tens of millions) of genuine consumers - and tens of thousands (maybe hundreds of thousands) of people who have built legitimate businesses.

I believe the short case is aiming to destroy these businesses to meet the fantasy of a narcissistic hedge fund manager and the shorts in this case are deeply immoral.

Over time I have noticed the company being moral to a fault - most notably in Venezuela where they support the existing distributor base at substantial financial cost. 

It is about time the Herbalife longs spelled out what is happening here. People whose evidence is incomplete to the point of fabrication have grabbed the moral high-ground whilst they take an immoral argument. 

It will be okay in the end - the longs will make a fortune and the shorts will have their finances redistributed. However I am getting a little frustrated at people suggesting that I have the moral low ground.


Thursday, August 7, 2014

More than ten thousand tonnes of fuel stolen: African Minerals edition

I was casually reading some "selected additional information" on the financial condition of African Minerals (a large iron ore mining company listed in London). [Hat tip to FT Alphaville.]

You can find the PDF here.

In explaining the abnormal charges from previous years there is the following explanation:
Fuel Misappropriation 
Our best estimate for misappropriated fuel of $18.0 million was recorded in 2012 within the aggregated income statement. This estimate has been based on extrapolation procedures and has therefore involved the use of estimates. We have taken a number of measures to mitigate the risk of further such losses occurring, such as employing a specialized in-house fuel consumption control team. The investigation is ongoing, however in 2013 there have been no developments which have led to an amendment to our original estimate.

Wholesale fuel prices are less than $1000 per tonne. Even by the time you get it to Sierra Leone the price is likely to be less than $1500 per tonne.

The amount of fuel stolen is likely to be over 10 thousand tonnes.

A quite large tanker truck contains 35 tonnes of fuel.

So this is 285 tanker trucks. Probably more as I have rounded down the amount of fuel and up the size of a tanker truck.

One per working day.

I wonder how they didn't notice them driving away.


Wednesday, August 6, 2014

For kicks: just how big is Herbalife? And a simple proof that this is not a pyramid.

Herbalife has 3.7 million distributors. There is very fast turnover amongst the lower-tiers of the distributor tree.

The core bear case for Herbalife is that these distributors are deceived - and that there are not huge numbers of real sales - and that the bulk of the sales are to people who are buying it for the business opportunity rather than to consume the product in its own right.

Indeed for this to be a pyramid at law the company needs to be selling the majority of its product to distributors who are not buying this for deliberate personal consumption but rather for the business opportunity.

If the majority of sales are to people who are not active distributors there is simply no way that this is a pyramid. A reasonable summary of the pre-Burn Lounge law from an anti-Herbalife slant is given by Dan McCrum at the FT.

Even he would concede that if a majority of sales were to people who were not active distributors with a valid distribution contract then Herbalife is not a pyramid scheme.

There are several steps to the argument.

Size of Herbalife sales

A large number of people on Wall Street have positions on Herbalife without having thought clearly about its size. It doesn't appear much in their social circles so it must be small.

Bill Ackman sneers at them when they say their competitor is McDonalds.

So lets detail it accurately.

Herbalife's main product is Formula 1. It is a protein shake powder used in meal replacement mostly for weight loss. According to the annual filings weight loss products (which are mostly Formula 1 and meal-replacement protein bars) are 63.5 percent of all product. Some of this is diet-suppressing herbal teas - but meal replacements alone are probably 58 percent of all sales - completely led by Formula 1. 

Here is an image of several 750 gram packets of Formula 1:

This is the product - above all others - that is associated with Herbalife.

Here is the label which gives a suggested meal-replacement size of 50 grams:

This is a multi-level marketing company. You qualify for various tiers of the distributorship by selling a certain number of volume points in a given time. [For example 4000 or 5000 volume points will qualify you for "supervisor" status depending on how fast you sell them.]

For all Herbalife product the price changes by country - but the number of volume points does not. So whatever country you are in a packet of Formula 1 counts as 23.95 volume points.

During the last quarter Herbalife sold 1.4 billion volume points of product. I have used this slide before showing volume points by region:

1.431 billion volume points would be the equivalent of 59.7 million tins of Formula 1 powder.

Each packet contains 15 fifty gram meal replacements (see the label above). So if it were all meal replacement there would be 896.2 million meals replaced per quarter.

That would be 3584.7 million meals annually.

Not all of this is meal replacement though. My guess [explained above] is that only 58 percent of sales are meal replacement.

That would suggestion 2079.1 million actual meals annually.

Mr Ackman sneers when the company compares itself to McDonalds. But hey - I want to. 

We want to compare this to the size of McDonalds. McDonalds serves roughly 70 million meals daily - or 25.5 billion annually.

Here is the comparison: based on number of meals served Herbalife is about 8 percent of the size of McDonalds. [For comparison Herbalife is about 5 percent of the market cap of McDonalds. It does not make sense to compare revenue because McDonalds has a lot of franchise revenue - but it is - for completeness - roughly 18 percent of the revenue of McDonalds.]

These sales numbers are growing by 5 percent annually although that growth rate is slowing.

Herbalife sales per distributor

The number of sales leaders in the company (again according to the above table) is about 340 thousand. To make the numbers work the average sales leader or their down-line is selling 6100 meals per sales leader per year.

If they can get their average customer to consume 200 meals per year [that is replace four meals per week] then they have about 30 regular customers each - and the total number of Herbalife customers is about 10.4 million.

The total number of distributors of Herbalife is 3.7 million many of whom sign up for their own consumption. [The proportion who sign up for their own consumption rather than for the business opportunity is a very big item of contention. Suffice to say that there are a reasonable number of both...]

This number is increased considerably from when Mr Ackman did his original presentation. The 2011 annual report listed 2.7 million independent distributors. 

Now here is a big observation: My calculation - there is enough Herbalife sold so that 10 million people globally replace 200 meals a year with Herbalife product.

But there are only 3.7 million people with an active distribution agreement.

We have three choices here. Either:

(a). The sales/revenue numbers cited above are completely fabricated, or

(b). The majority of Herbalife product is consumed by people who are not distributors or 

(c). There are massive piles of inventory around not consumed.

I think we can reject hypothesis (a) very easily. The company generates huge amounts of cash and was buying back stock rapidly before Bill Ackman came along without blowing the debt out unreasonably. [They have bought even larger amounts more stock since Bill Ackman and the net debt has now risen sharply.] They would not have had the cash to buy back stock if the revenue numbers were falsified.

And I think we can reject (c) above pretty easily too. I have spent considerable time looking for the inventory and I can't find it. It is not on Ebay or Craigs list (as per this post). Besides you can now return it for a full refund - so having unsold inventory sitting in the garage is stupid and unlikely.

So we are left with the middle choice - the majority of Herbalife product is consumed by people who are not distributors.

Bluntly: there goes the bear case.

The FTC will - after examining all the documents - come to the same conclusion. And at that point I would not want to be short this company.


Corrections and amplifications:

There are two amendments that need to be made to this post. The first is that I got the volume points wrong.

Here is a Herbalife label with volume points:

The 550 gram packet is 23.95 volume points. The 750 gram packet is 32.75 volume points. This would make my comparison less extreme and serves to undermine the argument above.

However the labels (and considerable practice) suggest that the way that this is consumed is mixed with skim milk and some fruit and blended - with the dose being 25 grams not 50 grams.

Putting those things together the calculations are more extreme, not less extreme than in the article above. [My guess - there are more than 15 million consumers who consume reasonable amounts of Herbalife product - meaning more than weekly.]

Bluntly there is too much Herbalife sold for a majority of sales to be internal to the distributor base. The sales must be external.

These numbers are utterly consistent with this press release (link) from Herbalife which suggests that 80 percent of sales are outside the network. In which case the FTC will go away.


Tuesday, August 5, 2014

Valeant Pharmaceuticals Part IX: A comment on the sale of the facial injectables business

Valeant missed analyst projections of revenue and guided down their so-called "cash EPS". Regular readers know that I don't hold much regard for Valeant's non-GAAP numbers (such as cash EPS) but for the moment lets consider them.

Valeant provided the following slide reconciling previous guidance to their new lower guidance. [The slide is number 28 in this linked document.]

Valeant announced the sale of the Facial Injectables (to Galderma) on 28 May 2014 - and according to the conference call the deal closed on 10 July.

To quote the conference call:

This past May, we announced that we were selling our injectable products to Galderma. By selling these assets early, we were able to clear the major FTC hurdle towards the June regulatory approval for Allergan and realize the full value for these products. 
We closed the sale to Galderma on July 10. The $1.4 billion raised by this transaction will be used for Allergan -- for the Allergan transaction and/or other future business development opportunities.
Now according to the above table not owning the Facial Injectables business from July 10 to December 31 (ie for 174 days) will reduce annual revenue by $230 million and reduce cash EPS by 50c per share.

There are approximately 341.3 million diluted shares outstanding (as per the 10Q) so 50c per share is 170.65 million.

The implied margin after tax and all expenses for the injectable business is thus 170.65 million on the $230 million of revenue forgone - or 74.2 percent. If you allow that the business has a three percent tax rate (which is the rate that Valeant claims more generally) the margin on the business pre-tax is 76.5 percent.

There are other things you can work out. 230 million drop in revenue comes from not owning the business for 174 days of the year. If we assume no seasonality then the annual revenue of the business is = 230*365/174 = 482.4 million. And given the post tax margin is 74.2 percent the annualized forgone earnings are $358 million.*

Valeant sold this business for $1400 million - so the apparent PE ratio of the sale was - 3.9 times.

This is a very simple calculation from the guidance slide. Nestle/Galderma it seems have got a bargain. A true bargain - a business with sales growth, extraordinary margins and an unlevered price earnings ratio below four.

There is an implication here: Michael Pearson - the CEO of Valeant - let the business go for a startlingly cheap price.

That implication is clearly wrong. Michael Pearson is according to the people who know him - incandescently brilliant and in the conference call he stated that they were - and I am quoting again - able to "realize the full value for these products".

The alternative implication: the guidance slide is wrong.

I know I have put together presentations quickly - and mistakes do creep into them.

I bring this to public attention - and I await an amended corporate guidance. I will publish it when it comes.


*The way I have annualized this was roughly confirmed in the conference call. Howard Schiller - the CFO stated: "[Valeant] had built into our previous guidance $230 million of revenue and $0.50 per share cash EPS for the second half of the year." If we assume these numbers relate to only six months as per the call Valeant sold the business at 3.1 times earnings. Clearly silly. Something is wrong here.

Friday, August 1, 2014

Steal three billion dollars, get a 700 thousand dollar fine: the scammers have a better business model - Sino Forest edition

Sino Forest - familiar to many of my readers - was a large forestry company listed in Canada with operations in China.

It claimed almost 1 million hectares of forest generating twenty cubic metres of chips per hectare per year.

Market cap was in the billions.

The only problem was that the forest did not exist.

Today the Chief Financial Officer admitted wrongdoing, paid a fine and agreed to disgorge some money for the benefit of victims of the scam.

The (Canadian) Financial Post notes:
Mr. Horsley agreed to pay $700,000 in the settlement, and is barred permanently from being a director or officer of a public company. Mr. Turner noted that Mr. Horsley also agreed to pay $5.6-million to settle shareholder lawsuits related to Sino-Forest’s collapse. He [the OSC chair] viewed that as an appropriate penalty, which is why he endorsed the relatively small OSC settlement.
Later the paper deadpans:

At its peak, Sino-Forest was the biggest forestry firm on the Toronto Stock Exchange, with a market value of more than $6-billion. It also raised a staggering $3-billion from investors between 2003 and 2010 before falling into creditor protection in 2012.

Simple question: Where did that $3 billion that was raised go?

Answer: Into someone's pocket.

Have you made a few billion dollars lately?

Repeat after me: the fraudsters have a better business model.


PS: There is out there a multi-billionaire fraudster who is completely absent from the Forbes list of global billionaires. Whatever: at a minimum the Forbes list is like Sino Forest: lacking credibility.

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The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.