Chapter 1
Ackman: The Activist Grandstander
It had taken William Ackman more than 18 months to get this farâwith zero to show for it. Over that time, the founder of Pershing Square Capital Management, with more than $15 billion in assets under management, had been hammering away at Herbalife, what can only be called a marketing machine that used so-called independent distributors to peddle nutrition and weight-loss products through a vast pyramid scheme. There was an enormous amount of money at stakeâAckman, who goes by Bill, had at one point borrowed some 20 percent of Herbalife's stock, worth more than $1 billion, through his brokers and then sold it. His goal: Expose the company as a fraud and repay those borrowed shares for pennies on the dollarâor nothing at all.
That's how short-selling worksâand Pershing Square had by now spent more than $50 million in research and fees alone on the effort.
Now, in July 2014, the six-foot-three-inch-tall Ackman was wrapping up an impassioned, polished presentation for the media and investors that laid out the details of how Herbalife entrapped its distributors through a system of so-called ânutrition clubsâ that were meant to lure people into the base of the pyramid scheme and goose sales by foisting products on them. In the U.S., the lion's share of distributors were low-income people, typically Hispanic-Americans, but Herbalife was pushing its weight-loss products in countries from India to Zambia.
Ackman singled out the Herbalife CEO. âMichael Johnson will go down in history as the best CEO of a pyramid scheme in the world,â he said, pointing out that the former Walt Disney and Univision Communications executive had extensive experience in marketing to Hispanic-Americans. He alluded to another famed notorious pyramid scheme, that of financier Bernard Madoff, who duped investors of some $20 billion. He compared Herbalife's marketing to that of the Nazis.
Then things got personal. His voice trembling with emotion, Ackman detailed his immigrant forbears' history in the United States, his great-grandfather apprenticing as an assistant tailor, the family's coat business, and his father's own formidable achievements as a mortgage broker. âI am a huge beneficiary of this country, okay?â he said, choking up with emotion. âMichael Johnson is a predator. Okay? This is a criminal enterprise. Okay? I hope you're listening, Michael. It's time to shut the company down!â
âThis is an ingenious fraud,â Ackman said and, wrapping himself in the Stars and Stripes, added that Pershing Square preferred to invest in companies that help America. âI said I'm going to take this to the end of the earth. We're going to do whatever makes sense.â
Before taking a break, he fired off: âThis company is a tragedy and it's also a travesty.â
Whew! Pass the water.
Beyond the Ackman histrionics, his argument had merit.
The accusation was that Herbalife virtually forced its distributors to commit to buying more product than they could sell to earn a living wage, and Ackman, with the help of a contract research firm, had just furnished the evidence for his claim that Herbalife was a sophisticated pyramid scheme, illegal under U.S. Securities & Exchange Commission (SEC) and Federal Trade Commission rules.
The son of a successful commercial real estate broker, Ackman was born with a proverbial silver spoon in his mouthâand a highly polished one at that. He grew up in lush Chappaqua, New Yorkâthese days home to former President Bill Clinton and his wife, former Secretary of State Hillaryâgraduating from one of the nation's foremost public secondary educational institutions, Horace Greeley High School. Ackman picked up both a B.A., magna cum laude, and an M.B.A. from Harvard. Immediately after graduation in 1992, with no formal training, Ackman launched his own hedge fund, Gotham Partners, which he eventually shuttered in the face of investor withdrawalsâbut not before making a high-profile, unsuccessful bid to gain control of New York's Rockefeller Center. Even friends say the hyperambitious Ackman comes off as overconfident and a know-it-allâbut one whose big bets and relentless drive have generated 20 percentâplus returns for investors in his current flagship fund, called Pershing Square Capital Management.
Ackman began his Herbalife campaign at a December 2012 event sponsored by the Sohn Conference Foundationâa charity that finances pediatric cancer research and care. Dubbing the presentation âWho Wants to Be a Millionaire?â after the television game show, he and colleagues spent an astonishing three-plus hours detailing a convincing case that Herbalife, which peddles nutrition bars, vitamins, and powdered smoothie mixes of soy, sugar, and protein, was a giant pyramid scheme with sales that year that would amount to $4.1 billion.
The business model required that independent Herbalife distributors pull in more and more distributors into their network to make real money, pushing those newbies in turn to recruit other hapless friends, acquaintances, and relatives to do the same. The takeaway: Products went in large part to distributors themselves instead of end customers, with the lion's share of the money paid to distributors for bringing in fresh candidates to the sales force, not selling the products.
That's basically the definition of a pyramid schemeâin which an ever-growing number of recruits is duped into paying off the previous set. âBasically, the large numbers are such that if you go back to that pyramid, you need a bigger and bigger base at the bottom to support it,â Ackman explained. âProblem is, the money at the top is made from losses of the people at the bottom, and there are a very few people at the top and a huge number at the bottom.â The arrangement works until it runs out of recruits.
By late 2012, Pershing Square was shorting Herbalife's stock, borrowing millions of shares and then selling them, hoping that exposing the alleged fraud would prompt regulatorsâthe SEC, the Federal Trade Commission, the Justice Department or perhaps states' attorneys generalâto step in and bring the stock crashing down, profiting Pershing Square investors. In the perfect scenario, the price would go to zero and the hedge fund wouldn't need to repurchase stock at all.
Failing that, the accompanying publicity, much of it based on third-party analysis by a boutique research firm called Indago Group, might cause investors to dump shares, scare the company's auditors who sign off on financial statements, or even rattle prospective Herbalife distributors who might have otherwise been attracted to the business scheme, effectively deflating what to Ackman was a blatant if fairly sophisticated scam.
For Ackman this was not just another investment gambitâit was a crusade.
Herbalife was also an extraordinarily risky bet, with Ackman borrowing and selling about one fifth of Herbalife's total stock outstanding. The shares could be called back by their owners for any reasonâmeaning Pershing Square was on the hook if those he had effectively borrowed the shares from wanted them back. Yet, the shares dropped 8 percent in the days leading up to the initial December 19, 2012, presentation as rumors of Ackman's upcoming speech began to swirl. He didn't disappoint.
Ackman's first rousing speech, which he made without prepared notes, hammered away at Herbalife products' stratospheric pricingâthree times as much as competing goods. He pointed out the lack of research and development (R&D) and marketing. And Ackman railed against Herbalife's use of Nobel laureate advisory board member Lou Ignarroânot for research, but for touting Herbalife's products at conferences. Former Secretary of State Madeleine Albright was a consultant too. Ackman showed a Herbalife video that the company played for its distributors, with one of the higher paid ones driving a Ferrari and living in a lavish Southern California mansion.
But it all came down to one simple accusation. âParticipants in the Herbalife scheme, the distributors, obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to distributors, not consumers,â Ackman told attendees back in 2012. That was, almost verbatim, the Federal Trade Commission's definition of a pyramid scheme. In a perfect world, it would have been an open-and-shut case.
Initially Ackman's bet looked like a winner. The day of the presentation, Herbalife shares tumbled a further 12 percent, hitting $33.34, and they continued to fall thereafter. The day before Christmas 2012, Herbalife shares bottomed at $26.06. It looked as if in Herbalife, Ackman had picked an enormous loser, or in the case of Pershing Square investors, a gigantic winner to the tune of more than $1 billion.
Then, as is often the case in short-selling campaigns, the market began to turn. Somebody was buying, and Herbalife stock began to climb. As shares rose, a coterie of hedge fund managers and other investors jumped on the chance to initiate a short squeezeâbuying Herbalife shares to drive up the price in hopes of forcing Ackman to cover, or buy back shares, at a big loss. A keenly watched metric in the short-selling game is called days to cover. That refers to the number of days, given average daily volume as a benchmark, it would take a short seller to cover a short position. And Herbalife's days to cover metric was off the charts.
So while Pershing Square's bet was huge, the size of his position left Ackman open to upward pressure on the share price if anyone wanted to buy shares and cause trouble by running up the priceâa so-called âshort squeezeâ in Wall Street argot. And the prematurely silver-haired hedge fund managerâone acquaintance dubbed him the Yeti, after the abominable snowmanâhad plenty of enemies.
It's easy to see why. In an industry known for its titanic egos, even Ackman's stood out. According to those who have dealt with him, he constantly proffered unasked-for advice to friends and rivals and compared his record to that of Berkshire Hathaway CEO Warren Buffett. Ackman was also bluntly direct, passing on the name of his nutritionist to an acquaintance who had added a couple of pounds or setting up single colleagues on blind dates. A Pershing Square board member once inadvertently smeared a dab of cream cheese on his own jacket lapel during a morning meeting and failed to notice it. While someone else might have taken the board member aside or whispered to him, Ackman bellowed across the conference table: âYou've got cheese on your jacket there!â
It did not escape notice that when Pershing Square floated shares of a closed-end fund it manages on the Amsterdam Stock Exchange, in October 2014, that he joked about the fact that they sold off, ending down 12 percent that day. âThe stock is down, which is good,â he quipped. âIf it had gone up, we'd have sold too low.â Holders included Qatar Holdings LLC, Blackstone Group, and Rothschild Bank AG.
Still, some look at Ackman's forthrightness and straight-shooting advice as just boldfaced honestyâcommendableâwhile others do not. Even before the closed-end fund offering, Ackman managed Pershing Square like a disciplined governance-centric corporation with a board that includes former New Republic owner and editor-in-chief Martin Peretz; an ex-chief financial officer of McDonald's Corp., Matthew Paull; and Harvard Business School management professor Michael Porter, who is both a mentor and colleague. That compares to other funds, which can often seem like alpha maleâdominated frat houses. Employees meet with the board without Ackman present so they can express their opinions about him forthrightly and deliver complaints about how the firm is run.
He maintains some high standards: Ackman, after consulting with the board, fired an employee for expensing a dinner that hadn't been on company time. (Of course, that was money out of his own pocket). More than anything else, though, what drove rivals of the 49-year-old hedge fund manager crazy was his knack for generating stellar returns, which, though volatile, were more than 20 percent annualized for his flagship fundâand with little leverage. That doesn't, ahem, include his closed Gotham Partners fund or his side pocket investments.
Full disclosure: Ackman, who is widely known for assiduously courting the media to an unusual, sometimes unseemly extent, declined to be interviewed for this book. It may have had to do with an unflattering article in the monthly Vanity Fair by the author William Cohan that appeared shortly before I made my request.
One investor harboring particular vitriol for Ackman at the time was Carl Icahn, chairman of Icahn Enterprises LPâthe onetime 1980s corporate raider and greenmailer; that is, someone who would buy up shares in a company, threaten a takeover, and then sell them back to the target at above-market prices in exchange for simply going away. It was deemed a louche manner in which to earn a paycheck.
But Icahn had successfully refashioned himself into the more honorable profession of activist investorâshaking up corporate boards and enriching all shareholders, not just himself. And Icahn, a native of the rougher parts of the New York City borough of Queens, was pretty good at itâagitating for the sales, breakups, or restructurings of companies like Kerr-McGee, Time Warner, eBay, and Yahoo! Returns for his public investment firm were more than 20 percent annualized since 2000.
Ackman and Icahn shared a litigious history. Faced with investor withdrawals and illiquid holdings, Ackman in 2001 was winding down his first hedge fund, Gotham Partners, which itself had made some public short bets. He cold-called Icahn about buying the fund's 15 percent stake in Hallwood Realty Partners, a real estate investment trust.
The wily Icahn was amenable. Ackman had another, higher offer of $85 to $90 a unit on ...
