Cast your minds back to this magnificent moment on CNBC, when billionaires Carl Icahn and Bill Ackman had a live bitching spat for almost 30 minutes.

Well, that was meant to reach a climax this week, when Bill Ackman declared that he would be delivering a “death blow” to Herbalife in a three hour webcast. But more on that in a moment. First:

The Background

  1. Bill Ackman is a famous short-seller.
  2. He borrows shares from people, sells them, and then tries to persuade everyone that the shares are worth nothing.
  3. When (or “if”) the share price crashes, he can then buy the shares back at the lower price, return them to the lender, and pocket the difference.
  4. If the share price doesn’t close lower, then he makes a loss.
  5. I drew a picture of how Bill Ackman operates:


Some people might think that’s a bit rude.

But that’s just the way of markets. And lest we forget, short-sellers brought us the Enron scandal. Short-sellers have the greatest incentive to deliver the real inside scoop of the general badness of big corporations – which is why they’re good to keep around.

The trouble is, it’s difficult to tell:

  • if Bill Ackman is just trying to manipulate us into thinking Herbalife is evil; or
  • if he really has a good point; or
  • if he really thinks that he has a good point, but is horribly mistaken.

The manipulation part is illegal – and I doubt he’s doing that. I mean – I guess. I have no idea. But it just seems a bit crazy to do something illegal in such a public way with Carl Icahn and the Herbalife execs out to accuse you of anything that’ll get you off their backs.

So that really leaves us with “good point” or “horribly mistaken”.

The Herbalife Claim

So Herbalife works as follows:

  • Herbalife sells weight-loss products.
  • And it does so through a “multi-level marketing” scheme.
  • Which works like a pyramid scheme – but it’s just sleazy, not illegal.

Only, Bill Ackman is saying that the multi-level marketing scheme employed by Herbalife is actually a pyramid scheme, and therefore illegal, and therefore Herbalife is worth nothing.

Let me try to illustrate that. I’m going to start by saying that Ponzi Schemes, Pyramid Schemes and Multi-level Marketing all work in much the same way.

The Ponzi Scheme

The Ponzi Scheme works when one person (the “fund manager”) promises high returns to investors, and uses the money of new investors to pay the returns to the old investors:

  1. Start by finding some investors, and take their money.
  2. Find more investors, take their money, use some of that money to pay back the original investors. 
  3. Use your track record to find even more investors, take their money, and use that to pay returns to the earlier investors from Steps 1 and 2. 
  4. And so on. 
  5. Until it all falls apart. Or you disappear with the money.
  6. Named after Charles Ponzi, who found fame doing this with postage stamps.

The Pyramid Scheme

The Pyramid Scheme works like a Ponzi Scheme – only, instead of the fund manager doing all the work, he says to his investors:

  1. Here is a really awesome opportunity.
  2. You’ll get higher returns for every new investor you bring in.
  3. And they’ll get higher returns for every new investor that they bring in – oh, and did I mention that you’ll also get even higher returns for every new investor that they bring in?
  4. And so on down the line.

So it turns every person in the pyramid scheme into the leader of his own pack of investors (ie. everyone is a “fund manager”), spawning their own packs of investors (or “fund managers”), and onwards until it collapses.

Multi-level Marketing

Multi-level marketing works in almost the same way as a pyramid scheme – but instead of money, there is the commissions on the products you sell, and you also earn commissions off the sales of the salespeople you recruit.


  1. Herbalife charges you money to be an authorised distributor of their product (you have to pay for a starter pack, etc).
  2. Herbalife then sells you product.
  3. You sell some of the product to your customers, and earn a profit.
  4. You also sell some of your product downstream to the salespeople that you recruited into the company, and earn bonuses and royalties back from Herbalife.
  5. The sales people that you recruited now either sell the product to real customers, or earn bonuses and royalties by on-selling downstream to the distributors that they sponsored to join the Herbalife sales force (which will also result in more royalties and bonuses to you).
  6. And so on down the line.

Bill Ackman’s question:

“So is Herbalife really selling stuff to paying customers?”

“Or is Herbalife selling stuff to Herbalife salespeople who are selling it to Herbalife salespeople who are selling stuff to Herbalife salespeople and so on until the salespeople run out of other salespeople to recruit and it turns out that Herbalife products have no real market other than the distributors that are part of this pyramid scheme?”

Bill Ackman believes the answer to the latter question is “Yes, this one”. Because “distributors earn 10 times as much from recruitment as they do by selling the company’s overpriced products to bona fide retail customers”.

And Herbalife’s response is mostly:

“That’s scandalous and outrageous. Agreed – about 78% of our members buy product from us and we have no idea if they on-sell it or use it for their own consumption, but at least they get to benefit from our wholesale discount. And how do you know that they’re not selling it for profit? And oh yeah – this is NOT a pyramid scheme!”

The Presentation

Bill Ackman’s presentation last Tuesday was, well, underwhelming. Sure – he compared Herbalife to the Nazis and got all choked up when he started talking about his great-grandparent. But he did nothing more exciting than that.

And embarrassingly, the Herbalife share price went up by 25% during his presentation.

So you might think that Bill Ackman is dead in the water… And in the red by plenty of margin.

Here’s another question though

Why is Herbalife not suing Bill Ackman for defamation?

Sure – a civil litigation suit would give Mr Ackman discovery rights, and access to internal financial data that he currently doesn’t have… But if he’s so clearly wrong, then what’s the problem?

Just askin’.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at