market folly

Earlier today, David Einhorn of Greenlight Capital surfaced on Herbalife's (HLF) conference call.  Below is a transcript of the questions the hedge fund manager asked and the company's responses.  Herbalife is multi-level marketing company focused on selling weight management and nutritional supplements via 2.7 million independent distributors.

Here's the transcript:



"Einhorn Question: How much of the sales that you’d make in terms of final sales are sold outside the network and how much are consumed within the distributor base?

HLF Answer: So, David, we have a 70% custom rule which is basically says that 70% of all products sold to consumers or actually consume my distributors for their own personal use. So obviously what we’ve seen with nutrition clubs is that we now have visibility for the first time to our customers. We know that we reported on this call for the first time the number of commercial clubs around the world, which is in excessive of 30,000, so that has given us feasibility to the tremendous amount of products that are being sold directly to the consumers and we see that as a growing trend in our business.

Einhorn: So, what is the percentage that actually sold to consumers that are not distributors?

HLF: So, we don't have an exact percentage David because we don't have visibility to that level of detail.

Einhorn: Do you have an approximation?

HLF: So well again going back to our 70%, where we believe is that it is that 70% or potentially in excess of that.

Einhorn: Okay. What is the incentive for supervisor to sign somebody up to become a distributor as opposed to – if they’re just going to consume for themselves as opposed to just selling them the product for the markup. How does the distributor – how does the supervisor come out better?

HLF: Sure.  So, I think there are two reasons for that. So, we know from our business today that many of our future supervisors and business builders come in as customers and then they become distributors. So, the benefit from a supervisor is the ability for greater retention of that customer/distributor because they are now earning a 25% discount. The second issue is that it preserves linage. So obviously, if I sign you up David as a distributor, my hope and my expectation is that based on the tremendous product result that you’re going to achieve that you’ll have friends and families go to you and say, gosh David you look great, what do you want. You’re going to respond to them, I’m on Herbalife, and that will encourage you to say, wow maybe this is a business opportunity I could be interested in. So, the benefit for me as your supervisor is one, the discount that you would get and that for my greater likelihood of retaining, it was a permanent customer and secondly, the hope that at some stage, you will decide to do the business and therefore that you are already in my lineage and is part of my group.

Einhorn: Right.  But just trying to understand this clearly, if I sell toa  customer, I bought it - I'm a supervisor, I buy at a 50% discount, I sell to a customer, I make 50 points, if he pays the full price.  If he signs up with a distributor and buys it himself, he gets a 25% discount and I get seven points as a royalty.  Is that how it works?

HLF: No, you would get the other 25%.

Einhorn: I will get 20% plus the 7%.

HLF: So, unless you're on royalty, you would simply (inaudible) in the difference.  So, you are in a 50% discount, you are selling at a 25% discount, and so the difference between the two is your profit on that sale.

Einhorn: Right, so if he signs up with a distributor and buys it for himself from Herbalife, I still get the 25%.

HLF: That is correct.

Einhorn: OK. Good.  One last question,  when you had your previous 10-K, you disclosed three groups of distributors at the low-end. You called 29% self consumers, 57% small retailers, and 14% potential sales leaders and then that disclosure did not repeat in the subsequent 10-K. So, I got two questions, first of all how do you track that and how do you characterize and know which ones are which? And second, why did you stop disclosing that in the last 10-K? Is that something that you stopped tracking or just stopped disclosing?

HLF: Hi, this is John. The criteria for grouping distributors into different classes was based off of their volume purchases and we are making assumptions that people below of certain volume. While doing the business, they were buying soft consumption and I don’t remember the exact amounts, but I can get it to you after the call, as how we delineated between the three classes.  And one the reason that we took out of the 10k is a change in CFO from which to me I didn’t view it is valuable information to the business or to the investors. However, we can easily provide the exact same breakout going forward if you would like [indiscernible] into our investors. Again, I don’t remember the exact delineation between the three classes, but I can certainly get it to you. Our objective is to be completely transparent, so."


It seems as though he's trying to determine how many actual retail buyers of the product (end game users) are out there versus the distributors.  The stock was down 20% today as traders postulated that Einhorn was short or thinking about shorting the company.  He has not disclosed a long or short in HLF.

For more on our coverage of this hedgie, head to why David Einhorn owns Dell as well as his extensive Q&A session from the CIMA Conference.