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Is Herbalife A Pyramid Scheme?

Jan 16, 2013
Originally published on January 16, 2013 6:34 pm

Herbalife, a company that sells weight loss shakes, vitamins and other similar products, is worth billions of dollars. The company has been around for more than 30 years, and it's traded on the New York Stock Exchange.

Bill Ackman thinks the whole thing is a pyramid scheme.

Ackman manages a hedge fund that has shorted more than a billion dollars' worth of Herbalife stock. If the stock falls — and Ackman says he thinks it will fall all the way to zero — the fund will make money.

Ackman and his colleagues made their case in a three-hour-long speech at an investment conference last month. The PowerPoint presentation had more than 300 slides. It's all online at a website Ackman created (and is advertising on Google whenever people search for "Herbalife").

Herbalife doesn't sell its products in stores. It sells them through an army of ordinary people who have signed up to sell the products on their own. The way the business is structured, these people can make more money by signing up other people to be Herbalife distributors.

This structure, known as multilevel marketing, isn't unique to Herbalife. Amway and Avon are two other big companies that use it. And there's nothing wrong with it — as long as there are real customers out there for the product.

Ackman argues that Herbalife is all about recruiting new distributors, and not about selling weight loss shakes and vitamins to real customers.

Not surprisingly, Herbalife disagrees. The company says it has millions of customers around the world. The CEO went on CNBC and accused Ackman of "market manipulation" — a typical accusation CEOs hurl against shorts.

So, who's right here? How hard can it be to tell whether a giant company is a pyramid scheme? In this case, weirdly, it's really hard.

For a company like Herbalife, the difference between being a legitimate business and being a pyramid scheme comes down to what happens on the ground with all those people who signed up to sell products.

If it's a legitimate business, they're mostly selling the products to people who actually want to use them.

Herbalife officials say that's exactly what's going on. The company recently commissioned a survey that found that 90 percent of the people who buy Herbalife products are not distributors; they're people who just want to drink the shakes or whatever.

Des Walsh, the company's president, says Herbalife has been doing steady business for years in Iceland and other small countries where a pyramid scheme wouldn't be able to endure.

Ackman argues that the company is constantly going into new markets, exploiting people and moving on. He says distributors often wind up stuck with thousands of dollars' worth of Herbalife products and no customers.

Herbalife got a boost last week when another big hedge fund manager, Dan Loeb, announced that his fund had recently bought Herbalife stock worth well over $300 million.

Loeb says the company is profitable and is growing. He points out that the federal government has cracked down on pyramid schemes in the past but hasn't had a problem with Herbalife. In a letter to investors, Loeb's fund wrote:

"The short thesis rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for three decades and will shortly awaken (at the behest of a hedge fund short seller) to shut down the company. We find this to be preposterous."

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Transcript

STEVE INSKEEP, HOST:

Let's report next on an American company accused of being a fake. The company is valued at billions of dollars. It's been around for decades and is traded on the New York Stock Exchange.

RENEE MONTAGNE, HOST:

And yet, none of that has persuaded a man who claims the entire enterprise is a Ponzi scheme. He's betting a billion dollars that he's right.

Jacob Goldstein from our Planet Money Team reports.

JACOB GOLDSTEIN, BYLINE: The company is called Herbalife. It sells weight loss shakes, herbal tea, vitamins - that kind of thing. The man betting against it is a hedge fund manager named Bill Ackman.

Sometimes, when investors bet against companies, they do it secretly. Ackman did not. He stood up at an investor conference last month and gave a three-hour long speech laying out his case. He used more than 300 PowerPoint slides. But you can boil it down to five words.

BILL ACKMAN: Herbalife is a pyramid scheme.

GOLDSTEIN: Herbalife doesn't sell its products in stores. It sells them through an army of ordinary people who have signed up to sell the products on their own. The way the business is structured, these people can make more money by signing up other people to be Herbalife distributors.

Ackman says the company is all about recruiting new distributors - and not about selling weight loss shakes and vitamins to real customers.

ACKMAN: No one's going to buy a white powder in a canister with a brand no one's ever heard of from a stranger.

GOLDSTEIN: Not surprisingly, Herbalife disagrees. Here's Michael Johnson, the company's CEO, on CNBC.

MICHAEL JOHNSON: We're not a pyramid scheme. That's a bogus accusation. We have millions of customers around the world.

GOLDSTEIN: Bill Ackman is shorting Herbalife stock. He's betting that the company's stock will go down in value.

Lots of people don't like the idea of somebody betting against a stock; and as CEO's often do when their company is under attack by shortsellers, Herbalife's CEO accused Ackman of manipulating the stock for his own benefit.

JOHNSON: This is blatant market manipulation. Mr. Ackman's proposition that Herb - the United States would be better when Herbalife is gone? The United States would be better when Bill Ackman's gone.

GOLDSTEIN: So, who's right here? How hard can it be to tell whether a giant company is a pyramid scheme? The answer - in this case - is really hard. For a company like Herbalife, the difference between being a legitimate business and being a pyramid scheme comes down to what happens on the ground with all those people who signed up to sell products.

It comes down to what happens with Wilfredo Davila.

WILFREDO DAVILA: Let's see.

(SOUNDBITE OF TYPING)

DAVILA: My post on Craigslist says herbal, aloe, hand and body wash - and so much more. Yeah. Exclamation points and nine dollars.

GOLDSTEIN: Wilfredo is 28. He left a job as a forklift operator a few months ago, and he and his wife went online to look for a business they could do from home. Before they knew it, they got a call from a woman named Maryanne.

DAVILA: She just started talking about Herbalife right away. She let us know that, you know, she was also an independent distributor.

GOLDSTEIN: If Herbalife is a legitimate business, the Wilfredos and Maryannes of the world are mostly selling shakes to people who actually drink them. And the company says, that's exactly what's going on.

Des Walsh, the company's president, points to a recent survey commissioned by the company. It found that 90 percent of the people who buy Herbalife products are not distributors - they're people who just want to drink the shakes or whatever.

And, Walsh said, the company has been doing steady business for years in Iceland and other small countries where a pyramid scheme wouldn't be able to endure.

DES WALSH: When you think of a pyramid scheme, what people think of is some sort of scam. I mean, that's reality. And yet, when you look at our business in these smaller countries where we've bee in business for, you know, 10 and 15 and 20 years, if it really was the case that we were not operating a legitimate business, everybody would know about us.

GOLDSTEIN: Ackman says it's not so simple. He says the company is constantly going into new markets, exploiting people and moving on.

ACKMAN: What Herbalife is doing is just actively taking money from poor people and promising - telling them that you can make it. It's just a question of how hard you work, selling them on hopes and dreams. And unfortunately, they're sold a bill of goods.

GOLDSTEIN: Herbalife got a boost last week when another big hedge fund manager named Dan Loeb announced that his fund believes in the company. His fund recently bought a stake worth well over $300 million.

Loeb says the company is profitable and it's growing. And he points out that the federal government has cracked down on pyramid schemes in the past, but hasn't had a problem with Herbalife.

Jacob Goldstein, NPR News. Transcript provided by NPR, Copyright NPR.