Description

Plenty of ink has been spilled on Herbalife, with much of it focused on the company’s US business – no doubt in part due to anchoring from the Ackman-Icahn saga years ago. The narrowness of that perspective has only been reinforced by the ubiquity of credit card and other alt data, which offers visibility into the company’s US operations (albeit with a poor predictive track record) but not much else. Yet almost 80% of Herbalife’s revenue comes from outside the US.

We have conducted extensive primary diligence on Herbalife’s international business, and we believe that volume trends in nearly every country/region globally are accelerating, putting the company on the path to return to top-line growth as early as the current quarter.  And therein lies what we believe to be an incredible setup – while investors are treating what they see of the 20% of revenue (soft credit card data for the US) as representative of the other 80%, in reality the 80% is materially inflecting and the 20% -- based on more reliable data sources than credit card panels – is actually stable.

No matter how the US market performs over the next 3 and 15 months, we think that Herbalife is on track to earn north of $3.00 per share this year and $4.00 per share next year, in each case more than 20% above current consensus estimates. At year-end, Herbalife will be run-rating at mid-single digit revenue growth on a global revenue base of $5B+, with 77% gross margins, mid-teens EBITDA margins and 50%+ EBITDA-to-FCF conversion. With the stock at $13 and change, you’re getting that profile today for 3x earnings, 4x EV/EBITDA, and a forward FCF yield north of 30%. Oh, and 14% of the float is currently short.

We would not suggest, however, that this business inflection and outperformance will magically remove the historical risk premium attached to MLM businesses in general and Herbalife in particular – but even if we are to take the absolute low-end of the valuation range that the stock traded at pre-COVID (10x P/E), our estimates imply a share price north of $40 (+193%) in the near-term, offering a setup that is about as asymmetric as it gets.

Our Diligence

Over the past six weeks, we have spoken directly to over thirty distributors, including three Chairman’s Club members and fifteen President Team Members. In aggregate, and without exception individually, a clear picture has emerged of accelerating performance in all non-US operations. In most cases, these are individuals that we have a long history of dialogue with – including during periods in which we were short Herbalife’s stock. From our backtest, we believe these distributors to be highly representative of the country or regional-level that we speak to them on, in some cases due to their scale (it is not uncommon for a top distributor to be responsible for a  high single digit or even double digit percentage of total volume in a country) or in others due to their connectivity with other top distributors in the regions in which they operate. From those conversations, we have drawn the following conclusions:

• APAC (32% of revenue) is on track for volume points to accelerate to up high single digits sequentially 3Q vs. 2Q, ahead of consensus, as the business in India is on fire (up as much as 15% sequentially) and Vietnam stabilizes.
• LATAM (16% of revenue) is on track for volume points to be flat sequentially 3Q vs. 2Q, ahead of consensus, as Mexico stabilizes and the rest of the region realizes double-digit growth.
• EMEA (22% of revenue) is seeing volume point momentum accelerating from that already shown in the second quarter and is tracking well ahead of consensus.
• China (7% of revenue) is likely to grow volume points more than 20% sequentially, which is well ahead of consensus.

Pricing in each of these regions is a known-known (both in terms of percentage increase and dates that the increases were made effective). FX impact is more complex to model but ultimately straightforward (on the revenue line) as well. Taken together with our estimates for North America, the above points imply 3Q revenues above consensus estimates.

Put differently, on the basis of our research, volume points would have to be down 30%+ in the US (versus consensus of -12.5%) for the company not to beat on the top-line this quarter. And there is no credit card or other data that would imply anything close to that decline. In fact, our primary work suggests a stable North America too.

The Why

All that begs the question of why now – what is fundamentally changing in the international business to drive this level of operational momentum now. The answer is actually pretty straightforward and will sound familiar to anyone that looks at other CPG businesses globally, albeit in this case with a human capital wrinkle: during COVID, resulting mass unemployment drove distributor recruitment to record levels, especially internationally where social safety nets were comparably non-existent. As economies normalized, many of those distributors returned to their prior employment, creating tough comps off of artificially high levels of distributor activity. That issue was then compounded by the company passing through some cost inflation via increased pricing, which – as was the case with pretty much all CPG peers – had a volume impact.  The “now” here then is twofold – Herbalife has finally worked through that distributor churn and is finally lapping those outsized price increases. Volumes are responding accordingly and region by region the business is inflecting.

To be fair, that explanation is incomplete – the challenges of the post-COVID period forced the company to innovate in both product (new Vegan line, for example) and customer acquisition (cross-pollination of regional best practices). And it has brought about management turnover -- prior CEO Michael Johnson returning in that role and their top distributor Stephan Gratziani joining as Chief Strategy Officer – that we think is already having a meaningful impact on distributor recruitment and productivity. But at its core, this turnaround is simply a business returning to trend – and that simplicity helps underpin our high level of conviction.

Evolution of the Business (Model)

The above warrants further discussion because while our primary work is showing near-term inflection in the business, it is the changes referenced that have us excited about the sustainability of that momentum.

First, on Stephan. The significance of Stephan joining management is not just because of who he is – one of the most successful distributors in company history – but because of where he is from. Stephan’s business was based in Europe, and he consistently outperformed the company by rapidly testing, adapting, and adopting best practices across his network that he was seeing at the country or even local level. He also was recently integral in spreading the ‘recipe’ of what was working for him to his peers across Europe. It is notable to us that Europe has been recovering faster than North America and that Stephan will now have his hands on the steering wheel for North America going forward. While our thesis is centered on the company’s international business, if Stephan can turn North America too, watch out – our upside case will be wildly conservative. Early indications from our checks are positive.

On selling, the company is evolving to not just allow but encourage DTC purchases (more on this below) but with the distributor still getting credit so as not to cannibalize the existing ecosystem. We see this as a material source of upside going forward both in terms of the multiplier effect it will have on the company’s reach, but also the benefit it will have to distributor economics (and, therein, retention and recruitment).

Supporting Stephan’s efforts and the opening of the DTC channel is the launch of Herbalife One – a new technology stack that creates a simplified and integrated digital experience for distributors and their customers globally. Herbalife distributors have effectively been operating without a CRM system this whole time. While some of the largest distributors built their own, none of what is in use will compare to what is being launched – which is the product of $400M (not a typo) of development costs. No impact is assumed in any of our forward estimates, but ultimately at the core of Herbalife’s earnings algorithm is the productivity of a distributed labor force. If Herbalife One enables distributors to be even just 10-15% more productive, Herbalife’s normalized earnings power can be as much as 50% higher than otherwise assumed.

When we bet against the company in the past, we were repeatedly surprised by the resiliency of the company’s business model – be it through slowdowns in consumer spending, management turnover, global pandemics, or even regulatory overhang/investigation. Looking back through the lens of what-will-be Herbalife One, that resiliency is even more impressive, as, again, this was a (very) global consumer products company selling through a (very) large number of distributors that was doing so effectively without a CRM and without DTC! This is the lowest of low-hanging fruit and we expect the benefits to come and to be of scale accordingly.

At a minimum, we see the Herbalife One launch, as well as Stephan’s involvement and the expansion of DTC, as catalysts for the operational momentum we’re seeing in the current quarter to continue if not accelerate. We also remain open-minded that the soon-to-be-evident benefits from the further digitization of the business and the further connectivity of the customer community could warrant a premium multiple in this post-COVID world. 

Cost Structure and Earnings Power

On top of the revenue upside highlighted, we also think that street estimates are failing to reflect near-term margin upside from a combination of cost reductions and the lapping of unfavorable freight and input costs (that lift with a 6-9 month lag vs. spot). While some of this upside is assumed in our earnings estimates shared at the top, we believe what we’ve baked in to be conservative, especially relative to the operating leverage benefits that will flow through if revenues accelerate as expected.

A Word on GLP-1s

One reason being cited for the stock’s current valuation is perceived exposure to mass adoption of GLP-1 drugs. To the extent this is true, this reflects a poor understanding of the company’s products (nutrition and not just weight loss), the drugs themselves (Herbalife products are exactly the type of accompanying lifestyle/diet adjustment that make the drugs most effective), and, most importantly, the markets in which Herbalife operates (we would love to see mass GLP-1 adoption cases made for India, Vietnam, China, Mexico, and other key EM markets of the company). It also conflicts with the reality on the ground -- out of all the distributors that we have spoken with, not a single one has said, when asked, that they are seeing any impact from GLP-1s on their business. And that includes those that we speak to who have been consistently negative on some of the strategic decisions that the company has made, as well as those that have historically been quick to highlight headwinds to their business.

The irony of this “overhang” is that GLP-1s are likely to be a net positive for Herbalife, and potentially a very material one. In a recent Morgan Stanley survey of over 300 GLP-1 users, respondents reported that they eat more weight management foods like protein bars and shakes. Put simply, the more people that are interested in and invested in a healthy lifestyle, the more potential customers there will be for Herbalife.

But an even bigger dimension of customer acquisition lies ahead. Quietly, Herbalife has been putting the pieces in place for its shake “curriculum” to be an accepted lifestyle modification program for the purposes of qualifying for insurance coverage of GLP-1s (like with the Blue Cross Blue Shield of Michigan announcement on September 21^st, we expect that insurance companies are going to require “proof of participation in lifestyle interventions for at least six months for initial authorization approval” for a GLP-1 prescription). To this end, we think it is notable that Herbalife was recently qualified to be a Recognized Diabetes Prevention Program by the CDC. We have not seen this written about or discussed elsewhere and we believe it to be a significant signal of the company’s intentions. One needs to look no further than Weight Watchers – up ~200% since buying a mediocre telehealth company for 5% of its enterprise value – to see what can happen when the GLP-1 narrative for a (heavily shorted) stock flips. We think that Herbalife can go similarly parabolic if the market gets even a hint of its actual positioning for the GLP-1 trend – and, given the CDC milestone, we wouldn’t be surprised to see company announcements on their upcoming earnings call.

(It is also worth noting in this regard that Herbalife, like Weight Watchers, has a massive database of health-conscious customers and would be a natural match for a lead-generation partnership with one of the many leading telehealth companies aggressively pursuing GLP-1 market share.)

From B2B2C to DTC

While we think the stock can more than double – and soon – on a continued normalization of operating trends internationally, there is additional blue-sky upside well beyond that $40 PT should the company successfully expand their business model to include broader distribution. Ultimately, this is a CPG company that is selling a product with close to $10B of “retail” revenue, with brand recognition globally and among some of the hardest-to-reach emerging, high-growth consumer populations in the world. And, critically, the product is good. We’ve consumed our fair share and would encourage anyone reading this or who might be long or short the stock to do the same.  The shakes are better (and healthier) than most if not all alternatives – especially when you remove your US-centric glasses and think holistically about the places in which the majority of the products are being sold. Were we a multinational CPG company looking for accretive acquisitions and/or differentiated distribution, we might take notice.

Conclusions

We are of course aware of the limits of primary research and hindrance of sample size, backtesting aside. It very well may take the company until the 4Q to return to top line growth, or perhaps even until the first half of next year. But what we love about the setup here is that not even that third scenario is priced in. Herbalife is instead being priced as a business that is not long to exist when the realities on the ground – especially outside the US -- emphatically say otherwise. If our diligence is correct, we think the stock can triple by the middle of next year. And if it is even fractionally correct, we think the stock can be up 70%+ by the end of this one.

Risks

The primary risk here is leverage. The company has $2.6B of gross debt outstanding, including converts, and so is levered north of 4x on a gross LTM basis. The company has a convert maturing in 2024 for which it already has net cash on hand to cover. Its next maturity is a $600M Senior Note due in September 2025. By our math the company will generate north of $400M of free cash flow next year – and so in that operating case, that maturity, and the leverage in general (down to sub-2x net by YE24), is not a remote concern. But we acknowledge that the capital structure introduces downside risk.

We believe, however, that it is much more likely that the stock is at $60 by or before that September 2025 maturity than it is to be facing insolvency concerns – so versus the current share price that is 5x up vs. 1x down, and that asymmetry relative to accelerating operating fundamentals is, in our opinion, exceedingly attractive (especially as the risk-reward for the upcoming quarter itself is probably closer to 10:1). For if our work is accurate, you can haircut our P/E multiple to 8x and the stock would “only” be headed to $33 a share, a level 140% higher than Friday’s close. 

Catalyst

Third quarter earnings on November 1st, 2023.