When the Wolves Bite

by Scott Wapner

  It was shortly after that visit, in the later winter of 2012, that Einhorn—who took on Allied and railed against Lehman—decided to short Herbalife stock, initiating a medium-sized position in the name.

  But Einhorn’s recon didn’t stop there.

  On March 23, 2012, the Greenlight analyst and Richard traveled to a Los Angeles hotel where Herbalife was holding its annual meeting, which is where company executives brief analysts and major shareholders on the state of the business and take their questions.

  Following the morning festivities, which began with a 6:30 a.m. boot camp workout and a speech by Johnson, Richard and the analyst made their way to lunch, where DeSimone was making the rounds in a meet-and-greet. DeSimone sauntered to the table where Richard and the analyst were sitting and stopped to say hello. Richard asked him several questions related to the old Amway decision of the 1970s and the level of actual retail sales the company was making—the same sort of questions Einhorn himself would ask on the earnings call in May two months later. DeSimone immediately grew suspicious and asked who the women were. Richard said she was doing research for the woman sitting next to her. DeSimone quickly left the room and alerted CEO Johnson.

  The next day, Herbalife held its President’s Team Summit, an extravaganza where Johnson would hand out $52 million in bonus checks to more than 350 of Herbalife’s top distributors.

  “The air will go out of the room on a few of those announcements,” Johnson told the investors, alluding to the sizeable payouts they awaited.

  “Good morning, Herbalife!” Johnson exclaimed the next morning as he officially opened the festivities. The crowd roared, while some in the audience threw their arms in the air as if Johnson were the Messiah.19

  Johnson laughed as he soaked up the adoration. “We’ve got something special at Herbalife,” Johnson said “Can you feel it? Can you feel it?!”

  Speaking for more than an hour, Johnson told of the company’s journey, reminiscing about his time at Disney and how it could be repeated at Herbalife.

  “I am more excited about this company today than I have ever been,” he said. “I am more excited about the promise of Herbalife than I have ever been, at any time in this company.”

  Music roared. The crowd stood and clapped in unison.

  “We give people the opportunity to improve their lives.… We give people an opportunity to change their lives,” he said.

  Each time Johnson spoke, the assembled rose to their feet.

  As Johnson basked in the glow of adoration, he acknowledged Herbalife’s doubters—those through the years who had criticized the company, and he urged his ranks to be at their best.

  “We’re going to get bigger, and more people are going to be skeptical about who we are and what we do. We have to be the best at what we do. We have to have the highest integrity at what we do. We don’t need to make anything up.”

  Richard and the Greenlight analyst sat among the faithful, soaking it all in. Both returned to New York moved by what they had witnessed. Richard felt that Johnson had oddly sensed they were in the room when he’d called out the doubters, as if he were referencing them directly.

  Not even two months later, Einhorn dialed in to the earnings call and began his now infamous inquisition. It was just a precursor of things to come. In just two weeks, Einhorn, along with John Paulson, Jeffrey Gundlach, and several other star investors, was scheduled to present at another Sohn Conference in New York. If Einhorn had merely fired warning shots at Herbalife on the earnings call two weeks earlier, most expected that he’d use the big event to go nuclear and admit he was actually shorting Herbalife shares.

  At 3:31 p.m. on May 16, 2012, Einhorn took the stage at Avery Fisher Hall inside Lincoln Center on New York City’s West Side. Anticipation in the performance hall was thick. The overflowing room darkened, except for a spotlight on the lectern.20

  Back in Los Angeles, the Herbalife executives were huddled in the conference room, listening to the presentation live thanks to a plant they’d put in the room. The operative had live-dialed Herbalife’s LA headquarters from the auditorium, leaving the phone open to hear everything.

  Up popped Einhorn’s first slide.

  “M-L-M,” it read—an obvious reference, those in the auditorium thought, to multilevel marketing, the kind of business Herbalife was. The assembled journalists and a cadre of finance bloggers clutched their phones, ready to tweet the news when it became official.

  Herbalife braced for the worst.

  And then…

  Martin Marietta Materials.

  It was all a ruse.

  M-L-M was the ticker symbol for the construction materials company and not an acronym for multilevel marketing. Einhorn was just screwing with the company, and laughed, as did all in attendance.

  Herbalife shares spiked 15 percent almost immediately out of pure relief.

  Michael Johnson, who should have been elated, had no idea what had just happened.

  The previous weekend, he’d gone over the handlebars of his mountain bike while riding with friends in Cheseboro Canyon in Agoura Hills, broke several bones, and was airlifted to a hospital, where he lay drugged up with painkillers at the very moment Einhorn spoke. While Johnson breathed a sigh of relief when he learned of the stunt, he was just happy to be breathing at all.

  In reality, the fakeout was classic Einhorn. This was, after all, a guy who routinely played high-stakes poker in Las Vegas, once winning $4.3 million in the king of all tournaments, the World Series of Poker Main Event.

  But what made Einhorn’s appearance all the more remarkable that day was that he was out of Herbalife altogether by the time he entered the hall that morning, a fact no one in the room knew. Not the media, not the audience, and certainly not its most interested and intrigued member—Bill Ackman.

  6

  THE BIG SHORT

  After returning an impressive 29.7 percent, net of fees, in 2010,1 largely due to the GGP home run and gains in other stocks within his portfolio, 2011 had gotten off to a rocky start for Pershing Square and its principal.2 The Target misfire dragged on the main fund’s performance and had dented Ackman’s reputation, but it was far from his only headache.

  In November 2006, Ackman had invested in the bookseller Borders Group,3 hopeful that the company could navigate the industry’s fast-changing landscape and perhaps pull off a merger with its main rival, Barnes and Noble. The investment followed the classic activist playbook—buy into a perceived undervalued asset, exert some muscle, and watch shares rise substantially over time. Ackman knew flipping Borders wouldn’t be easy, but if there was one thing he’d proven time and time again, it was that he had the endurance to wait. But whereas Ackman saw opportunity in Borders, others saw a broken story. Borders had missed the e-book revolution, and while competitors were either downsizing to meet the digital transformation or introducing new products, Borders continued to expand while amassing a heaping pile of debt. Ackman had held the stock for years, even boosting Pershing’s position over time, convinced he’d made a good investment. But by May 2012, things looked so dire that Ackman was looking for a way out. He offered to play matchmaker and even help fund a transaction between Borders and Barnes and Noble, but a deal never materialized.4 When it soon became clear that bankruptcy might be the only viable option, Ackman threw in the towel altogether and began dumping the stock. He sold one million shares at a reported $200 million loss, with the rest of the position soon to follow.5

  By the fall of 2011, Pershing Square, which had $10 billion under management, was down 15.6 percent, net of fees, a disappointment by any measure and even more so for a money manager used to double-digit returns.6

  Ackman didn’t plan to remain in the red for very long.

  In October, Pershing revealed a new 12.2 percent stake, or 20.6 million shares, in the railway Canadian Pacific.7 CP shares promptly surged 10 percent on the news, and for the most part didn’t stop. Between October and the end of December 2011, shares rose 18 percent,
effectively making, if not saving, Ackman’s year.

  Feeling revived by the Canadian Pacific boon, Ackman entered 2012 eyeing a more prosperous outcome. The real question was whether JC Penney could help him get there. Ackman had amassed a 16.5 percent stake in the retailer back in 2010 and had waged a boardroom upheaval, installing his handpicked savior, Ron Johnson, as the new CEO.8 Ackman’s hopes were so high that the company could reverse years of sales declines that he boosted his stake to 26.7 percent, telling his investors in a letter, “We don’t buy 26% stakes and join boards of directors unless we believe an investment has enormous potential.”9

  Others apparently didn’t share the optimism. By the spring of 2012, Wall Street was already losing faith in Ackman’s turnaround plan, which only grew worse that May when JC Penney reported dismal first-quarter sales numbers. Comparable stores sales, the industry’s key measure of revenue growth, declined 18.9 percent from a year earlier, with total sales declining more than 20 percent.10 When Penney’s stock opened for trading the following day, shares promptly dropped 19.7 percent.

  To make matters worse, Johnson appeared delusional, claiming in a statement accompanying the earnings results, “Customers love the new JCP they discover in our stores.”11 Ackman appeared undeterred, telling a reporter that despite the obvious challenges facing the company and the early disappointments, Johnson was “the best guy to run the company”—and that JC Penney “isn’t fundamentally broken.”12 Ackman had also put a $77 price target on the stock even though it was currently trading for less than $30.

  Canadian Pacific, however, looked much more promising.

  Ackman had become the company’s biggest shareholder. He won a proxy fight for seats on the board and would soon ditch its CEO for his handpicked alternative.

  By mid-2012, the large stakes in JC Penney and Canadian Pacific made up more than 40 percent of Ackman’s highly concentrated portfolio.

  Herbalife wasn’t exactly out of mind, but with Ackman preoccupied by Penney’s and Canadian Pacific, Shane Dinneen, the Pershing Square analyst who’d done more work on Herbalife than anyone, continued digging, unearthing new leads on the company’s business that only made him more skeptical. Dinneen lobbied Ackman to add Herbalife to the portfolio as a short position, but Ackman showed no sign of budging—at least not until the morning of May 1, 2012, when Einhorn dialed into the earnings call.

  Dinneen had dialed in too, heard Einhorn’s pointed questions, and was devastated. With his shoulders slumped, Dinneen walked into Ackman’s office down the hall and told his boss that Einhorn was on the Herbalife call and that they’d blown it.

  “Shane comes in and is depressed and the stock is down and I was like, oh, this is good!” remembers Ackman. “David Einhorn is a great short seller. He’s clearly going to be public. He’ll be the catalyst.”

  Ackman convened the Pershing Square investment team to discuss whether to get involved. Present were Ackman himself, along with associates Scott Ferguson, Paul Hilal, Roy Katzovicz, Ali Namvar, Ryan Israel, Jordan Rubin, and Brian Welsh. Ackman told them of Einhorn’s appearance on the conference call and that it was the perfect opportunity to short the stock.

  “When you’re sure someone else is taking the lead, number one you don’t have to be public and you can abandon it at any time,” said Ackman. “It’s not as big a commitment as when you buy 10 percent of the company and have to file. You can blow it out tomorrow.”

  While Ackman made his case to the assembled group, a debate ensued among some in the room as they wondered about a path to victory. Einhorn had already hammered the stock by 40 percent, some noted. Was there really much downside left? Others questioned whether regulators would have incentive to step in and shut the company down. It was a valid point for sure. Though some MLMs had been put out of business in the past, most of the larger, more recognizable names had survived, if not thrived.

  As the debate raged, Ackman offered up a much more matter-of-fact question. If Einhorn had already done the heavy lifting and was shorting the stock, he offered, “How do we lose?”

  He also figured the calendar was on his side. In a couple of weeks, Einhorn was set to present at the Sohn Conference, and just about everyone expected Herbalife to be his target. The implication was obvious: if Einhorn’s questions alone had tanked the stock, one could only imagine what a public takedown could do.

  With Herbalife shares getting killed on Einhorn’s appearance on the conference call, Pershing Square began shorting Herbalife, initiating a small position at an average of $48 per share. Shorting means you’re betting against a stock, and while it can be highly profitable, it carries risk. That’s because when you short a stock, you effectively borrow shares from another investor and sell them. If the shares lose value, you can them buy them back at a low price and pocket the difference. While gains can be enormous if the stock falls in price, losses can be endless if it goes up. There is no ceiling to how high a stock price can rise.

  On May 16, the day of the Sohn event, Ackman traveled the eight blocks or so from his office up Columbus Avenue and into Lincoln Center to give a sixty-slide presentation on JC Penney. Ackman stayed on message throughout and made no mention of Herbalife during his fifteen minutes onstage. He then took his seat as Einhorn took his turn in front of the crowd.

  When Einhorn walked onstage, nearly everyone in the room expected the snarky short-seller to hit Herbalife with a sledgehammer. But when Einhorn tricked everyone and called out Martin Marietta instead, Ackman was among those shocked. He headed straight back to the office, met with his team, and considered getting out of Herbalife right then and there rather than become the public face of the fight.

  “There was a lot of skepticism in the room about going public,” Ackman said. “We talked about it, and I said, look, Shane has done great work. Let’s put together a presentation, because there’s a certain discipline associated with that—let’s just do it for internal purposes only and see what it looks like, then we can make a decision.”

  Ackman wasn’t naive to the risks of going it alone, but countered that Pershing could easily fill the void left by Einhorn’s exit.

  “I said, I don’t know what David is going to do, but there could be an upcoming catalyst,” Ackman said he told the others. “We can be the catalyst.”

  Dinneen began working day and night on the presentation, even sleeping under his desk to turn over any stone he could find on Herbalife.

  “And Shane kept finding things, and I kept learning things,” said Ackman. “Then, we put more resources into it, and we hired a law firm.”

  Katzovicz, who was Pershing’s in-house regulatory expert, called Sullivan and Cromwell, hoping to retain the firm to do the forensics on Herbalife’s business even though it rarely worked on public shorts. Sullivan and Cromwell would have to investigate all of the possible scenarios Pershing could face if it took on the fight, the history of pyramid-scheme law, the likelihood that the government would intervene, and even the possibility that Herbalife could sue Ackman and Pershing Square.

  “I said, I think this thing is really interesting. I’ve never seen anything like it,” Ackman said he told the firm. “Why don’t you go and do two weeks’ worth of work on it and come back. If you think it’s interesting, we’ll keep talking. They started digging into it, and not only were they able to confirm our allegations, they found more damning evidence.”

  Even though pyramid-scheme law was more gray than black and white, the more dirt S&C found, the more convinced Ackman and the others in the office became that Herbalife was the fraud he and Dinneen had long suspected.

  Ackman then decided to up the ante.

  With the stock still hovering in the high $40s, Ackman proposed going nuclear—raising the value of the short position to one billion dollars—a massive 20 percent of the float, or the total number of shares available for trading. It was go big or go home—just the way Ackman liked it. And since Ackman was as much a showman as an activist, he proposed doing a splas
hy presentation in New York—a public execution for the whole world to see.

  Some thought the plan was insane, that unveiling such a large position could easily invite thrill seekers to take the other side. But Ackman had an answer for that too. By shorting Herbalife and winning, he argued, Pershing Square would not only make money for its investors but could do good at the same time by stopping a predatory business that preyed on minorities and the less fortunate. Ackman said those who had the balls to take the other side would essentially be taking blood money, and who would want to carry that burden? The idea led to a debate over whether Pershing Square’s real objective was to make money for its investors or to fulfill some altruistic or moral mission. Ackman won that argument as well, saying Pershing Square could do both.

  He told Dinneen he wanted a presentation ready by June, just a few weeks away. Now it was Ackman’s turn to plot the big reveal. He phoned a friend from the industry who just happened to have the perfect venue.

  “Bill called me ahead of the 2012 Ira Sohn Conference and said I have something really great but I’m not sure it’s going to be ready in time,” said Douglas Hirsch, one of the charitable event’s cofounders and a longtime friend of Ackman’s. “Then later, in October, early November, he called back and said, hey, remember our conversation? Well, I have something I’d like to present, so we came up with the idea of a Sohn special event.”

  With Hirsch onboard, Ackman booked the AXA Center on Seventh Avenue. It was Ackman’s go-to venue and large enough to hold the hundreds of people he hoped would show up. Timing was the only question. When October came and went, Ackman pushed the presentation to the week of Thanksgiving. But when Dinneen still wasn’t ready come November, Ackman set a drop-dead date of December 20, just before many on Wall Street would take off for the holidays.

  With the date fast approaching and the presentation looming, Dinneen worked around the clock to prepare the hundreds of slides they’d need for the deck. If they were going to bring Herbalife down, everything had to be perfect, including making sure enough people actually showed up to see it.