Take the Herbalife Challenge! Bill Ackman Goes Short, We Guzzle All the Weight-Loss Shake We Can Swallow

It was time for somebody to put his mouth where the money is, and to do so in a way that Wall Street and Main Street could truly understand: an eating challenge.

New York Film Festival Premiere of Sony Pictures Classics' "INSIDE JOB" The week before Christmas, superstar hedge fund manager Bill Ackman took the stage in a Manhattan auditorium and presented a bold new position: he was shorting shares in Herbalife. You know, the weight-loss aids and nutritional supplements that your Aunt Becky insists are going to make her very thin and very rich one of these days, and maybe you too, if you’d only give them a try.

It was a bravura performance. Mr. Ackman mocked the company’s promises to make its distributors wealthy—“Episodes of MTV Cribs?” he said of a particularly schlocky marketing video—and criticized its efforts to “buy” associations with prominent universities and scientists. That was just for starters. Over the next three hours and 340 slides, he presented his evidence that Herbalife met the Federal Trade Commission’s definition of a pyramid scheme and should be shuttered by the agency.

That Herbalife was the target of a big short shouldn’t have taken investors by surprise. In May, hedge fund manager David Einhorn jumped on an Herbalife conference call and asked a few pointed questions—pointed enough to send share prices into a tailspin. But Mr. Einhorn never disclosed a position in the company. Now Mr. Ackman had. In interviews after his presentation, he said he’d put $1 billion of his investors’ money into the bet, calling Herbalife his “highest conviction” trade ever, and targeting shares to hit the low, low price of zero.

Herbalife’s stock promptly plummeted, then rebounded in the last days of 2012. It wasn’t that investors liked the Herbalife business, exactly, or multilevel marketing schemes in general. Rather, they were betting against the investor’s hubris—doubting that the FTC would really close Herbalife and assuming the company had enough cash on hand to buy back shares and make the short seller’s position a bit uncomfortable.

In light of Mr. Ackman’s presentation, Herbalife has been subject to the media equivalent of a prostate exam. Analysts and armchair stock-pickers critiqued everything from its corporate structure to its revenue model and marketing copy.

But there was one thing nobody really bothered to do, and that was try the product—not just sip at a meager sample, but put its capsules and elixirs to the test, to get to know the company from his insides out.

With Herbalife planning to rebut Mr. Ackman’s arguments at a pre-scheduled investor conference on January 10, and Mr. Ackman brazenly vowing to rebut the rebuttal, it was time for somebody to put his mouth where the money is, and to do so in a way that Wall Street and Main Street could truly understand: an eating challenge. Herewith, the results.

11:09 a.m.: Recalling De Quincey’s opium experiments, mix first Herbalife shake late Monday morning. Two heaping scoops of the company’s Formula 1 to eight ounces of skim milk. Consistency: clumpy. Taste: chalky. “Replace one meal daily with a Formula 1 for healthy nutrition, replace two meals for weight loss.” Pumpkin Spice easy on the palate. Could get used to this!

Herbalife products are not easy to obtain. You can’t buy them in stores. To find our sample, The Observer journeyed deep into the Greenpoint section of Brooklyn, where we met a Herbalife distributor named Adam Guziczek and his wife Elizabeth in their walk-up apartment.

Mr. Guziczek’s involvement with Herbalife began 16 years ago, he said, when a secretary at the construction company he was working for told him she was making more money selling Herbalife during her lunch hour than she was pulling in from her day job. Mr. Guziczek signed up and found he liked the product. He said he worked as a distributor primarily to get the 30 percent discount off the wholesale price. He met his wife when she was buying a weight-loss formula. “She lost 30 pounds, and we got married,” he said.
“I lost the weight, then he married me,” Elizabeth chimed in from the kitchen.

12:18 p.m.: Two shakes down. A full 38 percent of daily protein! Taste bears hints of Cheerios. Feeling of mild euphoria. Or fear? Ask friend on Wall Street how much to consume. “If it’s milk-based, you’re going to have a case of the farts, dude.”

Did we mention that Herbalife was founded in 1980 by Mark R. Hughes, a 24-year-old graduate of a California reform school who decided it was his calling in life to become rich? If you were a regular viewer of 1980s late-night television, you might recall the Herbalife infomercial in which Mr. Hughes delivered a bubbly message of self-empowerment for mass consumption. (If you were a regular reader of circa-2000 gossip rags, you might recall that Mr. Hughes was eventually found in his underwear, dead of an apparent drug overdose.)
Today, Herbalife is run by a trio of former Walt Disney executives. It is especially popular with the Latino community, and markets itself with sponsorships of soccer teams like FC Barcelona and the Los Angeles Galaxy.

Many Herbalife distributors are middle-class strivers seeking their fortune. As a result, some onlookers view Mr. Ackman’s Herbalife short as the story of a big-city financier meddling in the lives of people he doesn’t understand. Others praise him for trying to save Herbalife’s distributors—who are also its chief customers—from themselves.

1:19 p.m.: A giant smoked turkey arrives in the newsroom, a belated holiday gift. Smells delicious. Then again, three shakes equals 57 percent of daily protein. Pass on turkey. Am I glowing?

There’s a small cadre of crusaders against multilevel marketing companies like Herbalife, and once you get them talking, it’s hard to get them to stop. Then again, why should they? It’s not every day that a superstar investor goes public with a billion-dollar short against the industry they despise.

“There’s a certain math paradigm that shows up,” explained Robert FitzPatrick, president of an organization called Pyramid Scheme Alert. “If you can only make money once, you have nine other people below you; it’s generally true that only one out of 10 can ever be profitable.”

Rick Ross, of the Ross Institute Internet Archives for the Study of Destructive Cults, Controversial Groups and Movements, said that he’d been hearing complaints about Herbalife for years. “The subculture around Herbalife is similar to the kind of program that would be considered thought reform,” he said. “You start attending their meetings and trainings, and you wind up in a thought bubble. Anyone who challenges the idea may be characterized as a dream-breaker or a dream-taker, or a slave, in the sense that they’re not a self-employed businessperson.”

2:04 p.m.: Halfway through fourth shake. Jitters starting to set in. Blood pulsing in calves. Detect the onset of promised flatulence. Legs trembling. Observer pantry running out of skim milk. Might have to switch to water. Can you overdose on vitamin D?

The math might be bad, the vibe might be culty, but if Mr. Ackman is really going to short Herbalife all the way to zero, it will only be because the FTC decides Herbalife is a pyramid scheme.

The FTC defines the term “pyramid scheme” in a particular way—essentially, a business in which participants make more money for recruiting other participants than they do by selling products.

In his December presentation, Mr. Ackman hauled out a lawyer and a research analyst to show that Herbalife meets the pyramid scheme criteria.

3:37 p.m.: Mouth full of chalk, pulse back to normal. What is normal? Persistant stomach noises. Will someone put away that damn turkey? Have consumed 100 percent recommended allotment for biotin and molybdenum. Note to self: Don’t Google biotin.

Mr. Ackman isn’t the only money manager to be vocal about his Herbalife position in recent weeks. Robert Chapman is a hedge fund manager who takes positions in companies, then tries to influence management. As he watched Mr. Ackman’s Herbalife presentation, he had two key thoughts. One, despite all those slides, Ackman hadn’t actually delivered any new information about Herbalife. And two, Mr. Chapman didn’t think Mr. Ackman really believed the FTC would shut Herbalife down.

He started buying the stock.

“I believe Ackman already had concluded the FTC wasn’t going to assist his crusade,” he wrote in a letter to investors explaining the decision. “Instead, he realized that he had to focus on existing and prospective distributors, praying the media attention would have a materially deleterious impact on any decision to join or to continue with the [Herbalife] team.”

5:36 p.m.: Have now consumed seven shakes in seven hours. Calves pulsing again. Is that Morse code? One shake an hour may be too much. Hitting a wall or catching second wind? Friends Gchat story about Al Roker “sharting” in the White House. Not funny. Is it cold in here? Definitely a second wind. Could drink these things all night. Somebody bring me some goddamn skim milk.

According to Joe Mariano, the president of the Direct Selling Association, the FTC rules are clear: “A pyramid scheme is an operation that compensates people for the recruitment of people in the plan,” he told us. Herbalife, he said, didn’t fit that mold. (Herbalife general counsel Brett Chapman is chairman of the DSA’s board.)

At any rate, that’s the bottom line for now. Since the late 1970s, when the criteria for pyramid schemes was established, the FTC has proved reluctant to slap the tag on multilevel marketers.

Of course, Mr. Ackman would know all that. In the days leading up to Herbalife’s coming presentation, he has reiterated to reporters that he’s only scratched the surface of his Herbalife research, and that he is in it for the long haul to convince regulators that the company is a pyramid scheme. Those words may mean more coming from Mr. Ackman, who has deep pockets to spend on his Herbalife short, and a track record of biding his time to make investors pay.

For the moment, however, Herbalife will most likely live on.

7:14 p.m.: One more for good luck. Feel strong. Energetic. Could stick with this. Not sure about the Pumpkin Spice. Mr. Guziczek said he prefers Vanilla. Nice guy, that Mr. G. Nice wife. Showed me a photo of himself with Mark Hughes. Herbalife founder looked awkward in photo. Better makeup for TV spots. I could see living in Greenpoint. Good restaurants, nice park. Expensive. Dining out. How to afford? Might need a side gig. Need a way to make real money …

-pclark@observer.com