Walk Like An Egyptian
O! My fortunes have corrupted honest men.
- Shakespeare, “Antony and Cleopatra”
During a state visit to Egypt in 1977, then-Israel Prime Minister Menachem Begin toured the National Museum in Cairo. When asked whether he would care to see the pyramids, he quipped, “Why not? After all, we built them.” Begin was taken by surprise when this attempt at humor was met with outrage on the part of the Egyptian public. Egyptians, it turns out, are proud of their own heritage — a heritage which includes the tradition that it was skilled Egyptian builders who built these massive structures. Not foreigners in the land. And not slaves.
Archaeological evidence appears to support the Egyptian narrative, both as to the age of the structures — the oldest known Pyramid was built in around 2630 BCE — and as to the treatment of the workers. Large settlements in areas around the Pyramids have been identified as workers’ towns, and everything from housing accommodations, to the waste from the food the workers ate, indicates they were well cared for, if not honored.
Scholars agree that the builders included large numbers of highly skilled artisans, as well as a massive complement of low-paid laborers who pulled, shoved, lifted and winched the giant stones into place. This should not surprise a Western observer — it is much the same template as the construction of the great European cathedrals. And the work force appears to have been similarly drawn from the lower economic classes — but not slaves. Indeed, it was apparently an honor to be involved in building the Pyramids, not something to be shared with outsiders.
But once you become identified with a narrative, it’s hard to shake it. In fact, there is another argument over a pyramid going on right now, pitting modern Pharaohs against one another in a war that will surely see its losers badly bloodied, though it is not clear what trophies await the winners.
Hedge fund Wunderkind Bill Ackman has tied up over a billion dollars of his Pershing Square fund’s capital in a massive, and well-advertised, short of Herbalife stock. True to the Wall Street tradition of first loading up on a position, then touting it to all the world, Mr. Ackman has appeared on major financial programs, accusing Herbalife of running a massive fraudulent pyramid scheme and describing in loving detail how Herbalife allegedly scams both the investing public, and its own customers-turned-sales force.
Squaring off opposite Mr. Ackman is Daniel Loeb, founder of hedge fund Third Point and a man who uses his multi-billion dollar perch as a bully pulpit to castigate executives whose behavior he finds wanting. It was Loeb who, in May of last year, broke the news that Yahoo! CEO Scott Thompson did not have a degree in computer science — Thompson tendered his resignation within two weeks of the disclosure. Challenging Ackman’s massive short of Herbalife stock, reported to be nearly 20% of the outstanding shares (Financial Times, 11 January, “Herbalife Hits Back At Pershing ‘Myths’”) Loeb’s Third Point has disclosed an 8.5% stake in the company, and there are other money managers with long positions. It’s game on in the land of the pyramids.
We do not consider ourselves expert on either Herbalife, nor on the investing acumen of Bill Ackman, Dan Loeb, or the other deep pockets who have stepped into the ring. (It is rumored that Carl Icahn has bought into Herbalife on the long side. Observers think this may have an element of Schadenfreude for an Icahn who would love to see Ackman lose this fight. Icahn and Ackman spent the better part of a decade locked in a tangled lawsuit that resulted in Icahn paying $9 million to Ackman. That’s not a typo. We’ll write it out, just to make sure you get it. After seven years of legal wrangling, Carl Icahn lost a judgment which resulted in him paying nine million dollars to Bill Ackman. He’s never gotten over it.)
Ackman told folks he believed Herbalife CEO Michael Johnson threatened him. Ackman told interviewers on Bloomberg TV he was concerned for his safety and the safety of his family after Johnson said the world would be better off without Bill Ackman. Other factoids from Johnson’s indignant rant included an allegation that Ackman went public with his accusations against Herbalife in the final days before options expiration, thus spiking the value of put options which, Johnson allowed us to infer, Ackman must own by the boatload. Would you buy a used short position from this man?
Ackman’s presentation, on the other hand, says that 93% of Herbalife’s independent distributors make zero gross revenues from their sales, while the one in 2,500 distributors who earn $300,000 or more equate to 0.04% of Herbalife distributors. Would you buy a used vitamin from this man?
Herbalife management has exhibited an unshakeable façade of high moral dudgeon over Ackman’s allegations. Ackman says Herbalife’s business model is based on people sucking others into an illicit web of upstream and downstream sales. He says most sellers make no profit whatsoever, but that a tiny fraction of those nestled atop the pyramid structure make scads of money. He says the profits in the company come, not from legitimate product sales, but from downstream salespersons bringing successive lower tiers into their pyramid. He challenges the legitimacy of Herbalife’s product line, saying the company spends “immaterial” amounts on research and development.
Herbalife just held a special investor conference intended to rebut Ackman’s claims. Mr. Ackman was vacationing but said he listened in on the presentation. His curt Blackberry response indicated he heard nothing to change his mind.
Maybe this comes down to an argument over semantics. Ackman says it is “very clear that it’s a pyramid scheme,” and that “pyramid schemes are inherently fraudulent.” This is an inverted two-step logical argument: you must accept the second part of it before you consider the first. In fact, a Belgian court has declared Herbalife an illegal pyramid scheme, a decision the company “is confident will be reversed on appeal.” While we are not experts on Belgian law, it appears at least some jurists accept Mr. Ackman’s definition. Meanwhile, though, no US regulator has used the P-word in connection with Herbalife. The company, in a carefully-worded rebuttal, says Herbalife “is not an illegal pyramid scheme,” which leaves room for it to be a legal pyramid scheme. Like the Federal Reserve.
In a nation whose societal stability and economic growth is predicated on what economist Hyman Minsky famously called “Ponzi financing,” having a federal agency shut down Herbalife for fraud is likely skating much too close to the edge.
Speaking of folks who are committed to their narrative, no-longer-quite-so-legendary investor Warren Buffett went public this week with a jolly prediction that “the banks will not get this country in trouble.” “I guarantee it,” said the Oracle of Omaha, the Dowser of the Dollar, the Prophet of the Portfolio. Asks one wit at the Huffington Post (10 January, “Warren Buffett: ‘The Banks Will Not Get This Country In Trouble’”) if this is a Guarantee, then “what will Warren Buffett give us if he’s wrong?” Given the increasingly incestuous relationship between Buffett’s checkbook and the federal government, we predict that Buffett will, by definition, not be wrong, at least not as far as Buffett is concerned.
This is the same Warren Buffett who testified openly to Congress that he invested heavily in Moody’s because it enjoyed a government-guaranteed monopoly. Far from using his influence to instill responsibility into the process of rating companies and the securities they issue, Buffett rode the crest of a wave carried on the backs of our flagging economy. Is it accurate to say that we — or you, or any other person — would have done exactly the same thing? Perhaps. Should we be entitled to expect more from our leaders? Yep.
Buffett’s latest big ticket item is bank behemoth Wells Fargo, the subject of the cover article in this month’s Atlantic magazine (January/February, “What’s Inside America’s Banks?”). The authors of this article raise a large number of areas of concern for the banking sector — though broadly, and without a lot of detail to beef up their argument. We cite a few points the editors chose to excerpt in boldface: “When we asked Ed Trott, a former Financial Accounting Standards Board member, whether he trusted bank accounting, he said simply, ‘Absolutely not.’” “The sheer volume of ‘trading’ at Wells Fargo suggests that the bank is not what it seems.” “As rules have proliferated, arguments about compliance have become more technical, and punishments have been rare. Not one senior banker from a major firm has gone to prison for conduct related to the 2008 financial crisis.”
The authors raise a host of issues relating to Wells Fargo, to the bank sector in general, and to new trends in financial regulation. All the points raised in the piece are important, and nearly every one has the potential to generate a host of deep-dive investigative articles. For our taste, the authors’ brush is too broad — we spend our waking hours wading in the open sewage of the industry and we crave deep detail. We urge folks who want to see a large number of critical issues tabulated all in one place to read this piece, though you will likely be more amused — and angered — by reading Matt Taibbi’s article “Secrets and Lies of the Bailout” in the latest Rolling Stone magazine http://www.rollingstone.com/politics/news/secret-and-lies-of-the-bailout-20130104#ixzz2HIrDzuGl
Bill Ackman gets a cameo in the Atlantic piece and we think it’s pertinent to today’s Herbalife dustup. Discussing the opacity of bank accounting, the authors write that “Bill Ackman’s journey is particularly telling.” They go detail Ackman’s 2010 purchase of nearly $1 billion worth of Citigroup stock — about 9% of total assets under management of Ackman’s Pershing Square management company at the time. Ackman, who had long given banks a wide berth, said “for once I thought you could trust the carrying values on bank books.”
“Last spring,” report the authors, “Pershing Square sold its entire stake in Citigroup, as the bank’s strategy drifted, at a loss approaching $400 million.” The article offers this as an example of how treacherous bank investing is. We read a different story: FDIC chair Sheila Bair made no secret, during the TARP negotiations, that she believed Citigroup was a ticking time bomb. Bair was opposed to extending the government bailout to Citi, and was quoted publicly well before Ackman’s $1 billion investment.
In her memoir Bull By The Horns, Bair lays out the political hornets’ nest that gave rise to the allocation of TARP funds. Discussing her repeated head-butting with Treasury Secretary Geithner, Bair said “he was in constant communication with [Citigroup CEO] Vikram Pandit… I felt like he and Vikram were figuring out what they were going to do and then trying to jam it on me,” (Huffington Post, 27 September 2012, “Sheila Bair: Timothy Geithner Did ‘What Citigroup Needed’”). Bair is convinced that many of the TARP decisions “were made through the prism of what Citigroup needed.” Interestingly, Bair believed many of the big banks did not need the 2008 bailout, but were forced to take government funds in order not to leave Citigroup exposed as damaged goods.
Reading between the lines, did Ackman try to pull a Buffett? Ackman’s investment in Citi followed the Received Wisdom of Geithner et al — the notorious “thirteen bankers” mentality, that the government must support the financial sector and must not interfere. Readers of the Wall Street Journal knew what Ackman appears to have not known: that Sheila Bair, the senior regulator who arguably knew more about how banks fall apart than anyone else in Washington at the time, believed Citigroup posed a unique set of threats to the nation’s financial system. We are not privy to Ackman’s thought process, but if he was betting on Geithner & Company to bail him out, he was obviously wrong.
Mr. Buffett appears to sleep soundly at night, secure in the knowledge that his Uncle Sam will pay his gambling debts. Mr. Buffett has won this favored position through a rare combination of clear-sighted analysis, transparency in the management of his affairs, and ultimately becoming not Too Big To Fail, but Too Big To Ignore. Buffett no longer needs to test his narrative. He is the narrative. For the rest — even the Loebs and Ackmans of the world still need to do their due diligence.
We hope Mr. Ackman reviewed his own narrative before plunging into the Herbalife short — by his own account, the single biggest transaction of his career. A perfunctory scan of Ackman’s investing track record reveals some giganormous successes, as well as some stunning losses. Over the years, Ackman has been a steady giver to worthy causes. We hope the Herbalife chapter will not close with Mr. Ackman bidding to become a beneficiary of one of those same causes. O fortuna!
Like Pharaoh, there is only one Warren Buffett. Everyone else has to work for a living.
from: Slouching Towards Wall Street… Notes for the Week Ending Friday, 11 January 2013 — Copyright (C) 2013 by Hedgeye Risk Management