On Einhorn and Herbalife

I stumbled across the crazy price action today in Herbalife ($HLF) which was the result of some questions that Greenlight Capital’s David Einhorn asked on the company’s earnings call.

The first thing I did was listen to the replay of the call  – of Einhorn’s questions.  You can listen to the audio here.  I immediately concluded that Einhorn’s questions were no big deal, and that there was no smoking gun in either the questions or the answers.  So I started buying the stock.

The $HLF Stocktwits stream was blowing up, with some people concluding that Einhorn was short the stock.  I listened to the questioning again, and I concluded that Einhorn wasn’t short the stock yet.  After all, he’s not the kind of guy who would take a position without knowing such basic commission structures as the ones he asked about.  That’s something Whitney Tilson would do (zzzzzing!).   I even argued as much on Stocktwits.

But I may well have been wrong!   I talked about this with a few colleagues, and one of them made some astute points.  My colleague wrote, in reference to the 70% direct sales inquiry:

“I think he asked to get management on the record so he can prove them wrong with his research.”

I replied that I was thinking mostly about Einhorn’s questions about the commission structure:

“interesting. I was talking more about the commission structure, and the incentives to become a supervisor.   He clearly didn’t understand the commish structure, and was straightened out by the CEO”

he countered:

“All of these answers can be obtained from an IR call.  The only reason to be on a conf call is to stick them on the record.”

me:

“so you really think he was playing dumb about the commission structure???”

him:

“Einhorn has analysts.  I don’t think he is in the business of doing diligence on public conference calls of controversial companies.“

And at that point I had an “uh oh”  moment.   My colleague’s point makes way too much sense.  I immediately remembered my own trading rule: Rule #2: “Know Why You Are In A Trade.”

I bought HLF because I had concluded quickly that Einhorn was asking an innocent question trying to get more information.   I had concluded that he was NOT yet short the stock, and wasn’t about to try to drop a bomb on it.   After discussing it and thinking it over some more, it became clear that my thesis may not be sound.   My colleague’s point was that David Einhorn doesn’t do exploratory research of pretty basic questions on public conference calls.  I agree with him on that, which crushes my bases thesis for my trading position.

Robert Sinn, aka, the StockSage, posted on Herbalife as I was typing this.   In his post, he wrote:

“I don’t believe that Einhorn would get on a publicly traded company conference call unless he already had a position in the stock and thought that he knew the answers to his own questions already. “

Duh! yes – and I can’t believe I missed that point, which was the crux of my colleague’s argument as well.   I guess I’ve been up here in the woods for too long – my poker skills are clearly rusty.

Anyway, what’s the moral of this story?   Don’t be afraid to admit that you were wrong.  I don’t KNOW that I was wrong, but I took a position in a stock that I knew nothing about for a very specific reason, and after further thought it quickly became clear that my reasoning may not have been sound.  Note that I’m making no call at all on the value of $HLF.  I have no clue – and I’m not willing to hold this as a core value position, as I will be offline for the latter half of this week and don’t want the unmanageable risk open.

Might the stock bounce over the next few days?  Absolutely.   Might the entire Street come out pounding the table on it as a valuation play?  Absolutely.  My circumstances and my trading rationale are unique to my situation,though, which in this case is “going on a trip starting tomorrow and I don’t want an open position in HLF.”

Note that the Ira Sohn conference is in two weeks, where David Einhorn will be speaking…

-KD

disclosure: I traded HLF all afternoon.  I bought it all the way down, and liquidated as it rallied. I closed the day with no position and a small trading gain, after having been down 10x as much at the lows.

ps – I just stumbled upon this, from the WSJ

“Following the plunge, at least one analyst thinks the stock has become a screaming buy. In a research note published after the conference call, Timothy Ramey, an analyst at D.A. Davidson, said the selloff in Herbalife shares has created “a major buying opportunity.”

He attempts to downplay Einhorn’s probing as a couple of “basic questions” about the company’s relationship between an independent customer and a distributor.

“If anyone else had asked the question we would have wondered why time was being devoted to such basic inquiries,” Ramey says.”

That is EXACTLY what I thought initially, and yet I realize why I now hate my logic.  As my colleague and StockSage each stated above, Einhorn doesn’t ask basic questions like this on a public conference call without good reason.    It’s important to recognize that my perspective is from a short term trading call, though – not a long term valuation call, which Ramey is making.

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