Hedge fund manager Bill Ackman had a bitter day after he failed to convince investors that nutrient supplement provider Herbalife Ltd. (HLF) was a pyramid scheme as the company's shares rallied 27.8% to hit $67.98 a share on heavy trading, with volume comprising more than 14 times of the average daily volume. One day after, the stock stayed over $65, and showed no signs of sinking.
Good Investigation, Bad Presentation
In the lengthy presentation on July 22, the billionaire Ackman choked up when he talked about how naive the members of Herbalife were who never realized the company is a fraud. He accused the company of targeting the poorest to build costly nutrient clubs, and bilking out them more than $3,000 to qualify to open such a club. With $50 million spent over a two-year campaign in their attempt to discredit Herbalife, Ackman’s Pershing Square Capital Management investigated 240 such clubs in several countries to build his case.
After elaborating for three hours about how Herbalife operates its nutrient club-centered retailing model, Ackman came to the conclusion that the company was involved in a pyramid scheme. He said the company was not selling weight-loss products, rather it’s selling business opportunities. “By becoming legal, they die,” he said,“Why? Because we don’t think there’s fundamental demand for the product.” To convince audiences, Ackman also played the hidden microphone snippets to show how the riches in the company lure the poor during the presentation.
After spending $50 million to investigate the company, why couldn’t he convince investors? What’s wrong with his presentation?
Indeed, on Monday the company's stock did sink 11% after he announced his evidence against Herbalife the next day. The announcement that Herbalife was going to collapse successfully pumped investors expectations, while the next day's dreary detailed presentation didn’t deliver the bombshell the audience wanted.
Erik Gordon, a professor at the University of Michigan’s Ross School of Business said Ackman had gone from helping his case to hurting it. “Less hyperbole might make for more credibility,” Gordon said.
The reality is that Ackman's investigative presentation is not "TV-friendly." That is, the three-hour presentation could easily bore audience and make them lost. Ackman step-by-step tediously laid out details of his investigation, methodology, and even the theories of investigation. For three hours.
If it is a lengthy investigative piece in a major newspaper or news website, it could have been the blockbuster Ackman expected. Some may argue that many good investigative pieces are good both on print and broadcast, but leaving the question whether Ackman's presentation is persuasive or not aside, the idea that the company's stock would plummet after a long, laborious and even tedious presentation is questionable.
Multi-level Marketing vs Pyramid Scheme
Ackman failed to convince investors, but is Herbalife really innocent? Ackman's argument maybe far from conclusive, while Herbalife's response does not clearly address some of his core accusation, either. For the most part, Herbalife was trying to discredit and denounce Ackman in person. The statement says: "Once again, Bill Ackman has over-promised and under-delivered on his $1 billion bet against our company… After spending $50 million, two years and tens of thousands of man-hours, Bill Ackman further demonstrated today that the facts are on our side.” Herbalife insisted it was just a normal and legal “multi-level marketing company.” While it’s subtle response could be just a PR crisis control, it didn’t prove them innocent, either.
There is a fine line between pyramid schemes and multi-level marketing, and the main difference concerns whether the company’s primary function is forcing recruited sales representative to purchase products to get rewards. In short, in pyramid schemes, companies ask sales reps to pay fees to earn, while legal MLM companies offer sales reps earnings when they sell. That’s big difference. Usually the only people that are making money on a pyramid scheme are those on the top of pyramid.
According to the United States Securities and Exchange Commission:
“The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same. The fraudsters behind a pyramid scheme may go to great lengths to make the program look like a legitimate multi-level marketing program. But despite their claims to have legitimate products or services to sell, these fraudsters simply use money coming in from new recruits to pay off early stage investors.”
Its business mode easily entices poor who are irresistible to high payment returns. In Herbalife’s case, according to Ackman, some Hispanic recruits are lured to on board to seize the opportunity to make $22,000 a month. The thing is, you never make more than the people that signed you, and you have to sign new members to make money. That’s why Herbalife’s nutrients club is suspected to be pyramid scheme.
In comparison, legal multi-level marketing, although sharing the same pyramid structure of pyramid scheme, in MLM its sales rep can actually make money from products they sell, they don’t have to sign new members, and they can make more money from people who signed them.
Because both MLM and pyramid scheme relies on pyramid-structured sales reps, they both have to intensively promote their products to attract buyer or possible recruiters. This sometimes leads to false advertising and misrepresenting.
MLM companies thus are often under FTC investigations because of its similar business model to pyramid scheme. Cases dated back to 1970s with FTC investigating Amway’s exaggerated and false advertising. Although FTC failed to find out evidence of Amway doing pyramid scheme, it still warned Amway not to falsely advertise.
Back to the battle between Ackman and Herbalife: after Ackman’s fiasco on that Tuesday, Herbalife’s stock still seemed safe. Plus, looking at statistic of the company’s report, the last quarters revenue rose by 12.4% compare to year-ago period, beating the industry average renew growth of 12.2%. The company’s strong return on equality also increased last quarter and exceeded the industry average.
While Ackman’s $1 billion bet blew, Pershing Square’s two-year campaign lobbying regulators to close Herbalife has gotten some steam. Regulators including the U.S. Federal Trade Commission have stepped into investigate. The legal answer whether Herbalife qualifies as pyramid scheme or not hasn’t been finalized.
But as Ackman has acknowledged himself, pyramid schemes are difficult to prove and time consuming. He companied that regulators including Securities and Exchange Commission didn’t investigate the company deep enough, while former SEC attorney in the enforcement division Peter Henning doubted regulators investigation would be positive to shut down the company in short time. “Are regulators going to commit $20 million of their enforcement budget to this? No.” Henning said. He estimated the investigation from the FTC could take at least a year.
To Ackman, he said he was very persistent on this case. “If I see something wrong, I don’t let go,” he said, but hasn’t indicated when he would back down again.
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