Bill Ackman: Why Short Positions Are Difficult

About 11 years ago I came out with a white paper called "It's MVI: A Triple-A" where I questioned the triple-A rating of a company called MBIA. I disclosed on page 1 of that report that I had shorted the stock and bought CDS, that kind of an insurance product betting on the company's credit deterioration, and it caused a bit of a stir. The company did not like the paper, and as the largest guarantor of New York state and city bonds, they decided they wanted to get back at me. They called up Eliot Spitzer, who was the then-presiding Attorney General in New York, and said, "Look, there's an evil guy saying that we don't deserve our triple-A rating. Moody's and S&P say we're triple-A. Who is this guy?" Moody's and S&P would later lose some credibility after this. But this was a 150-to-1 leverage company guaranteeing a whole sort of very risky subprime CDOs, CDO squared, CDO cube, and so on and so forth. It was insolvent based on the exposures, and a good analyst digging deeply could determine that. I came public with this and was largely ignored. I kept at it because I'm a persistent guy. I made a series of presentations, and no one was really paying attention. The stock was 73, the credit insurance just kept getting cheaper and cheaper, meaning no one believed I was right. One day at my last presentation, I said, "Oh, by the way, no one ever believes me on this one. They say, 'Well, you're short, so how can we believe you because you're going to profit if it declines?'" So I said at a conference, "Okay, I hereby commit to give away 100% of any personal profit I make from this investment." That day was the high for the stock. It went from 73 to $3 a share, and the credit protection went from 13 basis points to 2,500. We made a billion six or seven hundred million dollars. I personally made $150 million, and that $150 million seeded, I was really the maybe second or third grant, but the big grant that created the Pershing Square Foundation. So the Oxford program is an indirect beneficiary of the failure of MBIA. The financial system actually has a silver lining. I love that. The problem with short selling is that even though it's perfectly legal, it's something that people have a degree of discomfort with. It's almost perceived as un-American to bet against a company. We, by the way, only do it in very rare circumstances, and generally only when we believe it's good for America or good for the world for the company to disappear. In this case, you had a company that was assuming more and more credit risk and had only a tiny capital. They had $5 billion of capital and a trillion dollars worth of obligations they were guaranteeing. Because they were triple-A rated, banks and other institutions were not holding capital against these exposures because regulators said if it's triple-A rated, you don't need to hold capital. This was creating, in fact, in my testimony to the SEC, if you actually go to the book "Confidence Game," which is about my battle with the company, and if you go to the Confidence Game website, all of my transcripts of testimony to the SEC and the Attorney General are actually online. You can read them. In there, in early 2003 timeframe, I said there's going to be a credit crisis if you don't shut this company down. No one paid attention. Anyway, I think the giving away of the profits made people say, "Look, maybe this guy actually believes what he's saying." People paid a little more attention, and I think that helped. It's probably give the money away anyway. It's easy to give it away when you don't have it. After you receive $150 million, then it's really okay.

The second time round of consequence is a company called Herbalife. Herbalife is a company that purports to be in the nutrition business. They sell protein powder shakes, they sell vitamins, they sell herbal tea, they sell some nitric acid type things that are supposedly good for your heart. These are all commodity products. They're made by five, six, ten different manufacturers. You can buy them at your local pharmacy, you can buy them at your local GNC, you can buy them at your local supermarket. The price you pay at your supermarket is about a quarter to a third of the price you pay for the Herbalife product. So who in their right mind would buy this overpriced stuff? Herbalife's number one product is called Formula 1. No one's ever heard of Formula 1 other than the race, and it competes with a product called Slim Fast, which I guess many people in the room may have heard of. It's a product made by Unilever. Slim Fast sells $100 million, $150 million a year. Herbalife ostensibly sells $2 billion of the same product. How is it that Slim Fast sales have been coming down every year and the Herbalife product has been growing? It's all about what they call the direct selling model. The way that works is your name is Mary Ann. Mary Ann comes to me and she says, "Bill, don't I look terrific? I've been losing weight. I've got this product I've been using." I said, "Well, you look fantastic." She said, "Would you like to try it?" Sure, friend approaches me. So you try it, and then she says, "Hey, would you like to make a little money on the side?" In this economy, who wouldn't want to make a little money on the side? She convinces me to become an Herbalife distributor, and she tells me that if I sign up five friends, and each of them sign up five friends, and each of them sign up five friends, pretty soon I'll be collecting royalties and I can retire rich. Or if I'm less ambitious, I can make some little money on the side. For an unsophisticated, unemployed, low-income person, which is the target audience for Herbalife, this kind of pitch from someone I trust sounds appealing. The unfortunate thing is that something in order of 99% of the people lose money. There are about 50 that make $5 or $10 million a year, about a thousand that make a few hundred thousand a year, and the other 3.6 million lose anywhere between $300 and $3, $8, $10, $20, $30,000. It's really a money transfer scheme. It's a pyramid scheme. It's like a chain letter. When you were a kid, you know, send a dime to the following 11 people on the mailing list, and in three weeks you'll have a thousand dollars. If you think about what a Ponzi scheme is, it's a money transfer scheme without a product. A pyramid scheme is a money transfer scheme with a product. They do smart things like put the Herbalife logo on football jerseys of famous soccer stars and they back various teams. That's very appealing to the Hispanic community, which is actually the target audience that they've been very successful with. Now, unfortunately or fortunately, pyramid schemes are illegal. Here's a pyramid scheme with a $7 billion plus market cap that trades on the New York Stock Exchange. It's been in existence for 33 years. How is it possible that this company could be a pyramid scheme? The answer is it is. In fact, they've used their tenure as a public company, the New York Stock Exchange listing, the imprimatur of a Nobel laureate they paid $15 million to serve as representatives, and a lax regulatory regime in the US to allow this pyramid scheme to grow to an enormous size. The problem with pyramid schemes is they run out of victims and they inevitably collapse. I can actually prove to the audience very quickly that this is a pyramid scheme. I'll do that by asking you a question. Herbalife entered the UK in 1983, 30 years ago. Pepsi has been in the UK for a longer period of time, but after 30 years, Pepsi had a good quarter last quarter and they grew their sales 3% in the UK. What do you think Herbalife grew their sales last quarter in the UK? Let's have a guess in the audience. Raise your hand. It's no risk of being wrong. Yes, 1%? Okay, someone else? 140%? That's interesting. Okay, 20%, 30%? The answer is sales grew 92% last quarter. How is it possible that, I mean, maybe people are getting fat at an incredible rate here, but absent that, the reason why it grew very quickly is they found a new immigrant population to go after. This is a product where there is a boom as people get recruited, and then it goes very quickly when the population gets saturated, it collapses. Right now, the UK business grew enormously and then collapsed, and now it's beginning to grow enormously. I don't know, maybe the Vietnamese population. One of my investors said, "You know, I think the women who work cleaning the office are Herbalife distributors." I met with them. People are convinced to become Herbalife distributors that you have to buy $3,000 worth of inventory in order to start getting these royalties, what is effectively an inventory loading type scheme. Anyway, that's what the business is. We did probably 18 months worth of work before we came public. We hired one of the best law firms in the country, Sullivan & Cromwell, to do their own independent evaluation. If I'm going to say publicly a company is a pyramid scheme, I certainly would like the legal backing of one of the top law firms in the country. Both we and Sullivan & Cromwell concluded it was a pyramid scheme. On December 20th, they made a public presentation. There's a website called Facts About Herbalife. You can watch the presentation. There's lots of other data there. So far, so good, until Carl Icahn came along and bought 16% of the company, said it was totally wrong. Every day he goes on CNBC and says what a great company it is. Every time he says that, the stock goes up another couple of dollars. In the meantime, the company's reporting very good financial results. But I'll make a prediction. I don't know if I'll be back here in a year, maybe I will. You can bring me back. Okay, this business will be shut down. This business will collapse. I can't give you the precise date, but we will have made progress in that direction within 12 months. So that's my prediction.