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Herbalife Skips a Knockout Blow

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After weeks of anticipation, Herbalife (NYSE:HLF) defended itself against claims made by hedge funder Bill Ackman that the direct seller of nutritional supplements is a pyramid scheme.

Herbalife fired back with data that put the figures and analysis behind Ackman's billion-dollar-plus short trade in question.

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Still, while Herbalife presented a strong defense of its business, and in particular, Ackman's allegation that a majority of the company's sales don't involve bona fide retail sales, the company's presentation isn't likely to be a knockout blow.

In the background, on Wednesday an a 8.24% stake disclosed by Dan Loeb-run Third Point puts two of Wall Street's most vocal hedge fund investors pitted against each over the company's shares and business model.

After an over two hour presentation by the company and a subsequent CNBC interview with chief executive Michael O. Johnson, Herbalife shares were down over 1%, falling $0.54 to $39.84 in afternoon trading.

Highlights of Herbalife's presentation included a strong rebuttal to Ackman's assertions of a pyramid scheme by company president Desmond Walsh and chief financial officer John DeSimone.

Notably, both Walsh and DeSimone questioned Ackman's most damning allegations - that the bulk of the company's earnings come from signing up new distributors and not actual retail demand. "Zero fee is paid for recruiting," said DeSimone, of the difference between bona fide retail sales and what Ackman characterized as recruiting bonuses.

CFO DeSimone reiterated Herbalife's fourth quarter earnings forecast, and even hinted they could exceed estimates. According to Bloomberg data that compiles analyst estimates, Herbalife is expected to report $1 in earnings per share on revenue of $1 billion and net income of $113 million, in the fourth quarter. The data also shows Herbalife has beaten analyst estimates eight of the last eight quarters.

Walsh, Herbalife's president, also provided data that cut against a crucial Ackman allegation that a new distributor in Herbalife's chain has little chance making any money selling the company's products. Data presented by Walsh showed that at Herbalife's top rungs -- its Presidents club -- roughly half of distributors earn more than someone higher on the company's direct selling chain.

Separately, Lieberman Research, an independent research hired by Herbalife, said a study it conducted of over two thousand distributors showed 73% joined Herbalife to be discount retail customers.

That data undercuts Ackman's claim that the vast majority of the company's sales originate from simply signing up new distributors - his definition of Herbalife's alleged pyramid scheme.

An investor question and answer session allowed by Herbalife following its presentation indicated that while some major investors and analysts were impressed by the company's rebuttal to Ackman's allegations, they were also hoping for a knockout blow, which might not have come on Thursday.

Barclays (NYSE:BCS) analyst Brian Wang applauded Herbalife's presentation in the investor question and answer session, but pressed Herbalife CEO Johnson as to whether the timing of Ackman's allegations might create a self-fulfilling prophecy of distributor withdrawals that could undercut the company's business model.

Meanwhile a portfolio manager at Columbia Management, an investment manager that owns 332,297 shares, according to Bloombergdata, pressed Johnson on why Herbalife wasn't fighting harder against Ackman's assertions.

The portfolio manager noted that while Herbalife characterized many of Ackman's points as "myths" and "misleading," the company didn't make more convincing claims of "libel" and intentionally misleading investors.

In a CNBC interview following the presentation, Herbalife CEO Johnson acknowledged a Wednesday Wall Street Journal report that the Securities and Exchange Commission has opened an inquiry into Herbalife, but declined to comment on any specifics, or any prospective litigation against Ackman.

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Herbalife's presentation that the vast majority of distributors use the company's products for 'self-use,' and data it unveiled, which showed new distributors have a chance to earn money from being a distributor seriously undercut Ackman's characterization of the company.

Still, the use of independent research to rebut Ackman's claims is likely to draw a counter-punch by the hedge funder.

Dan Loeb's Third Point Capital said on Wednesday it has bought nearly 9 million shares in Herbalife, in a move that cuts against a short position in the embattled supplements seller by Bill Ackman of Pershing Square Capital Management.

Third Point's long position amounts to over 8% of Herbalife's stock, while Ackman holds a short position over double in size.

A 13-D filing with the Securities and Exchange Commission shows that Third Point has acquired 8,900,000 Herbalife shares, representing an 8.24% economic interest in the company. The filing does not state intent by Third Point in its large position.

In a letter sent to Third Point investors obtained by the New York Times, Loeb writes that allegations of a Herbalife pyramid scheme are without merit and are unlikely to to warrant a closer look by regulators.

"The pyramid scheme is a serious accusation that we have studied closely with our advisors. We do not believe it has merit," wrote Loeb.

According to Wednesday Wall Street Journal reports citing sources, the SEC has opened an inquiry into Herbalife.

Ackman, who unveiled his bet against Herbalife to CNBC on Dec. 19, subsequently told Bloomberg News that part of his intent in detailing the short trade just ahead of the New Year was to undermine confidence among Herbailife's distributors prior to their 2013 re-up, potentially toppling a pyramid scheme he alleges the company orchestrates.

A more than three hour long presentation made at the Ira Sohn Conference a day later detailed Ackman's reasoning behind his short trade and a web site created by the Pershing Square lists a 300-page plus powerpoint presentation made by the hedge fund.

Herbalife hired financial advisor Moelis & Co. and law firm Boies Schiller, as part of its defense, and CEO Johnson said Moelis helped in constructing the company's Jan. 10 investor presentation.

Wall Street has also provided Herbalife support against Ackman's claims. Herbalife shares have gained back most of their ground since Ackman unveiled his short trade on Dec. 19.

Hedge funders Robert Chapman of Chapman Capital and John Hempton of Bronte Capital say that Herbalife's business is legitimate.

Both funds, they say have made bets in favor of Herbalife and against Ackman.

"Despite beguiling and specious reasoning, Ackman will fail to influence/cause a material regulatory response or a HLF distributor exodus," wrote Robert Chapman, in a Jan. 1 blog post.

More directly, analysts such as Tim Ramey of D.A. Davidson& Co. simply refute Ackman's allegations that Herbalife could be deemed a pyramid scheme by regulators such as the Federal Trade Commission or the SEC.

While Ackman argued 90% of Herbalife's profits come from distributors and not bona fide retail demand, Ramey of D.A. Davidson wrote in a January note to clients the majority of Herbalife's earnings come from retail demand, disqualifying it as a pyramid scheme.

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