Hedge Fund Titans Bet Billions On Success Or Failure Of 'Herbalife'

A pair of prominent hedge fund managers have taken opposing positions on the nutritional-supplement company Herbalife. Bill Ackman of Pershing Square Capital Management says the multilevel-marketing company is a pyramid scheme and a bad investment. He's shorting the stock. Dan Loeb of hedge fund Third Point says Herbalife is a good investment. He's taken an 8.2 percent stake in the company and is betting that its shares will rise. Melissa Block talks with David Kestenbaum of the Planet Money team.

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MELISSA BLOCK, HOST:

A company that sells weight loss shakes and vitamins has found itself the subject of a billion-dollar wager. The company is Herbalife, and two hedge fund titans are making huge bets about it. One says Herbalife is a pyramid scheme that's bound to collapse. The other says it's a great company. So what's going on? NPR's David Kestenbaum with our Planet Money team joins us to explain. And, David, tell us more about this company and this billion-dollar wager about it.

DAVID KESTENBAUM, BYLINE: Herbalife is a - it's a pretty big company. It's been around for over 30 years, currently worth around $4 billion. And it sells weight loss shakes and nutrition bars and that kind of stuff all around the world. And the way it sells is really interesting. Have ever you been to a Tupperware party?

BLOCK: I have not, no.

KESTENBAUM: But it's basically like that. It's a - the company relies on people who use and love the products to sell them mostly out of their homes, stuff like that. And they reward people for recruiting more sellers. The technical term for this is multilevel marketing. It's the way Tupperware, Amway and Avon, companies like that work.

BLOCK: OK. So that's the company. And then in come these two hedge fund managers. Tell us more about them.

KESTENBAUM: So the first guy who says this is a pyramid scheme, his name is Bill Ackman, and he runs a very well-known hedge fund, Pershing Square Capital Management. And last month, he announced that his fund has taken out a $1 billion short position, basically betting that the stock is going to collapse all the way to zero. And if that happens, his hedge fund will make $1 billion.

BLOCK: Mm-hmm.

KESTENBAUM: So on the other side is another hedge fund manager, Dan Loeb. He runs a fund called Third Point, and he says it's preposterous. This is not a pyramid scheme. He is also betting that he is right. This week, he says his fund owns 8 percent of the company's entire stock because he thinks the stock is actually going to go up. So you have two really accomplished investors who've studied this. They come to opposite conclusions, and only one of them can be right.

BLOCK: And what's the argument behind the claim that Herbalife is a pyramid scheme? It's a really strong charge to make, a company that's survived for 30 years, as you say.

KESTENBAUM: Pyramid schemes can go on for years and years before they do collapse. But, I mean, the classic pyramid scheme, right, is like one of those chain letter scams. You get a letter that says, hey, here's a way to make $50,000 quick. Just pass this letter on to five of your friends. Each of your five friends will pass it on to five of their friends. They will pass it on to five of their friends and we'll each send $1 in the mail to some of people before us. And because the number of people involved grows exponentially, you will get thousands of $1 bills in the mail. But really, this only works for so long until you run out of people and you're just passing money up the pyramid to the earlier people who started it. And that's a classic pyramid scheme. That's illegal. And what Bill Ackman says, who's shorting the company...

BLOCK: Yeah.

KESTENBAUM: ...is that that what he think is happening here. The company, he says, is recruiting a pyramid of sellers. But they aren't really selling a lot outside the pyramid. He says they're basically just trying to recruit other people to get money, and he figures eventually the whole thing will eventually collapse.

BLOCK: Well, Herbalife is trying to debunk the claim that it's a pyramid scheme. They held a special investor meeting this week. You went to the meeting. Did it seem to make a difference?

KESTENBAUM: It was at the New York Four Seasons Hotel here and I went. And while the presentations were happening, I watched on my phone the stock price just to see how the markets were reacting to, you know, every word. And stock went up a bit, went down a bit, basically closed unchanged. Overall, since questions started being raised about the company, which was actually back in May, stock price is down significantly. It's lost about 40 percent of its value since then.

BLOCK: And is there any way, David, to say when we find might find out which of these two hedge fund managers is right about Herbalife?

KESTENBAUM: Pyramid schemes, you know, they are illegal, right? So the Federal Trade Commission could look into Herbalife. And if it can show this it's a pyramid scheme, it could shut the company down. There are news reports this week that the SEC has opened an investigation. I talked to Bill Ackman, the guy who's shorting the company, this week, and he says he thinks - I said, you know, when will we know? And he said, I think you will know within the year who is right. And he said, you know, of course, he thinks it's him who's right.

BLOCK: And one little footnote here. These two hedge fund managers are both friends, right?

KESTENBAUM: They definitely travel in the same circles and know each other.

BLOCK: Friends and rivals, I think.

KESTENBAUM: They just have very different opinions on this one matter.

BLOCK: OK. David Kestenbaum with NPR's Planet Money team. David, thanks so much.

KESTENBAUM: You're welcome.

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BLOCK: This is NPR.

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