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The Long Case for Herbalife

Often, when big-name short traders like Bill Ackman and David Einhorn start taking shots, your stock is in deep doo-doo. But one big-time investor isn’t scared by the recent sharks in the water circling Herbalife (NYSE:HLF).

In fact, he’s putting a third of his portfolio behind the chance Herbalife stock could soar soon.

Robert Chapman is the founder of Chapman Capital LLC, a Los Angeles-based investment firm specializing in turnarounds. And he’s banking on a big-time turnaround in HLF stock across 2013, based on a recently published report.

As Chapman puts it in his report, his “summary investment thesis” is as follows:

Ackman will fail to influence/cause material regulatory restraint or a HLF distributor disenchantment/exodus, consequently getting “short squeezed” mercilessly by a fast and furious combination of HLF share count shrinkage (buyback) and excellent operating performance (beat and raise dynamic).

Here are the details:

FTC Long Shot: Many criticisms are levied on the basis that the Federal Trade Commission will hamstring Herbalife by taking action against the company as an illegal pyramid scheme. But if it doesn’t? Well, Ackman’s “zero” price target is almost impossible to achieve. Furthermore, Chapman insists Ackman knows the FTC won’t act. He writes that “instead Ackman realized that he had to focus on existing and prospective HLF distributors, praying the media attention had materially deleterious impact on their behavior/decisions regarding joining the HLF team.”

Ackman Had Perfect Timing: Chapman goes on to write, “Essentially, my hypothesis is Ackman, with overall 2012 performance impaired by JCP’s descent into the teens, came to conclude he needed a big winner before year-end 2012.” He also states, “A classic bear raid involves creating abject panic in the market, and using the proximity to Christmas, the December option expiration, and the depth of Ackman’s presentation, the impact on the shares was maximized.” In other words, the timing of the crash was perfect for Ackman … but not permanent for shares.

Herbalife Isn’t Dead in the Water: Another plus of the late-year pile-on was that HLF had its hands full assessing and responding to the situation. But Champan says that is about to change in a hurry with its own PR campaign as well as the threat of litigation. Chapman writes pointedly, “Herbalife has reportedly hired Boies, Shiller & Flexner the law firm founded by famed litigator David Boies. Consider Boies’ HLF team to be the Navy Seals Team 6 of litigation — you really don’t want them on the other side of your war.”

Fundamentals and Valuation: Silliness of the short-side trading game aside, just look at the numbers. Growth is strong. Shares are being repurchased rapidly. Herbalife has plenty of wiggle room in its debt. It has a decent but sustainable dividend. HLF is fairly valued. What more do you want?

Strength on the Other Side for Herbalife: This is the most important point for true longs: After this Ackman mess, the uncertainty around Herbalife will be resolved definitively and favorably for all shareholders. In other words: “Ackman’s essentially fired nuclear missiles at HLF’s business model and its legality. When (and not “if”) HLF’s regulators and distributors essentially blow off Ackman’s claims as either old or no news, HLF will for all intents/purposes become bulletproof and battle tested.”

Now, there are some clear risks here, so don’t go racing to pile on. Yes, Herbalife stock has rebounded from lows of around $24 a few weeks ago to about $34 currently. But the 52-week high for shares is about twice current valuations, and a lot of negativity remains. Consider that after Bill Ackman web-streamed a 300-plus-slide PowerPoint presentation, he also helped create the website FactsAboutHerbalife.com — compiled and hosted by Ackman’s Pershing Square Capital Management. So while the initial story is old, the criticisms and facts remain out there and loom large in the short-term for anyone looking around for investing insight.

Also, hedge fund manager David Einhorn of Greenlight Capital is bearish on the stock, too. Einhorn correctly predicted the breakdown of one-time momentum darling Green Mountain Coffee (NASDAQ:GMCR) last year. And CNBC stock junkie Herb Greenberg shared his own concerns in May — notably about the “distributor” model. So Ackman is not alone.

Still, it’s very interesting to look at the other side of the trade here.

You can read the whole report from Robert Chapman on the blog of attorney Kevin Thompson.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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