The Billion-Dollar Short That Refused to Pay

In December 2012, hedge fund manager William Ackman of Pershing Square Capital Management announced a one-billion-dollar short position in Herbalife Nutrition, a publicly traded multilevel-marketing company that sells protein powders and weight-management supplements through a network of independent distributors. Ackman accompanied the short with a three-hour public presentation in which he characterized Herbalife as a pyramid scheme that he believed regulators would, sooner or later, shut down. The position was, by hedge fund standards, unusually public — most short positions of comparable size are accumulated quietly and disclosed only when required.

What followed was, by industry standards, an extraordinary five-year contest. Carl Icahn, another well-known activist investor, took the opposing position, accumulating a substantial long position in Herbalife and engaging Ackman in repeated public disputes through television interviews and SEC filings. Daniel Loeb, another hedge fund manager, also took a long position. The combination of Icahn and Loeb's buying, combined with a generally strong consumer-discretionary equity environment, produced sustained upward pressure on Herbalife's stock that compressed Ackman's short into substantial mark-to-market losses.

The FTC Settlement. In July 2016, the Federal Trade Commission settled with Herbalife on charges related to deceptive business practices. The settlement required Herbalife to pay two hundred million dollars and to restructure its compensation system to reduce the incentive for distributors to recruit additional distributors rather than sell products to retail customers. The settlement did not, however, declare Herbalife a pyramid scheme; the company was allowed to continue operating in modified form.

The Position Closure. Ackman maintained the short position for approximately five years before closing it in late 2017 at a substantial loss. The cumulative loss to Pershing Square, including the put options and shorts that comprised the position, was reportedly approximately a billion dollars. The trade became, by industry consensus, one of the most expensive single hedge-fund positions in modern history.

The Lesson Hidden in the Confrontation. What the Herbalife saga demonstrated, beyond the specifics of the company, was the structural challenge of activist short positions against companies with strong consumer-product moats and government-regulator dependencies. The short thesis required not only that Herbalife's business model be deceptive — which several observers, including the FTC, eventually agreed was partially true — but that the deceptive practices be sufficient to produce regulatory shutdown or commercial collapse. Neither outcome occurred. The settlement reformed the practices without ending the business. The stock recovered. The short closed at a loss.

The lesson, accumulated in subsequent activist-short campaigns, is that the time gap between the identification of a structural commercial problem and its regulatory or market correction can extend across years — long enough that an activist short with significant time decay (through options, borrowing costs, or capital tied up in the position) may be unable to maintain the position to the eventual resolution. The thesis can be correct without the trade being profitable. Ackman, who has continued to be one of the most prominent activist investors of his generation, has subsequently been more cautious about extended public short positions. The Herbalife trade is, in the Pershing Square lessons file, a particular kind of expensive instruction.