Despite the auditors of personal care supplements maker Herbalife  giving its books a clean bill of health, its stock remains far too risky to invest in one way or the other because its valuation is not being driven on the merits of its business but rather on the personalities behind the debate. 

As is well-known, hedge fund operator Bill Ackman took a big, vocal short bet on the supplements maker, declaring Herbalife was a pyramid scheme that would be shut down by the SEC. Coming as it did after David Einhorn at Greenlight Capital had seemingly questioned the veracity of its business model, shares of Herbalife plummeted. It was Einhorn, after all, who rose to fame by presciently shorting the stock of Lehman Brothers and proclaiming its accounting practices questionable. Considering how right he turned out to be, similar questions about Herbalife's practices followed by a massive short bet from another well-known hedge fund pro was too much for the market to bear.

On the level
Multi-level marketing operations are gray-area beasts that risk running afoul of the law by virtue of whether their highest-paid promoters make the bulk of their money selling product or recruiting more salesmen. In a legitimate MLM, it should be possible for a salesperson to make money by simply selling product directly to customers. Amway, Mary Kay Cosmetics, and Tupperware are the grand dames of MLM operations and have years of proven results to back them up.

Source: Herbalife.


Some, like Nu Skin Enterprises , seem to oscillate between accusations of running a pyramid scheme and making bloated claims about its products for which it runs afoul of federal trade regulators. 

Others, such as nutritional supplements seller Omnitrition in the 1990s, BurnLounge just a few years ago, and Fortune Hi-Tech this past January, have all been declared pyramid schemes by courts. While Omnitrition is still in operation today and BurnLounge is appealing its ruling, it's apparent that the shady practices of some cast aspersions over those who abide by the rules.

It's not me, it's you
Amongst the many charges Ackman levels against Herbalife is the claim that its operations don't abide by the law, that it makes more money recruiting sales people than it does selling product. Management disputes that, and the case attracted other high-profile investors like Carl Icahn and Daniel Loeb, who've said Ackman's accusations are ludicrous. With personal animosity driving some of the decisions, they've bought large long positions in the supplements maker, pushing its stock up.

The stock is up more than 80% over the past year, 135% in 2013, and 220% from its 52-week lows. The meteoric recovery has impaled Ackman on his convictions, with Pershing Capital losing more than $500 million on the short sale. He was forced into a strategic retreat from the stock last quarter, covering more than 40% of his position and realigning his bet to make it less exposed to a short squeeze.

Take this into account
Earlier this year, Herbalife's auditor KMPG resigned after it was revealed a senior executive leaked confidential information to a stock trader. PricewaterhouseCooper was brought on with the mandate to review its financials for the past three years. While Ackman said the accountant was conflicted, the SEC permitted the appointment and PWC issued its report on Monday essentially giving Herbalife a clean bill of health. Shares jumped more than 9% in response.

Ackman, though, contends it's not the role of the accountant to say whether Herbalife is a pyramid scheme or not, and previously said he would take the bet "to the end of the earth." 

With forces on both sides so passionate about their stake, and each willing to bet large sums of money on the outcome, common shareholders can't simply look at Herbalife's business or its (now clean) financials and come to a conclusion about whether the stock makes a good investment. Those factors have become secondary to Ackman, Icahn, and others pushing their agendas and until they've cleared out of the stock for good or ill, it's just not worth the risk to bet with one side or the other, no matter what you feel about Herbalife's merits.

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The article Herbalife's Clean Bill of Health Means Nothing originally appeared on Fool.com.

Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool has the following options: long January 2015 $50 calls on Herbalife and short April 2014 $90 puts on Tupperware Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Workathomedad

As Icahn said, The "Mother of all Short Squeezes"

December 20 2013 at 1:40 PM Report abuse rate up rate down Reply
Rene E Porcile

6 billionaires are long and ackman appears to be only ONE BIG investor who is short. Based on the volume and open interest in PUTS on this stock it appears billions have been made selling puts. JC Penny and now HLF should send all of Ackman's investors to other funds. This story is not over yet. stiritz is putting together an lbo and this could sent the shorts up above 120..it appears a lot more pain to come..stay tuned..

December 19 2013 at 10:26 PM Report abuse rate up rate down Reply
Workathomedad

Of course the audit means"nothing", but the short seller's made plenty of waves with this development, and also the Belgium court ruling earlier this year.

December 19 2013 at 11:37 AM Report abuse rate up rate down Reply