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Pershing Square December 2013 Investor Letter

Pershing Square December 2013 Investor Letter



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Published by zerohedge
Pershing Square December 2013 Investor Letter
Pershing Square December 2013 Investor Letter

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Published by: zerohedge on Dec 23, 2013
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 December 23, 2013 Dear Pershing Square Investor: Our goal in our communications with you is to give you the information we would want if our  positions were reversed, that is, if we were the investor and you the investment manager. Using this paradigm, we endeavor to inform you about business challenges and related developments as  promptly as practicable, as good news generally takes care of itself. It has been one year since our December 20, 2012 Herbalife presentation. In light of the passage of time, recent developments, and questions we have received, I thought it would be useful to review this investment and our approach year-to-date. After our presentation, we began a dialogue with U.S. and foreign regulators about Herbalife
illegal business practices. Our discussions with regulators included the information we presented in our presentation plus additional analysis and facts that we have not yet disclosed publicly. Contemporaneously, Herbalife became fodder for business television and other media, and the  public discussion moved from questions about the C
ompany’s business to
commentary about a  battle between Wall Street personalities. Because we believed that the Wall Street story was distracting to the regulatory community, we elected to discontinue our public dialogue and focus on our discussions with regulators. Since our initial presentation, scores of non-profit and community-service organizations as well
as local, State, and Federal legislators have come forward to decry Herbalife’s business practices
and to demand governmental investigations and remedial action. For example, last week, the President of the New York Police Department Hispanic Society noted in a press release:
The NYPD Hispanic Society is calling on the New York State Attorney General Eric Schneiderman to launch an investigation into the multi-national company Herbalife Ltd, which is a complex pyramid scheme unfairly targeting and misleading independent Latino distributors, promising profits that are all but unattainable. Many Latinos have been victimized by He
rbalife’s aggressive recruitment and illegal business
 practices. Many of these sellers known as distributors have discovered that selling the products has been harder than they thought. After reaching out to family and friends to buy these Herbalife products, some have resorted to spending hundreds and even thousands of dollars buying sales leads, which often times have led nowhere.
The real money is in recruiting others to sell the product, creating what’s known as a “down
line” of
distributors. The more distributors they recruit, the more money they are likely to make based in part on a combination of bonuses and commissions. Unfortunately, once new recruits become Herbalife sellers they
most often end up in debt and unable to make a profit. It’s difficult
 for these people to sell enough of the
 product in order to realize a significant return on investment. Many of these Latinos are ending up in serious
debt as a result of Herbalife’s recruitment and illegal business practices.
We believe that Herbalife’s r 
esponse to our initial presentation and its actions over the course of this year are notable. In our experience, there is a high degree of correlation between the
accuracy of a short seller’s arguments
and the aggressiveness with which the target company attacks the short seller. In contrast, in cases where a short seller is wrong, the target company typically responds by providing full transparency to the investing public in lieu of attacking the short seller. On January 10
, Herbalife management publicly committed to answer any questions from Pershing Square, but later refused to answer even one of our questions that we thereafter released  publicly to the Company. Herbalife continues to be unwilling to collect and disclose its distributors
 retail sales data which could serve to dispel some of the concerns we have identified. Instead, Herbalife has focused its resources on attacking Pershing Square.
In our experience, Herbalife’s response to Pershing Square is unprecedented in the history of
short selling. The Company has hired public relations firms, lobbyists, law firms, an investment  bank, and paid-for spokespeople to attack us in the media, on social networks, and in the halls of Congress. Herbalife has spent tens of millions of dollars attacking Pershing Square, going so far as to engage Moelis & Company in a campaign to convince Pershing Square investors to redeem from the Funds in an attempt to force us to exit our position. Moelis & Company even offered to stop this campaign if we would agree to no longer push our regulatory agenda and to refrain from any further public statements. We believe that the Company and Moelis may have recently abandoned this campaign as a result of media scrutiny. If Herbalife were confident it was not in violation of the law, instead of lobbying Congress to stop the FTC from launching an investigation, it would welcome an FTC investigation into the issues we identified. Similarly, its conference calls would not be limited to questions from only the most bullish analysts and buyside investors. When Kinder Morgan and its CEO Rich Kinder were attacked by short sellers many years ago, Rich Kinder held an open conference call in which he welcomed short sellers, and kept the call open for hours until all questions had been asked and answered. We note that on Herbalife earnings calls CEO Michael Johnson only reads prepared remarks and no longer answers questions. We challenge Mr. Johnson and Herbalife to respond to our questions and for the Company to invite the FTC to examine its business practices. If Herbalife is truly a legitimate operation, why would it not welcome a thorough investigation by its regulators to dispel what it calls
“confusion” about its b
usiness? Beginning in early January and up until the present, we have been contacted by a number of former Herbalife employees who have shared with us additional information that confirms the
illegality of the Company’s business practices.
We have also communicated with hundreds of former Herbalife distributors who have shared their stories of being seduced into the so-called
Herbalife “business opportunity
” and mani
 pulated into spending thousands, and often tens of thousands, of dollars on the false hopes of financial success as a distributor.
3 To date, we have shared the information we have received since our initial presentation and the analysis and results of our investigation only with regulators, and we have continued to respond to their ongoing requests for further information.
Why Have We Chosen to Keep Our Information and Analysis Confidential?
We have chosen not to disclose this information publicly in order to allow the regulators the time to do their own investigations and analysis. For this reason, at the recent Robin Hood investor conference, we were careful to limit our presentation to disclosures which would not interfere with ongoing regulatory activity. Our Robin Hood presentation described
the SEC’s recent
investor alert which identifies seven hallmarks of a pyramid scheme and an Herbalife victim video made by Make the Road, a well-regarded Latino advocacy organization. While we believe that our approach has been successful in garnering significant regulatory interest, there has been a substantial short-term economic cost to Pershing Square due to our silence. Because Pershing Square has a reputation for doing extremely thorough research, Herbalife investors incorrectly assume that we have disclosed everything negative we know
about the Company’s business, particularly in light of the more than 300
-page original  presentation. While the original presentation was certainly comprehensive, we limited it to an introduction to Herbalife and only those facts and issues that we could prove at the time, with a  plan to present additional information in future presentations as we completed our research. Other than the initial disclosure of the SEC Enforcement Division investigation in January, the lack of public disclosure from regulators over the past 12 months
 despite public calls for an investigation by members of Congress, other elected officials, and from consumer, Latino, and  public advocacy organizations
 has comforted Herbalife longs that no regulatory action will be forthcoming. Two recent developments, a Belgian appeals court decision and the recent completion of the Pricewaterhouse reaudit, have been mischaracterized by analysts and misconstrued by the market. When combined with the false rumor that Pershing Square has quietly capitulated on its  position, these developments have caused the stock to rally to new all-time highs.
Herbalife is now trading at the high end of its historical multiple of management’s
forward earnings guidance suggesting that the market believes the probability of regulatory action is zero. Analysts have made the argument that the absence of regulatory action over the past year,  particularly in light of the issues raised by Pershing Square, suggests that the business model and regulatory cloud that has historically overhung Herbalife has now been permanently lifted. While we and Herbalife victims would welcome prompt regulatory action, we are not surprised that, other than the initial disclosure of the SEC Enforcement Division investigation in January, there has been no other public disclosure of regulatory action at Herbalife. Pyramid scheme frauds are more complicated to analyze than accounting frauds with their phantom warehouses, fictitious inventory, off-balance sheet SPVs, concealed losses and debts, and inadequate reserves. Furthermore, the high profile nature of this situation has likely led regulators to take a more measured approach. Based on our recent discussions with regulators, we believe that they are making substantial progress, but it is difficult to predict the timing of regulatory intervention.

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