There's a lucrative new trading "set-up" a lot of investors are using now. But unlike classic approaches, like "don't fight the Fed," and "the trend is your friend," there are no rules on how to play this new game.
So let's change that today.
This is the true story about two billionaires' egos, their trading games, and what happens when they clash over the same stock.
It's a story you can profit from, too…
Herbalife: It's Time to Take Sides
Herbalife Ltd. (NYSE: HLF) is a 33-year-old, New York Stock Exchange-listed nutritional supplements manufacturer and distributor. With a $7 billion capitalization, it's currently trading near $74 a share.
The company distributes and sells its products as a multi-level marketer, or MLM. Other well-known MLM companies are Avon, Amway, and Tupperware.
Multi-level marketing has been very successful for several companies, notwithstanding the many others that have ended up as nothing more than Ponzi schemes. Chances are you know what I'm talking about.
Herbalife is no stranger to controversy. It's been accused of being a Ponzi scheme and saw trouble when its flamboyant founder Mark Hughes died unexpectedly, purportedly from using Herbalife's ephedrine-laced (since banned by the FDA) weight loss products.
Nothing ever came from early short-sellers trying to trounce the stock by claiming the company was a giant scheme… in fact, they got burned. After Mark Hughes died the company fell from grace and suffered from ephedrine-related lawsuits.
A couple of private equity companies took Herbalife private in 2002. They cleaned it up, amped it up, and made a $1.3 billion profit taking it public again in 2004. From 2005 to early 2012 the stock rose 1,000%.
Sometime in early 2012, an investment research boutique firm called The Indago Group, which sells its research for $10,000 a month to a handful of hedge funds, began pushing its latest work-up on Herbalife. The picture they painted wasn't pretty.
The Clash That Created Your Opportunity
Indago said, "Our research has shown that through manipulation and misrepresentation Herbalife conceals its true business model from distributors and the investing public, selling a financial investment in the pyramid scheme."
They pitched their research hard to client David Einhorn, the billionaire founder of hedge fund Greenlight Capital Re, Ltd (Nasdaq: GLRE). Shortly thereafter Einhorn started shorting the stock.
They also pitched billionaire hedge fund manager Bill Ackman, founder of Pershing Square Capital Management, a friend of Einhorn's. Ackman passed the idea along to his intern and a young Harvard grad on his team, but didn't act on the trade.
Then on a May 1, 2012, first-quarter earnings call with Herbalife executives, David Einhorn unexpectedly spoke up, asking the CEO what percent of distributors were also the final customers for Herbalife's products. The executive couldn't answer definitively.
Ackman's people were listening in on the call. Now they knew Einhorn was short and questioning the earnings and the company's business model. Ackman began shorting the stock while the call was ongoing. The stock plunged from $70 to $56 before the day was over.
Then things got messy, really messy. Egos and reputations and games came into play.
On May 16, 2012, at the Ira Sohn Conference in New York – a forum for hotshot hedgies and institutional managers to tell the investment community their best ideas – David Einhorn took the stage. Bill Ackman thought he was going to expound on making a fortune on waxing off the tarnished veneer of Herbalife. Einhorn's first slide simply read "MLM."
Everyone, especially Ackman, thought MLM stood for multi-level marketing and that Einhorn was going to bash Herbalife. Funnily enough, the forum, which isn't in any way illegal, is for "talking up your book," as the technique is known. It's a way to tell the world what position you are big into in the hope that your good idea will induce others into your position, which has the direct benefit of pushing your position further down the road of profitability.
Everyone knew Ackman was short, and he had begun his attack on the company. He expected others were following him, and with Einhorn leading the troops at the Sohn Conference, the piling on of more shorts would surely tank the stock.
Too bad Einhorn's next slide was Martin Marietta Materials Inc. (NYSE: MLM), whose stock symbol happens to be MLM…
Oops! The crowd, also expecting the idea to be shorting Herbalife, turned heel and sent out orders from the conference to cover their Herbalife shorts. The stock rose on the day.
Now Ackman was angry. He thought he was made to look like a fool. So what did he do? He added to his short position, eventually making a $1 billion bet with Pershing Square's money and, according to him, also bet his own money on the trade.
Ackman began shouting from any rooftop he was allowed on. He used the media to bash the company, calling it a Ponzi scheme and calling the FDA and SEC and anybody who'd take his calls, demanding they look into the company and shut it down. Of course he wanted the stock to go to zero, which is where he said it was heading and where he said he'd cover his giant short position.
You Can Exploit This Ongoing Conflict
Now, here's the thing about Bill Ackman and shorting. Bill isn't exactly a well-liked guy. He's got a large ego and more than a few people in the business I'm familiar with (I've never met Bill Ackman) say he's arrogant and worse. There's a problem with being disliked and telling the world you're short more than 20 million shares of a thinly traded stock. Your enemies and even your quasi-friends are more interested in making millions than considering your feelings or your pocketbook or the returns your investors expect. They are going to gang up on you, eventually, when the time is right.
Bill Ackman then went about setting himself up perfectly, for the kill that is.
Ackman arranged for a special session of the Sohn Conference on December 20, 2012. While it was extraordinarily odd to ask for a personal forum under the auspices of the Sohn Conference, Ackman drew 500 investors and another 1,300 followed him online.
Ackman produced 330 slides over a 3-hour stand-up, supposedly extemporaneous performance, which he titled Who Wants to Be a Millionaire.
The stock went from $42.50 on Dec. 18 to $26 on Christmas Eve.
A fine rundown indeed…
But, now the stock was at a very attractive level. And another one of Ackman's former friends, who had become disillusioned with him, saw his chance. Besides personality differences, Ackman's former friend was still smarting from a 90% loss he sustained when he gave Ackman $200 million of his fund's capital to invest. Unbeknownst to the friend, Ackman was putting all the money into an ill-timed trade on Target Corporation (NYSE: TGT).
Ackman's former friend, billionaire hedge fund manager Daniel S. Loeb, founder of Third Point LLC, began to acquire Herbalife, quietly at first.
Eventually Loeb let it be known he'd accumulated an 8.9% stake in Herbalife for the bargain basement price of only $300 million, thanks to Ackman's shorting efforts. Loeb said the stock was a value and he expected to see it back up above $70 and that he was counting on a 40% to 70% gain on his position.
As if that wasn't hard enough to swallow, another Bill Ackman basher, multi-multi billionaire investor par excellence Carl Icahn began to buy huge amounts of the stock, taking shares quickly to the $40 level.
Carl Icahn has a lot more money and friends than Bill Ackman, so what happened next shouldn't surprise anybody… though it did surprise Bill Ackman.
Other very well-heeled and legendary investors began buying Herbalife. They now include Stan Druckenmiller, the Soros Family Office, Richard Perry, Kyle Bass, Bill Stiritz, Robert Chapman, John Hampton, and Sahm Adrangi.
Herbalife is now trading just shy of $70 and Bill Ackman is sitting on at least $500 million in losses.
How You Can Gain from the Next Development
What's there to learn from this story – and could you have made money following this saga? What will likely happen next? And are there other trading scenarios like this out there?
The answers will surprise you. Check back later this week for your profit potential…
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.