El Sifrino and the Transitive Property.

It pains me to say it, but I have to give Bill Ackman credit. Through all the pomp and circumstance he unleashed upon all of us in an effort to convince us Herbalife is a scourge that must be vanquished from the now portly, inactive face of the world, much of his message was lost on me. It's not his fault. It's my fault. His level of detail and precision is unparalleled and I simply can't keep up. It's like I'm watching his brain bound up the subway escalator two steps at a time while I patiently wait  to ride the fetid and dank elevator, accompanied by a morbidly obese 40 year old in her rascal power scooter with her chain smoking toddler in the front basket and the homeless alligator skin guy who is wearing the NY Post for underwear. 

What can I say, he's a smart guy and it took me a long time to catch up to him. It wasn't even his presentation that did it. Nor was it the Bostick order, or the letters he sent to the SEC, or the conference calls he set up with the FTC, or his claims of product safety, or his letters to his investors or his short "restructuring", or his "Questions For Herbalife", or his www.Factsaboutherbalife.com website. No, it was none of that; it was his touching and heartfelt letter to PwC that turned me. Specifically it was page 19 of Ackman's letter to PwC. The heading on that page is "Are Herbalife's Venezuelan Assets Overstated? Should Herbalife Venezuela Be Consolidated?" In that section he does NOT go easy on the company. For such a non emotional kind of guy I was really surprised at just how viciously he went after Herbalife on those pages. He really only grazes them with his FASB ASC 830-10-45 thrust, but he virtually impales the company as he deftly wields his ASC 830-20-30-2 like a Hattori Hanzo, defiantly flicking the red ink across the faces of Michael Levitt and Leroy Barnes as he swaggers out of the Herbalife Audit Committee proceedings. I will spare you all the gory details of this section, saving you the indelible traumatic mark that has been burned into my mind, but suffice it to say that it is a horror scene. Numbers everywhere. Numerators lying next to denominators that were clearly not theirs. Pencil shavings and shredded eraser nibs covering the floor. It was hard to distinguish Dollars from Bolivars. It was a massacre and there was nothing I could do to stop it because Ackman moves too damn fast. 

I was so stunned by his prowess it took me a few days before I was even able to look at the company's 10Q and run through his allegations regarding the company's' Venezuelan operations.

So, without comment, I present the pertinent section taken directly from the company's latest earnings below (dense, but worth a read; don't have a couple minutes, not to worry as also paraphrased after the copy/paste):

Venezuela is a highly inflationary economy under U.S. GAAP. As a result, the U.S. dollar is the functional currency for our subsidiaries in Venezuela. Any currency remeasurement adjustments for non-dollar denominated monetary assets and liabilities held by these subsidiaries and other transactional foreign exchange gains and losses are reflected in earnings.The Venezuelan government has established one official exchange rate for qualifying dividends and imported goods and services. That rate was equal to 4.3 Bolivares Fuertes (VEF) to one U.S. dollar through February 12, 2013. Effective February 13, 2013, the Venezuelan government devalued its currency relative to the U.S. dollar from 4.3 to 6.3 (official rate). The remeasurement of our balance sheets in 2013 to reflect the impact of the devaluation resulted in a net after-tax charge of $236 million ($0.08 per share).  There will also be an ongoing impact related to translating our income statement at the new exchange rates.  Moving from the 4.3 rate to the 6.3 rate will reduce future total Company reported net sales by less than 1% on a going basis.  This does not impact our organic sales growth rate, which excludes the impact of foreign currency changes.  Versus our existing business plans, the exchange rate change reduced our reported earnings per share by approximately $0.04 per share in 2013.Transactions at the official exchange rate are subject to CADIVI (Venezuelan government's Foreign Exchange Administrative Commission). Our overall results in Venezuela are reflected in our Consolidated Financial Statements at the official rate, which is currently the rate expected to be applicable to dividend repatriations.In addition to the official exchange rate, there had been a parallel exchange market (SITME) that was controlled by the Central Bank of Venezuela as the only legal intermediary to execute foreign exchange transactions outside of CADIVI. The published rate was 5.3 through February 12, 2013. The notional amount of transactions that ran through this foreign exchange rate for nonessential goods was restrictive, which for us essentially eliminated our ability to access any foreign exchange rate other than the official CADIVI rate to pay for imported goods and/or manage our local monetary asset balances. When the government devalued its currency in February, 2013, it also eliminated SITME, but established a new exchange rate market program, referred to as SICAD.  As of June 30, 2013, there is little official information available on the new auction process or the underlying auction rates. As of June 30, 2013, we had net monetary assets denominated in local currency of $913 million. Local currency balances decreased 14% since June 30, 2012 due to the impact of the February 2013 devaluation and an increase in payments by the government through CADIVI, partially offset by an increase in the net amount of indirect value added taxes (VAT) receivable from the government from goods receipts and shipments. Prior to the February 2013 devaluation, a portion of our net monetary assets denominated in local currency was remeasured using the SITME rate because we planned to use that amount of the net assets (largely cash) to satisfy U.S. dollar denominated liabilities that do not qualify for official rate dollars. The remaining net monetary asset balances had been reflected within our Consolidated Financial Statements at the 4.3 official exchange rate. However, as noted in the preceding paragraph, the parallel SITME market was eliminated at the time of the February 2013 devaluation, and there is little information available on the SICAD mechanism.  Accordingly, all of our net monetary assets are measured at the official 6.3 exchange rate at June 30, 2013.
Additionally, the Venezuelan government enacted a price control law during the second half of fiscal 2012 that negatively impacted the net selling prices of certain products sold in Venezuela.
Depending on the ultimate transparency and liquidity of the SICAD market, it is possible that we may remeasure a portion of our net monetary balances (the amount of the net assets needed to satisfy U.S. dollar denominated liabilities that do not qualify for official rate dollars, approximately $240 million as of June 30, 2013) at the SICAD rate. This would result in an additional devaluation charge. Over time, we intend to restore net sales and profit to levels achieved prior to the devaluation. However, our ability to do so will be impacted by several factors. These include the Company's ability to mitigate the effect of the recently enacted price controls, any potential future devaluation, any further Venezuelan government price or exchange controls, economic conditions and the availability of raw materials and utilities. In addition, depending on the future availability of U.S. dollars at the official rate, our local U.S. dollar needs, our overall repatriation plans, the creditworthiness of the local depository institutions and other creditors and our ability to collect amounts due from customers and the government, including VAT receivable, we may have exposure for our local monetary assets. We also have devaluation exposure for the differential between the current and potential future official exchange rates.

For those of you that have skipped through that because it's earnings and your hair is on fire, I will paraphrase as best I can.

1. Venezuela is a highly inflationary economy under U.S. GAAP and the U.S. dollar is the functional currency for our subsidiaries in Venezuela. 
2. Any currency remeasurement adjustments for non-dollar denominated monetary assets and liabilities held by these subsidiaries and other transactional foreign exchange gains and losses are reflected in earnings.
3. Hugo Chavez royally shafted everyone in February by devaluing the Bolivar from 4.3 Bolivares Fuertes (VEF) to 6.3 (per US Dollar). 
4. The remeasurement of our balance sheets in 2013 to reflect the impact of the devaluation resulted in a net after-tax charge of $236 million ($0.08 per share).  
5. The fun doesn't stop there because WTF knows where the Bolivar is going?
6. There used to be a parallel exchange market (SITME) that sucked another 20% out of our conversions at 5.3 Bolivars/dollar, but that is gone now too.
7. SITME was replaced by SICAD, but as of June 30, we really have no idea how SICAD will screw us because it really isn't operating. Rest assured it will most likely screw us though as its operations, once operating, are designed to screw us.
8. As of June 30, 2013, we had net monetary assets denominated in local currency of $913 million and all of our net monetary assets are measured at the official 6.3 exchange rate at June 30, 2013.
9. Depending on the ultimate transparency and liquidity of the SICAD market, we will probably remeasure $240M of US Dollar denominated liabilities because we think we'll probably never get those $240M out of the country under the official exchange programs, so we're telling you now we're going to take the charge.
10. Because we don't plan to just completely abandon our operations there, we will likely remain exposed to the risk of additional devaluation of the Venezuelan Bolivar, although that may be obviated by our Venezuelan counterparties going bankrupt first.

After reading through all this, Ackman decided because he viewed Venezuelan monetary policy as presenting a lack of  exchangeability that is "other-than-temporary", that the company's Venezuelan operations should be deconsolidated. He also argued that even if the company were to conclude that the lack of exchangeability were actually temporary, that the company's Venezuelan assets "should be remeasured at the fair market value based upon observable market transactions." The only oversight of  Bill Ackman's with respect to Venezuela is actually best described by something I learned in 5th grade math:  the transitive property. You'll remember that the transitive property deals with equalities and inequalities (If a = b and b = c then a = c). 

You see while Bill Ackman was O'ren Ishii'ing Herbalife over the consolidation of their Venezuelan operations and scampering his way up the conference room table toward Dennis Nally and Robert Moritz, he forgot about the double edged sword of equality.  This is particularly important in light of the fact that the pertinent section taken directly from the company's latest earnings which I quoted and paraphrased above, was actually not from Herbalife's latest filing, but was from Procter & Gamble's; of which Ackman owns the equivalent of 33,940,133 shares.  Maybe Bill actually meant to send his PwC letter to Deloitte instead. He probably would have gotten more bang for his buck if he had because P&G has $913M worth of Bolivars measured at 6.3, while Herbalife has $124.6 million in Bolivar denominated cash and cash equivalents at the same rate. Whereas P&G couldn't even be bothered to project some sort of reasonable sensitivity analysis to the Venezuelan assets, Herbalife offered a 75% devaluation projection in their sensitivity analysis that could result in a $93M charge, which they laid out very clearly in their 10Q. By Ackman's math, if a = b and b = c then a ≠ c if Pershing Square owns 33.9M of c, or is short 24.5M of a. Maybe Herbalife is just overconfident with respect to their Venezuelan assets because practically every other company has consolidated their Venezuelan assets just like Herbalife has. Colgate-Palmolive has only been around for 150 years longer than Ackman, so what do they know, right? 

I for one don't care how other reputable companies are doing it nor why Herbalife has done it the way they have because Bill says they're wrong and that's good enough for me. I can't wait to help rip apart their accounting 7 days from now. Like I said, I'm pitching for team Bill now. As hard as it is to give advice to someone you so obviously idolize, I'm going to go out on a limb here and suggest that as infallible as El Sifrino's logic is, he should consider having his kids teach him some basic pre-algebra and geometry. I'd hate for anyone to think he doesn't know what the transitive property is or that he was unfamiliar with the shape of a pyramid.