I have been a Registered Investment Advisor for 43 years, and during that time I have seen some money managers become so obsessed with an investment that the clients needlessly suffer. Over the recent past, Bill Ackman has demonstrated an obsession to my way of thinking with Herbalife. On December 20, 2012, Bill Ackman the head of Pershing Square Capital reported a short position in Herbalife.
Former Herbalife CEO Michael Johnson said, “We urge the SEC to investigate these series of events to protect the rights of investors. This appears to be yet another attempt to illegally manipulate the market by a group of overzealous short-sellers.” Mr. Johnson’s remarks are not uncommon for companies that are being attacked by short-sellers.
Quick overview of Herbalife over the past few months. Herbalife reported that they had more than three million retail transactions with receipts in May of 2017 and 90% of the sales in the U.S. for that month were customers with receipts for purchases. The Federal Trade Commission had demanded about 80% documented sales as part of a settlement and Herbalife exceeded those targets. Also, the company now has over 400,000 members registered as customers, as distinct from distributors who buy health care products then sell them to the end customers who use the products.
For my readers, let me take a quick moment to explain a short sell and how people make and lose money. A short sale occurs when an investor, usually a large institution or firm such as Pershing, believes that a company’s stock is overvalued; that is, the price is too high. They think that the markets will see that the stock could fall back to a reasonable price say $75. Here is an example: XYZ has had a big run and is now selling at $100 a share. Traditional pricing models say the fair market price is $75. The short seller thinks the stock will fall back to the $75 target. So they borrow the stock from a brokerage firm and sell the stock as a short sale. In this case the short means that they do not own it but are selling and hope to buy it back and cover the short at a lower price. With XYZ right now at $100/share, and if the stock price falls to $75 the short seller will cover their short and make $25 a share.
What about risk in a short sell? The maximum amount of money you can make is the price you shorted to zero bankruptcy. In our example, the maximum amount of net profit you can make is $100 /share, once the $75/share is paid back to the brokerage firm. On the other side, how much can you lose? The potential loss to a short seller is unlimited, the higher the stock price goes, the more they will lose if they don’t cover the short sale.
The vast majority of short sellers are not interested in putting companies out of business. In the case of Mr. Ackman and Herbalife, I’m not sure that is true. Let’s look at some numbers. According to the fund’s most recent report, the Herbalife short position is the largest holding in the Pershing Fund. We don’t know what price Ackman shorted the Herbalife stock, but we are aware that on the day he announced the short, the stock was selling for $37.00, and at the beginning of the month December 3, 2012, it was trading at $46.19. If he shorted at the start of the month, he would have been up almost 20%, but that was not enough.
The following week after announcing his short position, he held a 3.5 hour 342 slide presentation on why he shorted the company. Over the ensuing five plus years, he has spent almost $400 million on lobbyists who supported his contentions about Herbalife.
Now for the twist in this story of intrigue. Some aggressive short sellers are famous for spreading rumors, or fake news about a company to scare people into selling their shares. Townhall.com suggests that behind the scenes, Ackman orchestrated stories by financial writers to encourage people to sell their shares, which potentially would lower the share price, making money for Pershing. Two members of Congress, Ed Markey (D-MA), and Linda Sanchez, (D-CA), both sent letters to the Federal Trade Commission about Herbalife. Both later denied they read or knew the contents of the letters they signed.
However, other investors did not agree with Bill Ackman’s evaluation of the company. Ackman claimed the iconic investor Carl Icahn offered to sell him his stake in Herbalife. Icahn not only denied the story, he is quoted saying, “I have increased my slate in Herbalife to 35%.” About Ackman, Icahn went on to say, “It amazes me that a guy who hasn’t any knowledge of my internal investment thinking believes he is in a position to go on television and tell the world what I am thinking,” Icahn further wrote. “Amazing! He has no right to do so and even more, I’m sure his unsubstantiated, obsessive comments, especially about Herbalife, have cost investors a great deal of money over the last few years.”
So is Ackman’s obsession more about Carl Icahn and less about Herbalife? Is it about who is the better investor and has nothing to do with the value of what the company provides to consumers?
Let’s close by looking at the numbers as reported above, the price of the stock. On the day Ackman announced his short position, the stock was selling at $37 per share, and as of the close of business on July 14, 2017, it closed at $73.34 or up about 200%. Perhaps the price action of the Herbalife position has had no adverse impact on the Pershing Square share price. The chart below shows the history of the value of Pershing.
In this case, I believe that obsession has clouded the judgment of the short seller, Ackman. If Pershing still holds the same position, it could explain the under performance of the fund when compared to a simple index and why investors are redeeming their shares in it.
One final comment: many years ago I helped build the first global Government Mutual Fund. I spent many hours in Switzerland talking with the Swiss money managers, trying to understand how they manage money. I asked one investor this question, ”What is the difference between American and Swiss investors in how they make investment decisions?“ He answered with one word, “Emotion.” “Americans, he said, invest based on emotion, while the Swiss use facts.”
In our example with Pershing, clearly, emotions have cost investors a serious amount of money. So ask yourself what type of investor are you? Are you an Icahn or an Ackman?
Dan Perkins is an author, radio and TV talk show host, current events commentator on seven blogs, and a philanthropist. His books are available on Amazon.com. More information about him, his writings, and other works are on his website: danperkins.guru.