Herbalife – The market value, Icahn, big name investors, the short squeeze – it’s all a dangerous illusion that foolish speculators still cling to. The short squeeze was real for a brief window after Bill Ackman announced his position, but it is long gone now. The punch bowl has been taken away, the party room door has been locked (with Icahn inside, unless he wants to kick it open and let himself out) and the day traders are still cheering for their hero inside. Icahn’s loyal Twitter followers should consider why he has been silent for so long, not regularly talking and tweeting on Herbalife, as he excitedly did in the beginning.
My father is 84 and also amused by new technology. After a steady stream of Icahn’s media and Twitter promotion about Herbalife, there came messages and questions about whether his promotion-like actions, together with his position as 17% stockholder, insider status and board representation, could one day hold him liable for aiding and abetting a fraud, if that’s how Herbalife played out. Since just about that time, Icahn has gone dark on Herbalife, other than the obligatory, “Ackman and I agreed to disagree.” Maybe it’s a coincidence, maybe not.
Like the Pied Piper (pun intended), Carl Icahn vengefully bought up 17% of Herbalife, leading the charge that almost resulted in a serious short squeeze. I was concerned about a parabolic squeeze a la VW/Porsche and there was no way I could sleep if I was short the stock. So I bought the long dated, deep out of the money puts instead and had no trouble sleeping. A few weeks later Ackman announced he did the same thing. I was relieved because I figured everyone would realize the squeeze was over. I was reminded to never underestimate… (well, there are too many observations to list and elaborate upon.)
In any event, Loeb was in it for the squeeze play. I wasn’t fooled by his LP letter making a fundamental value case. At first I started laughing while reading it, but then I thought, wow, isn’t it better to just say nothing than write that? That letter fits right in with the MLM double-speak. He owned less than 5% so he could trade in/out without reporting in real time. Soros hasn’t managed money in forever, so at least let’s stop invoking his reputation and use Scott Bessent’s name or find out who the PM is over there. Either way, they aren’t really fundamental value investors anyway, they conspicuously owned under 5%, I suspect for the same reasons. The same goes for Perry. I don’t understand why Kyle Bass is relevant, he’s a one-hit-wonder, I’m not aware of any long term equity-oriented track record to speak of, but he gets a lot of TV face time, he’s rich and people know his name, so I guess he adds credibility to the long case? He had a puny position anyway. Druckenmiller had a puny position, too, so intelligent people ignore that. Did I miss anyone? (I get to Stiritz below.)
Now, having put all that in context so we don’t just throw high profile investor’s names around, I acknowledge that collectively there was a potentially serious short squeeze in the making – up until the point when Ackman covered (the majority of) his short and bought puts. After that, the stock was being driven up by an incremental, finite buyback. Several hundred million at first, $1.5 billion cumulative over 2 years, in a fear driven frenzy, management pissing up a rope “defending the stock.” It is one of the stupidest things a management team can do, but short-term speculators love it – on both sides of the trade. It will eventually end, unless they have unlimited capital, and in time “interim equilibrium” will be restored. But that is not the same as the hoped for short squeeze.
Ironically, I thought the management frenzied buyback was analogous to Soros and Bessent betting against the British Pound. The layman’s explanation is (as I understand it from published reports and reading an interview Bessent did): the British government was “defending for political reasons” and they believed that was stupid, all things ultimately are economic and true, and as long as they have the financial staying power, when the Government runs up a big enough bill or quits their folly, it will quickly adjust back to market equilibrium. Which is exactly what happened – with the British Pound and Herbalife. I recall in an interview with Bessent where he said about that trade (paraphrasing) it was like studying for an exam and knowing you aced it, but having to wait for the grade. I feel the same way with Herbalife. While I’m waiting for my grade, I’m trying not to get run over and killed. “To finish first, you must first finish.”
Since management overpaid with the buyback, as I believe they did, the net result of the leveraged buyback was a good thing for my negative investment thesis, even if it was annoying along the way, because the “interim equilibrium point” is now lower than it was before. (This fundamental analysis sets aside the case that the company is illegal and the Feds will shut it down. My overall investment thesis is that Herbalife eventually goes to $0, which is why I refer above to an “interim equilibrium”.)
Icahn’s plan was to: join the board, lead the charge, engineer a leveraged recap and nail Ackman to the wall for tenaciously pursuing, winning and embarrassing him in the Hallwood Realty litigation. In a most unlucky twist, soon after Icahn joined the Herbalife board and signs a shareholder lock-up agreement, the Herbalife audit partner gets arrested for insider trading, 3 years of audited statements get pulled, and the whole plan gets put on hold for a year. Whoa… need a Plan B: The company uses its cash on hand to buy back stock in a frenzy. The other tag-a-long shareholders trade in/out at a profit. Lucky for them, no lock-up agreement and they don’t own 17 million shares.
A year later, the company finally gets the re-audit (quite the amazing feat) and gets off a $1.1 billion convert. Only a convoluted synthetic transaction is doable because nobody really wants to be long, because this thing has been lingering in the regulatory spotlight forever, which would soon prove prescient when a slew of regulators announce investigations. Poor old Icahn is now stuck owning more like 20% of the reduced share count and it looks like he’s increasingly alone. Fast forward 5 months, and the Convert is busted, trades at 80 and yields 6%+ to maturity. (I believe the convert is going to yield “negative your entire principal to maturity” if you aren’t properly protected.)
Along the way 2 board members quit and Icahn has to eat those, too. Was anyone really buying that he wanted to add two more directors? Having leveraged itself buying back a huge amount of stock at inflated prices, the company sucked up a large part of the publicly traded float and daily trading volumes dropped dramatically. I wonder if Icahn will go down with the ship or if he’ll blow the stock out on his loyal band of day trading twitter followers. They’re all talk about a short squeeze, but it sounds more like a long squeeze. Who’ll buy 17 million shares? The answer used to be “Bill Ackman, obviously.” But he covered a while ago and owns mostly puts now.
I keep hearing the media infotainers and Herbalife talk about Ackman’s “Billion Dollar Bet.” But if he owns January ’15 45 puts on 30 million shares, it’s $150-200 million depending on the day (after covering the short and eating what was sure to be few hundred million of losses, which are yesterday’s news.) It’s 1-1.5% of his fund and if Herbalife goes to $0 before Jan ’15, he makes 7-10x or $1.5 billion. If he believes his $0 thesis is still intact and buys another year, he pays another 2% of his fund, give or take. Both scenarios have very interesting risk/reward profiles, but obviously he’d like to only pay the premium once. (This is my thesis, except it’s more than 1% for me.) The irony is, of the three main players with capital at risk, Bill Ackman has the least amount of dollars currently exposed. Carl Icahn has $850 million currently at risk. Bill Stiritz currently has $350 million at risk. (at $50)
Back to the storyline. In a weird twist that I cannot explain, Bill Stiritz walked into the middle of all this, buys 7% and says, “Herbalife is an American Icahn.” (or did he say Icon?) It was very, very strange. He, too, added a flurry of promotion to Herbalife, including some LBO talk, then went dark. The best managers avoid denial like the plague, seek the truth, admit mistakes and change course quickly. Stiritz still has a shot at selling his 7 million shares before the damage gets worse.