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George Soros Looks to Ignite Short Squeeze

Monday - 8/12/2013, 4:06am  ET

George Soros, the man who famously broke the Bank of England on Black Wednesday, earning more than $1 billion in profit on the trade, has been rumored to have taken a large stake in Herbalife . In my opinion, this is a move on Soros's behalf to try to ignite a short squeeze in Herbalife shares. 

Short interest in Herbalife currently stands at more than 30 million shares, or more than 35% of the float. Certainly, the largest short seller of Herbalife shares has been Bill Ackman who is now down more than $300 million on his $1 billion short bet against Herbalife. Ackman has been very public with his case that Herbalife is a pyramid scheme destined to collapse. However, the result has been that Ackman has likely garnered more negative comments than Herbalife.

Carl Icahn, a much wealthier and, judging by net worth, more successful investor than Ackman has accused Ackman of publicly taking down Herbalife in late 2012 in order to boost returns. Icahn then announced a large long position in Herbalife stock, which has performed quite well. I am not going to spend more time here discussing the ongoing feud between Icahn and Ackman as it has already been discussed at length by the media. Instead, I will turn my attention to the latest news: George Soros's long position.

Some Facts on Herbalfie 

  • Currently trades at 13 times projected forward earnings. 
  • Had traded at as much as 20 times forward earnings in 2012 and as little as 7 times forward earnings in early 2013. 
  • Pays an annual dividend of $1.20 giving shares a current yield of just under 2%, well above the current yield on the 5-year Treasury. 
  • Q2 net sales of $1.2 billion, an 18% increase from a year ago. 
  • Q2 EPS of $1.41 per share compared to $1.09 per share a year ago. 

Based on the facts, Herbalife seems to be something of a normal stock, trading in the middle of its historical valuation range, paying a healthy but not massive dividend, and growing earnings at a reasonable pace. This is what leads me to believe that Soros's bet is really a play on Herbalife the stock's short interest and not Herbalife the company's fundamentals.  

How a short squeeze might happen

So far, Ackman has made it clear that he has not covered any of his short position. However, a continued move higher in Herbalife shares, which will lead to more paper losses for Ackman, will put more pressure on Ackman to cover.

Additionally, another possible cause of a short squeeze is if Ackman faces large investor redemptions. Ackman's Pershing Square finished 2012 with a net return of 12.4%, which was less than the 16% return on the S&P 500. While it is difficult to speculate on Pershing Square returns so far for 2013, it should be noted that Herbalife shares are up 100% so far in 2013 and J.C. Penney shares, another controversial holding for Ackman, are down 30% so far in 2013. Of course, Ackman longs such as Procter & Gamble and Canadian Pacific railway have done well, both up about 20%, but so too have the indices. The S&P 500 is up more than 15% so far in 2013.

Soros J.C. Penney stake

In late April, George Soros revealed a 7.9% stake in J.C. Penney, a name that Ackman's Pershing Square owns nearly 18% of. It would not surprise me to see Soros use his position in J.C. Penney to put additional pressure on Ackman. By selling his shares, Soros could put additional pressure on J.C. Penney shares over the short-term, which could lead to more negative publicity for Ackman.

Perhaps of more importance than Ackman's sizable positions in both Herbalife and J.C. Penney is the publicity surrounding both of these positions. These are not quietly poorly performing holdings, they are loud poorly performing holdings, which could help influence investors to withdraw capital from Pershing Square. A capital flight from Pershing Square would force Ackman to cover Herbalife shares, leading to a short squeeze.    

Canadian Pacific impact

Ackman has recently announced plans to sell up to seven million shares of Canadian Pacific over the next 6-12 months. Pershing's total position in Canadian Pacific is currently valued at more than $3 billion. If Soros, through his positions in J.C. Penney and Herbalife is able to ignite an Ackman run in which investors withdraw a substantial amount of capital from Pershing Square, Ackman would likely decide to liquidate his Canadian Pacific position more quickly. Canadian Pacific is Ackman's largest holding and also a holding he has already decided to being selling so it would make sense for Ackman to speed up this process if needed.

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