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Bet against Herbalife is a loser -- so far

This has been a good year so far for Herbalife Ltd. shareholders -- and a painful one for Bill Ackman, the activist manager of hedge fund Pershing Square Capital Management.

Ackman last year shorted 20 million shares of Herbalife stock, about one-fifth of its outstanding shares, betting $1 billion that the Los Angeles nutritional products company would fail.

Herbalife’s stock, instead, has surged more than 75% this year, hitting a 12-month high Tuesday and leaving Ackman and his Pershing Square down $169 million by Friday afternoon.

“Assuming he still has the position, it’s been painful for him. That’s all you can say about it,” said Lawrence Harris, a finance professor at USC.

Ackman declined to comment for this story. A person close to Pershing Square said the fund still holds the short position on 20 million shares.

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Short-selling a company’s stock is a risky proposition even for Wall Street professionals. It is not for the fainthearted.

Investors short a company’s stock by borrowing shares, putting cash or assets down as collateral. Then they quickly sell the stock, essentially trading shares they don’t own.

If the stock price falls, they can buy the shares at the lower price and return them to the lender, making a profit. If the stock price rises, short-sellers have two choices: Wait it out or buy at the higher price and lose money.

In order to wait it out, short-sellers whose investments are in the red must have enough collateral on hand to cover their losses.

They also must pay other fees and charges, including a stock’s dividend payments. Ackman, for instance, has to pay Herbalife’s regular quarterly dividend of 30 cents a share on the stock he shorted -- a total of about $12 million for the first two quarters this year.

“The thing about a short position is there’s no limit to how much you can lose,” said Jonathan Berk, a finance professor at Stanford University’s Graduate School of Business.

“When you buy a stock, the most you can lose is the price you paid for it,” Berk said. “Usually people with short positions will have some rule: If it gets to a certain position, they get out.”

Ackman would not reveal details about the borrowed stock, but the amount he put on the line for the number of shares shorted means that the average price was about $50 a share.

Ackman won’t realize a loss unless he buys the shares at a higher price to cover his short position, something his lenders haven’t required yet. Waiting can be risky. If Herbalife stock reaches $100 a share, Ackman would be out $1 billion.

Rarely does a single investor short as many shares as Ackman did.

On Dec. 19, Ackman went public with his $1-billion bet against Herbalife, saying he believed that the company operates an illegal pyramid scheme and will be shut down by federal regulators.

The next day, he highlighted his case with a multimedia presentation on Wall Street, arguing that most of Herbalife’s independent salespeople lose money while a fortunate few -- those at the top of the pyramid -- are rewarded for recruiting others into the business.

The company denied Ackman’s allegations, arguing that its business model is legal and similar to many other multi-level marketing companies, such as Amway and Avon.

Herbalife said it pays bonuses to its independent salespeople, called distributors, for sales they make and for sales made by others they recruit into the business. No bonuses are paid for simply recruiting, the company said.

Ackman’s gamble looked good at first. On Christmas Eve, the stock fell to its 12-month low of $24.24 during the trading day, closing at $26.06. Had he cashed in at the bottom, Ackman could have booked a gain of nearly $500 million.

Then billionaire investor Carl Icahn, a longtime Ackman nemesis, started buying Herbalife stock, helping to shore up the price.

Icahn said he decided to invest in Herbalife after asking a consumer protection lawyer to review Ackman’s allegations, which are posted on www.factsabout herbalife.com. The lawyer said Ackman’s case was without merit, Icahn said.

The stock closed at $59.39 on Monday, putting Ackman’s position in the red by about $200 million. It reached a 52-week high of $62.23 in early trading Tuesday before tailing off. That prompted Herbalife to throw a barb his way.

“We believe the investment community as a whole has done their homework and realized that Pershing Square’s thesis on Herbalife is inaccurate,” Herbalife spokeswoman Barbara Henderson said.

Icahn said last week that he was ahead more than $250 million.

Herbalife shares have slipped since Tuesday. They rose 99 cents, or 1.7%, to $58.45 on Friday.

The stock has been one of the more volatile on Wall Street over the last year, trading mostly in a range of $35 to $55.

Herbalife shares rose after positive quarterly earnings reports in February and April.

They fell after KPMG resigned April 8 as its independent auditor and withdrew its approval of past financial reports. One of KPMG’s senior managers participated in an insider trading scheme in several companies, including Herbalife. Herbalife has hired a new auditor.

Ackman has said he intends to hold his short position until Herbalife shares hit zero. His strategy relies on government action confirming his view that the company is little more than a pyramid scheme.

In February, Herbalife acknowledged in a regulatory filing that it had received an inquiry from the Securities and Exchange Commission’s enforcement division about its “business and financial operations.” The company said it would “fully cooperate with these inquiries.”

Last week, five consumer and Latino civil rights groups met with the Federal Trade Commission to request an investigation of Herbalife’s business. The FTC declined comment.

Brent Wilkes, national executive director of the League of United Latin American Citizens, said he thinks the company exploits Latinos by promoting distributorships as a business opportunity when fewer than 1% of distributors make more than $25,000 a year.

Herbalife said Wilkes’ comments were “misinformed.” The company did not elaborate.

Ackman appears financially capable of weathering the controversy he has stirred up.

Pershing Square has more than $13 million under management, according to regulatory documents filed with the SEC. So the $169-million loss to date on the Herbalife short position would represent little more than a 1% hit to its portfolio.

And there are no signs that Ackman is reducing his short position. A total of 30 million Herbalife shares are being shorted as of July 15, according to the most recent data available.

Tim Ramey, an analyst with D.A. Davidson & Co. who is bullish on Herbalife, said he believes that Ackman’s allegations are misguided. He said the company may ultimately face some sanctions from regulators but will survive, as it has since 1980.

Indeed, Herbalife reported a $477-million profit last year on more than $4 billion in sales. The company sells protein shake powders, vitamins, supplements and skin care products in 88 countries.

“There’s no validity to the thesis that Herbalife will be forced out of business and will go to zero,” Ramey said. “Pyramid schemes don’t make products, don’t do research.”

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stuart.pfeifer@latimes.com


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