Herbalife Tumbles as FTC Opens Investigation

Updated from 2:23 p.m. ET to include Kerrisdale Capital comment

NEW YORK (TheStreet) - The Federal Trade Commission has opened an investigation of multi-level supplements seller Herbalife (HLF). The move comes over a year after hedge funder Bill Ackman of Pershing Square Capital Management took a $1 billion short position in Herbalife's shares and accused the company of being a pyramid scheme.

Herbalife disclosed the probe on Wednesday afternoon and said it "welcomes the inquiry" and will cooperate fully with the FTC. Dan McCrum of the Financial Times Alphaville blog first reported of the inquiry.

"Herbalife welcomes the inquiry given the tremendous amount of misinformation in the marketplace, and will cooperate fully with the FTC. We are confident that Herbalife is in compliance with all applicable laws and regulations," the company said.

"Herbalife is a financially strong and successful company, having created meaningful value for shareholders, significant opportunities for distributors and positively impacted the lives and health of its consumers for over 34 years," the Los Angeles-based company added.

A Pershing Square spokesperson declined to comment.

Shares of Herbalife, which were halted earlier today, were down 8.2% at $60.03 in mid-afternoon trading.

"It's interesting the stock is down only 8% on the news of the civil subpoena from FTC. I think the idea is that we'll finally put the regulatory issues to rest after the FTC investigation, although it may take a long time for the FTC to conduct its investigation," Sahm Adrangi, founder and CIO of hedge fund Kerrisdale Capital, a Herbalife investor, said.

"Given that it's practically impossible for the FTC to shut down the company's non-US operations, this development will accelerate the time when the long-term fundamentals of the story will ultimately overshadow the headline risk concerns."

Kerrisdale Capital believes Herbalife shares are worth over $100 a share under all regulatory scenarios and the firm won't be selling shares at current levels Adrangi said.

The FTC's inquiry is one of the most dramatic twists to Ackman's trade since he disclosed his short bet in December 2012. Since then, hedge funders such as Dan Loeb of Third Point Management and Carl Icahn have taken opposing bets to Ackman's short trade.

While the Herbalife hedge fund battle has cooled in recent months, the battle between the company and Ackman has moved to Washington and a high stakes lobbying war.

Ackman, in a Tuesday presentation, also pressed a case that Herbalife's practices in China were fraudulent, an accusation the company quickly denied.

Ackman Goes to Washington

Ackman and Herbalife both upped their lobbying efforts in 2013, as each party sought to make their respective arguments in Washington.

That comes as Ackman's losses forced the hedge funder to amend his short trade. He also conceded that succeeding or failing on his Herbalife short would ultimately come down to regulators in Washington. Ackman has lobbied hard to have both the FTC and the Securities and Exchange Commission investigate Herbalife.

Whether the FTC's review has been in the works for months, or was the result of Ackman's lobbying efforts is to be seen. A review of publicly disclosed political campaign donations indicates that Herbalife spent about 10 times the amount that Pershing Square did in Washington in 2013.

In January, Sen. Edward J. Markey (D., Mass.) asked that the SEC and FTC to seek more information into Herbalife's business practices. A day later, the League of United Latin American Citizens applauded Markey's probe.

In 2013, Pershing Square began lobbying in Washington, spending $90,000 with the Wexler & Walker Public Policy Association and $48,000 with the Moffett Group, a lobbyist that Politico reported worked to gain signatures on a letter Rep. Linda Sanchez (D-Calif.) sent to the FTC to investigate Herbalife's business practices. Pershing's lobbyists targeted signatures from the Congressional Hispanic Caucus (CHC), according to Politico's reporting. Prior to 2013, Pershing Square hadn't conducted lobbying in Washington.

Herbalife meanwhile spent $1.34 million on lobbying in 2013, according to OpenSecrets, including $950,000 from the company's lobbying group Herbalife International of America. The company also has spent lobbying money with Downey McGrath Group, Ogilvy Government Relations, the Podesta Group, Glover Park Group and International Business-Government Counsellors.

In addition to lobbying money, Herbalife's political action committee has generally increased its spending on elected officials. The PAC donated $61,478 to elected officials in 2011, $51,993 in 2012 and $106,600 in 2013.

Amended Trade

After suffering large losses, Ackman amended his Herbalife trade so as to have synthetic short exposure to the company instead of a direct short. At an investor conference earlier in 2014, Ackman said his potential profit from the Herbalife short, however, has grown. Around that time, Herbalife entered to a share repurchase agreement through a convertible note offering that Ackman said indicated the company might be struggling to obtain bank financing.

He also vowed to continue his fight against the company no matter the near-term performance and compared his trade to a short position in bond insurer MBIA (MBI) that eventually paid off.

-- Written by Antoine Gara

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