What makes Herbalife so interesting is that all the principal players (and even some of the tangential players) live out their character flaws in public. It’s sort of refreshing. And how many mistakes or errors in judgment have been made, by so many intelligent people, on both sides. When I blogged yet again about Herbalife, a friend told me “Write about something else!” I told him, “Everything else is boring and ordinary by comparison. Investing is boring. I have other good investments I own, sure. But this thing is like The Book of Genesis or Dante’s Divine Comedy.”
As you probably know, I believe the government will eventually take action that will cripple Herbalife. As that plays out, I also believe the fundamentals of the company will deteriorate for myriad reasons – some external, some internal – I’ve touched on that a bit here. And the financial leverage the company added from a misguided buyback will be gasoline on the fire.
That brings me to yet another glaring example of “Why Men Shouldn’t Run the World”. Any mother would know that managing the checkbook as Herbalife has over the past 2 years is just plain idiotic. If your household is going to war or anticipating a multi-year crisis, you don’t come home and tell your wife, “Honey, I’ve got a great idea. I just spoke to my new friends Carl and Bill and they think we should spend everything we have in the bank and max out our credit cards in anticipation of the crisis we are about to confront!” She would (or should) get that look on her face that women get and say, “Michael, are you a F%&*@) idiot?!? We will do no such thing. Where is the checkbook? We will hoard all of our cash, you will give me every nickel of your cash flow and paycheck, we will PAY OFF our debt and cut up our credit cards. You’re a moron and I can’t believe I married you and had children with you! (I should have married your best friend instead!) Your “new friends” Carl and Bill are manipulating you! They just want to party with our credit card money. And when its all gone, they’ll be gone and we’ll have to live with the debt! Can’t you see that? Even your friend, Michael Levitt, who has been a friend of this family/company for years, thinks that’s a stupid idea. Maybe that’s why he quit being our friend and doesn’t come around anymore!” (This story could go on and on… I could write in points of view for the friends, Carl and Bill. e.g. Bill tries to persuade them by telling them not to worry, he’s done this with another family (but of course it’s an old line, stable family with a very well known name, recognized all over the world), but the wife reminds Bill that they’re just regular folks, they don’t have the same kind of name or reputation, predictable, stable income or assets and are on pretty shaky ground. The husband, Michael caught in the middle, full of fear, says all sorts of crazy things. It could really get fun and interesting. (I can’t stop laughing as I write this. If it wasn’t so serious, it would be a comedy.)
Which brings me to the next part. Sometimes, we get lucky. We all make investment mistakes. What separates the long term winners from losers is how we adapt and respond to our own errors, and the errors of others. It’s also important to honestly admit to ourselves which is which. Here’s a fact: I’ve lost money when I was right on the fundamentals. I’ve made money when I was wrong on the fundamentals – I got lucky. I know the difference and I know it is dangerous to lie to myself about it.
Recently, The Specialist (a Contributor to Seeking Alpha) wrote a great article you can read here. It is a great point of view about the myth of an evil witch being the cause of stress and problems in a town or community. Once the witch was identified and disposed of, usually in a 3 hours public trial, all would be good again. Except if it wasn’t, then they had a real problem. The minute I started reading, I said “Oh man… the Witch is dead. They’re exposed now! Nobody to blame.” But let’s not get carried away. Bill Ackman is very smart. Smarter than I am. But let’s not confuse smart with “He may have planned it this way, killed himself so they wouldn’t have a witch to blame.” That’s a bit of a stretch.
(A quick side note: One of the comments in The Specialist article got his Witches confused and mentioned the Tin Man, Scarecrow and Wizard of Oz. I couldn’t help myself. I had to ask if he was referring to Icahn, Stiritz and Johnson? Yes… pun intended. I thought all the loyal Munchins on Twitter would appreciate that.)
Ackman has investment discipline and conviction, and responds very well to events on the ground as they unfold. But a real killer is a sniper, who from under cover shoots his prey in the head and they never see it coming. (I’m not suggesting I’m an investment sniper, just pointing out that it’s ridiculous to think it’s all a carefully scripted plan – for either side.)
Back to Ackman (the self-sacrificing witch) It was not a good idea to short 20% of the stock and announce it to the sharks in the tank. By his own admission he didn’t anticipate that Hedge Fund managers would “eat one of their own”. So he ate several hundred million of losses (temporary, in his view and I agree) and adapted, restructured it into mostly long dated out of the money puts, and continued with a much more favorable risk/reward profile. A great tactical move, but a response to an “error” nonetheless. By error, I mean obviously it would have been better from the outset to say to his team “My thesis is Herbalife is going to $0. I’d like to be a catalyst for that. But I don’t want to get run over by a truck, a la VW/Porsche, on the way home. Anyone have any ideas how to express that view?” I am certain he won’t make that mistake again, because he has the analogy seared in his memory now. Highly intelligent people analogize, just as Ackman did during his Bloomberg interview, recalling the Technical Schools. He’s added many to his repertoire during the past 2 years and he’ll continue to adapt.
His Nutrition Club presentation really is a death blow. He showed the world 240 times over what I know 7 times over in my town directly from the people who live with me. I believe it is a death blow, he believes it is, he doesn’t think he hyped it at all, nor do I. He thinks the media and markets don’t understand or don’t care about the illegal activity of the company (which is apparently and unfortunately true.) His view going into it was, “Management has been telling everyone they are not a pyramid scheme because they have all this “retail daily consumption” in Clubs that clearly puts a majority of the revenue into the “retail bucket”, and I’m going to show the world that the Clubs are nothing more than recruiting motivated consumption and the whole Club thing is a fraud! Bingo! When you throw the Club volume into the “recruiting bucket” it’s not even a close call. It’s absolutely a pyramid scheme.” The market didn’t just yawn, it popped like a cork. That’s crazy in my view. But I think lots of stuff is crazy.
To suggest it was all part of his plan, though? Maybe luck played the part. (And I’m not taking anything away from him.) The fundamentals started crapping out when he was screaming it’s a fraud. But just like with MBIA, the smart thing was to be short the fraud with an asymmetric risk/reward profile if MBIA crapped out. The lucky thing was the whole housing market sh*t the bed. Ackman did not have that same asymmetric risk/reward with the initial Herbalife short stock position. He now has it with the longer dated, out of the money puts, even if he has to pay the premium again.
I own puts that used to be deep out of the money (not so deep anymore.) I’m considering moving their value into lower strike price puts, so I get more bang for the same buck when it goes to $0.) My strategy is: (1) stay negative, maximize my risk/return profile, and (2) stay flexible, try not to get run over by a truck in the meantime.