Earth to Herbalife: Go Private

Herbalife (HLF - commentary - Cramer's Take) must be quite an annoying stock to own. The company consistently beats analysts' earnings estimates and guides up, has a 1.9% dividend yield, generates huge free cash flow and trades at a dirt-cheap valuation.

However, while the fundamentals themselves are fantastic, the company's controversial business model makes it an entity that should no longer be public.

On its Web site, Herbalife describes itself as "a leading global nutrition and direct selling company offering a range of science-based weight management products, nutritional supplements and personal care products ("Outer Nutrition") to support weight management and a healthy lifestyle." In other words, Herbalife sells nutritional products to people who wish to run their own small businesses selling those products to others. In addition, those sellers recruit people to sell under them, getting a cut of the profits.

Now here's where the problem comes in. People sometimes view direct-selling companies (also known as multi-level marketing companies) as Ponzi schemes, where only a small number of people at the top make any real money. When I first recommended Herbalife in the Breakout Stocks newsletter, I would typically hear comments like "Isn't that a pyramid scheme?" In reality, the practices of direct-selling companies are legal, even if they may sound a bit fishy.

Further Firestorms

The problem of a controversial business model is compounded by former corporate criminal Barry Minkow's Fraud Discovery Institute organization, which has had a massive bulls-eye painted on Herbalife. Right on the FDI's Web site, you can download a report titled "How Wall Street Gets Fooled by Multi-level Marketing: Herbalife's Latest Ruse." I actually don't place much stock in the FDI's work, since much of it is opinion-based and consists of rehashes of disclosed information. But Minkow's assault on Herbalife is a negative spotlight that the company simply does not need.

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In keeping with TSC's editorial policy, Michael Comeau doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Comeau is a research analyst at TheStreet.com. In this role he performs stock analysis for TheStreet.com Breakout Stocks, and is also a regular contributor to RealMoney.com. Prior to his arrival at TSC in June 2004, Comeau worked as a Consultant to Toyota Motor North America, performing in-depth research on automotive industry issues, primarily in the areas of alternative engine technologies, competitive analysis and macroeconomics. His primary market interests include consumer technology, specialty retail, and small-caps. Comeau received a bachelor's degree in Finance from Brooklyn College, and has completed Level 1 of the CFA program.. He appreciates your feedback; click here to send him an email.