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Herbalife defends its honor as Ackman presses case

By Brad Dorfman

(Reuters) - Herbalife Ltd executives defended their business on Thursday as a "legitimate company" with customers outside the network of people who sign up to sell its nutrition products, stepping up the defense against pyramid scheme accusations by short seller Bill Ackman.

The hedge fund operator, who has placed a huge bet that Herbalife stock will fall, has argued that the company is an unsustainable scheme because distributors earn more than 10 times as much from recruitment as they do by selling company products.

Ackman's Pershing Square, which has spent months researching the company, has also promised to fire off more specifics. For his $11 billion fund, the $1 billion short position is a key holding.

Herbalife has quickly transformed from a somewhat obscure purveyor of weight-loss products into a battleground for the biggest names in the hedge fund industry. Third Point's Dan Loeb has taken the other side of Ackman's trade, calling his thesis "preposterous" and predicting a sharp rise in the stock.

Loeb reached out to Herbalife through a third party and met with Chief Executive Michael Johnson one time within the past few weeks, Herbalife President Des Walsh said in an interview. He did not provide details of the meeting.

The feud brings to a head rumblings that started in May, when star hedge fund manager David Einhorn of Greenlight Capital asked questions about corporate disclosure on a conference call, putting the shares under severe pressure. (Einhorn has declined to say whether he took a position in the stock).

At a meeting with investors and analysts in New York, Herbalife executives said 31 percent of its U.S. orders in 2012 were shipped to customers who were not Herbalife distributors, and an outside researcher hired by the company said 92 percent of Herbalife's customer base was not part of the company's distributor base.

Herbalife operates on a multilevel marketing structure, where distributors not only make money for their own sales, but also for sales by people they recruit to become distributors themselves. Chief Financial Officer John DiSimone said Thursday that all payments to distributors are based on sales, not rewards for recruiting.

Also, in 32 years as a company, only one court, in Belgium, has found that Herbalife is a pyramid scheme, and Herbalife planned to appeal that ruling, Herbalife President Des Walsh said at the investor meeting.

Herbalife shares were down about 4 percent at $38.41 on Thursday on the New York Stock Exchange after rising as high as $42.99 during the day.

NO "POP-AND-DROP"

Ackman, who oversees some $11 billion in assets at Pershing Square Capital Management, said December 19 he was betting against Herbalife. A day later, he delivered a three-hour presentation, using more than 300 Powerpoint slides to back his position.

During the presentation, Herbalife management disputed many of Ackman's assertions and also repeated that they would have answered his questions about the company if he had contacted them before his presentation.

Ninety-two percent of the growth at Herbalife comes from markets the company entered more than 10 years ago, Walsh said, trying to counter allegations that there is a "pop-and-drop" factor with sales jumping when the company gets into a market and then falling off.

He also said that there are no minimum purchases required by distributors, denouncing so-called "pay to play" allegations.

Walsh said that as far as the company is concerned, it has dealt with the substance of Ackman's argument. The company, which has hired the law firm of Boies, Schiller & Flexner in the matter, has not yet decided if it will pursue legal action against Ackman.

"We are reviewing all our options," he said.

Yet just minutes after the company's presentation ended, Ackman's hedge fund claimed Herbalife did not answer Pershing Square's points as it said it would.

"The company distorted, mischaracterized, and outright ignored large portions of our presentation," Ackman said in a statement.

One analyst who was at the presentation said that Herbalife did not present much new information, but did respond well to Ackman's attack.

"I think they did a good job of helping people understand what a pyramid scheme is and why it is not one," D.A. Davidson analyst Timothy Ramey said. He has a "buy" rating on the stock.

BATTLE OF THE HEDGE FUND STARS

Having two hedge funds, even big and prominent ones like Pershing Square and Third Point, on the opposite side of a trade is not unusual. Greenlight's Einhorn once found himself on opposite sides of a trade with investor Bruce Berkowitz when Einhorn called land developer St. Joe's overvalued and began shorting it, while Berkowitz had a long position and tried to shake up management to improve performance.

But what makes this showdown unique is the one-on-one quality of the battle pitting two of the industry's biggest stars against one another.

The battle lines are being drawn, with each man commanding a loyal following of investors and a brash self-confidence to take on some of the financial world's most sacred cows.

"This will be a battle of firepower," said David Tawil, who runs hedge fund Maglan Capital.

Amid all the interest on both sides, SunGard's Astec Analytics said Thursday that the cost of borrowing Herbalife shares to sell short rose two percentage points just in the last day, a substantial move.

Herbalife shares closed at $42.84 on December 18, the day before Ackman disclosed that he had shorted the stock.

The shares fell as low as $26.06 in subsequent days, but have recovered most of their losses as investors questioned whether the Federal Trade Commission would take any action against Herbalife, as Ackman wanted.

Separately, the U.S. Securities and Exchange Commission's enforcement division has opened an investigation into Herbalife, a source familiar with the matter said.

(Additional reporting by Sam Forgione and Adam Kerlin in New York, Svea Herbst-Bayliss in Boston, Aruna Viswanatha in Washington and Siddharth Cavale in Bangalore; Editing by Jeffrey Benkoe, Bernard Orr)

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