Editor’s note: This article was first published in September 2013 as a snapshot of the Herbalife battle: the Pershing Square value, Ackman’s losses and the investment example are from that month. The FTC investigation ended in a 2016 settlement, and Ackman later closed his short position.
William Keep is dean of the business school at a New Jersey university, and his specialty is the murky world of multi-level marketing (MLM), where the line between a legitimate multi-level business and a pyramid scheme is sometimes very thin and hard to see. For now, Herbalife is walking that thin line.
For the first time in Wall Street history, investment titans from the leading hedge funds are facing off against each other.
In similar cases, William Keep has been called by the government as an expert witness on multi-level and pyramid systems, and his opinion has counted when deciding whether a company is legitimate or not. Everything suggests that if an investigation into Herbalife’s system is finally opened, Keep will be called to testify.
According to William Keep, a Ponzi scheme can be told apart from a multi-level business perfectly well, because in a Ponzi scheme users are paid with the money from new recruits and there is no product at all. It’s an obvious fraud that is “very easy to catch”. The problem comes with multi-level marketing, because it takes a costly investigation to determine whether it’s a legitimate business or a pyramid scheme.
Members of a multi-level system can earn money both by selling products and by recruiting new members who join the system. Of course, it becomes a pyramid scheme the moment sellers earn more from recruiting new sellers than from selling products.
And that’s what needs to be analyzed at Herbalife. Bill Ackman’s bet rests on the claim that Herbalife’s sellers have no repeat customers for the products and nothing that sets their products apart from the competition’s, so most of their income comes from constantly recruiting new members. He also presented figures on what Herbalife’s sellers earned, showing a huge gap between how little the active part of the company (the base) earned and how much the passive part (the top) took in. (Here’s how much Herbalife’s sellers earn.)
Rumor has it that Bill Ackman spoke with this researcher before placing his bet against Herbalife, although rumor also has it that Carl Icahn and George Soros spoke with him too, and they, by contrast, have made a big investment in favor of the company.
William Keep, for his part, has said that he never gives investment advice or anticipates the outcome of an investigation, so these big fund managers have invested based on their own judgment and analysis of Herbalife’s business.
For now, Bill Ackman, manager of the 11-billion-dollar Pershing Square fund, is the one losing this fight: given the rise in Herbalife’s share price, his losses already exceed 300 million dollars.
Ironically, if the figures on what Herbalife sellers earn on average are true (and everything suggests they are), they would have made much more money buying Herbalife shares than selling Herbalife products: anyone who had invested 10,000 euros in the shares at the start of this year would have gained more than 8,000 euros.
Further reading
- The fascinating life and career of Bill Ackman
- The remarkable life and career of Steve Cohen, the Wall Street legend
- Warren Buffett turns 83: the best of the greatest investor
Featured image: Bain News Service, publisher, Public domain, via Wikimedia Commons.
