Revenge can be so sweet, especially when it takes nearly a decade.
It all started 10 years ago when Bill Ackman's first hedge fund was imploding. Ackman reluctantly turned to fellow hedge fund manager Carl Icahn for help. What has followed is a decade of warring that has now culminated into feelings of mutual hatred.
All this appears to be coming to a head as the two are in opposite corners in a battle over Herbalife (NYSE: HLF). By all accounts, it looks as though Icahn may finally get his long-awaited revenge.
Ackman is short 20 million Herbalife shares, and Icahn is long 17 million shares, or around 20% of the company. From a confidence and conviction standpoint, Ackman is the clear leader. He has a $1 billion bet on Herbalife; his Pershing Square Capital hedge fund assets are only $11 billion. Icahn's position is worth $765 million, compared with the more than $21.5 billion in assets he manages.
Life is full of dilemmas over what is ethical versus what is merely legal, and Herbalife might be one such dilemma. Ackman has claimed that Herbalife's business model takes money from the "poor" and makes the "rich" richer, where only a small number of Herbalife distributors actually make money. Although this sounds rather unethical, the question comes down to whether it is indeed legal.
By all indications, Ackman's "Herbalife is a pyramid scheme" thesis has been willfully overlooked by the market. Back in December, Ackman put a price target of zero on Herbalife, and while the initial pullback was nauseating, the rally following has been nothing short of riveting for Herbalife investors.
If Herbalife is not a pyramid scheme and its business model is legal, then Ackman's short position is in serious trouble, as the company is an earnings machine. Herbalife has cash of $850 million versus debt of only $960 million. Its stock is still relatively cheap, trading at a price-to-earnings (P/E) ratio of 10.8 times forward earnings, while fellow multi-level marketing companies Avon (NYSE: AVP) and NuSkin (NYSE: NUS) both trade in excess of 14.
What's more is that analysts are predicting robust earnings growth, with the company expected to grow earnings per share (EPS) at an annualized 15% over the next five years. This puts the company's price/earnings-to-growth (PEG) ratio at a low 0.80.
A Decade Of Feuding
As mentioned, the heated Icahn-Ackman rivalry all started nearly 10 years ago. Ackman was closing down his Gotham hedge fund and, as the story goes, Ackman reached out to Icahn in an effort to sell his stake in Hallwood Realty, which was trading for $60 per share, but Ackman believed the fair value was close to $140.
|Earlier this year, Ackman and Icahn hurled expletives at one another in a heated phone conversation on CNBC.
Icahn agreed to pay $80 per share for Hallwood, and also agreed to split the profits with Ackman if he was able to sell the company within a three-year period. Turns out, Hallwood was part of a merger deal that valued Hallwood at $137 less than a year later. Icahn refused to pay Ackman because the deal was a merger and not a sale.
Ackman took Icahn to court, and a seven-year feud came to a head in 2011. Ackman was victorious, collecting $9 million from Icahn -- half of which was interest alone. But it appears the feud between the two is not settled. In an infamous war of words on CNBC earlier this year, the two hurled expletives at each other and rehashed their own accounts of the Hallwood deal.
The $4.5 million the two went to court over is pocket change to these guys, with Ackman having a net worth of more than $1 billion and Icahn's being a whopping $20 billion. But it was never about the money. One might go as far as to say that Icahn's investment in Herbalife is in an effort to settle a personal score with Ackman.
Icahn Has The Wind At His Back
But at what point does fiduciary duty outweigh ego? For Icahn, there is no such inflection point: He now manages his own money after returning outside capital to investors back in 2011. Icahn invest his money as he pleases, accountable only to himself.
Ackman, on the other hand, has investors.
And although Ackman claims to take a 50-year view when considering investments, he knows his investors will never allow him to tie money up in a Herbalife investment for 50 years. Look at his less than than three-year investment period in previously failed investments Target (NYSE: TGT) and J.C. Penney (NYSE: JCP).
Thus, Icahn would appear to have the greater staying power.
Icahn also has billionaire George Soros in his corner. Soros owns just over 5 million shares of Herbalife. In early August, Ackman filed a complaint with the Securities and Exchange Commission over Soros' purchase of Herbalife stock, citing a breach of insider trading rules. Ackman believes that Soros told other hedge funds about its impending Herbalife purchase before the news was public. After the allegation, Soros reportedly pulled out some $250 million he had invested in Ackman's Pershing Square hedge fund.
Icahn got another vote of confidence last week when Post Holdings (NYSE: POST) CEO William Stiritz invested over $300 million of his personal wealth in Herbalife. Stiritz now owns more shares more than Soros: 5.4 million shares, just over 5% of the company.
Ackman With The Wind In His Face
As with many things related to the Federal Trade Commission and the SEC, these understaffed and underfunded government agencies can be slow-moving. Ackman has compared Herbalife to infamous Ponzi schemer Bernie Madoff, but even Madoff lasted two decades. We could be seeing a classic case of the market being able to stay irrational longer than Ackman can stay solvent.
By all accounts, Herbalife appears to be a strong business (assuming, of course, that it is not a pyramid scheme). David Simon of Twin Capital Management has noted that if the majority of Herbalife's sales to distributors is an issue, "then the FTC would need to shut down Avon, Mary Kay and others."
The deck is just too heavily stacked against Ackman. With an enterprise value of $6.7 billion, Icahn could feasibly take Herbalife private. And given the two's disdain for each other, Icahn might do it just to spite Ackman. That's just the kind of relationship these guys have.
Risks to consider: If you're long, the biggest risk is that Herbalife is indeed a pyramid scheme and the stock goes to zero. If you're short, the biggest risk is that an investigation never materializes and the stock continues its surge -- where by all indicators the company is a money-making machine.
Action to take --> Investing in Herbalife is in essence like betting on which hedge fund manager has the greatest staying power. Ackman appears to be outgunned, but as an investor, I would choose to watch this battle play out from the sidelines and avoid becoming collateral damage in this clash of the titans. If Ackman eventually abandons his short position and admits defeat, Herbalife could be worth taking a look at from the long side.