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What If We Were Too Transparent?

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It is very rare that I see a commercial that makes me laugh out loud, but this one did:

I could watch it a hundred times. In fact, I probably have.

If you haven't watched the commercial (come on, it's only 30 seconds), the grandfather is too transparent about his answers to some questions and unfiltered with his thinking.

The commercial was the first thing that came to mind this blog post by John Hempton, Chief Investment Officer, Bronte Capital:

"I agreed with Bill Ackman that Herbalife is mostly about ripping off distributors and people at the end of the chain. The product is more than twice as expensive as competitor shakes. I called Herbalife 'scumbags'. But they are highly cash flow positive scumbags and they will use the cash flow to buy back shares. ... They are scumbags then - but they are scumbags working for stock market investors."

So John Hempton's theory is that defrauding people ("ripping off distributors" to use his own words) is okay as long as the company is publicly traded and funnels some of the ill-gotten profits back to investors.

I wonder if he'd support and invest a public company that simply robbed banks if it paid a handsome dividend. Sounds like he would.

Where do you draw the line on being fine with illegal activity as long as it helps stock market investors? Would he back Murders 'R' Us?

Let's continue with some more of his blog post:

"That I pointed out was similar to tobacco companies. Tobacco companies kill 5 million people globally per year - 400 thousand of them in the USA. Is anyone stupid enough to think the government would close them? That has been a bad short thesis for decades!

Bill Ackman is shorting a profitable company - and his argument is that they run an illegal pyramid scheme. By implication his argument that the government is going to somehow close them down.

That is a really truly awful short thesis - the short thesis that Government is going to come and help poor people and a billionaire hedge fund manager! Normally neither group is high on the agenda!"

First off, I'd be all for the government shutting down tobacco companies. I don't know why the government hasn't done it long ago unless lobbying and political contributions are keeping them in the game.

However, there's a difference between ripping off distributors and tobacco. Is there anyone out there who isn't aware of the dangers of tobacco? It's not like people think tobacco is healthy and is going to make their lives better. Yet the marketing of MLM is that it is good and going to better the lives of distributors. Tobacco is bad, but it isn't fraud.

It's worth taking note that the government shut down Bernie Madoff's scheme. So Hempton thinks it is going to cherry pick which schemes to shut down? He thinks the government is going to ignore fraud, because it doesn't want to help a billionaire hedge fund manager? I honestly think that the government has more on its plate than caring about Bill Ackman.

To be fair this blog post of Hempton's was written over 18 months ago. With the benefit of that hindsight, we know that the FTC is investigating Herbalife. So the process to shutting them down is underway.

I couldn't let it go unnoticed that even when some people admit that MLM is fraud, they shrug their shoulders and support them anyway. One has to wonder how Hempton got in the position to be a chief officer of anything with the lack of logic... maybe the lack of morals got him the position. Can't imagine why anyone would put a dime of their investing dollar with Bronte Capital.

Last updated on August 18, 2014.

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4 Responses to “What If We Were Too Transparent?”

  1. phr3dly says:

    I’m not sure why you’d say Hempton is “supporting” Herbalife. He’s arguing that, in his opinion, it may be a good investment. He’s argued that for the last 18 months, nearly since the beginning of the Ackman short.

    So far he’s been right. Since the post you reference, HLF has recovered from a post-Ackman $25 to $80, though has since retreated to $50.

    I’m not sufficiently invested (by which I mean at all) in Herbalife to care whether it’s illegal or not, but it seems that even among those who are, the jury is out as to whether it’s an illegal enterprise. You assert that Hempton thinks it’s a fraudulent enterprise. I’ve not read anything of his that I can recall that supports your assertion. “Ripping people off” is not fraud.

    I’ll also note that it’s a very, very long road from “the FTC is investigating Herbalife” to “shutting them down”. You’re implying that a shutdown is in the works. That’s a ridiculous assertion, unless somehow nobody else noticed and thus continues to value HLF at nearly $5 billion.

  2. Lazy Man says:

    I think arguing that something is a good investment and making the investment himself (as a manager of some kind of investment firm) qualifies as “supporting” in my book.

    I may have taken some liberties with the word “fraud”, but I think they were reasonable. He says, “I agreed with Bill Ackman that Herbalife is mostly about ripping off distributors and people at the end of the chain.” This looks to me, and if I’m looking at it wrong please help me see it in another way, to be an admission that he agrees it is a pyramid scheme. He’s not saying that everyone is ripped off equally, just the people at the end, which seems to be a key characteristic of a pyramid scheme. Even without the pyramid scheme aspect, the term “ripping people off” is considered by some definitions as “cheating” people or “stealing” from them, which I think is fair to characterize as fraud.

    As for whether Hempton has been right, from the time of his post to today HLF is up 38.49% while the S&P 500 is up 36.42% according to Google Finance. I think it’s a lot of risk to take for very little upside.

    Yes, I’m implying that a shutdown is in the works. I believe it to be true when I read the following companies are actively probing Herbalife for being a pyramid scheme: the FBI, the SEC, the FTC (a particularly good article from the Verge there), and the US Department of Justice.

    Is it so ridiculous to presume that when just about every regulatory body is investigating a company that it is likely to be shut down? I don’t know if Enron was investigated by this many regulators (maybe it was?). It’s not that no one else has noticed, it’s that there is a long of history of regulators not acting, so some are betting history repeats itself. There’s a great article on Seeking Alpha about how regulators can’t afford to let Herbalife off the hook given the evidence that’s publicly available.

    In addition Herbalife has been buying back shares at an enormous rate which helps prop up the stock. The price/earning ratio is a little more than 11 which for their growth is extremely low. If you were to judge HLF from the financials and ignore the investigation, it is extremely cheap. So people are willing to take the risk that the regulators give it a clean bill of health and their money doubles. It’s very much in the middle of a tug-of-war between one valuation that would have it trading at $100 and another having it trade at $0. So it sits in between.

    I think that if HLF isn’t a pyramid scheme and their profits are generated by the value that people find in their product, they should change their distribution and get away from MLM completely. That way they’d put all these investigations behind them (or at least show they are 100% legit going forward) and the stock could trade at a fair valuation.

  3. Kevin says:

    “ripping off distributors and people at the end of the chain” does not equate to a pyramid scheme. Yes, people at the bottom of a pyramid scheme get ripped off, but so do a whole host of other consumers. Pay-day loan customers, anyone who buys a defective product, the “sucker” purchasers of crappy mortgages, the list could go on and on.

    I take issue with the definition provided by your link. I think anyone in the above scenarios would feel ripped off, even though they weren’t directly stolen from, and since those actions have (mostly) been determined legal, and steeling isn’t legal that would fly in the face of the definition of “ripped off” provided.

  4. Lazy Man says:

    Good discussion.

    To me, in the context of MLMs, “ripping off distributors and people at the end of the chain” DOES equate to a pyramid scheme. Just like in pyramid schemes the people at the end of the chain get ripped off. So how does that line NOT equate to it being a pyramid scheme in the context of the discussion of whether Herbalife is a pyramid which is Ackman’s thesis? Maybe in some other context it could be taken differently, but I don’t see how it could be in this one.

    And yes, people get ripped off in numerous ways. In the cases you mentioned, it isn’t the people at the end of a chain that are getting ripped off. There’s a level of fraud where Herbalife people are promising a business opportunity that really isn’t there. It’s different than getting a payday loan… they aren’t telling you that you’ll make money by getting it. They disclose interest rates. If the defective product was intentionally defective, then we are back to fraud. If it wasn’t intentionally defective then I don’t think people can say they were ripped off as long as they can use the return policy. Enough people got ripped off by crappy mortgages that it was indeed deemed fraud and banks for fined billions of dollars. They weren’t at the end of a chain where people who got the mortgages early made out with millions of dollars while people at the end were ripped off.

    In fairness my previous link to ripped off also said “cheated”, not just “stolen from.” I think in all those cases you could say that someone could feel cheated from. I think the idea of the definition is that includes scenarios where people feel cheated and those where they were stolen from. It’s a broader more general term in my view.

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