Herbalife: A pyramid within a pyramid?


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Bill Ackman's latest attack on Herbalife targets the company's nutrition clubs.

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Herbalife: A pyramid within a pyramid?

  1. 1. Herbalife Nutrition Clubs: A Pyramid Within a Pyramid? Source: Herbalife.com
  2. 2. Why do nutrition clubs matter?
  3. 3. Why do nutrition clubs matter? They generate much of Herbalife’s revenue According to Herbalife’s management, nutrition clubs accounted for 33-41% of Herbalife’s revenue as of the end of 2012. Pershing Square believes this number is closer to 50% today. Even assuming the 40% figure, the loss of the nutrition club business could wreak havoc on Herbalife’s financials – cutting its earnings per share figure from $5 to just $0.41. Source: Herbalife.com
  4. 4. Why do nutrition clubs matter? Source: Pershing Square Presentation 7/22/14, slide 230
  5. 5. What are nutrition clubs?
  6. 6. What are nutrition clubs? A bizarre setup Herbalife nutrition clubs are hard to categorize. At first, they seem like retail stores -- places where customers come to purchase Herbalife’s shakes. But the rules are strange, and appear to discourage successful operation. The clubs must cover up their windows, and cannot promote -- they can’t show a Herbalife logo to the outside world or even reveal if they’re currently open. Source: Pershing Square presentation 12/20/12, slide 271
  7. 7. What are nutrition clubs? Source: Pershing Square Presentation 7/21/14, slide 59
  8. 8. But people are showing up to these clubs, and consuming Herbalife’s products, so what’s going on? A pyramid scheme within a pyramid scheme, according to Pershing Square
  9. 9. Pyramid within a pyramid Fake customers Pershing Square believes nutrition club customers are fictitious: Rather than represent real retail demand, the people frequenting these clubs are doing so only as a way to participate in Herbalife’s scheme. Source: Pershing Square presentation 12/20/12, slide 272
  10. 10. Club 100 Source: Pershing Square Presentation 7/21/14, slide 83
  11. 11. Club 100 The origin of nutrition clubs Herbalife sells its product through a network of independent distributors. These distributors are supposed to work within a set of guidelines, but are free to innovate. Nutrition clubs were an innovation of one such distributor -- a Mexican named Jorge Ruiz. Ruiz’s system is known as “Club 100”. Through an exhaustive investigation, Pershing Square was able to figure out how Club 100 operates. Source: Pershing Square presentation 12/20/12, slide 273
  12. 12. Club 100 More accessible To attain the rank of Supervisor in Herbalife’s business, a distributor must purchase around $3,000 worth of Herbalife product. While possible for a middle class American, it’s daunting for a person living in an emerging market. Club 100 allows would-be distributors to break that $3,000 up into bite-size pieces -- $2, $3, or $4 a day, spread out over several months or years. Source: Pershing Square presentation 7/22/14, slide 17
  13. 13. Club 100 Source: Pershing Square Presentation 7/22/14, slide 118
  14. 14. Club 100 Training Would-be nutrition club operators are encouraged to go through an exhaustive training process. It is this process that creates the “customers” that regularly attend Herbalife nutrition clubs, according to Pershing Square. Herbalife nutrition club trainees attend a host club regularly, supposedly to learn how to operate a club successfully. Each time they attend, they buy product, and do work for the club for free. (Pershing Square believes this is a major violation of labor laws, but is largely secondary to their overarching thesis.) Source: Pershing Square presentation 7/22/14, slide 89
  15. 15. Club 100 Where customers come from They also convince their family and friends to attend the clubs to support them, and make visits to other, larger clubs. Once they’ve passed the training, they can start their own club, and work to recruit other club owners beneath them. High-ranking distributors have said explicitly that nutrition clubs profit through “duplication.” Pershing Square believes the desire to participate in the nutrition club scheme, and the associated “training”, is what produces the majority of nutrition club customers. Source: Pershing Square presentation 12/20/12, slide 276
  16. 16. Club 100 Source: Pershing Square Presentation 7/22/14, slide 115
  17. 17. Club 100 Club 100 goes global While originally the work of just one distributor, Herbalife management is aware of how nutrition clubs operate, and the system has been adopted and spread to many other countries, particularly other emerging markets. These markets have generated Herbalife’s recent growth. Source: Herbalife.com
  18. 18. Pyramid within a pyramid Herbalife shareholders are exposed to regulatory intervention According to Pershing Square, Herbalife cannot afford to shut down nutrition clubs, as it would destroy the company’s financials. At the same time, they seem to run afoul of anti-Pyramid Scheme laws, as the demand is based on recruitment, rather than legitimate retail sales. Should regulators act, either shutting Herbalife down completely or significantly curtailing its operations, Herbalife shareholders could be devastated. Source: Wikimedia Commons
  19. 19. Now learn about Warren Buffett’s worst nightmare