Monday, November 4, 2013

Herbalife (HLF) - When a Stock Price is Not a Measure of Valuation, but a Measure of Gambler's Appetite

HLF is trading $62.03, down 1.7% with IV30™ roaring up 20.6%. The Symbol Summary is included below.

Provided by Livevol

Herbalife Ltd. is a global network marketing company that sells weight management, nutritional supplements, energy, sports and fitness products and personal care products through a network of approximately 2.7 million independent distributors, except in China, where the Company sells its products through retail stores.

This is a vol and stock note in one of the most interesting companies around.  This is a firm that has endured some of the most open claims of impropriety (and just fraud) I have ever seen and some very open discussions from huge investors of massive short positions taken in the stock.  If you don't know the full story, here are a few articles to read:

1. Why Bill Ackman Is Wrong on Herbalife

2. Will Herbalife Earnings Finally End the Ackman-Icahn Wars?

3. Investor Cuts Risk of Short on Herbalife

4. Ackman Stands by Herbalife Pyramid Claim as He Reduces Short

Some snippets:

“We have not learned any facts that are inconsistent with our belief that the Company is a pyramid scheme that engages in unlawful and deceptive marketing practices,” Ackman wrote. “In fact, there have been a number of materially positive developments that increase the likelihood of regulatory intervention and the Company’s closure.”

Herbalife has repeatedly denied Ackman’s allegations and Barb Henderson, a company spokeswoman, today declined to comment on the letter.

Ackman has accused Herbalife of swindling unsophisticated consumers with false get-rich promises using overpriced products that hide a pyramid scheme. He has urged U.S. regulators, elected officials and community activists to help shut it down.
Source: 4

Hopefully Ackman will explain how a “pyramid scheme” lasts 32 years without an army of disabused and dispossessed latecomers to the party clamoring for refunds. Hopefully he accounts for the fact that net cash from operations went from $271 million in 2007 to $509 million four years later. Perhaps he’ll note that sales are set to rise another 17% this year, after a 26% leap in 2011. Or that Herbalife allows distributors to return unsold product for up to a year, and that returns have accounted for less than 0.5% of sales in recent years.

If he can reconcile these audited results with his suspicions, more power to him. Otherwise Occam’s razor points to more “Look at Me!” self-promotion of the sort that’s made so much money for Einhorn, Ackman, Carl Icahn and other titans of speculation who can induce a desired result simply by attaching their name to it.
Source: 1

Herbalife has drawn huge amounts of controversy for a long time, as its multilevel marketing business has Ackman and others accusing it of being a pyramid scheme. Yet, from a fundamental standpoint, the industry has been highly successful. Nu Skin rode success in China to strong earnings earlier this week, and USANA also reported solid results, albeit with negative guidance. The big question for Herbalife investors is whether the Ackman-Icahn battle will continue overshadowing Herbalife's fundamentals. Let's take an early look at what's been happening with Herbalife over the past quarter, and what we're likely to see in its report.
Source: 2

Activist hedge-fund manager William Ackman has restructured his big bet against Herbalife Ltd. to protect against further paper losses, he told investors in a new letter Wednesday.

Mr. Ackman said he wanted to mitigate his firm's risks while still providing for big gains if Herbalife shares decline within the near future, as he expects.

"In recent weeks we have restructured the position by reducing our short equity position by more than 40% and replacing it with long-term derivatives, principally over-the-counter put options," he wrote in the letter, dated Oct. 2.

Mr. Ackman, head of Pershing Square Capital Management LP, publicly alleged that Herbalife was a pyramid scheme last year and announced a $1 billion short bet against the company.

Although Herbalife, a nutritional-supplement maker, saw its shares dip after Mr. Ackman's broadside, it has been one of the strongest gainers in the stock market this year. The Wall Street Journal reported last month that Mr. Ackman's losses on the bet were more than $300 million.
Source 3

So there you have literally a tiny taste of that is going on with HLF, Ackman and Icahn. But there is a big event that everyone is awaiting, and this is restatement of HLF financials. but even that is murky as to timing. Here is a snippet from yet another source:

Herbalife hired PricewaterhouseCooper to re-audit its statements after its previous auditor KPMG had to resign in the wake of an insider-trading scandal. The company said back in July that it expects the process to be completed by the end of the year, but some analysts hoped that the results will be announced earlier. Now the company's CFO cautions investors that they may have to wait a bit longer:

Source: Seeking Alpha via yahoo! Finance Herbalife At A Standstill , written by Andrei Volgin.

And now, finally let us turn to today. The implied vol is up and the stock stock is down. Let's turn to the Charts Tab (two-years) below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

Provided by Livevol

There is so much to see in the stock chart, massive dips down both off of earnings and non-earnings related events, and not to be discounted, a huge rally from annual lows $23.79 to now over $62.  I mean it, don't forget that.

But let's look more myopically -- specifically at the last couple of weeks.  On 10-8-2013, HLF closed at $63.14 then rose to $67.92 on 10-28-2013 -- the last earnings date.  The earnings release was good, sort of.  Here are a few snippets from that Seeking Alpha article cited above:

I believe that many investors overestimate the capacity of Herbalife to borrow money. The latest quarterly results did not change the situation much: the net tangible assets of the company increased only by $22 million, less than 0.35% of its market cap, after the company spent $110 million buying its own shares during the quarter. The company may continue to spend $100-120 million on share buybacks per quarter, but this is not enough to offset the selling pressure if Icahn and/or Soros decide to liquidate their positions soon. Note that, unlike Icahn, Soros is not required to report any sales of Herbalife stocks, so we do not know yet if Soros sold any shares in October.

[T]he results for the last quarter were not as impressive as they sound. Sales increased 22.2% and earnings grew by 26.8% compared to a year ago period. Sequentially, however, both sales and profits were slightly lower, and the consensus estimate for the next year now calls for a moderate 10% growth in revenues and earnings.

We can see the stock actually hit a high of nearly $71 on 10-29-2013, but since that intra-day pop, it has fallen ~$9.  And why is that?... First, due to the reality that earnings may not have been as good as initially thought, but really, this is not about earnings, this about a gigantic event -- the restating of the firm's financials (using the same Seeking Alpha source):

It seems more and more likely that the re-audited financials will be released at the end of January, when the company reports its annual results. This delay is a cause of concern for investors, because Carl Icahn, who owns 16% of the company, has agreed not to sell any shares until the end of February 2014. Icahn is sitting on very substantial gains, and he may be tempted to realize his profits. The problem is that Icahn's stake is worth more than a billion dollars even after the stock price declined in October. Selling so many shares quickly without driving their price further down is nearly impossible - unless there is another large buyer willing to step in.

Icahn hoped, no doubt, that this buyer will be Pershing Square, a hedge fund with a massive short position in Herbalife shares, or the company itself. Pershing Square, however, replaced 40% of borrowed shares with long-term puts. This maneuver reduced the possibility of a short-squeeze - a situation when short-sellers are forced to buy shares on the market to cover their positions. Now a delay in the audit process leaves the company with a very narrow window to line up the financing for a share buyback before a standstill agreement with Icahn expires.

This firm is facing a volatility event. We have some direction on timing, but nothing absolute. We also have nothing absolute not just to the results of the restatement, but most importantly, the way that event is interpreted. We will hear very loud voices (VERY LOUD) arguing distinctly opposite analysis of the same data. The question is, who will the market listen to, and who will be right (not necessarily the same answer)?

Let's turn to the two-year IV30™ chart, below.

Provided by Livevol

We can see that enormous spike to ~150% about a year ago, but since then, times have been calmer.  Then, there is today, a 20% rise in IV30™.   Here's the thing about HLF, the valuation is based in large part to interpretation, and that is just not a good place to be, no matter what the truth is at the core. The stock represents not company valuation, but risk appetite for a bet -- with some huge gamblers.  With that the case, the volatility into Dec and Jan (and even Feb) is in play.

Finally, let's turn to the Options Tab.

Provided by Livevol

Across the top we can see the monthly vols are priced to 60.02%, 66.16% and 63.39% for Nov, Dec and Jan'14 respectively.  Here's an opinion... one of the vols is too low.  I don't know which one, but it's soon -- and while the vol may dip (maybe) substantially on release of the restated financials as often ties happens when long awaited news is released, the stock might move more than the vol that's priced into the options right now.  Look back at that stock chart -- can this stock gap up or down on news and "interpretation?"  Yeah, it really can.

This is trade analysis, not a recommendation.

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1 comment:

  1. Ackman shorted $1 billion worth of Herbalife stock a year ago, but has since reduced his short position by 40% and replaced it by buying puts to protect his fund from mark to market losses