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Herbalife Shares Up 25% as Ackman's Accusations Fizzle Out

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Shares of the nutritionist company Herbalife Ltd (HLF - Free Report) climbed more than 25% yesterday after activist investor William Bill Ackman, hedge fund manager of Pershing Square, failed to establish his claim of Herbalife operating illegally during a presentation in New York on Jul 22.

A day before making the presentation, Ackman had reportedly stated that he had evidence that Herbalife is running a pyramid scheme business model. i.e. it employs deceptive marketing practices for improving business. Ackman had the notion that the nutrition clubs run by Herbalife's distributors focus on recruiting instead of selling products.

The billionaire investor stated that he had spent nearly $50 million in investigation of the operations of Herbalife's nutrition clubs for two years and had hours of recorded video and audio as evidence to prove his allegations. Ackman’s statements led panicked investors to sell stocks, thus driving the shares down by more than 11% on Jul 21. (Read: Herbalife Shares Tumble Ahead of Ackman Presentation).

However, the fear did not last long as Ackman during his presentation could not convince Herbalife’s shareholders to turn their backs on the company. Ackman argued that Herbalife salespeople are promised huge success and big money, but the company does not even pay its employees under training at storefront nutrition clubs. He also said that an average Herbalife nutrition club operator loses around $12,000 a year. Herbalife, however, denied these claims.

In fact, retaliating against the accusations, Herbalife issued a news release before Ackman's speech. It stated that Herbalife had hired an economist to review its operations who concluded that its business model is not a pyramid scheme and that its sales force has a genuine opportunity to profit. According to a recent study commission by the company, 87.5% of nutrition club operators are satisfied with the money earned and 92% of them want to continue with their club.

The battle between Ackman and Herbalife started two years back in December, when Ackman first accused the company of making money by recruiting new sales people and not from its sales. Ackman also unveiled a $1 billion short position in the company's shares in 2012.

In Mar 2014, media reports stated that the billionaire investor told his clients that Herbalife is likely violating multi-level market restrictions in China. (Read: Herbalife Faces Another Ackman Attack).

Earlier in Jan 2014, First Financial Daily, a Chinese newspaper, suspected Herbalife of adopting illegal marketing practices in China. Later in the same month, the Canadian Competition Bureau announced a formal investigation into the pyramid scheme business model complaints against the company, as per a report by New York Post.

Ackman's allegations have prompted investigations by the Securities and Exchange Commission, Federal Trade Commission, FBI and at least two state attorneys general, but so far none has taken action.

This Zacks Rank #2 (Buy) company, on its part, has been denying the charges since 2012. We also appreciate the fact that despite numerous attacks on its multi-level marketing model, the company’s earnings continue to increase. This signals that the stock has potential and will continue to move higher, going ahead.

Herbalife is not the only company, which employs sales representatives to sell its products. Other multi-level marketing companies like Nu Skin Enterprises Inc. (NUS - Free Report) , USANA Health Sciences Inc. and Avon Products Inc. (AVP - Free Report) also follow the same distribution model.

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