Questioning Herbalife’s 'Research': Greenberg

When a company brags about the amount of research it does, you would expect to “research and development” broken out as an expense somewhere in its SEC filings.

Source: Herbalife

At most companies, maybe, but not at Herbalife, the fast-growing multi-level marketer of nutritional shakes and weight-control supplements.

Reason for my focus: In a recent appearance on Jim Cramer’s Mad Money, Jim asked CEO Michael Johnson, “How much of what you are doing right is because you have taken to take this company to develop product superior to others?”

Johnson replied, “Jim, if it's a product development question, we have a terrific team in here of doctors, scientists, researchers doing research around the clock in this company.”

The company isn’t shy about its obsession with research. In a section of its website headed “Research & Development,” Herbalife says: “We are advancing the science of nutrition through scientific research conducted around the world. Since 2003, we’ve increased our research and development expenditures dramatically to advance the product-development process.”

Herbalife even has a “product development” section in its 10-K where it says, “Our research and development is performed by in-house staff and outside consultants.”

But then, a little further down the R&D disclosure, the company says (oh by the way — and this is the important part): “Research and development costs were expensed as incurred and were not material.”

Not material?!

What about all of those scientists, researchers and consultants? What about the working “round the clock?”

In response to my inquiry, a spokeswoman offered a lengthy explanation (this is just part of it):

“The type of expense that would constitute R&D under the FASB, such as the type of molecular compound research that a pharmaceutical company would undertake, is different than that commonly performed in the food and dietary supplement industry. Please don’t misread this to say that we are not doing extensive work that would commonly be considered R&D in our industry. The statements that Michael made on Mad Money were referring to this more common connotation of R&D. Our research and development efforts are both internal and external, with both types of resources expanding as the company is growing. Our internal product development staff consists of scientists, chemists and other professionals who formulate new products, line extensions and make adjustments and improvements to existing products to reflect the changing scientific and regulatory landscape in our 81 markets."

The company added: “These expenses, which are either in our financial reports as SG&A or an inherent part of our cost of goods sold, are not specifically called out as research and development in our public filings.”

But they should be, or at least they should be broken out somewhere. “Without being overly technical, let’s just say whatever costs are incurred for R&D activities does indeed belong to R&D and should be expensed,” says Pennsylvania State University accounting professor Ed Ketz, co-author of the Grumpy Old Accountants blog. “Common sense tells you that everything Johnson is talking about comprises R&D. Not to include it as R&D is incorrect, to say the least. If the items are expensed, I don’t see why the firm is mislabeling these activities.”

So why not break it out? Maybe because despite the R&D hype, and per the fine print in its 10-K, Herbalife doesn’t really spend much money on it. After all, last year 29 percent of the company’s revenue last year came from a product it has been selling since for 32 years.

Which gets us to the question: What is Herbalife?

To Wall Street, the company is anything but just a multi-level marketing company.

Yet according to its 10-K, Herbalife describes itself “a global network marketing company that sells weight management, nutritional supplement, energy, sports & fitness products and personal care products.” Those products are sold through 2.7 million “distributors” — most of them individuals, and many of them selling to family and friends.

So, it’s a multi-level marketing company, right?

Herbalife to me: “While we will always sell through the MLM channel, limiting our peer group to the channel, not the products, creates a skewed and limited view of the business universe. We believe the more accurate comparisons are between Herbalife and other multi-national food and personal care companies. “

One big difference: Multinational food and personal care companies spend hundreds of millions of dollars on R&D (which they disclose in their annual SEC filings). At General Mills and Procter & Gamble it’s 2 percent of annual sales. Another: The multi-national food and personal care companies sell through retailers. And still another: Most of the big food and personal care companies manufacture most of their products. At Herbalife, according to its 10-K, "The majority of our weight management, nutritional and personal care products are manufactured for us by third party manufacturing companies."

Why should Herbalife investors care? Because it’s always a red flag when a company tries to convince Wall Street it is something else.

None of this is meant to take anything away from the company’s strong revenue, earnings and stock price growth over the past two years, the quality of its products or management’s execution and innovation. It’s about whether Herbalife is being valued as something it isn’t.

“It’s not being valued properly,” says Auriga USA analyst Gary Albanese, referring to other analysts, whose price targets suggest multiples well in excess of 20-times 2012 results.

Albanese has steadily been increasing his targets to reflect the company’s growth, but believes regardless of its claims Herbalife really is little more than a multi-level marketing company. MLM’s typically trade at around 12 times earnings), but given its growth he gives Herbalife shouldn’t trade at much more than its current 16-times forward earnings. Put another way: Little room for error.

My take: Herbalife, which pays a 2 percent dividend, has not only generated impressive growth, but its ability to generate free cash flow is nothing short of outstanding. Still, I don’t like it when companies try to position themselves as something more than what they are — and say one thing to Wall Street and something else in their SEC filings. It just makes you wonder what else isn’t quite as it appears.

Questions? Comments? Write to

Follow Herb on Twitter: @herbgreenberg

Find Herb on Google+