Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Summary

  •  Herbalife raised $1.15 billion from Convertible Note offering in February.
  • Company immediately invested $810 million to repurchase 9.9 million shares.
  • Latest repurchases were executed at prices well above current market levels.
  • Investors in Herbalife (HLF) are well aware of the importance placed by the company on share repurchase programs. According to the company's 2013 Form 10-K (Statement of Cash Flows, Page 97), HLF spent more in each of the last three years (2013, 2012, 2011) on its share repurchases than on its capital investments

    For example, in 2013, HLF used $306.4 million to buy back stock compared to spending only $150.8 million on its total "Investing Activities." The 2013 buyback program repurchased 6.2 million shares, at an average cost of $49.41 per share. We note that during the fourth quarter of the year, HLF bought back 337,828 shares at an average price of $74.02 per share. In 2012, the company used a total of $556.7 million to repurchase 11.5 million shares at an average cost of $48.34 per share. The total payment in 2011 was $321.6 million for 6.0 million shares or $53.66 per share.

    It is important to look at the net buybacks in each of these three years, since HLF was issuing shares to cover the exercise of stock options and the sale of shares under the employee stock purchase plan. In 2013, the net reduction in shares was 5.8 million. Comparable net reductions for 2012 and 2011 were 9.4 million and 2.3 million respectively. If we subtract the proceeds from these stock option exercises and stock sales from the buyback totals, the net payments for repurchases are $305.5 million in 2013; $545.4 million in 2012; and $299.4 million in 2011. If we add these three amounts, we see that a net total of $1.15 billion was spent to buy back 17.5 million shares. This analysis yields an average repurchase price over the three year period of $65.71 per share.

    On February 3, 2014, HLF announced that it had increased its share repurchase authorization from $652.6 million at the end of 2013, to $1.5 billion. The next day, the company announced the pricing of a Convertible Note issue that raised $1.0 billion, and was later increased to $1.15 billion. The Notes carry a 2.0% interest rate and are convertible at $86.28 per share, a 25% premium to the HLF share price of $69.02, the closing price on the previous day. The Notes mature on August 15, 2019 and will be settled in cash or HLF stock depending on the terms of the Notes' Indenture.

    According to Note 15, pages 133-134 of the 2013 Form 10-K, HLF did not waste any time using the proceeds from the Note offering. To reduce future dilution from the convertible issue, HLF spent $124 million to enter into a series of "Capped Call Transactions." The company then spent $686 million to enter into a series of "prepaid forward share repurchase transactions." These two amounts total $810 million which amount will be reflected as a reduction of shareholders' equity. These two expenditures will cover the repurchase of 9.9 million shares. Only the $686 million will be applied against the $1.5 billion share repurchase authorization, but the $810 million has been spent, leaving only $314 million from the $1.15 billion offering (less $26 million is fees and deal expenses) for future repurchases. This $810 million figure equates to an average price of $81.81 for the 9.9 million shares repurchased.

    The company did have cash assets of $972.9 million at the end of 2013, but it also carried $931 of total debt at that date. The March quarterly balance sheet will reflect the new debt, the new repurchases and the new cash balances, but one fact is clear--debt has been doubled and total equity reduced by the $810 payments. Initially, the debt will be booked at a discount to the $1.15 billion to reflect the convertible equity feature, but this discounted value will be accreted each year by an increase in interest expense to move the total figure at maturity to the full $1.15 billion amount.

    No one could have predicted when or if the FTC would launch a formal investigation into the HLF business practices, but this event has pressured the HLF stock price down to the low $50s, well below the levels of the recent stock repurchases. HLF holders should rightly be asking 'What was the rush?" to invest the bulk of the Convertible Note financing so quickly without leaving the company a larger cushion to take advantage of lower stock prices.

    Disclaimer: Tom Burnett CFA is Director of Research at Wall Street Access. He does not own Herbalife securities. Wall Street Access or its affiliates does not beneficially own 1% or more of the HLF common equity securities. In the past 12 months, Wall Street Access did not manage or co-manage public offerings of securities of HLF or receive compensation for these services. Wall Street Access does not intend to receive compensation for investment banking services from HLF in the next three months. At the time this article was published, Wall Street Access did not make a market in the HLF securities.



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