Herbalife Is Resembling a Trip to the Casino

NEW YORK (TheStreet) -- The Federal Trade Commission is investigating the sales and trade practices of Herbalife (HLF), a multi-level marketing heath food and supplement supplier. As ugly as it may be, you had to see this one coming. Anyone taken by surprise Wednesday genuinely needs to reflect if Herbalife is a stock in which they want exposure.

Increasingly we will witness Herbalife become political. Once politics enters it's a crapshoot what will happen. Forget about right and wrong. Politics is about wielding power and influence that doesn't necessarily get it right. Take Tesla Motors (TSLA) as an example. The electric-powered automaker was shown the exit door by New Jersey because the company offers an innovative and customer-centric purchasing process.

Tesla didn't stand a chance. A state-sanctioned exclusion of Tesla was an easy layup for a well-organized and numerically superior dealership network fearful of losing their lucrative business model. Tesla and shareholders can anticipate the drama and results of New Jersey to play out in many more states to come. Is it right and just? No way, but it's reality and Tesla will need to find an alternative (and perhaps more expensive) solution.

The battle being waged in network marketing stocks is at a whole different level. The rewards and risks are eyeball popping, with billion-dollar bets being wagered in every direction. The average investor has no idea what's going to happen next until after it happens. Regardless if you're long or short, you may make the right call and still lose.

If you owned Herbalife early in 2012 or earlier, there's a fairly reasonable chance that if May's price crash didn't shake you out of your shares, December's did. Investors that exited to limit losses only to watch the company make new all-time highs were frustrated, but shorts who bought into Pershing Square Capital Management's Bill Ackman short thesis had their heads handed to them.

Pershing Square is risking enormous amounts of money that the wheels will fall off of Herbalife. Political contributions and lobbying expenses are a small cost of doing business if it hastens a regulatory unfriendly environment for Herbalife. On the other side of the coin is activist investor Carl Icahn with resources, influence, and financial wherewithal to go toe-to-toe with Bill Ackman.

Adding confusion and a wild card element are health-related mega-network marketing suppliers Nu Skin Enterprises (NUS) and Usana Health Sciences (USNA). These companies have the capacity to cause losses for Herbalife investors. Guilt by association could turn into Herbalife's greatest liability.

Citron Research, a Web site well known for exposing Chinese frauds claims Usana Health Sciences and Nu Skin Enterprises' investors should carefully question the companies' business practices in China. 

If Citron Research is correct and China drops a hammer on one or both of these companies like New Jersey did with Tesla, a spillover onto Herbalife is inevitable. Any issues for these and the endless other network marketing companies may shift the perception of the network marketing business model.

In politics, perception is everything, and even a small snowball can become a serious avalanche in the right situation. You can bet Ackman is searching to find the right snowball and is more than willing to help it get started rolling.

We don't know if Ackman or Icahn will win, but it's necessary for investors to understand that unlike most companies, Herbalife could be more about political gamesmanship than market strategy. If you're not prepared for that possibility, you may not want to have long or short exposure.

Those brave or with enough conviction may want to consider options as a risk mitigation tool.

For example, with shares trading near $58, a May $50 put option can be bought for about $3.90. A put option gives the right but not the obligation to sell shares for $50. During a worst-case scenario, if the wheels totally come off Herbalife, you can exercise your put option and sell at the strike price of $50. This effectively caps your loss at $12 ($58-$50=$8+$4 option price totals $12).

Other strategies include selling calls to offset the cost of a put option or simply selling a call to lower your risk while not paying the high cost of option premium.

I don't think what's happening with Herbalife is fair, and I hope when the dust clears it comes out on the other side. That said, I would be amiss if I didn't emphasize the perils the company and investors face.

At the time of publication, Weinstein had no positions in securities mentioned.

Follow @RobertWeinstein

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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