When the Wolves Bite

by Scott Wapner

  Though Ackman told the group of investors he wouldn’t reveal the investment in advance, he raised $2 billion from fifteen different money managers in a matter of weeks, a testament to his growing prowess in the industry.

  “He was able to raise money, in a blind pool, from the smartest guys in the business,” said one of those who gave Ackman a chunk of cash. “Two billion in fourteen days, and he told us the stock is broken, that it’s an iconic company and easy to fix.”

  But the investment was a disaster from nearly the beginning.

  Though Ackman would get Target to sell a portion of its credit card business, the timing of the investment was far from perfect. It was made right before the Great Recession, which threatened to bring down the global financial system. Stocks plunged, including Target’s, which crushed the value of Ackman’s investment. Target also refused Ackman’s demands to spin off its real-estate assets, saying the plan was “risky and speculative.”40

  Ackman launched a proxy fight, hoping to grab five seats, including one for himself, on the company’s board of directors. “The deficit of experience on Target’s board had contributed to the company’s underperformance,” wrote Ackman in a letter to shareholders.41

  On May 29, 2009, at the Target Annual Meeting in Waukesha, Wisconsin, Ackman addressed shareholders, twice appearing to choke up while quoting John F. Kennedy and Martin Luther King Jr.42

  “We launched this contest to make sure Target is never known in the future as a once-great company,” he told the room before the results were revealed. When the official numbers came out, 70 percent of shareholders had voted to keep the incumbent board members, handing Ackman a sweeping and resounding defeat.

  The corporate governance expert Claudia Allen told the Minneapolis Star Tribune that the vote was a milestone for the company, if not for activism itself. “It’s a referendum on the strategic direction of the company,” she said, “and management and the board obviously made a more compelling case.”

  After the vote, the headline in the hometown paper blared, “Shareholders: Target 4, Ackman 0.”

  Target may have won its first-ever proxy fight, but it was a costly affair—reportedly $11 million in expenses, not to mention hundreds of hours of agita. But the battle, and subsequent stock slide, would prove even more costly for Ackman and his band of billionaires.

  The Target trade would end up losing nearly 90 percent of its value, pissing off many of the original investors. To make matters worse, many felt Ackman wasn’t contrite enough afterward. Ackman acknowledged as much in a letter to the group that offered an opportunity to withdraw what was left of the money and waive performance fees for future investments if they chose to make them.

  “In my effort to get last week’s letter out promptly,” he wrote, “I neglected to apologize. I am deeply disappointed by (the) dreadful performance and I apologize profusely for the fund’s results to date.… Bottom line, PSIV has been one of the greatest disappointments of my career to date.”43

  To some, the words rang hollow, and they’d never forgive Ackman for the devastating loss of capital.

  By late 2010, Ackman was smarting.

  He’d not only hurt people who were his friends, but the Target investment also called into question his own abilities to manage risk. Some investors later told me they thought the plan was doomed from the start.

  Whether it was to prove his mettle in the retail industry or to simply right the Target wrong, on October 8, 2010, Ackman revealed he’d taken an almost $1 billion stake in JC Penney, the 111-year-old company that had been floundering for the better part of two decades. Ackman had convinced Penney’s board to oust longtime CEO Mike Ullman and replace him with Ron Johnson, a hotshot from Apple who was credited with helping design the tech company’s snazzy retail stores.

  Johnson quickly blew up Penney’s “old” identity. He redesigned stores to have a “town square” feel, even pushing the idea of free ice cream and haircuts while you shopped, which seemed almost comical to some observers. Johnson introduced a “store within a store” concept, where the big box itself would have dozens of brand-name boutiques inside it to draw in shoppers with a wide array of interests. And, in the biggest upheaval of all, Johnson ended JC Penney’s sales and signature coupons in favor of a more democratic “fair and square” pricing plan.

  The plan bombed.

  Sixteen months after Johnson took the helm, JC Penney shares had lost 50 percent of their value. More than nineteen thousand employees had lost their jobs. Sales dropped a stunning 25 percent.44 Johnson was later fired, leaving JC Penney in shambles.

  Ackman found himself ducking for cover. Among CEOs, Ullman was well liked and well respected. By taking him down, Ackman had angered a whole community of highly influential people.

  Starbucks’ founder and CEO, Howard Schultz, went on CNBC and unloaded on the investor. “Here’s the situation,” a clearly agitated Schultz said. “This is the truth. This is not fiction. Bill Ackman was the primary engineer and architect of recruiting Ron Johnson to the company. He and Ron Johnson co-authored a strategy that has fractured the company and ruined the lives of thousands of JC Penney employees.… Bill Ackman has the blood on his hands for being the architect and the recruiter of Ron Johnson and then the co-author of the strategy.”45

  Ackman would call JC Penney “probably the worst investment I’ve made.”46

  By mid-2012, with the Penney’s debacle escalating and the Target wound still fresh, Pershing Square Capital was underperforming the S&P 500 Index and the Dow Jones Industrial Average.47

  Bill Ackman was feeling the heat.

  4

  SELLING A DREAM

  The ambulance eased its way through the security gate of 33064 Pacific Coast Highway in Malibu just before 11 a.m. Paramedics had received a frantic call about a man lying “lifeless and unresponsive” in the queen-sized bed in the master suite with no obvious signs of trauma on the body.1

  Once inside the sprawling $27-million estate by the sea, medics pulled the six-foot, 190-pound man dressed in a black T-shirt and bikini briefs to the carpet, tried CPR to no avail, and pronounced the man dead on the scene at approximately 11:15 a.m.2

  There, deceased in his mansion and already in rigor mortis, was forty-four-year-old Mark Reynolds Hughes, the flamboyant founder and chief executive officer of Herbalife International, Inc.

  It was May 21, 2000.

  Hughes’ wife, Darcy, told the two LA police detectives who arrived at the house that her husband was drinking wine the night before and had fallen asleep following a birthday party for his eighty-seven-year-old grandmother. Darcy had tried to rouse him from the couch near midnight, then again at 1 a.m., but couldn’t, and so she went to sleep. When she awoke the following morning, she’d found Hughes facedown in bed, thought “he did not look right,” and immediately called 9-1-1. Security guards had first tried to revive him but couldn’t.3

  Nearly one month later, following a formal autopsy, the LA County coroner ruled Hughes had died of an accidental overdose following a four-day binge of alcohol and a toxic level of the prescription antidepressant Doxepin. His blood-alcohol level was 0.21 percent, more than twice the legal limit.4

  According to the coroner’s report, Hughes had a history of binge drinking, had suffered from pneumonia the prior February, used two inhalers for asthma, and was on a handful of prescription medications. Darcy Hughes told investigators her husband was normally very health conscious and didn’t use narcotics but that he smoked six to eight cigars a day.

  It was an untimely death for a man who, in many ways, had become larger than life.

  Hughes left an estate worth nearly $400 million.5 He controlled more than half of Herbalife’s publicly traded stock and owned homes in California and Hawaii. He was a revered figure within Herbalife, as much for what he’d made of the company as for what he had made of himself, even if Hughes’ real persona was hazier than most knew.

  Hughes told people he’d grown up in a mostly La
tino part of La Mirada, in Southeast Los Angeles County, but in reality, it was a predominantly white middle-class neighborhood. It was the kind of place where most families had what they needed and kids didn’t long for much.6

  Hughes was brought up with two other boys by Jo Ann and Stuart Hartman, but even that was complicated. Stuart Hartman was one of two men who claimed to be Mark’s biological father.7 The Hartmans lived in La Mirada until the early 1960s, when the family packed up and moved ninety minutes up the 101, northeast to Camarillo, where Mark’s father had started a new business supplying the US government with airline parts.8 The new venture prospered, and with their improving financial situation, the family traveled, had a Cadillac in the portico, and had plenty of toys for the boys.9

  But the good times were short-lived.

  The Hartmans often fought over how to discipline the children, until ultimately they divorced when Mark was thirteen. During a deposition, Stuart told of a woman hooked on painkillers who occasionally used the family grocery money to support her costly and growing habit. Following his parents’ split, Mark would go with his mother to live with her family, taking her maiden name with him.10

  But while the surroundings may have been new, trouble never seemed too far away. As a teenager with his home life deteriorating, Hughes was busted multiple times for drugs and then shipped off to the CEDU institute in the San Bernardino Mountains to get clean. There, he befriended a staff member, whom he would accompany on the center’s fund-raising trips to the ritzier parts of Los Angeles, like Bel-Air and Beverly Hills. On one such trip, the young Hughes coaxed $500 out of California’s governor at the time. His name was Ronald Reagan.11

  Then, on April 27, 1975, when Hughes was just nineteen and still at CEDU, his mother died from an overdose. Hughes told people she was thirty pounds overweight and had tried every quick fix in the book before reverting to diet pills, which had killed her. It would have been a heartbreaking story—had it been true.12 The official toxicology report showed Jo Ann Hartman had a deadly level of the painkillers Darvon and Percodan in her system. She was just thirty-six years old.13

  “That’s why I dedicated my life to finding a better way to help people manage their weight,” Hughes later said of his mother’s passing, pushing the phony story until well after her death.14

  In the mid-1970s, Hughes began selling weight-loss products for the Slendernow brand, which was owned by the Seyforth Laboratories.15 Its founder, Mark Seyforth, was a pioneer in the fast-growing direct-selling industry, where products are sold by individuals acting as independent contractors.16 People who signed up would either use the products themselves or sell them to family, friends, and co-workers, sometimes trying to recruit new salespeople into the operation. Their pay structure was controversial. Seyforth had invented a system where the independent contractors, called distributors, were compensated for what they sold as well as for how many new recruits they brought in. This multilevel marketing (MLM) structure was booming at the time.17 Mary Kay Cosmetics, Amway, and Tupperware were well-established brands with histories dating back to the 1950s, but in the 2000s the practice was experiencing a rebirth, and these familiar companies were doing well, along with hundreds of lesser-known brands. At the same time, the structure was often criticized. Skeptics said MLMs were nothing more than pyramid schemes.

  In 1975, the US government decided to take a closer look at the industry. On March 25 of that year, the Federal Trade Commission (FTC) sued Amway.18 The FTC said the company’s distributors had made deceptive statements about the business opportunity and that distributors were really only selling to others inside the Amway network and not to real customers.

  The case dragged on for four years, but in 1979, Amway won when a judge ruled that the company’s distributors were selling to legitimate customers. Amway could continue to operate, but, as part of the deal with regulators, was forced to put in a series of safeguards to better protect consumers. The court required that 70 percent of all products sold had to be to customers outside the Amway network. Sales reps had to document at least ten real retail sales per month, and, to protect new recruits from being scammed, Amway had to buy back any unsold inventory their sellers might have purchased for a full refund.

  The so-called Amway Decision cleared the way for other MLMs to prosper, and Hughes seemed a perfect match for the controversial, yet mushrooming enterprises. Hughes became one of the top one hundred earners for another weight-loss company, Slendernow, in the years before it went bankrupt. He’d do a stint with yet another MLM selling exercise equipment before he appeared ready to start his own operation.19

  Hughes had traveled to China, where he’d observed the Eastern philosophy of medicine and thought combining it with the West’s burgeoning supplement industry could be a good business opportunity.

  In February 1980, Mark Hughes founded Herbalife International, Inc. out of the back of his car, making the products in an old wig factory in Beverly Hills.20

  He was just twenty-four years old.

  Herbalife’s early products were a meal-replacement shake called Formula 1, an herbal tablet called Formula 2, and a multivitamin, which the company claimed would help people lose weight.21 The products were expensive, with the full line costing about $3,000. To counter the hefty cost, Hughes gave customers who agreed to become distributors a 25 percent discount, figuring they’d be able to purchase more if they got a deal. And, taking a page from the old Seyforth plan, Hughes paid distributors commissions based on how many new recruits they brought in. The more people who signed up and bought Herbalife products, the more money people could make, and the faster they’d climb the Herbalife food chain. The most successful distributors could earn commissions on what they sold and on their “downline,” which referred to sales made from the recruits below them. Top sales people could move up to the President’s Team and, ultimately, to the promised land—the Chairman’s Club, where nearly every member was a multimillionaire.22

  In Herbalife’s first five years, revenues went from $386,000 to an astonishing $423 million, with Hughes serving as the company’s leader and CEO, which in this case might as well have stood for Chief Evangelical Officer.23 Hughes looked the part too. He was well tanned, with dark, feathered hair; he wore expensive suits, spoke with the cadence of a preacher, and pitched Herbalife at flashy spectacles inside local sports arenas.

  “Trust me… I can tell you with absolute sincerity,” he said at one event. “Anything is possible if you just keep using and talking and do it over and over and over and over again. The wildest dreams you’ve ever thought of can come true in Herbalife.”24

  Hughes was almost messianic in the way he preached Herbalife’s virtues to his growing numbers of believers. Herbalife events were shown on cable television, with Hughes clad in a tux, wearing his trademark lapel pin that read “Lose Weight Now, Ask Me How?”25

  “You can go as far as you want to go… because that’s the way it is in Herbalife!” he’d exclaim.

  Customers ate it up, and by 1985 Herbalife had more than seven hundred thousand distributors around the world, many of whom were sold on the promise of amazing wealth.26

  “I used to drive a truck, and I made $80,000 last month,” said a female distributor at one Herbalife extravaganza. “You want to join this sucker or not?”

  “We haven’t been in the business a year, yet our ninth royalty check was $40,883, and we’re excited!” said a couple that same night.

  Hughes chartered DC-10s, flying planeloads of distributors off to faraway places, including Sydney, Australia, for an extravaganza at the famed opera house. At one such fete, Donnie and Marie Osmond entertained. Ray Charles and Natalie Cole performed at another.27

  It seemed as though nothing could stop Hughes, or Herbalife.

  “Let me tell you what we’re going to do with a company called Herbalife,” he’d say. “We’re going to take the company, customer by customer, and distributor by distributor, and we’re going to take Herbalife around the entire
world.”

  By the mid-1980s, Hughes was a player in the Los Angeles entertainment scene. He owned two Rolls-Royces and had bought an estate in Bel-Air for a reported $7 million from the entertainer Kenny Rogers.28 Raucous parties were the norm.

  In 1984, Hughes married Angela Mack, a former beauty queen from Sweden. Wayne Newton played at the reception. Mack was the second of Hughes’s four wives.29

  But in March of 1985, Herbalife was in trouble.

  The California attorney general sued the company, charging it with making false claims about its products. The suit also claimed Herbalife was an illegal pyramid scheme.

  In May of 1985, Hughes was called to testify before Congress, where he was grilled for two days by a Senate panel about Herbalife’s research and testing. Lawmakers had been urging regulators to take a stronger stance on the diet and supplements industry, and Herbalife—along with its swashbuckling CEO—seemed as good a target as any.

  While Hughes sat on the hot seat inside the hearing room, outside, a legion of Herbalife distributors marched in support of their leader. Hughes was defiant, telling questioners of the diet experts who’d already testified, “If they were such experts on weight loss, why were they so fat? I’ve lost sixteen pounds in the last few years!”30

  The exchanges were testy.

  Senator Warren B. Rudman, a Republican from New Hampshire, peppered Hughes on how he could possibly be an expert on the business when his own formal education history had stopped in the ninth grade.

  Hughes replied, “I defy anybody to be able to produce the results that this company has.”

  “Do you believe it’s safe to use your products without consulting a doctor?” Senator William V. Roth asked.

  “Sure,” replied Hughes. “Everybody needs good, sound basic nutrition. We all know that.”31