International multi-Level marketing nutrition company Herbalife (HLF) will report 4th quarter earnings Thursday afternoon. The stock is down more than 50% and many investors are doing just like Bill Ackman, betting against the company.
The hedgefund manager Bill Ackman has been leading a crusade against Herbalife and has accused Herbalife of running an international pyramid scheme. A long string of large earnings beats and an investment from Carl Icahn fueled Herbalife`s fire in 2013.
Herbalife failed to live up to expectations in its 2nd quarter of 2014. They missed on the top and bottom line again last quarter and the stock got punished even further. What`s going on in Herbalife? Is it a house of cards that is on the brink to collapse?
(Picture: Money pyramid. When money stops to come in at the top, the pyramid will collapse. This is why Ponzi and Madoff failed.)
Thursday`s reports will show us how the company is doing it right now. The consensus expectations is that 4th quarter earnings will fall from $1,28 last year to $1,22. Revenue growth has decelerated rapidly in the past six months from 20% to 4% and is forecast to decrease by 9% this quarter.
Herbalife is trading at $33,66, up 2,43% today.
The SEC (Securities and Exchange Commission) recently sent a tweet from @SEC_News reinforcing an investor alert, where the company defined the updated characteristics of a pyramid scheme (The note was titled «Bevare of Pyramid Schemes Posing as Multi-Level Marketing Programs»).
The lines of legality for MLM business models are very thin, and SEC outlines 7 different hallmarks to beware of when considering joining an MLM company. The hallmarks make it easier to make a decision about these types of business models.
Compare the hallmarks to Herbalife, amid open investigation by the SEC, FTC and FBI. Bill Ackman is not in doubt and say that the stock will plunge – down to zero.
A pyramid scheme is an unsustainable business model that involves promising participants payment or services, primarily for enrolling other people into the scheme, rather than supplying any real investment or sale of products of services to the public.
The chart in the picture below shows how pyramid schemes can become impossible to sustain:
(Picture: The unsustainable exponential progression of a classic pyramid scheme)
In a pyramid scheme, an organization compels individuals to make a payment and join. In exchange, the organization promises its new members a share of the money taken for every additional member that they recruit.
The directors of the organization also receive a share of these payments. For the directors, the scheme is potentially lucrative, whether or not they do any work. The organization`s membership has a strong incentive to continue recruiting and funneling money to the top of the pyramid.
Such organisations seldom involve sales of products or services with real value. Without creating any goods or services, the only ways for a pyramid scheme to generate revenue are to recruit more members or solicit more money from current members. Eventually, recruiting is no longer possible and the plurality of members are unable to profit from the scheme.
But Herbalife are selling products, so what is the problem?
The network marketing or multi-Level marketing (MLM) business has become associated with pyramid schemes. According to the U.S Federal Trade Commission (FTC), many MLM schemes «simply use the product to hide their pyramid structure». While some people call MLM`s in general «pyramid selling,» others use the term to denote an illegal pyramid scheme masquerading as an MLM.
The Federal Trade Commission warns, «It`s best not to get involved in plans where the money you make is based primarily on the number of distributors you recruit and your sales to them, rather than on your sales to people outside the plan who intend to use the products”.
The FBI warns you and their website states:
Pyramid schemes—also referred to as franchise fraud or chain referral schemes, are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of new distributorships. Emphasis on selling franchises rather than the product eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses.
This is all about human psychology.
Herbalife`s products are overpriced and critics say they are exploiting poor people who are tricked into paying thousands of dollars for products they will not be able to sell or want to consume. Critics say Herbalife is targeting groups of people who are easily victimized by false promises of riches.
Pyramid Scheme Statistics:
- 88 percent of the members will be on the bottom level of most pyramid schemes will lose their investment.
- In a naked (productless) pyramid scheme, 90.4 percent of people lose their investment.
- In product-based pyramid schemes, 99.88 percent lose their investment.
Herbalife is a pyramid if people earn their money only from other members. Their market cap is $3,08 billion, and how much of that is earned from their products to nonmembers? Herbalife won`t reveal that number and do not belive it is relevant.
Bill Ackman, the head of the hedge fund Pershing Square, say a tiny fraction of members make money. «There is no profitable retail opportunity here», he said. In order to get people in, they have to mislead them. Not all investors shares Ackman`s views.
Investor George Soros added shares in fourth quarter.
Regulators struggle with these grayer areas, where fraud can be camouflaged. The legal tests are confusing and inconsistent. For example how are regulators to determine how many of the shakes in various members basements are for resale versus personal use?
Herbalife have a network of approximately 3,2 million independent distributors, and sell its products in 88 countries, as of December 31, 2012. Herbalife has been on the market for 37 years and every year they lose half of the people who have qualified for bonuses, but they have so far been able to replace them. How long can that continue?
As long as new members and money comes in, it will never stop.
This is why Ponzi and Madoff failed. New money didn`t come in at the top of the pyramid and boom (!), the pyramid collapsed. Pyramid schemes are a scam, plain and simple. Multi-Level Marketing schemes are barely legal, but offer very little return for their required investment of cash and time. Stay away!
Bill Ackman will profit if Herbalife collapse.
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