Bill Ackman Thoughts On Herbalife $HLF

On November 1, 2016, Herbalife reported its third quarter financial results. Modest financial performance in the quarter, disappointing 2017 guidance and the unexpected announcement of a CEO transition caused the stock to decline. HLF stock has traded down more than 33% since the announcement of the company’s settlement with the FTC on July 15th, 2016, a 15% year-to-date decline, as investors have come to increasingly ignore the company’s fraudulent characterization of the FTC settlement. At its December 2, 2016, price of $47.99 per share, HLF currently trades at approximately the price at which we shorted the shares in 2012.

On a consolidated basis the company reported net sales of $1.1 billion for the quarter, up 1.7% year-over-year. Headline adjusted net income of $105 million for the quarter (down 3% YoY) translated into adjusted EPS of $1.21 (down 4% YoY). On a constant currency basis the company reported net sales growth of 5%, driven by EMEA (+15%), Mexico (+14%) and North America (+10%).

The deceleration of Herbalife’s China business during the quarter is notable. Once a high-flying growth market (regularly posting 20-30%+ top-line growth), the China business has slowed in recent quarters, achieving modest 1% currency-adjusted, year-over-year top-line growth in Q3 (or negative 5% on actual basis).

Along with earnings, Herbalife announced that Michael Johnson is slated to transition to Executive Chairman in June 2017 at which point Rich Goudis, the current COO, will take over as CEO. Goudis has been largely absent from the public eye in recent years.

Since HLF’s earnings call, two other notable events have taken place. First, on November 6th, John Oliver’s Last Week Tonight aired a 32-minute segment on multi-level-marketing companies with a focus on Herbalife. In his typically colorful style, John Oliver points out the hypocrisy and fraud inherent in Herbalife’s business and shines a spotlight on how the company harms hundreds of thousands of people every year. You can watch his scathing take-down of HLF here. To date, the John Oliver segment has been viewed on YouTube more than 8 million times including over 1.7 million views of the Spanish-language version representing about 11% of the Hispanic households in the U.S. These 8 million views are in addition to the 4.1 million viewers of Oliver’s show on HBO and millions more on Facebook.

Second, on November 7, 2016, the documentary film “Betting on Zero” secured distribution rights, which will include a 30 or so city theatrical release in early 2017 and online video-on-demand dissemination thereafter. We believe that the John Oliver segment and the wide distribution of the film are materially positive developments which will help elevate the Herbalife story beyond traditional financial news media.

Despite its weak financial outlook, Herbalife is trading at $47.99 or about 10 times the midpoint of management’s new 2017 guidance ($4.60 – $5.00). Importantly, however, this guidance does not assume a significant disruption in Herbalife’s U.S. business. We believe the negative earnings impact is likely to be substantial as the U.S. accounted for ~23% of Herbalife’s contribution margin this past quarter (a measure of profitability before general selling and administrative expenses), and a substantially higher portion of earnings when giving consideration to the inherent operating leverage of the business.

Furthermore, Herbalife’s “definition” of earnings continues to exclude certain items which we believe are actual ongoing costs of the business but which Herbalife adds-back (including ~$0.46 for “non-cash interest expense”). This excludes additional fines and/or injunctive relief that may arise from other regulatory agencies. On a pro-forma basis, assuming a modest decline in the U.S. business and expensing the add-backs, we estimate Herbalife is currently trading at 12 to 15 times 2017 pro forma earnings (and a potentially much higher multiple depending on the magnitude of the impending U.S. decline).

Fundamentally, pyramid schemes are confidence games. The CEO exit, deteriorating earnings, the declining stock price, and the John Oliver segment should materially impact Herbalife distributor confidence. When distributors reduce their purchases and/or leave the company, the financial results of the company should decline on an accelerated basis. Furthermore, we believe the injunctive relief demanded by the FTC is likely to significantly impact Herbalife’s financial performance beginning in the second quarter of 2017. Coupled with decelerating growth in many international markets, especially in China, we expect earnings to decline in 2017. We remain short Herbalife because we believe its intrinsic value is zero.

Bill Ackman Thoughts On Fannie Mae And Freddie Mac

Fannie and Freddie’s underlying earnings continue to progress modestly in the core mortgage guarantee business, while the non-core investment portfolio continues to shrink to a smaller and appropriate level, resulting in a more profitable and lower-risk business model. The strength in underlying earnings growth reflects two factors: (1) an increase in guarantee fees as the fees on new mortgages exceed the average fees on the existing portfolio, and (2) lower credit losses as the portfolio’s credit quality has meaningfully improved since the financial crisis.

There were a number of legal developments this quarter. In the Federal Court of Claims case, Judge Sweeney granted the plaintiffs access to 56 documents the government had claimed were privileged, many of which were contemporaneous with the period just prior to the Net Worth Sweep and involved high level government officials. The plaintiffs have not yet had access to the privileged documents as the government has appealed Judge Sweeney’s ruling. We find it interesting that the government is fighting so hard against this ruling, as it has previously complied with the judge’s prior motions to turn over documents.

A new lawsuit was filed in Texas that makes claims similar to the Perry case, but also makes several new arguments. First, the lawsuit argues that the Housing and Economic Recovery Act (HERA), which grants FHFA rights as conservator, is invalid and violates the separation of powers. Second, the lawsuit contends that the FHFA has affected a liquidation of the GSEs in violation of HERA by creating policies such as a common securitization platform and credit risk transfer agreements which are designed to minimize the GSEs role in the marketplace.

Since the election, Fannie and Freddie’s share prices have appreciated materially as investors believe that a more business-oriented administration that did not implement the Net Worth Sweep would be more likely to seek a consensual resolution that benefits all stakeholders. Recent statements by Steven Mnuchin, the presumptive Treasury Secretary, have also contributed to the recent stock price increases. In an interview on Fox Business, Mr. Mnuchin stated:

It makes no sense that [the GSEs] are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe. So let me just be clear— we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again. But we gotta get them out of government control.

We strongly agree with Mr. Mnuchin’s views about the GSEs.

Bill Ackman Thoughts On Valeant Pharma $VRX

Since our last update in August, Valeant has bolstered its management ranks, improved dermatology average selling prices (ASPs), stabilized its salesforces, and experienced acceleration in Salix script trends. Despite these positive developments, financial results  continue to be challenged as certain unexpected events impacted Valeant in Q3 and weakness in Valeant’s U.S. Diversified Products segment continues to weigh on near- to medium-term earnings.  

Valeant reported quarterly revenue of $2.48 billion, Adjusted EBITDA of $1.16 billion and Adjusted EPS of $1.55. This represented sequential improvement of 2%, 7% and 11%, respectively, as the business continues to stabilize following the disruption of recent quarters.  

Beginning this quarter, management provided disclosure under the new financial reporting structure. The business is now aligned across three verticals: (1) Bausch + Lomb / International (“Durable”), (2) Branded Rx (“Growth”), and (3) U.S. Diversified Products (“Cash Generating”). This new disclosure is consistent with Valeant’s commitment to greater transparency. Over time, Valeant has indicated that a substantial mix-shift will take place in its business as Bausch + Lomb / International and Branded Rx target mid-single digit revenue growth (high-single digit operating income growth) while Valeant’s U.S. Diversified Products segment declines. As this mix-shift happens over time, a greater percentage of Valeant’s profits will come from higher quality, higher growth and more valuable businesses.  

In conjunction with announcing Q3 results, management updated 2016 guidance, reducing full year estimates. Full year Adjusted EBITDA and EPS are now projected to be $4.25 billion to $4.35 billion (down from $4.8 billion - $4.95 billion) and $5.30 to $5.50, respectively (down from $6.60 to $7.00). Implicit in updated guidance is a sequential decline in Q4 versus Q3. Management addressed some of the key factors on the earnings call contributing to this dynamic, some of which are permanent headwinds while others are temporary.  

Valeant management provided initial perspectives on 2017 results on the earnings call including an expectation for Bausch + Lomb / International and Branded Rx to achieve mid-single-digit revenue growth and high-single-digit operating profit growth. Management anticipates that this growth will be more than offset by the decline in U.S. Diversified Products (specifically the neurology and generics business) as a result of patent expirations and generic competition. Management announced the planned implementation of a zero-based-budgeting initiative, expected to save $75 to $100 million in 2017 and a goal to improve gross profit by $150 to $250 million by 2020 through supply chain rationalization

Management reiterated its commitment to achieve more than $5 billion of debt reduction over the next 18 months from a combination of cash generation and asset divestitures. We believe that asset sales are an important catalyst for value creation and stock price appreciation at Valeant. Valeant has identified approximately $8 billion of assets that are non-core which it has begun to market for sale.

Bill Ackman Thoughts On Chipotle Mexican Grill $CMG

On September 6th, we announced a 9.9% stake in Chipotle Mexican Grill which we purchased at an average price of $405 per share. Chipotle has built a superb brand pioneering the “fast casual” restaurant industry with the success of its outstanding product offering, unique culture and powerful economic model. We have followed the business for years, noting how it has disrupted the fast food industry with its high quality, delicious and customizable hot meals that are prepared quickly and sold at affordable prices. The company has been significantly negatively impacted by food safety issues beginning in the fourth quarter of 2015 which caused a peak decline in average unit sales of 36%. In response, the company has implemented best-inclass food safety protocols over the past year, and worked to win back lost customers. While traffic and sales have begun to recover, average unit volumes are still 19% below peak levels.

We have always believed that a good time to buy a great business is when it is in temporary trouble. While Chipotle’s reputation has been bruised, we think that with the passage of time and improved marketing, technology and governance initiatives, the business will not only recover but become much stronger. Chipotle’s sales recovery will be neither smooth nor predictable over the next few quarters; yet, we believe that all of the key drivers of Chipotle’s powerful economic moat and long-term success remain intact. These drivers include:

1. A strong and relevant brand built by visionary leadership

2. A differentiated product offering with a highly attractive value proposition

3. Substantial scale in the fast casual industry and first-mover advantage in real estate

4. Strong unit economics and extremely high returns on capital, driven by a well-honed model that facilitates best-in-class throughput

5. Enormous growth opportunities including new units and operating enhancements such as mobile ordering and catering

Strong Brand

The Chipotle brand was developed by founder Steve Ells with the philosophy that food served fast does not have to be a traditional “fast-food” experience. This vision later evolved into an ambition to change the way the world thinks about and eats fast food. Chipotle’s authentic brand developed a loyal following, which allowed the company to grow from one restaurant to more than 2,100 relying primarily on customer word of mouth, supplemented by non-traditional marketing techniques including digital and social media, owned content, and local events. Today, we believe that Chipotle is one of the most compelling and authentic large-scale food brands in the U.S.

Differentiated Product Offering

Chipotle’s product offering is differentiated by the fact that it successfully competes in all the desirable attributes of out-of-home fast food. As part of our research, we compared Chipotle’s customer value proposition to those of fast casual, quick service, and casual dining competitors across six key metrics: food quality, taste, in-store experience, customization ability, speed, and  value. We believe Chipotle’s food quality is superlative given the focus on cooking from scratch with the best available ingredients. Chipotle’s “burrito line” service format engages customers from the moment they walk in the door, allows exact customization of each order to accommodate individual preferences, and facilitates the fastest throughput in the industry. The product price point offers outstanding value given the quality and quantity of food served. While some other concepts can successfully compete on one or more of these attributes, we believe that few are able to replicate the Chipotle offering at comparable price points at scale.

Enormous Growth Opportunity

Prior to the recent food safety issues, Chipotle’s average unit volumes were approximately $2.5 million, nearly the highest in the industry, despite only serving two day-parts, and with limited store hours, i.e., 11 versus as much as 24 hours for other fast food competitors. We believe that initiatives such as mobile and digital ordering, loyalty program development, catering, and menu innovation including dessert will drive an accelerated rate of same-store sales growth for the foreseeable future, incremental to the impact of recovering lost customers. Returns on capital for new units remain extremely compelling even at today’s lower sales levels. We believe that the U.S. can support about 3,000 additional Chipotle restaurants, a total of 5,000 units representing 2.3 times the current store base.

Food Safety

We have researched the initiatives that Chipotle has taken to address food safety. While food safety risk can never be completely eliminated in any restaurant, we think the company has done an excellent job of significantly reducing the risk of another incident while maintaining the freshness and taste of its food. Chipotle has a number of other attractive attributes which include limited global macroeconomic sensitivity and foreign currency exposure, a simple business model with limited non-GAAP earnings adjustments, a high effective tax rate of nearly 40% (which means the company will be a big beneficiary of lower U.S. tax rates if implemented by the Trump administration) and an unlevered balance sheet with a strong net cash position.


Given Chipotle’s depressed near-term earnings due to the recent decline in sales and its detrimental impact on operating margins, we do not believe it is appropriate to value Chipotle using a multiple of next year’s earnings based on comparables or estimated growth rates. To estimate the intrinsic value of Chipotle shares, we have valued the discounted cash flows of the business over its life using reasonable assumptions. In our base case, we have assumed a longterm restaurant count of 5,000 units, some recovery of lost customers over the next several years, and moderate same-store sales growth over the long-term driven by the impact of new technology initiatives (like mobile, online ordering and loyalty) and day-part extension initiatives (like catering). We conservatively have assumed that profit margins will be at a discount to peak levels reflecting the cost of new food safety procedures as well as increased investments, offset over time by thoughtful management of overhead costs and increased operating leverage.

Marcato Capital Letter To Buffalo Wild Wings Franchisees $BWLD

As you may know, Marcato is a significant investor in Buffalo Wild Wings (“BWW” or the “Company”). Over the life of our investment, we have observed a lack of urgency among the Board and senior executives that is crucial in today’s difficult operating environment. We strongly believe in the proven BWW brand and the substantial future potential of the business. In our view, if the Company’s strategy – including the franchise business model – is redesigned and executed properly, there is a significant opportunity to create substantial value for all stakeholders.

In order for the brand to achieve its full potential, we have proposed that Buffalo Wild Wings make substantial changes to its business. Returning to a predominantly-franchised business model and putting franchisees first are key components of our proposal. For this reason, we are writing to you directly to keep you informed about our work and views.

Since June, we have sought to share our views with the Company’s Board of Directors and management team. In many cases, our overtures have been ignored. While some of our communications are already public, we have launched a dedicated website where you can access ideas and materials we have shared with the Company at:

We believe it is important that all franchisees are fully aware of our ongoing dialogue with the Company and that you have the opportunity to express your perspective on how Buffalo Wild Wings can be improved.

The points below summarize how our efforts can benefit your business and the BWW brand:

I) A BRAND MANAGED FOR AND BY FRANCHISEES. We strongly believe that the future strength of Buffalo Wild Wings will be best realized through a return to a majority-franchised model, in which serving the needs of franchisees will be the key to growth and innovation. Under our proposal, Buffalo Wild Wings would adopt a franchisee-first approach:

  • Franchising will be the top priority of the business, and the franchisor will no longer be conflicted by aspirations of company-operated unit expansion.
  • Guest initiatives and related investments such as tablet order and pay, Guest Experience Captains, and loyalty programs will be vetted for franchisee feedback, ROIC analysis, and business improvement. Initiatives that do not deliver measurable and compelling results should not be rolled out.
  • Franchisees will receive equal and immediate access to new systems, tools, marketing initiatives, and operational improvements that are proven at company-operated units.
  • The result will be a franchisee-oriented corporate partner, with a leaner structure that can be more responsive to your needs.

II) DEVELOPING NEW GROWTH OPPORTUNITIES FOR FRANCHISEES. Currently, the business favors the expansion preferences of the corporate parent. We believe that markets and territories currently reserved for future corporate development should be made available to franchisees:

  • We believe all stakeholders would benefit from seeing the system transition to a 90% or higher franchise mix. To achieve this target, approximately 600+ company units would be refranchised, inclusive of expected future system growth.
  • Refranchising company-owned stores provides you an opportunity to reinvest your cash flow into additional units, leveraging your operating expertise, managerial infrastructure, and local marketing resources. Qualified existing franchisees will be favorably positioned to acquire company units in new, overlapping, or adjacent markets.
  • Seasoned, well-capitalized operators from other brands will have a unique opportunity to participate in refranchising, allowing for cross-pollination of operations best practices and sales-driving ideas, and engendering greater system diversity.
  • International growth will be a significantly larger focus of time and resources to take advantage of this largely untapped growth opportunity.

III) PRIORITIZING RETURN ON INVESTED CAPITAL IN ALL BRAND AND CAPITAL INITIATIVES. We believe Buffalo Wild Wings must refocus its priorities for capital allocation and business spending on maximizing returns on invested capital. We are concerned that capital allocation discipline and ROIC have deteriorated in support of corporate growth at any cost:

  • New unit development has been constrained due to ever-increasing capital costs and pre-opening expenses, which have reduced the number of potential locations that can achieve the volumes to justify the required investment. Our plan would initiate a value-engineering review to reduce the costs of new unit development, improve ROIC, and expand the addressable market for BWW franchisee units.
  • Capital for expensive Stadia remodels should be deployed only where supported by observable returns. The cost of these remodels should simultaneously be minimized through our proposed value-engineering process.
  • “4-wall” profitability should have pride-of-place over Average Unit Volumes through initiatives to reinvigorate the mix of alcohol sales and to reexamine the current menu design and labor model.
  • Marketing campaigns will be:
    • Considered an important financial investment evaluated through the lens of ROIC.
    • Measured against specific business objectives (comp sales / traffic, day part patterns, improved mix, etc.).
    • Data-driven so that resources can be redirected to only those programs that demonstrate quantifiable success.
  • Investments in technology, take-out, and delivery should be structured to minimize upfront cost and maximize incrementalprofits without cannibalizing in-store visits and high-margin alcohol sales.
  • This framework will drive higher returns on existing units, open more opportunities for profitable growth, and enhance the brand’s attractiveness to potential buyers of franchisee networks.

IV) THE COMPANY KEEPS THE BEST OPPORTUNITIES FOR ITSELF. The Company has retained many choice “greenfield” markets in high-AUV regions, such as California, Florida, Texas, and Washington, D.C., for its own development, effectively capping the growth opportunities available to existing franchisees and deterring investments from new entrants.

V) REMOVING OBSTRUCTIONS TO M&A AND HIGHER FRANCHISEE VALUATIONS. We believe that our recommendations would improve the valuations of franchisee networks and transaction dynamics in favor of franchisee growth:

  • The Company’s tendency to exercise its Right of First Refusal (ROFR) option reduces the universe of interested buyers who fear that their time and energy is being wasted as a stalking horse bidder.
  • A committed refranchising program would dramatically increase the demand for BWW franchisee networks, both in number and purchasing power of interested buyers. These well-funded buyers have been forced to focus on other, potentially less-desirable restaurant investment opportunities due to the low availability of BWW acquisition candidates, limited growth potential in current franchised markets, and overly-restrictive franchisee policies at Buffalo Wild Wings.
  • Availability of new Area Development Agreements would add value to your network, with a known and contractual development opportunity.
  • We have engaged multiple M&A advisors specializing in franchise transactions who believe that there is tremendous appetite for BWW franchise platforms and that the market would enthusiastically absorb any and all units to be refranchised, bringing fresh growth-oriented capital into the system.


  • The Board of Directors must include directors with real restaurant operating experience; with the financial acumen to appropriately evaluate the business considerations of BWW’s brand and strategy development; and with an appreciation for the importance of a healthy and prosperous franchise system.
  • Management incentives must be redesigned to deliver on these goals.

We believe the path that creates the most value for both franchisees and the franchisor is a strong franchise-based system in which the corporate franchisor is focused on maximizing the value of the BWW brand and empowering franchisees with the tools and opportunities to profitably grow their businesses.

We would enjoy the opportunity to hear your perspectives. Please visit to read more of our work and for a link where you can send us your ideas.