Activist hedge fund manager Bill Ackman said he has closed nearly half of his short position on the stock of Los Angeles nutritional products company Herbalife Ltd. but said he still firmly believes it is a pyramid scheme that will attract regulatory action.
In December 2012, Ackman told investors that he believed Herbalife operated a pyramid scheme and would ultimately be shut down by regulators. He announced that he had taken a $1-billion short against the company's stock, a move that would allow his fund to profit if Herbalife shares fell.
Herbalife insisted that Ackman was wrong, saying that its multilevel marketing business model is legal and similar to many other companies. Herbalife has been in business since 1980.
The stock has been climbing relentlessly for much of 2013, gaining 110% so far this year and causing Ackman's bet to lose hundreds of millions of dollars in value. In a letter to his investors on Monday, Ackman said his fund has cut its short position by more than 40%, or more than $400 million. The fund has replaced it with "put options" that will allow the fund to profit if Herbalife stock falls "within a reasonable time," without the risk of a short squeeze, Ackman wrote.
"While we have endured mark-to-market losses on this investment as Herbalife bulls have promoted the stock and downplayed the probability of government intervention, we believe it is only a matter of time before the company is shut down and prosecuted by regulators," Ackman said.
Herbalife has acknowledged in regulatory filings that it is cooperating with an investigation by the Securities and Exchange Commission. Several consumer and civil rights groups also have urged the Federal Trade Commission to investigate.
The primary issue is the way Herbalife pays its independent sales people. These distributors buy the company's diet and health foods at a discount and receive commissions based on their sales and the sales made by others that they recruit into the business. Fewer than 1% of its distributors make more than $25,000 a year, a fact that led Ackman and others to conclude that only a fortunate few at the top of the pyramid make money, while scores of others fail.Ackman noted that Herbalife shares had climbed recently after an analyst's report that the company was planning a large buyback of its shares.
"The principal driver of the stock price appears to be the belief by bulls that government regulators will do nothing, and that the company will continue to generate strong earnings and cash flows which will be returned to shareholders in the form of share repurchases, which could force shorts, including Pershing Square, to cover," Ackman continued.
It has not been a good year for Pershing Square. Ackman sold his huge stake in JC Penney recently, taking a loss of about 50%. The fund is flat for the year, compared to a gain of about 20% for the S&P 500 index.
Herbalife shares were down about 5% in morning trading.
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