Bill Ackman on Short Selling

You I would be remiss if we spent this time together and we didn't talk a little about Herbalife. Herbalife, for those of you who don't know, and Bill's gonna explain more, is a Direct Selling scheme. The day I came to see you in New York, you were about to, or that day you were launching your PhD-length report on all the various problems with Herbalife. You then had a substantial short position. For those of you who don't know finance, so that's basically sitting a position such that you benefit when the stock goes down.

There was a very public and nasty battle with Carl Icahn, and in the last few days, I see restructuring your position from shorts to put options. Forget about that for those of you who don't worry about finance. One element of this deal which was extremely novel—I mean the whole thing was novel—was your announcement that you would donate your profits from the trade to charity.

Can you explain what's going on at Herbalife and, in particular, made me focus on that last piece? This will be a bridge to some things on philanthropy. You know, what were you trying to accomplish in this, and what was this announcement about donating profits from the trade to charity, and why did you do that?

Okay, so as you mentioned earlier, about eleven years ago, I came out with a white paper called his MBIA Triple A, where I questioned the Triple A rating of a company called MBIA. I disclosed on page one of that report that I had shorted the stock and bought CDS, a kind of an insurance product, betting on the company's credit deterioration, and caused a bit of a stir with this paper. The company did not like the paper, and they, as the largest guarantor of New York state and city bonds, decided they wanted to get back at me.

They called up Eliot Spitzer, who was the then presiding attorney general in New York, and said, "Look, there's an evil guy saying that we don't deserve our triple-A rating. You know, Moody's and S&P say we're triple-A. Who is this guy?" Moody's and S&P would later lose some credibility after this, but this was a hundred fifty to one levered company. I was guaranteeing a whole sort of very risky subprime CDO/DO, and so forth, and it was insolvent based on the exposures.

A good analyst digging deeply could determine that, and I came public with this, and I was largely ignored. I kept at it—some persistent guy—and I made a series of presentations. See if I remember some of the names of them. But anyway, I made a series of presentations, and no one was really paying attention. The stock was 73; the credit insurance just kept getting cheaper and cheaper, meaning no one believed that we were right.

One day, at my last presentation, I said, "Oh, by the way, no one ever believes me on this one." They say, "Well, you're short, so how can we believe you? Because you're gonna profit if it declines." So I said, up at a conference, I said, "Okay, I hereby commit to give away a hundred percent of any personal profit I make from this investment." That was, that day was the high for the stock. It went from 73 to three dollars a share, and the credit protection went from thirteen basis points to twenty-five hundred.

We made a billion six or seven hundred million dollars. I personally made a hundred and fifty million dollars, and 150 million dollars seeded, I was really the maybe the second or third grant. But the big grant that created the Pershing Square Foundation, so the Oxford program is an indirect beneficiary—the failure of MBIA—a silver lining.

So, the problem was short selling. It's something that, even though it's perfectly legal, it's something that people have a degree of discomfort with. You know, it's almost perceived as un-American to bet against a company, and we, by the way, only do it in very rare circumstances and generally only when we believe it's good for America or good for the world for the company to disappear.

In this case, you had a company that was assuming more and more credit risk and had only a tiny capital. They had five billion of capital and a trillion dollars' worth of obligations they were guaranteeing because they were triple-A-rated. Banks and other institutions were not holding capital against these exposures because regulations say if it's triple-A rated you don't need to hold capital.

This was creating, in fact, in my testimony to the SEC—and if you actually, there’s a book called Confidence Game, which is about my battle with the company—and if you go to the Confidence Game website, all of my transcripts of testimony to the SEC and the Attorney General are actually online. You can read them. In there, this is early 2003 timeframe, I said there's going to be a credit crisis if you don't shut this company down. No one paid attention.

Anyway, so I came across a company—so I think the giving away of the profits made people say, "Look, maybe this guy actually believes what he's saying." People paid a little more attention, and I think that helped. That's probably gonna give the money away anyway.

So it's easy to give away when you don't have it. After you receive 150 million, then it's really okay. So the second time around, the consequence is a company called Herbalife. Herbalife is a company that's importantly in the nutrition business. They sell protein powder shakes, they sell vitamins, they sell herbal tea, they sell some nitric acid type things that's supposedly good for your heart.

These are all commodity products; they're made by five, six, ten different manufacturers. You can buy them at your local pharmacy; you can buy them at your local GNC if they have that here; you can buy them at your local supermarket. The price you paid at your supermarket is about a quarter to a third of the price you pay for the Herbalife product. So, who in their right mind would buy this overpriced stuff?

The Herbalife number one product is called Formula One. You know, no one's ever heard of Formula One other than the race, and it competes with a product called Slim Fast, which I guess many people in the room may have heard of. It's a product made by Unilever; Slim Fast sells 100 million, 150 million a year. Herbalife ostensibly sells two billion of the same product.

How is it that Slim Fast sales have been coming down every year, and the Herbalife product has been growing? It sold what they call a direct selling model, and the way that works is your name is Mary Ann. So Mary Ann comes to me and she says, "Bill, don't I look terrific? I've been losing weight. I've got this product I've been using." And I said, "Wow, you look fantastic." She said, "Would you like to try it?" Sure!

A friend approaches me, you know, and says, "Hey," and so you try it, and then she says, "Hey, would you like to make a little money on the side?" And in this economy, who wouldn't want to make a little money on the side? She convinces me to become an Herbalife distributor, and she tells me that if I sign up five friends, and each of them sign up five friends, and each of them sign up five friends, pretty soon, I'll be collecting royalties, and I can retire rich.

Or, if I’m less ambitious, I can make a little money on the side. As an unsophisticated, unemployed, low-income person—which is the target audience for Herbalife—this kind of pitch from someone I trust sounds appealing. The unfortunate thing is that something, an order of 99% of the people lose money. There are about 50 that make five or ten million a year; there are about a thousand that make a few hundred thousand a year; and the other 3.6 million lose anywhere between $300 and $38,000, $10,000, $20,000, $30,000.

It's really a money transfer scheme—a pyramid scheme. It's like a chain letter when you got one when you were a kid, you know. Send a dime to the following 11 people on the mailing list, and then in three weeks you'll have $1,000. If you think about what a Ponzi scheme is, it's a money transfer scheme without a product. A pyramid scheme is a money transfer scheme with a product, and they do smart things like put the Herbalife logo on football jerseys of famous soccer stars, and they back various teams.

That's very appealing to the Hispanic community, which is actually the target audience that they've been very successful with. Now, unfortunately, pyramid schemes are illegal. Now here's a pyramid scheme. It's got a seven billion-plus market cap, it trades on the New York Stock Exchange, and has been in existence for 33 years. How is it possible that this company could be a pyramid scheme? The answer is, it is.

In fact, they've used their tenure as a public company and the New York Stock Exchange listing and the imprimatur of a Nobel laureate they paid fifteen million dollars to, to serve as representatives of the company, and the lax regulatory regime in the U.S. to allow this pyramid scheme to grow to an enormous size. The profit in pyramid schemes is they run out of victims, and they inevitably collapse.

I can actually prove to the audience very quickly that this is a pyramid scheme, and I'll do that by asking you a question. So Herbalife entered the UK in 1983—thirty years ago, okay? Pepsi, we've been in the UK for a longer period of time, but after 30 years, Pepsi had a good quarter last quarter and they grew their sales by three percent in the UK. What do you think Herbalife grew their sales last quarter in the UK?

Let's have a guess in the audience; raise your hand. It's no risk of being wrong. Yes? 1%? Okay, someone else? 140 percent? Interesting. Okay, 20, 30 percent. The answer: sales grew 92 percent last quarter. And how is it possible that—I mean, maybe people are getting fat at an incredible rate here—I mean, but absent that, the reason why it grew very quickly is they found the new immigrant population to go after.

This is a product where there is a boom as people get recruited, and then it went very quickly. When the population gets saturated, it collapses. Right now, they have, you know, the UK business grew enormously and then collapsed, and now it's beginning to grow enormously again. I don't know; maybe the Vietnamese population. You know, I was with one of my investors, and said, "You know, I think the women who worked cleaning the office are Herbalife distributors."

I met with them, and people are convinced to become Herbalife distributors. You have to buy $3,000 worth of inventory in order to start getting these royalties, and what it is is effectively an inventory loading-type scheme. So anyway, that’s what the business is. We did, you know, probably 18 months worth of work before we came public.

We hired one of the best law firms in the country, Sullivan & Cromwell, to do their own independent evaluation. If I'm going to say publicly a company is a pyramid scheme, I certainly would like the legal backing of one of the top law firms in the country. Both William Sullivan concluded there was a pyramid scheme, and on December 20th, they made a public presentation.

There's a website called Facts About Herbalife; you can watch the presentation. There's lots of other data there, and so far so good until Carl Icahn came along and bought 16 percent of the company, saying it was totally wrong. It seems like every day he goes on CNBC and says what a great company it is, and every time he says that, the stock goes up another couple of dollars.

In the meantime, that company's reporting very good financial results, but I'll make a prediction. I don't know if I'm back here in a year; maybe Adam will invite you back. Document, okay? This business will be shut down. Okay? This business will collapse. I can't give you the precise date, but we will have made progress in that direction within 12 months. So that's my prediction for today.