Unfortunately, Hempton did nothing of the such. His argument against Ackman’s thesis is built on a faulty premise, and he fails to disprove the claim that Herbalife Ltd. (NYSE:HLF) is a pyramid scheme.
Hempton: why Herbalife is not a pyramid scheme
Hempton’s argument comes down to one simple claim: there aren’t enough Herbalife products being sold on Craigslist or eBay Inc (NASDAQ:EBAY).
According to Hempton, if one accepts Ackman’s claim — that Herbalife Ltd. (NYSE:HLF) is a pyramid scheme — then:
- Failed distributors should be sitting on thousands of tons of unsold Herbalife products
- These failed distributors should dump the unsold products on the secondary market
- Craigslist and eBay are good representations of the secondary market
- Picking any local Craigslist or eBay at random should reveals tons of failed Herbalife distributors selling the product at a steep discount
Hempton then proceeds to check France’s eBay and LA’s Craigslist, and concludes that there aren’t enough fire sales for his liking.
Problems with Hempton’s argument
Of course, there are numerous problems with Hempton’s test.
For starters, while I think Ackman would agree that failed Herbalife distributors are sitting on thousands of tons of unsold product, it’s too big of an assumption to claim that all the distributors would sell the unsold product on the secondary market.
Sure, that’s exactly what a smart investor like Hempton would do. But the typical Herbalife Ltd. (NYSE:HLF) distributor lacks Hempton’s business acumen (otherwise they wouldn’t be a Herbalife distributor in the first place).
It’s possible that the unused Herablife product is getting tossed in the trash, given away, or still sitting on the shelves of the failed distributors.
Moreover, it’s a big leap to assume that Craigslist and eBay are accurate representations of the Herbalife secondary market, or that any one of these sites chosen at random is a good sample.
In the US, Herbalife’s distributor base is disproportionately composed of Latinos (over 60% in 2007), and internationally, the reception to Herbalife has been quite varied. Belgium, France’s neighbor to the north, found Herbalife to be a pyramid scheme, and outlawed the company in late 2011.
Photos of Herbalife Ltd. (NYSE:HLF) nutrition clubs in the US show signs written in Spanish. Why then would one turn to english-based Craigslist?
Lastly, even if one accepts that every Craigslist and eBay is an accurate representation of the secondary market, Hempton makes no attempt to figure out what the right threshold is.
In other words, if Hempton’s test is valid, there should be some magical threshold, of which a number above said threshold indicates that the company in question is a pyramid scheme. For example, if Herbalife is a pyramid scheme, one would expect to find 10 Herbalife products for sale on LA’s Craigslist on a given day.
But Hempton provides no such number. (He finds five apparently failed Herbalife distributors in Chicago, but seems to dismiss that number as too small given the size of the city.) Ultimately, he concludes that there just isn’t enough online evidence to suit his liking.
The existence of any online discounts is a strike against Herbalife
Hempton does not dispute Ackman’s original notion — that Herbalife Ltd. (NYSE:HLF) products can be purchased online at a steep discount. In fact, he finds evidence to support it, pointing to a particular eBay seller who has a history of offering Herbalife products at a 35% discount.
If Herbalife products can be easily purchased online for a greater discount than what the company offers to distributors, then why would anyone pay to become a distributor for the purpose of self-consumption?
Other multi-level marketing firms suffer from a similar problem
The other two publicly traded multi-level marketing firms, Nu Skin Enterprises, Inc. (NYSE:NUS) and USANA Health Sciences, Inc. (NYSE:USNA), suffer from the same problem — their products are freely available online at a steep discount.
For example, Nu Skin Enterprises, Inc. (NYSE:NUS)’s ageLOC Future Serum has a suggested retail price of about $200. A distributor receives a 30% discount, but bottles of the serum are listed on eBay for around $50 — a 75% discount.
Likewise, USANA Health Sciences, Inc. (NYSE:USNA) Essentials have a “retail price” of $51 per box. The wholesale price is about $42, and there are many on eBay offering USANA Essentials at or near wholesale.
In both cases, it begs the question as to why customers would become distributors for the purpose of self-consumption. In the case of Nu Skin Enterprises, Inc. (NYSE:NUS), the products are freely available online for less than what it cost distributors to buy them from the company directly. The USANA Health Sciences, Inc. (NYSE:USNA) discounts do not appear to be as steep, but buying them from eBay avoids the hassle of having to purchase a Business Development System.
Investing in Herbalife
Hempton’s attempt to disprove Ackman’s thesis failed, and he may have actually strengthened Ackman’s case by pointing out that these products are widely available online at a discount.
Nevertheless, as long as Pershing Square remains short Herbalife Ltd. (NYSE:HLF), the controversy around the stock — and the entire MLM industry in general — is likely to persist. Yet, it hasn’t been a good year for the bears, as shares of Herbalife are up a staggering 80%, while the other MLMs — Nu Skin and USANA — have posted equally impressive gains of 68% and 159%, respectively.
Until Ackman covers, or the FTC slams the company, this stock story is far from over.
The article No, Bronte Capital Didn’t Debunk Ackman’s Herbalife Thesis originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
Joe Kurtz has no position in any stocks mentioned. The Motley Fool has the following options: long January 2014 $50 calls on Herbalife Ltd. (NYSE:HLF). Salvatore “Sam” is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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