Herbalife (HLF) is fighting a losing battle for its life. The company is being forced by the FTC to operate legitimately from an injunction that will be active for the first entire quarter on the forthcoming September quarter results; but only a mere 9 weeks after announcing (1 August), the horrendous 2Q 2017 results and earnings downgrade for the rest of the year, Herbalife has been obliged to announce a further downward revision in its outlook. This was nicely camouflaged as an update to its recently announced self-tender offer seeking to purchase up to $600m of its ordinary shares; due to a highly active share buyback program (who else I ask, would buy this sinking ship with more holes than a colander) which was NOT factored into the shares outstanding, the company will manage to roughly maintain its earnings per share for the September quarter. But in order to dispel any ambiguity, I submit the sales forecast for the September quarter, announced 9 weeks ago and updated yesterday.

Forecast on 1 August:

Three Months Ending Mid-Point
September 30, 2017
Low High
Volume Point Growth vs 2016 (7.0%) (2.0%) (4.5%)
Net Sales Growth vs 2016 (5.0) 0% (2.5%)

Forecast now, a mere 9 weeks later:

Three Months Ending Mid-Point
September 30, 2017
Low High
Volume Point Growth vs 2016 (6.0%) (4.8%) (5.4%)
Net Sales Growth vs 2016 (3.4%) (1.9%) (2.65%)

A bull might retort, “But hey what are you quibbling about, it’s less than one percent of a change!” My response would be, “Yes, it’s only 1%, but in 9 weeks – extrapolate that to a year! Also it portrays how effective the FTC injunctions are and how the walls will continue to close in on HLF’s deceptive practices.”

To fully comprehend how the injunction has destabilised the modus operandi, one has to revert to the June quarter Conference call:


When asked by an analyst on the CC for the June Quarter,

Just wanted to touch on the U.S. business, down 18% in the quarter, I know you said that was in line with the updated expectations you gave in June. But just wondering how you’re thinking about that business in the back half of the year….

John De Simone, Herbalife CFO:

As we enter the second half of 2017, we are entering into a new chapter for the Company. Internally, we’re calling it the pivot…

This quarter, we are pivoting the entire organization to once again be laser-focused on growth, attracting new customers and distributors to our business, and providing with the products, tools and resources they need to be successful. It truly is a new chapter of our Company and it’s an exciting time to be involved with Herbalife Nutrition…

In other words, dear Herbalife bulls, this is a shrinking business, despite management’s dandy pivots and pirouettes to stimulate growth. Sales are declining and the slide will continue. Despite vigorous management protestations that HLF will be able to grow legitimately within the boundaries imposed by the FTC, we are actually seeing the first signs of the deterioration that will only gain momentum…

Note that the only reason HLF did not announce a downward revision in earnings is due to a smaller share count, due to share repurchases and the imminent Dutch auction. However, it’s impossible to grow or even maintain earnings by share buybacks when sales are falling.

In the words of ex-FTC Chairwoman Edith Ramirez:

Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered,

The market valuation of HLF needs to adjust to a maximum lifespan of a decade, as deceitful income claims and illegitimate recruiting practices are now, by law, no longer part of its arsenal. This gives me a value of $16 per share.

HLF still up to its old tricks

The reason for my confidence that the FTC vice will continue to tighten and impact sales is that HLF is still trying its old tricks, despite explicit prohibitions by the FTC. In the updated 8K disclosure dated 2 October the ‘risk factors’ announced a new class action suit titled Rodgers, et al. v Herbalife Ltd. This has been expertly analysed by a fellow SA Contributor, illustrating how HLF might have continued violating the FTC injunction , through non-disclosure of costs, deceptive income claims and minimum purchase quantities enforced on aspirant distributors. Doubtless, blatant contempt of the FTC injunction will not be taken lightly and the restriction of the above practices will dent sales further in the future.

All the herbal tea in China…vanishing!

The bull case for Herbalife places much emphasis on China. The sheer size of the market makes it enticing, if it could be tapped. After an initial spurt of growth where Volume Point growth was almost always in the double digits, China rose to become HLF’s second largest segment. However, momentum has moderated significantly of recent. This can be attributed to more rigorous scrutiny over pyramid schemes and corruption; in fact, HLF currently faces ongoing intense scrutiny over its business model in China. On close inspection of the risk factors in each successive quarter, the increased regulatory supervision is very evident. Yet again, HLF probably under fear from a more vigilant SEC, deemed it necessary to update its risk factors (already a voluminous 2 pages of it!) regarding China.

A comparison of the 2q risk disclosure and the updated 8K SEC disclosure of 2 October reveals the following addition, highlighted in bold.

The regulatory environment in China is evolving, and officials in the Chinese government, including at the local and central level, exercise broad discretion in deciding how to interpret, apply, and enforce regulations as they deem appropriate, including to promote social order. Regulators in China may change how they interpret and enforce the direct selling regulations, both current interpretations and enforcement thereof or future iterations. Regulators in China may also modify the regulations. We cannot be certain that our business model will continue to be deemed by national or local Chinese regulatory authorities to be compliant with any such regulations. The Chinese government rigorously monitors the direct selling market in China, and in the past has taken serious action against companies that the government believed were engaging in activities they regarded to be in violation of applicable law, including shutting down their businesses and imposing substantial fines. For example, in August 2017, China’s State Administration for Industry and Commerce, Ministry of Education, Ministry of Public Security and Ministry of Human Resources and Social Security published a notice announcing they are carrying out a three-month campaign ending on November 15, 2017 to investigate pyramid selling activities in order to eliminate activities prohibited under relevant regulations. The campaign seeks to eliminate organizations that use recruitment to lure and mislead people into participating in pyramid schemes. As a result, there can be no guarantee that the Chinese government’s current or future interpretation and application of the existing and new regulations will not negatively impact our business in China, result in regulatory investigations or lead to fines or penalties against us or our Chinese Members. If our business practices are deemed to be in violation of applicable regulations as they are or may be interpreted or enforced, or modified regulations, in particular with respect to the factors used in determining the services a service provider is eligible to perform and service fees they are eligible to earn and to receive, then we could be sanctioned and/or required to change our business model, either of which could have a significant adverse impact on our business in China.

In other words, HLF has deemed it necessary to further inform investors that China has clamped down on pyramid selling and the use of misleading recruitment; it is also informing investors that HLF is under scrutiny, and if they are found to contravene applicable regulations – most likely by November 15 – their business in China could take a serious hit. In light of the damming FTC injunction just instated on their US operations and the intrinsic deceitful nature of the HLF’s DNA, need one say more.