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Bloomberg: Chirag Saraiya on “Herbalife Ripens for Suitors Dismissing Ackman: Real M&A”

By Brooke Sutherland and Duane D. Stanford

For suitors willing to bet Bill Ackman is wrong, Herbalife Ltd. (HLF) is a prime candidate for a buyout.

Ackman’s assertions that Herbalife is a pyramid scheme pit him against company backers including Carl Icahn and Bill Stiritz, chairman of Post Holdings Inc. Stiritz, the fourth-largest holder, said last year he’d support a buyout. Herbalife reported record annual profit this month after auditor PricewaterhouseCoopers LLP gave it a clean bill of health.

The $6.8 billion company offers private-equity firms substantial cash flow to pay down debt, said Emerald Asset Management Inc. It has a lower earnings multiple than 98 percent of its peers, according to data compiled by Bloomberg. Ackman’s criticism is weighing down the stock and Herbalife would fetch a higher valuation in a takeout, said Kerrisdale Capital Management LLC, which sees a sale price more than 35 percent higher than last week’s close.

“I would be the first to say that over the last few years, I had questions about certain elements of their sales practices, but it feels to me like they’ve addressed a lot of them,” David Volpe, managing director and fund manager at Emerald, which oversees $3 billion including Herbalife shares, said in a phone interview. “Given the controversy surrounding the business model, it might make sense for them to be a private company.”

Barb Henderson, a spokeswoman for Cayman Islands-based Herbalife, didn’t return a call seeking comment. Pershing Square Capital Management LP, the New York-based hedge fund run by Ackman, declined to comment. Stiritz declined to comment.

Ackman Short

Herbalife sells its vitamins and meal-replacement shakes through a network of independent distributors, each of which earns revenue and incentives based on product sales by them and distributors they recruit.

Ackman announced in December 2012 that he had bet on a stock decline by selling short at least 20 million Herbalife shares. His bearish wager is based on a conviction that Herbalife misrepresents sales figures, misleads distributors and sells a commodity product at inflated prices.

While the investor replaced some of the position with long-term put options, he has vowed to take his crusade “to the end of the Earth” and urged regulators to shut it down.

U.S. Senator Edward Markey, a Massachusetts Democrat, has urged the Securities and Exchange Commission and the Federal Trade Commission to look into Herbalife’s business practices, while an advocacy group called the League of United Latin American Citizens met with FTC Chairwoman Edith Ramirez to describe alleged abuses by the company.

‘Regulatory Sword’

“There is a regulatory sword hanging over it that could severely impair business on any day,” Whitney Tilson, managing partner and founder of Kase Capital Management, who has a short position in Herbalife, said in a phone interview.

Herbalife, which operates in more than 80 countries, has repeatedly denied Ackman’s claims, and executives have met with congressional staff in an effort to reach out to lawmakers.

The shares more than doubled in 2013, making Ackman’s investment the biggest loser in Pershing Square’s history, as Kyle Bass, Richard Perry and George Soros took positions betting the stock would rise. Icahn, whose 16.8 percent stake makes him the largest holder, has called Ackman’s assertions “nonsense.”

Herbalife increased 0.4 percent to $67.01 today.

Shareholders probably would be open to a buyout, making Herbalife stand out as a target for private-equity firms looking to put capital to work, said Sahm Adrangi, chief investment officer at New York-based Kerrisdale Capital, which oversees about $300 million including Herbalife shares.

Cash Hoard

Private-equity firms that consider LBOs are sitting on $416 billion in unspent capital globally, according to London-based research firm Preqin Ltd. That’s up from $400 billion a year ago and $354 billion in February 2012.

“Oftentimes when private equity is looking at public companies to take private, there’s a lot of logistical issues that get in the way,” Adrangi said in a phone interview. “You need to get the board to sign off on the take-private, you need management to be properly incentivized, and you need some of the large shareholders to be supportive of the take-private. In Herbalife, you potentially have a lot of those criteria in place.”

Stiritz, also Post’s chief executive officer, said in November that the Herbalife situation was “pregnant for a recap or leveraged buyout.” Last month, Stiritz confirmed that Post had hired Tim Ramey, who covered Herbalife as an analyst for D.A. Davidson & Co. and was one of the company’s biggest advocates, to serve as director of strategic ventures on a consulting basis.

‘Very Undervalued’

When Icahn disclosed his investment in February 2013, he said he would seek talks with the company on strategic alternatives, including taking it private. Herbalife President Des Walsh said later that month the company would “certainly” consider a buyout “in the right circumstance.”

For buyers willing to take the leap, Herbalife is cheap. The skin-cream seller trades at 12.4 times its earnings the last 12 months, lower than all but two of 83 other makers of food and household products valued at more than $5 billion, according to data compiled by Bloomberg.

“It’s very undervalued,” Thomas Vandeventer, a fund manager at New York-based Tocqueville Asset Management LP, which oversees about $11.4 billion including Herbalife shares, said in a phone interview. “There’s an opportunity for somebody to do an LBO on it and probably generate very high returns.”

Cash Flow

The company’s steady cash flow, which can be used to pay down debt, offers another draw for private-equity suitors, Emerald’s Volpe said. It generated a record $626 million in free cash flow in 2013 and has a 9.2 percent yield that’s more than double the median of its peers, according to data compiled by Bloomberg.

“It’s got a lot of potential upside” for a private-equity buyer, David Jordan, a Fort Collins, Colorado-based fund manager at Tributary Capital Management LLC, which oversees about $1 billion, including Herbalife shares, said in a phone interview. “They would be able to service a higher level of debt than what they currently have.”

Herbalife this month sold $1 billion of convertible bonds with terms that are in line with those of similar transactions over the last five years. That may be a positive sign of the company’s ability to tap debt markets for a buyout, said Volpe of Emerald.


While some investors buy convertible bonds to short the underlying stock in a wager on volatility, they’re also betting the company won’t implode, according to Bill Feingold, co-founder of Valhalla, New York-based Hillside Advisors LLC.

“They’re not necessarily betting that everything is just totally hunky-dory,” Feingold, who has written two books on convertible bonds, said in a phone interview. “You want there to be some volatility, but you don’t want so much that it’s a question of is the company going to survive.”

With funds from the bond sale targeted for buying back shares, Herbalife may be going the way of a public company LBO instead, where it “steadily but aggressively reduces the shares outstanding,” Robert Chapman, founder of hedge fund Chapman Capital LLC in Manhattan Beach, California, wrote in an e-mail. Chapman Capital has a long investment in Herbalife.

Selling $1 billion of convertible bonds isn’t the same as raising the amount of debt that an LBO may require, said Chirag Saraiya, Principal at Training The Street, which teaches new hires at investment banks about deals.

Red Flag

“From a lender standpoint, I’d be a little bit concerned,” Saraiya, a former M&A adviser at Bank of America Corp., said in a phone interview. Given the controversy, “there will be certain lenders that don’t want to touch this.”

Herbalife’s decision to use convertible debt to repurchase shares, rather than a traditional loan at historically low interest rates, is a red flag, said Kase Capital’s Tilson, who sees a buyout as unlikely.

“The market spoke and the traditional debt markets are closed to Herbalife because lenders do not want to take significant risk of loss of principal,” he said.

Vandeventer of Tocqueville disagrees. He said Herbalife should be able to secure financing after its clean audit and could fetch about $90 a share in a sale. The stock closed at $66.72 last week.

“This company has just hit a number of potholes in the past two years,” he said. “At some point, that noise will abate. If you were going to do it, it’s kind of like, at some point, ‘What are you waiting for?’”