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Why are Dan Loeb and Bill Ackman fighting over the future of Herbalife?

Hedge fund manager Bill Ackerman says Herbalife is a pyramid scheme and has bet $1 billion on its fall. Hedge fund manager Dan Loeb begs to differ and has bet $350 million that the stock will rise in value.
Hedge fund manager Bill Ackerman says Herbalife is a pyramid scheme and has bet $1 billion on its fall. Hedge fund manager Dan Loeb begs to differ and has bet $350 million that the stock will rise in value.

Herbalife has a headquarters in downtown Los Angeles, is incorporated in the Cayman Islands, is run by CEO Michel Johnson, a former Disney executive, and has been in business for more than 30 years. It did $3.5 billion — yes, that's billion — in net sales in 2011, has 6,000 staff employees and three million — that's million — independent distributors worldwide.

And since late last year, it's been under assault by Bill Ackman, who runs Pershing Square Capital Management, a New York hedge fund. Just before Christmas 2012, Ackman conducted a three-hour presentation is which he worked through 343 PowerPoint slides (see it here and add to Business Insider's over three million page views for the post) and laid out the case that Herbalife is a pyramid scheme. Ackman has set a target price for the company's price of zero. 

Yes, zero. (The stock closed at $39.95 Wednesday).

He's also set up a website to push his story.

For Ackman, this is a holy crusade against what he considers to be a company that's less interested is making money by selling its than it is in signing up new suckers to sell its products. That's how pyramid schemes work — those at the top get rich by exploiting a much larger number of people at the bottom. 

Herbalife has never been declared a pyramid scheme in the U.S., but a court in Brussels did call it one. Companies that engage in "multi-level marketing" are often charged with being pyramid schemes. 

Ackman characterizes the alleged victims of the scam as "low income" people who don't have a lot of options are fall for Herbalife's pitch — entrepreneurship leading to financial independence.

He's not fooling around. Ackman has amassed a $1 billion-plus short position, using 20 million Herbalife shares. After he made his presentation on December 20, 2012, the company's share price completely tanked. It has since recovered somewhat — and Herbalife CEO Johnson has posted a video to the company's website that defends the business and extols its virtues.

On Wednesday, Dan Loeb, who runs hedge fund Third Point, announced he was buying  nearly nine million Herbalife shares — 8.2 percent of the company, worth $350 million. Loeb has been busy. In 2011, he agitated for changes at Yahoo until he forced out CEO Scott Thompson and got him replaced with Google's Marissa Mayer. He's also made a bundle betting on Greek debt, a risky deal if there ever was one.

Ackman and Loeb are reportedly friends, but they're on opposite side of this trade. Some Wall Street insiders have speculated that Ackman built his "Big Short" against Herbalife and accused the company of running a Pyramid scheme late last year so that he could book profits for his fund in 2011. He says that isn't case, and that his team committed a huge amount of time — almost two years — and resources to analyzing Herbalife's business. 

For his part, Loeb doesn't buy it and has laid out his own counter-thesis for investors. Bottom line: He sees a lot of upside in Herbalife and doesn't think Ackman is going to succeed in his crusade.

Robert Chapman, an L.A. investor, has joined Loeb and, further, written a long analysis of why Ackman is wrong, all wrong. Chapman's argument is that Ackerman needs the Federal Trade Commission to put Herbalife out of business, in order for the company to go to zero. And Chapman doesn't see any real precedent for the FTC taking on Herbalife.

However, the Securities and Exchange Commission is taking a look at Herbalife, the Wall Street Journal reported Wednesday.

Herbalife has scheduled an investor and analyst presentation for 9 a.m. ET/6 a.m. PT Thursday. I'm going to live blog the webcast to see how the company deals with Ackman's accusations. 

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