Thursday, July 25, 2013

Stocks DD Rebuts to Bronte's article

Read, understand and consent to the blog's DISCLAIMER here before proceeding to read the article
Disclosure: I am neither short or long. I wrote this on my own.

Investing in Herbalife (Short or Long side) 
First of all, let me state I have no position (either long or short) in Herbalife. I think there are good reasons NOT to be on the either side considering the risks and the uncertainty on both sides. I would not be a long because of the legal risk or potential FTC action in the US. (I am not saying Herbalife is compliant or non-compliant. I am not a legal expert). Although it is important to note that the US is only 80% of Herbalife's business. 

Even if you truly believe FTC would eventually come down hard on Herbalife, I would not be short because of the trading risk. Nobody can predict the timing of regulatory investigation or action, if any. Also, nobody can predict in the short term where Herbalife would trade at and it is just risky to be on the short side. A bunch of rogue traders, momentum trading, follower-based investing, media coverage could feed onto itself and create a short squeeze. I am pretty sure this is Ackman's biggest nightmare today, if he has not already hedged his short position in some way or he has not covered. ( It is quite possible that Ackman may covered his position but is still lobbying for FTC action to protect his ego. We all have seen infamous (ego?) fight b/w Icahn and Ackman)  Existence of Amway business for decades, the international nature of Herbalife, does bolster's the longs thesis from a risk standpoint. However, one should undermine the power of Ackman.  A major legal precedent had to be set in General growth for Ackman's 10-bagger long thesis. And lo and behold that legal precedent was set and Ackman made >10 times his investment. 

Setting the Record Straight with Bronte's Capital's John
Bronte Capital's John wrote the following yesterday:

"One of the dumbest arguments I have heard (made insistently by StocksDD amongst others) is that the turnover in Herbalife customers/distributors is enormous and therefore Herbalife must be evil or at least burning the customers.
I would love to see the customer retention rate scatter amongst Herbalife distributors (my guess is the average is low and the spread is wide) and say Weight Watchers (probably with a similarly low average and wide scatter). The people I have met who are the most convincing Herbalife sales people have lost a lot of weight and kept it off for several years. These people are I expect the exception. Turnover and failure would be the norm."

The Rebuttal
First of all, I never said Herbalife is evil or that Herbalife does not meet the threshold of retail sales. I just asked Bronte a question the answer to which ONLY people can speculate. Why do a large %(90%?) of  distributors leave ?

Second, it is a complete red herring to try and correlate the secondary stock resales or resales in ebay/craigslist to the Product's genuine retail demand. Why ? I can give 10 different reasons. Let's start with these a few...

1. How many people will take the pains of stock reselling ? They may as well keep it and consume it until it lasts. 
2. Some may just trash it.
3. Some may just give it away to friends as gift or "sell" it for 20 cents to a dollar.

So, the billion dollar question still remains;
How many distributors sign up to primarily avail discount and are real consumers  ?

Here is a potential Solution for the Regulator: For every distributor that does NOT renew its membership a.k.a "failed distributor" (I have heard the churn rate here is >90%), the regulator should require a mandatory survey taken every single former distributor: So this is not a sampling which I believe was done by Liberman's research for Herbalife

The survey would go something like this:

A. What was your Primary intent to join MLM ?
1. To be Consumer and avail the discount.
2. To make Full time income (>30k or higher).
3. To make Supplemental income (1k-10k).
4. I was simply obligated to buy it because of a friend/relative. If I had a choice I would not have bought it. 

Depending on the answer to the 1st question, one of the 3 below groups of questions could be asked.

B. Primary Intent to join MLM: Consumer
1. Would you have joined MLM(paying annual fees and buying mandatory stock) to just get a discount but were NOT allowed to sell/distribute product ?

C. Primary Intent to join MLM: Full time income 
1. Are you quitting because you realized that you could never achieve the full time income that you expected to make when you joined ?
2. Were you misled to believe that you could achieve full time income ? Were you aware of the odds of first time distributor achieving full time income when you joined ?

D. Primary Intent to join MLM: Supplemental income
1. Are you quitting because you realized that you could never achieve the supplemental income that you expected to make when you joined ?
2. Were you misled to believe that you could achieve supplemental income ? Were you aware of the odds of first time distributor achieving supplemental income when you joined ?

By having real responses from real distributors that fail to sign up again, regulators could get an idea of the following:
1. Of the distributors that are leaving (remember the 90% churn rate), what % were bona fide consumers or bonafide retail demand ? So 'yes' to A1B1 and A4, implies he/she is a real consumer.
2. Of the distributors that are leaving, what % answered Yes to question C/D.1) (Real distributors) and No to question C/D.2) ( were sold unreasonable expectations of income by the MLM).

Regulators could set threshold % compliance limits for each MLM. For example, >50% have to be consumers and >25% could not have been sold unreasonable expectations of income.  In my opinion, when you have 10000's failed distributors taking these survey these statistics will not lie. You will ultimately know the reason for the demand. 

I would appreciate feedback from readers. 

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