Sometimes, truth is stranger than fiction.
Labeled "The Greatest Moment in Financial History" by financial news website Business Insider and reminiscent of the dragout, verbal battles made popular on TV shows like Jerry Springer, billionaire and activist investors Carl Icahn and Bill Ackman verbally attacked one another during a recent CNBC interview.
Hurling insults like they were two young boys fighting in the school yard, the money managers held nothing back.
The subject of this knockdown "drama" was a publically traded multi-level nutritional marketing company named Herbalife (NYSE: HLF).
Ackman, who is the founder of $12 billion hedge fund Pershing Square, asserts Herbalife is nothing but a well-managed, illegal pyramid scheme. And it's not just words, either. Ackman has his money where his mouth is with a $1 billion short position in the company.
Meanwhile, Ichan, whose fortune is estimated at about $15 billion, says he believes Herbalife is a legitimate company with a bright future. He also has his money where his mouth is, owning a little more than 16 million shares, worth $657 million at March 7 closing price of $41.
But Icahn is not the only billionaire who believes in the company. Daniel Loeb, manager of hedge fund Third Point, has more than an 8% stake in Herbalife.
At the core of the Herbalife dispute is whether the company operates as an illegal pyramid scheme, which, according to the Federal Trade Commission (FTC), is "any organization that the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers."
Two other signs of a pyramid scheme are that distributors sell more products to other distributors than to the public, and if they make more money from recruiting than they do from selling.
And clearly, Ackman thinks this is all true for Hebalife. He even published a scathing 40-page indictment of the company, questioning its compensation plan, internal numbers and deceptive income claims.
On the other side of the coin, Herbalife recently agreed to add two board members chosen by Icahn and permit him to increase his ownership in the company to as much as 25%.
But Icahn has threatened Ackman with the mother of all short squeezes. Herbalife countered Ackman's research reiterating that all of Herbalife's payments to distributors are tied to product sales and that the company is operating legally. There are also talks of Herbalife being taken private and other strategic alternatives for the company.
Is Icahn simply trying to crush Ackman or does he truly believe in the company?
Only time will tell…
The wildcard in this situation is that regulators at the FTC and the Securities and Exchange Commission have refused to comment on whether they are investigating Herbalife or intend to launch a probe. If an investigation is undertaken and the company is deemed to be a pyramid scheme, as I suspect, then the stock may plunge into the single-digit figures, providing Ackman and his followers one of the greatest trades in history.
The technical picture
Shares of Herbalife have climbed roughly 20% this year. The stock spiked when Icahn revealed his position increase. However, the stock remains solidly below the 200-day simple moving average and has been trading in a tight range between $35 and $41 since Feb. 1, not including the Icahn-inspired spike outside of the channel.
Risks to Consider: There are heavy risks on the long and short side of Herbalife. Should the regulators decide not to investigate, then the stock will likely continue higher as Icahn adds to his position, eventually cumulating in a short-squeeze rally. If the regulators decide Herbalife is indeed a marketing scheme, then shares will likely plunge regardless of Icahn's support. Either direction, this stock is extremely speculative and risky.
Action to Take –> I believe Ackman's research is credible and well designed, and that the regulators will eventually investigate the company, finally concluding it is a pyramid scheme. Therefore I am short Herbalife.
The only question is how long will it take. However, it's critical to remember, that I am only speculating and no one knows the future for certain.
– David Goodboy