Tuesday, July 19, 2016
Sunday, July 17, 2016
Whilst the settlement is agreed there are very substantial differences between what effect the FTC says the settlement will have and what effect the company says it will have.
The company states this:
The terms of the settlement do not change Herbalife's business model as a direct selling company and set new standards for the industry. With the settlement agreement announced today, the FTC's investigation of Herbalife is completeThe FTC state something almost the opposite - stating in their title of their release that "Herbalife Will Restructure Its Multi-level Marketing Operations". They also put out a particularly aggressive press release that stated "it’s no longer business as usual at Herbalife".
The bull case is thus the government risks has gone away and there will be no substantial change in business model. And the bear case is that the conditions placed are so large they will cause the business to collapse in the US and that those changes will be exported globally.
The disagreement regarding this settlement is enormous. The stock traded - and I can scarcely believe this number - 35.3 million shares. Almost 40 percent of all shares changed hands. Obviously some people think this settlement is really good news, some think it is really bad news. And clearly some people are just flat day-traders.
The disagreement is almost total to the facts too. There is a form of settlement in the United States which does not accept nor deny liability but accepts a fine. This settlement does not follow that form. The company disagrees with all facts in the FTC complaint except that the court has jurisdiction.
The only thing that they agree on is that the FTC did not declare Herbalife to be a pyramid scheme. But even that is a limited agreement. The FTC has stated that it did not declare that Herbalife was not a pyramid scheme - they just don't want to use pyramid language.
That said the FTC's rhetoric is unimportant. And for that matter so is Herbalife's rhetoric. They can say whatever they like about the settlement and that does not make it true. What matters is what Herbalife has agreed to do and what effect it will have on the business.
So bluntly what have they agreed:
a) That Herbalife will pay $200 million in restitution - but the details about how that restitution will be paid are left open. [I have a pet suspicion that they will find it hard to find well documented losers who lost anything like $200 million - but again that is irrelevant - Herbalife has agreed to pay it and it is cash out the door.]
b). They have agreed a change in business practices. The exact form requires a fairly detailed understanding of Herbalife's compensation scheme - but this is the list as described on the FTC's website:
- The company will now differentiate between participants who join simply to buy products at a discount and those who join the business opportunity. “Discount buyers” will not be eligible to sell product or earn rewards.
- Multi-level compensation that business opportunity participants earn will be driven by retail sales. At least two-thirds of rewards paid by Herbalife to distributors must be based on retail sales of Herbalife products that are tracked and verified. No more than one-third of rewards can be based on other distributors’ limited personal consumption.
- Companywide, in order to pay compensation to distributors at current levels, at least 80 percent of Herbalife’s product sales must be comprised of sales to legitimate end-users. Otherwise, rewards to distributors must be reduced.
- Herbalife is prohibited from allowing participants to incur the expenses associated with leasing or purchasing premises for “Nutrition Clubs” or other business locations before completing their first year as a distributor and completing a business training program.
The big condition is the first one requiring a distinction between "discount buyers" and "distributors".
This goes to the crux of one of the biggest Herbalife arguments. By far the bulk of Herbalife distributors do not sell sufficient product to qualify as a sales leader and thus are entitled to almost no checks based on downstream consumption. At the last 10-K Herbalife had approximately 4 million distributors globally. There were "only" 364 thousand "sales leaders". Only a "sales leader" is entitled to checks from the company based on indirect sales down many levels. (There are trivial circumstances non sales leaders will receive checks. These are described below.)
Globally there are about 4 million distributors and less than 400 thousand sales leaders thus there are 3.6 million distributors who are not sales leaders.
We do not know how many of these are in America - but as the sales leaders are about 20 percent in the United States I would guess that 20 percent of the distributors who are not sales leaders are also in the United States. That is about 720 thousand people or almost a quarter of a percent of all people in the United States.
The default for these people will be that they are recategorised as "discount customers" and this will change their relationship with the company. The importance of these changes is open to dispute (and discussed below).
The first way that it will change their relationship is that they cannot harbour any illusions of receiving a check from the company based on downstream sales. If they are customers rather than "distributors" there is no "business opportunity".
I would argue most of them were under no such illusions anyway - but this removes the possibility altogether.
But we can be very precise about the way in which their relationship with the company changes.
In the old days I could buy Herbalife from a distributor and pay full freight. (Some people do.) Or alternatively - for $70 a year - I could sign up as a "distributor" and buy Herbalife (delivered by UPS) for a 25 percent discount. The 25 percent discount applies at almost all levels of purchase (volume points) that are consistent with personal consumption.
There are two advantages for buying it at a 25 percent discount. The first is that I get it cheaper (which is nice if I want to consume it myself) and the second is that I might sell it to someone (at par) and pocket that 25 percent myself. If someone bought it from the company at par and named me as their distributor then I would be entitled to 25 percent of their sales (a check from the company). However at the 25 percent level my volumes must be small. Volumes consistent with a solid diet by three to four people would entitle me to more than 25 percent discount.
Whatever - the volume of checks from the company for 25 percent distributors was trivial. (Sure some was sent but the total dollar value was small. They occurred only in the case that a small distributor convinced someone to buy product from the company at par and name them on the order form as the up-line.)
For a 25 percent customer who never convinced anyone else to order directly from the company (ie most of them) paying full-freight there has been no change.
Calling this person a "discount customer" rather than a "distributor" changes nothing. A 25 percent distributor is still entitled to buy it at a 25 percent discount. And if they actually manage to sell some at par (above list price) they can probably pocket the 25 percent anyway (but they can't formally tell the company). If they managed to convince someone to buy it at full freight ordering direct from the company they have lost that - but in toto this is not very much because 25 percent distributors are buying only volumes consistent with personal use. (Bigger volumes would entitle them to more than a 25 percent discount.)
I have met many 25 percent discount customers and almost none are selling the product ever. By number these are - by far - the bulk of the 4 million Herbalife distributors globally.
The company has always asserted that are not really distributors anyway - they always were discount buyers. By contrast the shorts - led by Mr Ackman - have asserted these people are "distributors" rather than customers - and when they work out the income and failure rate of distributors they always include these people in the denominator which makes the failure rate look high and incomes distributed by the company look pathetic. (After all they are counting in the denominator a huge number of people who were not selling any - so were not entitled to a check from the company anyway).
The volumes associated with these distributors cum discount customers are typically less than 600 volume points per year - an amount entirely consistent with personal consumption of diet products.
There are a small number of distributors who do greater than 1000 volume points but less than 4000. 4000 volume points entitles you to be a "sales leader". These people are entitled to buy the product at 35 percent or 42 percent discount depending on their volume (rather than a 25 percent discount) and if they sell it to someone else they make a somewhat larger "retail profit". None of that changes.
However if this customer were to sign up another discount customer (say at 25 percent) they would be entitled to a check from the company for the difference between the customer's 25 percent and their 42 percent. The aggregate amount of such checks from the company is trivial but they do exist. These people are going to either become distributors (to qualify for this check) or remain as discount customers. To qualify as a distributor they will now need to submit a business plan. My guess is that very few of them will do so. There will be a small loss to the company from people who become distributors accidentally - joining for the discount and selling a little on the side.
The shorts have fairly continuously asserted that the "discount customers" do not exist. Here is a typical Seeking Alpha assertion of precisely that. The longs have asserted that most distributors are in fact discount customers.
Bluntly this is the crux of the argument. If the 25 percent "distributors" are in fact people who dream of receiving checks from the company then telling them they cannot will cause the scheme to collapse. If that huge swathe of people are just "discount customers" the formalising the arrangement will have almost no effect on business.
This is the first Rorschach Test: if you believed in advance that the discount customers were a myth you believe now the FTC conditions will collapse Herbalife. If you (like me) believe that the bulk of distributors were in fact discount customers then calling them such will have almost no effect.
What is great about this is that the existence or not of discount customers is easily determined. Go and visit half a dozen decent sized herbalife distributors and find their downline. (This will take you four days maximum - but you will need to use shoe-leather.) If you don't find many discount customers you can short the stock. (The shorts will be right.) If you find plenty you can go long the stock. (The longs will be right.)
And the beauty of this is that you can know. You do not need to take my word for it. Just do it yourself and make some money.
My assertion is the people I think are "discount customers" and Bill Ackman thinks are "failing distributors" are about a quarter of one percent of the US population. It should not be hard to find them if you look.
The second business change demanded by the FTC
Here again is the provision from the FTC website:
Multi-level compensation that business opportunity participants earn will be driven by retail sales. At least two-thirds of rewards paid by Herbalife to distributors must be based on retail sales of Herbalife products that are tracked and verified. No more than one-third of rewards can be based on other distributors’ limited personal consumption.
The shorts have continuously asserted that retail sales do not exist. (See the above discussion of whether discount customers do not exist.)
If you believe that retail sales do not exist then the requirement that two thirds of sales in the downline of a distributor be retail sales (rather than sales to another distributor) will be very hard to achieve.
If you believe like me that retail sales exist and are widespread the FTC requirement above becomes merely an auditing requirement.
Again you should not take my word for it. Get on the road. Go find some distributors. Talk to their customers.
But if the discount customers are in fact discount customers (see the discussion above) then this should be trivial.
But lets put some numbers around it. A distributor who is entitled to multi-level compensation is (with the trivial 42% distributor described above excepted) someone who is a "sales leader". Sales leaders are entitled to a share of sales up to three sales leaders below them.
To become a sales leader you need to have 4000 volume points annually. A meal replacement is roughly 1 volume point. So you need to be ordering roughly 4000 meal replacements per year.
The most anyone reasonably personally consumes is two meal replacements per day for them and their spouse. This is about 1400 volume points a year. Only in the extreme example of a couple who sell precisely the minimum number of volume points per year and personally consume the reasonable maximum is this provision even going to bind.
In other words the provision does nothing at all (once you have decided that retail volume truly exists). As a long I am utterly unconcerned about this provision. But the shorts (who think that retail volume does not exist) think this provision will be lethal too.
Again you can test it. Just get put on the shoes and allow yourself a few days to check it out.
The 80 percent rule company wide
Under the third condition the company is required to ensure that 80 percent of volume company wide is sold to must be legitimate sales and (as per the consent decree) specifically this means sales for reasonable personal consumption plus verified retail sales. This should not be hard even if you restricted it to retail sales.
In North America there are 76 thousand sales leaders doing 1.1 billion volume points. This is about 14,500 volume points per sales leader. The maximum amount of personal use (as estimated above) is about 1400 volume points per year.
This rule should be trivial to meet. Absolutely trivial.
Of course if the retail sales don't exist and the 25 percent distributors are really failed customers all bets are off. But again that debate is easily solved by using shoe leather.
Requiring at least a year as a distributor before opening a club
The final change demanded by the FTC will change business practices. It will require that a distributor be a distributor for at least a year and submit a business plan before they open a club.
Normally I would find it odd and patronising that the Government tells people (and in this case mostly Hispanic people) that they can't open a business. Notwithstanding that I am going to cheer the condition.
I have visited several viable clubs - and several non-viable clubs. But the viable clubs are barely viable. I blogged about that here. In that post I argued that clubs would be better if the number of clubs were restricted. I stand by that view. The FTC has done club owners and the company a favour.
The FTC settlement is a Rorschach Test. You will see in it what you want to see in it.
If you see a pyramid scheme in advance then the conditions that the FTC has imposed will cause that scheme to collapse.
If you see something that is not a pyramid scheme then lo - the FTC conditions will do almost nothing.
You can check this out yourself. Shoe leather. It's really an opportunity for you to make money on primary research.
I have for a long time asserted that Herbalife is not a pyramid scheme. I was worried however that some bureaucrat would (in direct contradiction of the facts on the ground) decide it was and try to shut it down. Indeed the extreme time that it took for the FTC to come to a settlement on Herbalife increased that risk dramatically. We had limited our position size (a little) to account for the insane-bureaucrat risk. That risk has gone now - and I upped the position (slightly) near the close on Friday.
But of course if this is a pyramid scheme then the conditions imposed by the FTC will cause the scheme to collapse. And so shorting it now is a low risk proposition.
Again - as stated - the FTC conditions are a Rorschach Test. You can see what you want to see.
One worthwhile detail is that more than a dozen top distributors signed non-disclosure agreements and okayed the settlement with the FTC. They did not think it will affect their business adversely. They did not bear the cost of litigation - so they only had an incentive to sign an agreement that did not hurt their business.
Take that detail as you wish.
Finally I remain resolute in my view that Herbalife is not only not a pyramid - it is a highly ethical organisation.
I think that the FTC might actually have trouble finding enough "victims" to distribute the $200 million in restitution. I intend on FOIA requests over time to monitor that.
The "restitution" makes me think of the FTC not as a competent and honest regulator but rather an extortion racket. I am a liberal and I always thought the argument that the US Government was an extortion racket was far-fetched. But I find myself agreeing with this article in The Economist.
The only saving grace is that the $200 million was "restitution" and not a "fine" and is therefore tax deductible.
I think by owning Herbalife you will make a lot of money.
But more - you will be standing up for an ethical company against lies and extortion. I am proud of the money we have made thus far, expect to make more and am proud of the position.
The FTC decision is now made and the arbitrary government decision risk is removed. If this is a pyramid scheme then the conditions imposed will cause it to collapse.
On that I think I am safe.
PS. There are a few other FTC provisions which should have very limited effect.
The company already gives distributors a refund for any unsold product including postage. The deal with the FTC forces Herbalife to offer that refund for a longer period.
Also the deal with the FTC prohibits auto-refilling orders at Herbalife. Herbalife has previously disclosed that about 0.5 percent were auto-shipped. This won't be a big change.
The company already requires distributors to order directly from the company if you wish the volume to count towards sales leader classification. There is already good granular data on these purchases. Refunds are readily available.
Tuesday, July 5, 2016
Whatever - they are growing now through a credit card business where they are hawking cards on the street. And they are shrinking their foundation business which involves selling loans and collecting debt door-to-door.
That business - Provident - has a network of 5,500 agents who call each week at the homes of 900 thousand people in the UK. That is 32 homes each per working day.
And they originate credit and collect loans.
Here is an extract from the annual report:
According to this the agents are primarily paid commission on what they collect, not what they lend.
Just imagine this job. Being paid for collecting on tough debts in the rainy, dark north of England, a bit like an old rent collector, just a little more seedy.
By comparison my life (and probably yours) is sheltered and easy.
Monday, July 4, 2016
Australia has a socialised medical system (called Medicare) that by most objective measures works well. Health outcomes are good. Health expenditure as a percentage of GDP is not outrageous (but is on the high end of the non-USA OECD).
Medicare it is very popular.
Indeed if you polled conservative voters in Australia they would resoundingly vote for socialised medicine.
Medicare has been so well run and is so accepted that it has become a sacred cow in Australia. A politician who even tinkers with it takes considerable risk.
That said, it does not work perfectly.
Many years ago when I was a public servant the then Labor Government introduced a copayment for pharmaceuticals for pensioners. Up until then pensioners could get their scripts filled for free. After that there was a very small (two dollar) copayment introduced.
The then government had an estimate how much money this would save. And they were wrong. It saved more, much more.
It turns out that there were a surprising number of elderly women (and they were mostly women) whose idea of a social life was to go to a different doctor every day, get a different script filled every day and go to a different pharmacist. After all those young doctors really are handsome men.
Adding a trivial copayment drastically reduced these behaviors. It saved money and improved heath outcomes.
To get more rational use of healthcare you did not need to hit these people with the full marginal cost of their services. Just a little bit of market did most the work that market does.
And the lesson was learned, socialised medicine works better with just a little bit of market in it - just to make sure the incentives are lined up. Its a lesson I have held ever since.
I disliked the Abbott (conservative) government in Australia a great deal. But they did try to introduce a general copayment (five dollars) for visiting a doctor in Australia. It was howled down in political protest. Like a lot of Abbott policies it was a bit ham-fisted. The welfare effects could have been ameliorated by introducing for example a maximum number of copayments. But none of that was tried.
Most importantly the government did not sell the policy well. The discussion above was not part of the discourse.
And it also gave the (conservative) government in Australia a reputation for tinkering with Medicare. That reputation for tinkering came back to haunt them.
We just had an election on the weekend. The conservatives were not beaten - but the swing against them and to minor (sometimes extremist) parties was strong.
One element of that result was a the scare campaign about Medicare. That is a great pity because there really are tweaks around the edges that will make it work better.
Some of those involve small copayments. But others are very left-field. For example teaching elderly people to use Facebook and smart-phones probably saves Medicare money. People are just less lonely with Facebook.
I don't know how we have a bipartisan debate on this stuff in Australia. A "Medicare taskforce" requires "scare quotes".
But I think it is also a good idea. Indeed demographic trends for socialised medicine are not pretty - and this sort of tinkering might be necessary to protect the system.
Monday, June 27, 2016
Friday, June 17, 2016
I don't normally blog about macroeconomic issues because I know enough to know that I will be wrong most the time. However I feel I need more than the 140 characters on twitter to explain why I am unconvinced that negative rates are that unnatural.
Alas you are going to have to go through a fairly long-winded argument. And I am far from sure of all this - so I really want the comments to criticise my thesis. I am apt to change my mind.
Step 1: the impossibility of collectively deferring consumption
Very roughly almost everything I have consumed this year was made this year. The restaurant meal, the haircut, even the flight I took. There are a few exceptions. The plane trip that I made was made in a seven year old plane (but it wasn't made in a 20 year old plane).
Very few services I consume at all are produced in any way more than say a decade ago (or with capital equipment more than a decade old).
There are a few exceptions.
- I snitched a 15 year old bottle of wine from the cellar last week (it was very nice).
- And much more importantly the housing services I consume are in a house that was built 30 or 40 years ago.
But with those exceptions what I consume in this decade is almost entirely produced in this decade.
And for that matter what I consume in the five years from 2030 to 2035 will almost entirely be produced in those five years.
I can inter-temporarily move consumption around (saving money/capital now) and consume a little more than I earn in 2035.
Everyone individually can do that. That is what capital markets are for in part.
But collectively we can't.
You see everything that everyone consumes in the years 2030-2035 will roughly be made in the years 2030-2035.
We can all save individually saving money, deferring consumption, but collectively we do not defer consumption. We just rearrange claims on that consumption.
Step 2: ageing populations
In every country that matters economically populations are ageing - very sharply. Indeed this is the most rapidly ageing population in human history.
And ageing people want to defer consumption. Individually we have huge populations wanting to defer consumption.
Step 3: the problem - we cannot collectively defer consumption
And now you see where I am going. Individually we all want to defer consumption. Collectively we cannot because what is consumed in 2030-2035 will roughly what is produced in those years.
So I am going to assert that collectively we are very likely to be disappointed. People will not get (in returns) what they expect to get.
Step 4: How is this disappointment to be settled on people?
Since I am asserting that collectively we are going to be disappointed (as we can't collectively defer consumption) the next twenty to thirty years will be in large part trying to work out how to settle that disappointment on people.
And if you can work out all the ways (and timing) that settlement is disappointed on people you should be able to make money (trading the other side). I would love to be able to do this. But here are a few suggestions.
- Pensions default. We all think by working hard and earning a pension we are looking after ourselves - but collectively we are disappointed.
- Inflation takes away our savings
- Interest rates don't keep up with inflation - we have 20 years of negative real rates - maybe sharply negative after taxes,
- Asset prices in real terms fall for decades - so your Singapore apartment isn't going to be worth what you think it is - nor is that Sydney or London place, and equities are destined to disappoint.
But one is pretty obvious to me. The market clearing real interest rate is negative and should be for some time.
Thursday, June 9, 2016
We have a competitive edge in our ability to create value.
The Kirin Group leverages its advanced technological capabilities and manufacturing capabilities to produce high-value products, and it has superior capabilities in the creation of value. One example is Kirin Hyoketsu®. With this product, we have created an invigorating drinking sensation by mixing refreshing vodka with juice, selling it in an original diamond-cut can.
If mixing vodka and fruit juice is leveraging your "advanced technological capabilities" I should be able to cope even when plastered...
Tuesday, May 17, 2016
PS. I am currently on a business trip to the United States. Maybe it is just bad luck - but the quality of Uber service has dropped fairly dramatically since the last time I was here. I no longer feel the need to recommend Uber to friends - and indeed am coming close to advising against it.
Monday, May 9, 2016
Wound up at a cool blues bar on Bourbon Street. But the highlight was a busker. Her name was Heidi Keltner and she had a great sense of rhythm, a decent bluesy voice and could hold the crowd she had built up.
Its got to be a tough life trying to be a musician in Nashville. Heidi had to leave later to start a 3AM shift at UPS...
The street scene wound up as a jam with a drunk African American woman trying to do Aretha Franklin (whilst holding onto me for physical support and complaining I smelt like a white guy).
But lets stick to Heidi. Her original songs were fine.
Her YouTube channel is badly underproduced. But put on headphones and listen to this. You won't be disappointed. (The band is called the Narwhal Empire... but I only saw Heidi.)
Saturday, May 7, 2016
If someone disagrees with you they are certifiably crazy: Bill Ackman, Valeant and Herbalife edition.
There is quite a deal here - but I got to this email from Bill Ackman to Mason Morfit (of ValueAct) and Mike Pearson (the then CEO of Valeant). I can't resist posting it.
Mike and Mason
Please see below from my PR folks. The idea that Ubben blames me for the decline in VRX stock is absurd. I don't care but I think it is not good for Valeant.
I had never previously heard of Andrew Left and I don't think his short position was motivated by animus for me. I just think he wanted to make money. With respect to John Hempton, I have never met him or spoken to him. He happens to be long Herbalife and certifiably crazy. How can I be responsible for his behavior?
With respect to my email apology for the WSJ article, I don't understand what value it brings Valeant for the recipients to have shared it with the FT. I did my best to shape the WSJ article in a way that would be good for Valeant and I didn't love the outcome. I therefore apologized. Isn't that the appropriate thing to do?
I just want to put this up for posterity. But I wish to assure Bill that on both stocks I am research driven and quite sane.
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.