Thursday, October 10, 2013

Has Ackman Outfoxed the Short Hounds? (Probably Not)

Herbalife closed on October 2nd at $73.09. Later that evening Ackman revealed in a quarterly investor letter that they had restructured 40% of their Herbalife short, transitioning this to options, and on the following trading day Herbalife shed 6.6% to close at $68.25. Herbalife has since shed an additional $4.96 to close today at $63.29.

It is estimated that prior to restructuring their position that Pershing Square was short approximately 24.5 million shares at an average cost of $50.50/share, indicating that Ackman covered approximately 9.8 million shares. If you err on the more conservative side and estimate that he was short 20 million shares, Ackman still covered roughly 8 million shares, creating at most a net difference of 1.8 million shares. 

Tonight the short interest data for the period between September 14th and September 30th was published and it revealed that the Herbalife short interest had been reduced by -4,151,579 to 24,481,019 from 28,632,598 shares during that time. This is a stark difference from the 9.8 million shares that Pershing would have covered during this period. It is important to note that Ackman's quarter ended on September 30, which is the same day that the most recent short interest reporting period was settled. We can thus reasonably deduce that all of the covering that Ackman had participated in took place after September 13th and before September 30th. During this period, total trading volume in Herbalife was 37,763,625 shares. Pershing Square's short covering was responsible for between 21-26% of total demand in this period. There is no doubt this had a significantly positive effect on herbalife's stock price during the same period.

Prior to this, during Herbalife's Q2 conference call on July 30th, Herbalife noted that they had not been participating in share repurchases following the forced resignation of KPMG. This left Herbalife management with $787 million remaining in a pre-exiting share repurchase program and it was burning a whole in their pockets. They then noted on that same call that after having engaged a new auditor, the buyback program was back on. They stated that the guidance provided included a minimum of $50 million in buyback per quarter, but also that they "believe that our balance sheet is underlevered and we have available cash, and therefore, we may decide based on the discretion provided to us by our board to repurchase more than the amount included in guidance."

Using the VWAP for the period of July 30th through September 27 (which was the last trading day prior to Herbalife's earnings blackout period) of $65.83 we can set a reasonable price for any share repurchases they may have completed during the period. We know they would spend a minimum of $50M in Q3, but because they committed to spending at least another $50M in Q4, they could have purchased anywhere between $50M-$737 in shares during Q3. Even though $737M in repurchases in Q3 is feasible, I believe it is more likely they would not blow their load on a single quarter. Although Herbalife generates an incredible amount of cash on a quarterly basis, which could easily replenish such a large repurchase(assuming they obtained additional authorization from the board), Herbalife probably recognized that $787 million in repurchases would not be enough to push out Ackman completely and that it would not be prudent to utilize such a tool all at once. I think it is much more likely that they would split the authorization over the two remaining quarters in an effort to apply pressure, without leaving themselves empty handed if more pressure was needed as they close out their year.
Based on these numbers I estimate that Herbalife repurchased 5.9M shares this quarter with a possible range anywhere between 760K and 11.2M shares. This represents anywhere between 0.4% and 7.4% of total demand for Herbalife shares during this period. The supply constrictions coupled with the increased demand for Herbalife shares created by share repurchases and Pershing Square's short covering helped push the stock from its July 29th close of $60.57 to as high as $73.46 on September 19th. Now that short covering and share repurchases have both stopped, we are seeing price decline as result of decreased demand.

Herbalife's public float is 95.8M shares. Once you remove Icahn because he is an insider that leaves 78.9M shares floated. Soros owns 5M shares and Stiritz has disclosed holdings of 5.4M shares. If Soros and Stiritz were to call back their shares, or were to be classified as insiders by being named to the Herbalife BoD, that would further constrict the float to 68.5M shares. Even if you assume that no one has called back their shares, this puts the short interest at 31.1% of the float. Share buybacks during the quarter would have buoyed the short interest to anywhere between 31.4%-36.2%. If Soros and Stiritz were to call back their shares this would increase the short interest to between 36.2-42.7% of the float. 

Ignoring the possibility of a $2B debt financed partial tender that would theoretically increase any intact short interest to 79.8% of the remaining float, share buybacks alone could easily make up for the recent net decrease in short interest resulting from short coverage.

It may very well be that Ackman is the fox to a group of Wall St. hounds and he has managed to put some distance between himself and their snapping jaws before he could be squeezed between them. Maybe Ackman's trail is the only scent they care about with respect to a potential squeeze. I've met a lot of hounds in my day and I don't ever recall coming across one that was so discerning that it cared about the color of the fox, so much as that it had a fox to bite into. Based on the most recent short interest data and Herbalife's prior commitment to buyback shares in the quarter, I would venture that there are just as many foxes for the hounds to chase down as there ever was.

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