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Buyout Bid Juices Herbalife

Michael Comeau

Herbalife (HLF Quote) received a takeover bid Friday after the close, and we'd like to update readers on the implications. The stock is trading sharply higher to $39.50, and we are moving it to a Two rating and trimming 200 of the 550 shares in the Breakout Stocks model portfolio.

Private-equity firm J.H. Whitney issued a proposal to acquire Herbalife for $38 a share in cash, a 15% premium to Friday's closing price. Whitney actually took Herbalife private in 2002 with another private-equity firm, Golden Gate Capital, before taking it public in December 2004. Whitney owns 27% of Herbalife's stock, and its managing partner, Peter Castleman, serves as chairman of Herbalife's board of directors. So Whitney has a good understanding of Herbalife's business.

We have written numerous times that Herbalife could be an attractive takeover target because of its hefty cash flow, which would allow the company to support a lot of debt. Accordingly, Whitney expects to raise $2 billion in debt financing for this deal.

After trading above $41 a share in November and December last year, Herbalife shares fell as low as $29.25 in January when the company lowered 2007 revenue guidance. The weaker outlook stemmed from difficulties in Mexico, though Herbalife kept earnings guidance intact. This slump in the share price has given Whitney an opportunity to attempt to take the company private ahead of Herbalife's expected approval to begin network marketing in China.

Such an announcement would undoubtedly bolster Herbalife's addressable market and increase the value of the company. For comparative purposes, shares of Nu Skin Enterprises (NUS Quote) rose 17% the week that the company announced it had received approval to begin network marketing in China.

In addition, the $38-a-share bid implies an 8% discount to Nu Skin based upon expected 2007 earnings before interest, taxes, depreciation and amortization, or EBITDA, even though Herbalife is increasing sales faster. Combining this data with the fact that the China catalyst has not yet hit Herbalife's shares (but has already boosted Nu Skin's), we believe the bid is not as high as it could have been. The market seems to agree, implied by Herbalife's rally above the offer price early Monday morning.

We are moving Herbalife to a Two rating (a stock that should not be bought at its current level) as the stock is already pricing in expectations of a bid above $38. In addition, today's rally has brought the position up to about 8% of the model portfolio.

We noted in a prior Alert that we planned to trim the position ahead of the company's fourth- quarter earnings release Feb. 26 because we believe the company could cut its 2007 earnings outlook. So we want to take advantage of today's price action to reduce this position. This sale will leave us with a 5% position to participate in any further upside.