You may have heard of Herbalife (HLF) before. It’s a multi-level marketing company that’s in the business of supplements…or is it? Herbalife’s business model is not like that of the traditional supplement companies. It’s more like that of a traditional pyramid scheme, though the executives at Herbalife would probably prefer the term “multi-level marketing” organization.
Notice how that “multi-level marketing” diagram is the shape of a pyramid. That’s because whether you call it a multi-level marketing company or a pyramid scheme, you’re tooking about the same thing. Members get other members to sell unde them in order to advance in the organization. All the money is essentially funneled to the top.
Well, it appears as though the FTC, while not deeming Herbalife’s activities “illegal” in the sense that it needs to shut down completely and cease all operations, has forced a settlement that involves Herblife forking over $200 million and doing some serious restructuring of it’s business.
So what is Herbalife in the business of really? Supplements? Or is it more complex than that?
The product that’s being exchanged is supplements, but the company isn’t selling to consumers like a traditional company would. Instead, it recruits “members” to promote and sell it’s products to others with the promise upward mobility in the organzation. Members are financially incentivized to recruit other members in order to move up. Here’s a chart from Herbalife’s site that shows the various positions in the structure:
Members essentially “buy in” by purchasing a certain amount of Herbalife products to start and are then given some recommended retail prices for them to go sell those products to others.
To be clear, this is not an original strategy developed by Herbalife. The same basic model has been used by tons of different companies in every industry imagineable because, quite frankly, it works. This structure also allows Herbalife to remain a very “lean” organization at it’s core. It has thousands of people “working for it” but they aren’t actually on the books. They’re “independent distributors” who put up they’re own money and assume all the risk from Herbalife.
This strategy has proven extremely successful for herbalife. See for yourself:
That number under-lined in red is Herbalife’s net sales for 2015, after they account for the money they make from “shipping and handling”. Note that each number is expressed in millions, meaning Herbalife pulled in an astounding 4.4 billion last year.
When you’re talking about billions, that whole 200 million FTC settlement suddenly doesn’t seem so bad but, as per the income statement above, that’s about two thirds of Herblife’s Net Profit for 2015. A pretty big blow, certainly in the eyes of Herblife executives.
The general consensus among shareholders, however, is positive. This settlement marks the end of a battle against the FTC that may have been weighing on the share price. Herbalife stock popped immediately after the settlement was announced.
Remember, the price of a stock reflects the publics perception of the future. Everything that is known (or assumed) about the future is factored into the price. If there’s one thing the market hates, it’s uncertainty. Herblife has been battling the FTC for a while now and uncertainty about how it would all play out equates to risk in the mind of the average shareholder. Now that a concrete number has been established, that uncertainty is no longer there.
But the bigger blow to Herbalife may really be the additional terms of the settlement which mandate a massive restructuring of the business model. If Herbalife complies, it will mean the end of the strategy that has made the company so successful in the first place. It may be that the market isn’t factoring in the longterm implications here.
For a company that has relied on marketing instead of making good products, it’ll be difficult for Herbalife to stay afloat from here on out. Judging by the above balance sheet, it would appear as though profits are starting to stagnate (if not decline) anyway, so we may very well be witnessing the downfall of Herbalife.