Episode 431: A Billion-Dollar Bet Against Weight-Loss Shakes

Jan 19, 2013
Originally published on January 18, 2013 8:46 pm

Herbalife, a company that sells weight loss shakes, vitamins and other similar products, is worth billions of dollars. The company has been around for more than 30 years, and it's traded on the New York Stock Exchange.

Bill Ackman thinks the whole thing is a pyramid scheme.Not surprisingly, Herbalife disagrees.

Ackman manages a hedge fund that has shorted more than a billion dollars' worth of Herbalife stock. If the stock falls — and Ackman says he thinks it will fall all the way to zero — the fund will make money.

On today's show, we talk to Ackman and to Herbalife. And we consider what it means when an investor bets that a company will fail.

Music: The Dream's "Shawty is a 10." Find us: Twitter/ Facebook/ Spotify/ Tumblr. Download the Planet Money iPhone App.

Copyright 2018 NPR. To see more, visit http://www.npr.org/.


It started out as a totally ordinary phone call - a conference call.

UNIDENTIFIED MAN #1: Good morning. And thank you for calling - joining the first quarter 2012 earnings conference call for Herbalife Ltd.

KESTENBAUM: Herbalife is a company that sells weight-loss shakes, herbal tea, vitamins, that sort of thing. And like a lot of companies, Herbalife holds a conference call like this every quarter to report to investors and anyone who wants to listen how the company is doing.- and it was doing really well.

UNIDENTIFIED MAN #2: For the first quarter, we reported net sales of $964.2 million, an increase of 21.3 percent compared to the first quarter of 2011.

KESTENBAUM: The company's CFO talks some more - blah-blah-blah. And then they take questions, which is when it happened.

UNIDENTIFIED MAN #1: And your next question is from the line of David Einhorn with Greenlight Capital.

DAVID EINHORN: I've got a couple questions for you.

KESTENBAUM: That name, David Einhorn - that's how it's supposed to be pronounced - it can strike fear into the heart of a CEO. Einhorn is a hedge-fund manager, and he's famous for what's called short-selling - betting against companies, betting that they will fail. And now he was on this conference call of a weight loss shake nutrition company.

EINHORN: First is - how much of the sales that you make in terms of final sales are sold outside the network and how much are consumed within the distributor base?

KESTENBAUM: This may sound like some innocuous technical question but it was not. For people in the know, the meaning was clear. Einhorn was asking - is your company a giant fraud? After he asked his couple questions, just asked questions, the stock price plunged 20 percent.

As it happens, another guy heard this conference call, another big New York hedge-fund manager who decided to act. He took out a one-billion-dollar bet against Herbalife. And then the stock price dropped even further. Today on the show, the story of this billion-dollar bet over weight loss shakes and about short-selling. How should we feel when people bet that others will fail?


KESTENBAUM: Hello and welcome to PLANET MONEY. I'm David Kestenbaum.


And I'm Jacob Goldstein.

The guy who heard that conference call, the guy who placed that big bet against Herbalife, his name is Bill Ackman. He runs a big hedge fund called Pershing Square Capital Management here in New York. And he went about this whole bet in a very dramatic way. I mean, if you're betting against a company you can just keep it to yourself, do it secretly. Or you can do what Ackman did. You can stand up in front of a room full of investors and spend three hours attacking the company.


BILL ACKMAN: OK. So we've got a lot to cover today. So we're going to move pretty quickly.

KESTENBAUM: He and a colleague went through Herbalife's products and sales numbers, all the research they had done.


ACKMAN: Company had a market cap of about $4.6 billion prior to yesterday.

KESTENBAUM: This went on for over 300 PowerPoint slides.


ACKMAN: Feel free, by the way, go to the men's room, ladies room. If you go to the top of the stairs you can find it. I'll keep going though for people on the web.

KESTENBAUM: But Ackman's bet, it all boiled down to just five words.


ACKMAN: Herbalife is a pyramid scheme.

GOLDSTEIN: It's worth noting that the company Ackman is attacking here is not some little company. It's been around for over 30 years. It's traded on the New York Stock Exchange. It's worth over $4 billion.

KESTENBAUM: When news of Ackman's short got out, the thing that often happens in these cases happened. The CEO of the company went on television - fast.


BRIAN SULLIVAN: Welcome back to "Street Signs," everybody, on CNBC. There's Herbalife stock down 14.6 percent, the news - Bill Ackman, noted investor, shorting this stock. And right now, we are joined by the CEO of Herbalife, Michael Johnson. He has called in.

KESTENBAUM: Johnson couldn't wait to talk.


MICHAEL JOHNSON: We're not a pyramid scheme. That's a bogus accusation. We have millions of customers around the world. Mr. Ackman's proposition that the United States would be better when Herbalife is gone? The United States would be better when Bill Ackman is gone.

GOLDSTEIN: So is Herbalife a pyramid scheme or isn't it? How hard can it be to answer this question? It turns out because of the unusual way Herbalife sells its shakes and herbal teas and whatnot, it's actually really hard to answer this question.

KESTENBAUM: We called up Bill Ackman and we asked him to make his case.

Hi. Can you hear us?


KESTENBAUM: Thanks for making time.

ACKMAN: No problem at all.

GOLDSTEIN: Ackman told us the thing that struck him when he first started looking into Herbalife was that it was this big company but he'd never heard of any of the brands, like this weight-loss shake that Herbalife sells called Formula 1.

ACKMAN: You know, Formula 1 is a nearly $2 billion brand. And it competes supposedly with SlimFast, which is certainly something I'd heard of - never heard of Formula 1. And I asked everyone in the office, have you heard of Formula 1? No one had ever heard of the product.

GOLDSTEIN: Ackman tried Formula 1. He thought it was fine. And he tried the company's herbal tea. He said, this is fine. It tastes like Twinings. But the numbers for the company, they just looked odd to him.

ACKMAN: Herbalife spends nothing advertising the products, spends effectively nothing on R&D. And they don't sell in any store. And if you wanted to buy it tomorrow, you wouldn't know where to get it. And how is it possible that they have $4 billion in revenues?

KESTENBAUM: Herbalife products are sold exclusively by ordinary people, often just out of their homes. Anybody who wants to sign up can be an Herbalife distributor. And the way the system works, distributors can make even more money if they sign up other people to be Herbalife distributors. So the key to understanding whether Herbalife is a pyramid scheme is figuring out what's happening on the ground with all those distributors.

So we went to visit one.

WILFREDO DAVILA: Wilfredo Davila.

GOLDSTEIN: How old are you?


KESTENBAUM: We're at Wilfredo's mom's apartment in Queens. That's where he's living now. He was working as a forklift operator in Pennsylvania, but that didn't work out. And now he's trying to sell Herbalife products. He showed us an ad he put on Craigslist.

DAVILA: My post on Craigslist says herbal aloe hand and body wash and so much more.

GOLDSTEIN: Three exclamation points.

DAVILA: Yeah (laughter) three exclamation points and $9.

GOLDSTEIN: Check it out. You will not be sorry you did. And millions of people around the world use Herbalife to look their best and achieve financial independence.

Where did you - did you take that from somewhere, that line?

DAVILA: Yeah. That came right off the website.

KESTENBAUM: Wilfredo is just starting out as an Herbalife distributor. A few weeks ago, he and his wife were looking for a job they could do at home. And they Googled and found this webpage - online-business-systems.com. And they registered. And before they knew it, they got a call from a woman named Marianne (ph).

DAVILA: She just started talking about Herbalife right away. She let us know that, you know, she was also an independent distributor.

KESTENBAUM: The way Herbalife's business works is that every time Wilfredo sells an Herbalife product, Marianne can get a cut of the profits. And if Wilfredo really gets his business going, goes out and signs up other Herbalife distributors, Wilfredo and Marianne can both get a share of their profits. This could go on and on. A tiny fraction of Herbalife distributors make hundreds of thousands of dollars collecting a cut of profits from thousands of distributors downstream from them.


GOLDSTEIN: This is a video that's posted on YouTube. And it's one of those super-successful distributors telling his rags to riches story.


UNIDENTIFIED MAN #1: The car I was driving was probably, you know, a $2,000 car. And I remember a Saturday night, you know, just pulling my car into the Lexus dealership. And I remember going in there 10 minutes before they closed. And I wrote a check. And I bought a brand new Lexus. And that's what I buy my kids on, you know, for Christmas now. But, I mean, at the (laughter) time it was like, you know, it was so huge.

KESTENBAUM: On its own, this way of recruiting sales people, it's actually a clever way to have millions of salespeople all over the world and to encourage your salespeople to recruit other salespeople. There's even a term for it. It's called multi-level marketing. Other companies like Amway and Avon, they also work this way.

GOLDSTEIN: But where it runs into trouble and where it can even become illegal is if all those sales people, if all the Wilfredos and Mariannes aren't selling many Herbalife shakes to people who actually want to drink them. The question at the center of this whole thing is - who is buying Herbalife products? If it's mostly people who actually want to use the products then there's no problem. But if it's mostly people who are buying products just to become distributors, just to get in on the action, on the business opportunity, then it's a pyramid scheme.

KESTENBAUM: The classic example of a pyramid scheme - and this sort of helps me think about it - is a chain letter. Have you ever gotten one of these things?

GOLDSTEIN: Maybe a long time ago.

KESTENBAUM: So I remember getting one. And it, you know, it's - you get a letter. And it says, here's a way to make a lot of money quickly. Send $1, a $1 bill in the mail to each of the five people listed here. Then make copies of this letter. Put your name on the list, and send it to five of your friends. Each of them will send it to five of their friends. Each of those people will send it to five of their friends. And soon, you'll be getting thousands of dollar bills in the mail. The problem is that if you do the math...

GOLDSTEIN: And, David, I'm not surprised that you did the math.

KESTENBAUM: ...If you do the math, after 15 rounds of this, of people sending the letter to five of their friends, you actually run out of people on the planet. It grows that quickly. The people early on in the chain, yes, they get a lot of money, but it comes from the people further down who sent the money. And those people lose. This is what Bill Ackman says is going on with Herbalife.

ACKMAN: What Herbalife is doing is it's effectively taking money from poor people and promising - telling them that you can make it, it's just a question of how hard you work - selling them on hopes and dreams. And unfortunately, they're sold a bill of goods. It's a pyramid scheme.

KESTENBAUM: How sure are you about that?

ACKMAN: I think it's a certainty.

KESTENBAUM: So you're short a billion dollars worth of Herbalife?

ACKMAN: That's correct.

KESTENBAUM: That's a big bet.

ACKMAN: It's a very big bet. It's probably one of the bigger shorts of all time, I would say.

GOLDSTEIN: So that is Ackman's side of the story. And last week, Herbalife held a conference of its own to tell its side of the story. It was last week. It was here at a Four Seasons hotel in New York. And we went there. We even had some sample weight-loss shakes.

UNIDENTIFIED MAN #2: This is the chocolate. And this is the cookie and cream.

KESTENBAUM: Which one is better?

UNIDENTIFIED MAN #2: I like them both, to be honest with you.

GOLDSTEIN: Herbalife executives spent hours presenting their data. They had plenty of PowerPoint slides of their own. And, afterward, they made an executive available to talk to us.

DES WALSH: First name is Des - D-E-S - short for Desmond but - D-E-S - Des Walsh. And I'm the president of Herbalife International.

KESTENBAUM: I asked what I thought was the question that got to the heart of whether Herbalife was a pyramid scheme or not. If Herbalife is a pyramid scheme, then it can only keep going by recruiting more sellers. Otherwise, the whole thing would collapse. So I asked - if you could not recruit any more sellers, would what you have be sustainable? He had a one-word answer.

WALSH: Absolutely.

KESTENBAUM: He said you can see that's the case because there are some small countries where they aren't really - they sort of reached their natural size. They aren't growing and recruiting new distributors anymore, countries like Ireland and Iceland. And he says business there is doing just fine.

WALSH: And these are countries where we've been in business for many, many years. I mean, if you think about it, when you think of a pyramid scheme, what people think of is some sort of scam - I mean, that's the reality. And, yet, when you look at our business in these smaller countries where we've been in business for, you know, 10 and 15 and 20 years, if it really was the case that we were not operating a legitimate business, everybody would know about it because in these smaller countries, everybody knows everybody. Everybody is related to everybody.

GOLDSTEIN: We also asked him - of all the stuff Herbalife sells, of all the shakes, all the vitamins, everything, what fraction goes to people who actually want to use the stuff, who actually want to drink the shakes and take the vitamins?

And here he said they couldn't really say. And that's because Herbalife ships its shakes and teas to its distributors, and the company just can't know all the details of what happens after that. But he did say they know enough to be confident that Herbalife really is in the business of selling shakes and teas to people who really do want to drink them.

KESTENBAUM: So that - that is the pyramid scheme to me. But there is this other issue that goes beyond Herbalife, this whole question of shorting, betting against companies. Clearly, companies hate it when people short their stock.

Here's more of Herbalife CEO Michael Johnson when he was on CNBC.


JOHNSON: This isn't about Herbalife's business model. This is about Bill Ackman's business model. This is wrong. This is totally wrong what's taking place. Where's the SEC protecting the individual shareholder right now? This is blatant market manipulation. This appears to be another attempt to illegally manipulate the market by a group of short-sellers.

GOLDSTEIN: And you can see why Johnson would be upset. I mean, imagine you're in his shoes. Just by sowing these doubts, the person betting against your company is driving the stock price down. He's making money, and your company is suffering.

KESTENBAUM: And you don't necessarily need short-selling. I mean, we could say if you like a company, you can buy the stock. And if you stop liking it, just sell the stock. We don't need to have a separate way to say - I hate this stock. I mean, on Facebook, there's a like button. We don't have a hate button. But Bill Ackman, the guy who's shorting Herbalife, not surprisingly says the world is better with shorting. Without shorting, you're basically left with shareholders and with people who work at the company. And those people all have the same incentive, to talk about how great the company is.

ACKMAN: You know what's interesting? In America, if you find a great company, you work to make it better. People think that's a great thing. But if you find a fraudulent company and you short it and you're going to profit if it goes down in value, a lot of people somehow feel uncomfortable about that.

GOLDSTEIN: You must have spent, I don't know, a hundred thousand - hundreds of thousands of dollars researching Herbalife before you shorted the company?

ACKMAN: Well above a million dollars, well above. I mean, if you think about the cost of the people, I would say millions of dollars.

KESTENBAUM: This, you could say, is an argument in favor of letting people bet against companies. It gives people a financial incentive to be skeptical, to find out when things are going wrong. And once they've made their bet, it gives them an incentive to speak out.

ACKMAN: I believe that short-selling is a noble pursuit. I really believe it.

KESTENBAUM: I mean, suppose, just suppose you are wrong in this case and you end up taking down this company by sowing doubts about it. And it's actually a healthy company. Just suppose that were true. I know you don't believe that's true but suppose it were.

ACKMAN: Yes, that would be a very bad thing. So let me tell you one thing. OK. This is the first time I've ever said a company is a pyramid scheme. OK. For me to be willing to say that publicly - first of all, I'm rich already. (Laughter) OK. I don't mean to be - I don't need this.

You know, I can find plenty of stocks to buy and companies to work on. I shorted the stock because I was in my - an interesting position. I had figured out that a company is a pyramid scheme. It's kind of like figuring out that Bernie Madoff was running a Ponzi scheme. What obligation does one have in that circumstance? What if you knew that Bernie Madoff was a fraud and you never told anyone and you allowed that to go on for another 20 years?

So I basically concluded, you know, fundamentally, I almost had a moral obligation to share my thinking on this company.

KESTENBAUM: However you feel about shorting, about people who bet others will fail, this is the way our system works. If you're Bill Ackman and you think a company is fraudulent, you can short it. And if you disagree with Ackman, you can go out and buy the stock and tell everybody how great you think the company is.

GOLDSTEIN: And, in fact, this is exactly what happened. Just last week, yet another New York hedge fund manager, a guy named Dan Loeb, told the world that he had recently purchased a stake in Herbalife. That stake is now worth well over $300 million. And Loeb, he says he thinks Ackman's view of Herbalife is, and I'm quoting here, "preposterous."

KESTENBAUM: These two hedge fund guys, they cannot both be right. And the one who is wrong stands to lose a lot of money. And you could argue - this is what we want, rich guys making huge bets and having this big fight in public. Is Herbalife a fraud or is it a great company?


THE-DREAM: (Singing) Shawty (ph) rock the beat for your boy. Shawty, yeah, do it.

KESTENBAUM: As always, we'd love to hear what you think of the show. You can send us email - planetmoney@npr.org. If you're an Herbalife distributor, we'd love to talk to you.

GOLDSTEIN: You can also find us on Facebook and on Twitter.

I'm Jacob Goldstein.

KESTENBAUM: And I'm David Kestenbaum. Thanks for listening.


FABOLOUS: (Rapping) They say she a Pisces. I heard they are feisty. You know how to treat her, she'll be sweeter than a Hi-C. Clean up very nicely, shoes are kind of pricey, match them up precisely, good jean, ice tea, like her food spicy and she is the same, hotter than a flame, but I do not know her name. Is it Keisha (ph)? Is it Tisha (ph)? Maybe Lisa (ph) or Teresa (ph). It could be Tia (ph), maybe Aaliyah (ph). I guess I'll find her one day. For now, I'm going to say... aye Transcript provided by NPR, Copyright NPR.