Herbalife's Earnings, And Carl Icahn's Activist Strategy, Summarized In Two Charts

Moments ago, Herbalife reported results which at first blush were far stronger than expected: revenues of $1.26 billion above the expected $1.23 billion, with (non-GAAP) EPS of $1.50 compared to expectations of $1.30, and well above the $1.27 last quarter. What, won't get much emphasis is that of this $1.50, a whopping $0.66, or $66.6 million, is an addback related to "remeasurement loss relating to Venezuela" - considering the country is a devaluing basket case, to assume that any FX related losses in the banana republic are "one-time" is the height of folly. However, as everyone knows, for a company like Herbalife actual earnings hardly matter. What matters is how much shareholder friendly magic will the Icahn-controlled management team pull out of its hat. And it pulled out a lot.

Perhaps the most notable announcement was that the company would terminate its $30 million/quarter dividend in order to "accelerate cash returns to shareholders" in the form of share buybacks. Surely great news for William Ackman who no longer will have to pay the dividends courtesy of his stock short, this is what HLF said:

The company now expects to repurchase a total of $581 million of its outstanding common stock during the second quarter of 2014 as part of its previously announced $1.5 billion share repurchase program. The $581 million is comprised of the approximately $315 million expected to be purchased in April as part of a 10b5-1 trading plan ($255 million already completed as of Friday, April 25); plus the $50 million included in previous guidance and $216 million that otherwise was expected to be returned to shareholders in the form of quarterly cash dividends over the next eight quarters.


Mr. Johnson stated, “Our strong sustained financial performance and the current market valuation of our shares make repurchasing stock the most attractive method of returning capital to shareholders and reflects our continued commitment to creating long-term value for our shareholders.”

And just as notable in addition to the acceleration of the stock buyback (why does the company suddenly feel the urge to hand over its cash to shareholders - would several investigations into whether it is a Ponzi have anything to do with it), is the amount of debt Herbalife issued in order to find its $695 million Q1 buyback (and $581 million expected in Q2). But instead of telling, we'll show.

The chart below summarizes the three key cash sources and uses of funds for Herbalife: cash from operations, stock buybacks and debt issuance proceeds. See if you can spot the pattern:


And just to clarify the pattern above, here is a chart of Herbalife's total debt. It probably needs no highlighting, but toal debt doubled in the first quarter to $1.85 billion, with well over half of the debt issuance proceeds going to fund the stock bought back in the quarter.


What to make of this, and why the sudden scramble to make Herbalife into the biggest cash piggybank available?

Simple: the FTC, DOJ and FBI are investigating Herbalife whether it is a Ponzi scheme, that much is clear. However, neither iCahn, nor the management team, nor shareholders are looking forward to being around when the conclusion of said inquiries is revealed. And, as a result, by the time the various probes are over, Herbalife will be a massively levered debt-to-equity passthrough vehicle, which uses a tiny fraction of cash from operations, together with gargantuan leverage, to syphon off as much cash from the company to (activist) shareholders as humanly possible.

In fact, if Uncle Carl succeeds, by the time the FBI is done investigating, Herbalife will have so much debt it will be weeks if not days away from a bankruptcy filing. In the meantime Icahn will reap all the benfits of the operational entity, and leave the discarded, debt-bloaded carcass to John Q Public, without having to worry at all what happens to the company once the debt spree is finished and what happens to the company in bankruptcy court.

Activism 101, QED.