In The Herbalife Ltd. (HLF) Aftermath, Should Investors Buy Multi-Level Marketing Companies?

With all of the uncertainty surrounding Herbalife Ltd. (NYSE:HLF), thanks in part to billionaire Bill Ackman’s barrage of attacks, we decided to dig a bit deeper and look at the multi-level marketing company industry. The major MLM companies include a few of Herbalife’s key peers: Avon Products, Inc. (NYSE:AVP), Nu Skin Enterprises, Inc. (NYSE:NUS), Weight Watchers International, Inc. (NYSE:WTW), and Medifast, Inc. (NYSE:MED).

Herbalife has been beaten down over 30% the past week mostly due to short positions announced by Bill Ackman of Pershing Square Capital and Whitney Tilson of T2 Partners. Being called into question are Herbalife’s business practices. In a detailed presentation, Ackman questions Herbalife’s sustainability given its above-average product prices, minimal R&D spending and virtually nonexistent product advertising (check out Bill Ackman’s newest picks).

Ackman has trouble understanding why Herbalife’s products are so successful, especially when the company “spends ‘de minims’ dollars on advertising.” In his opinion, Herbalife is a big supporter of its name and logo, but not its products. This is the foundation of Ackman’s argument: that Herbalife is hiding its true motives and practices, where he believes the company is spending an out-sized amount of its retail profits on recruiting rewards – well in excess of the 50% allowed by the FTC.

The pressures on Herbalife and its peers stem from the fact that there is a fine line that MLM companies must toe in order to avoid being labeled a pyramid scheme. The FTC defines pyramid schemes as operations that rely on continual recruiting as opposed to product sales.

Worth noting is that despite all of the concerns that Ackman has brought to light, he has failed to drag down the entire MLM industry as far as HLF has fallen. Herbalife is down 40% over the past month and other major peer Nu Skin is down 25%, but Avon is down only 2%, and Weight Watchers (-7%) and Medifast (-13%) are down close to double-digits.

So what can investors do?