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Company: Herbalife Ltd. | Ticker: HLF
Recommendation: Strong Sell
Price: $37.04
Target Range: $4 to $8
Shares Outstanding: 108 Million
Market Cap: $4 Billion
Short Interest as % of Float: 37%
Are Herbalife’s Nutrition Clubs Operating in Violation of the Law?
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February 7th, 2013
Introduction
As a longtime entrepreneur and business owner, I can understand the allure of Herbalife (HLF) Nutrition Club. Distributors are able to launch their own establishment with minimal upfront investment. Combine that with the assurance of riches from their mentors and many see the business opportunity as the chance of a lifetime.
The addition of Nutrition Clubs to Herbalife’s selling model has provided Herbalife with the potential to dramatically increase revenue and provide it with its most essential success catalyst-its ability to recruit new distributors and increase the retention rate of current distributors.
It was so surprise that the clubs were a major focus for Herbalife during its analyst presentation on January 10th. While Bill Ackman presented some less that desirable photos of Nutrition Clubs during his “Who Wants to Be a Millionaire” presentation, Herbalife responded with a heartwarming video to show that you can’t really judge a club by its cover.
Ackman presented some of the onerous restrictions placed on club owners (as discussed in the next section), yet in our opinion he failed to unearth what we believe is a significant concern – the legality of the Herbalife Nutrition Clubs.
The Rules
If you want to open a Herbalife Nutrition Club you need to abide by an exhaustive list of rules and regulations. Yet, they are also sure to note that distributors are independent business operators and that Herbalife does not “approve, endorse, authorize, guarantee or assume any obligation with regard to Nutrition Clubs”.
With that noted let’s highlight some of the key points in the Herbalife Nutrition Club Rules:
1. Nutrition Clubs are not franchises
2. Nutrition Clubs are not restaurants or carry-outs
3. Nutrition Clubs are not food service establishments
4. Nutrition Clubs are not retail stores
5. Nutrition Clubs cannot post prices for products but may charge a membership fee
6. Nutrition Clubs may keep inventory on hand and may sell product at retail
7. Nutrition Clubs owners must deface or destroy product labels and containers before disposing in order to protect against counterfeiting
8. Nutrition Clubs must cover the windows so that the interior of the club is not visible from the exterior
9. Herbalife instructs distributors that all opened products must be consumed on club premises.
10. Herbalife instructs distributors that any opened product cannot be removed from the club. Following these instructions, distributors are given the false information that: “This is a key differentiation from operating a retail location, which is not allowed”.
11. Herbalife’s Nutrition Club Manual is 32 pages; yet devotes a mere 54 words describing regulatory requirements, i.e., business, tax, and health permits and/or licenses in connection
12. Open/Closed sign cannot be visible from the exterior.
13. Clubs cannot advertise on radio or television
Whit is Herbalife Concealing its Nutrition Clubs?
The aforementioned club rules are just a sample of the restrictions placed on distributors who run Nutrition Clubs. Some of the restrictions are just plain laughable:
3-H Proper Disposal of Product Containers
To protect against those who might seek to counterfeit Herbalife product, Club operators are required to deface or destroy product labels and containers before disposing of empty containers.
At first blush I thought Herbalife enacted the above procedure to ensure concealment of Nutrition Clubs from the public and regulators. Good for Herbalife for taking all steps necessary to ensure that bands of dumpster divers don’t have an opportunity to find an empty Herbalife product container, which could obviously be used for the illicit purpose of counterfeiting Herbalife’s products.
3-D Product Retailing
Nutrition Clubs are social gatherings, bringing people together with a focus on good nutrition. They are not retail stores or outlets, nor are they restaurants or carry-out establishments. Club operators may keep product inventory on hand, and they may sell their inventory at retail. All Herbalife products must be sold unopened and in their original Herbalife packaging.
Well, there you have it! Nutrition Clubs are NOT retail stores or outlets. This is curious, given the fact that “Club operators may keep product inventory on hand, and they may sell their inventory at retail”.
So, just to be clear, a Nutrition Club is not a retail store, but a club may sell inventory at retail.
Please not this exchange between top sales leaders Amber Wick and Mary Holloway at the Herbalife Nutrition Training Seminar at Herbalife Extravaganza 2011: (note these comments are made with the Vice President of Global Ethics and Compliance Frank Lameberti sitting on the stages)
AMBER: When we say we’re not a retail establishment, does that meant that we cannot retail out of the establishment? No. it means that when we walk in the front door, we don’t necessarily want I to look like a retail smoothie shop.
This is a building where we do many things…it doesn’t mean thought that we don’t retail out of the nutrition club. In fact, it is that we want you to retail.
We don’t wait it to look like exclusively like a RETAIL smoothie shop because it’s not. There are so many more things that are done inside of the building. But I hear sometimes that people don’t necessarily want to retail out of the nutrition club.
Well we do wellness profiles at a table, one on one presentations…where people walk out with their program.
MARY: But they didn’t go to the shelf to pick it up. We had it in the back, and we just go pull it in the back from our cabinets and bring it out front and write up on it and get em going on the products.
Herbalife explicitly says that a Nutrition Club is “not a retail store or outlet”. You also “may not operate on the premises of retail establishments”.
But according to Amber and Mary as stated above, you can ‘hide’ the product in the back room and bring it out when someone wants to buy it. It’s clear that Nutrition Club owners are selling product, they just don’t want anyone to know about it.
The big question: Why would Herbalife go out of its way to conceal the fact that they are actually retailing products from these locations?
It is in our opinion that Herbalife is intentionally attempting to conceal the fact that these are “retail operations” because of the increased scrutiny and obligations that Herbalife would be exposed to.
Note that Herbalife is also quick to distance itself from any association with the word ‘Franchise’. From Jon Taylor, a noted MLM expert:
“Are MLMs franchises? Though many promoters refer to their MLMs as –like a franchise or as an—unfranchise—or even as a –personal franchise, the last thing MLM executives want is to have to comply with franchise disclosure requirements, including a franchise disclosure document that could be hundreds of pages long with financial data, backgrounds of founders, etc.”
In one look at the requirements of the Franchise Disclosure Document, it’s clear that there are many disclosures that Herbalife would rather avoid—especially point 19, which relates to Financial Performance Representations.
While we are less concerned about the Franchise issue, Herbalife is concealing the fact that they are operating Retail Food Establishments because they are fully aware that they are in violation of FDA, state and local laws and regulations.