Why Herbalife Is a Risk Worth Taking

NEW YORK (TheStreet) -- In life and in business, "innocent until proven guilty" has always been my motto. So despite hedge-fund bear Bill Ackman's claims about Herbalife's (HLF) "shenanigans," I wasn't going to rush to judgment.

We now know that the Federal Trade Commission has opened an investigation into Herbalife, which Ackman claims is nothing more than an elaborate pyramid scheme. The company has posted sales of more than $5 billion.

Herbalife stock was trading at about $57.95 at 3:50 p.m., up 1.12% for the day and down 26.33% for the year.

Herbalife, which has been in operation for 34 years, has certainly fooled a lot of people if these allegations are true. The company operates in more than 90 countries and employs almost 4 million direct salespeople. Not to mention, the company has Madeline Albright, among others, as a paid spokesperson.

Herbalife's business -- commonly known as multi-level marketing -- is based on a recruitment system. Salespeople, or "distributors," will build their own distribution system by having people work under them to sell products.

Likewise, new recruits are encouraged to recruit more people. And it goes on and on. In terms of compensation, the commission from each sale trickles upward until it reaches the person at the top -- thus, Ackman's reference to a pyramid.

But pyramid is not inherently a pyramid scheme.

This is the same model used by Primerica (PRI) and Amway. In response to Ackman's claims and the FTC's probe, Herbalife says:

"We welcome 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 continues to stand by its business model and its reputation.

Investors aren't taking chances, however.

Since this new inquiry was made public, Herbalife stock has dropped from the $68 range to the $58 range -- that's a collapse of about 15% in two days. This is despite reports suggesting that the investigation might take more than a year before it is completed. 

I see this as an overreaction.

Even so, despite the stock's recent pressure, Ackman, who insists that Herbalife shares are worthless, still has a long way to go to recover his $1 billion bearish bet.

According to SEC filings, Ackman's hedge fund Pershing Square Capital Management revealed that it was down close to 50% on its short position betting against Herbalife.

From my vantage point; until the FTC's investigation is final, the risk remains on both sides. And selling this stock too soon may prove to be a regrettable decision.

It's true that taking a position and/or holding the stock at this point exposes investors to plenty of risk. But it's hard to ignore the potential opportunity that exists both in the short-term and long term.

As it stands, Herbalife is now trading at less than 12-times trailing earnings. This means the company is being valued on an assumption of very little growth. Consider that Herbalife's price-to-earning ratio of 11.67 is 6 points and 9 points below GNC (GNC) and Vitamin Shoppe (VSI), respectively.

This tells me that the Street is already discounting the stock based on the risk factors with this ongoing investigation. From a trade perspective, it seems the risk/reward ratio favors the reward side.

Carl Icahn, who has a 17% long stake in Herbalife, agrees.

But with $1 billion on the line, Ackman is not going to give up. And with a 17% stake, Carl Icahn is equally motivated to monetize his investment.

So investors will need to take a side. It's true there are plenty of uncertainties, as we've discussed. But uncertainty brings opportunity. And with each dip in the stock, opportunity knocks even lounder.

At the time of publication, the author held no position in any of the stocks mentioned.

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

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