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Likely Outcomes of Herbalife FTC Probe

Herbalife Versus FTC

Herbalife (NYSE:HLF) disclosed today that The Federal Trade Commission is opening a civil probe into the business activities of the MLM supplements maker. After being briefly halted, shares of Herbalife dropped 17% before rebounding and closing down more than 7% for the day.

While I have no position in the shares of Herbalife, it has been interesting to watch this Wall Street Soap Opera unfold over the last 14 months ever since Bill Ackman from Hedge Fund Pershing Square unveiled his short position back in December 2012.

It will very likely take some time (more than 6 months) before we know what the outcome of the FTC investigation but while no one knows for sure what the outcome will be; it is a safe bet that it will be one of the following 3:

Herbalife will be exonerated and, effectively, given a clean bill of health by the FTC

Herbalife will be found in violation of some FTC rules and will be fined several million dollars but will continue as a going concern.

Herbalife will be found to have material violations and will be forced to materially change the way it conducts its business and forced to pay a very sizable and material fine (hundreds of millions of dollars).

Those bullish on Herbalife will be expecting the first outcome or full exoneration while those who agree with Bill Ackman will be expecting the third outcome or material violations in the way the company conducts its business.

Given the fact that Herbalife has been in business for a long period of time in a fairly heavily regulated industry and has been scrutinized by regulators in the past, it is hard to believe that it can be significantly running afoul of the law for so long. It is of course not impossible but I see it as improbable.

Likewise, expecting the FTC to give a clean bill of health to Herbalife is also unlikely as it never is a good thing to be investigated by the government. Is it likely that Herbalife has cut some corners when it comes to adopting best practices in its industry and that any compliance slack will be identified by this FTC investigation? I say the odds are significantly greater than zero. But, will those violations be material from a financial or business standpoint? I believe that any violations, if any, will likely not be material.

So what happens to the stock in the meantime?

Herbalife shares hit a 2014 high of $83.51 on January 8th and have been trading lower ever since closing at $65.39 on the day preceding the FTC announcement. One can make the argument that investors have been anticipating some bad news but nevertheless, a 22% decline off the January highs is noteworthy. The company is expected to announce quarterly earnings in late April and until then the stock is likely to move based on the actions, rather than the words, of the main antagonists in this saga. Carl Icahn who currently owns 16% of the company sits on the Board and is likely restricted from trading in the company’s shares until after the next earnings report – that is if he has any interest in increasing his already sizable stake. So essentially, the stock will likely continue to be volatile without any major catalysts on the upside or downside until the company announces earnings. Professional options traders selling volatility are likely the ones to be making any money trading Herbalife in the near future.

At this point, it looks like both sides of the fight have expended most of their bullets. Carl Icahn and the company have been pitching a flawless game up until this point while Ackman’s relentless lobbying has finally gotten him to first base today with this FTC probe. The game is far from over and the score is heavily in favor of the HLF longs up to this point.

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About Mohannad Aama

Mohannad is a Portfolio Manager at a NY-based Investment management firm. You can follow him on Twitter here

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