The Switch from Private to Public and What to Expect from Herbalife

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The Switch from Private to Public and What to Expect from Herbalife
Anna Serna
Seminar in Accounting Topics
ACC 700-X3318
Southern New Hampshire University













The Switch from Private to Public and What to Expect from Herbalife

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Table of Contents

Executive Summary.. 3
Motivations to Go Private..4
Costs of Switching and the Culprit Known as SOX..6
Conclusion.7
References..9


















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Executive Summary
Prior to the Sarbanes Oxley Act of 2002 (SOX), it was incredibly common to see companies
make the move from a privately held company to a publicly traded status. Rieger (2006)
stated, The key reasons companies go public is to tap into the capital markets as a source of
cash for growth and capital improvements. Being listed on the stock exchange was
considered to be prestigious and it allowed a company to extend their brand to a wider variety
of markets. In addition to this, going public also means more investor control over operations
and decisions, unlike a private company that is management-friendly. The privilege of being
listed on the stock exchange also means vulnerability to investor scrutiny; the quarterly
reports are the main concern to company shareholders and a bad quarter can have an adverse
effect on management. The focus may shift to misstating financial statements to deceive the
public into believing that the company is successful each quarter. Once accounting scandals
started dominating the news, Congress took measures to ensure that auditors were truly
independent from their clients and that the financial statements released by publicly traded
companies were presented fairly. With new regulations come new expenses to stay in
compliance. This paper will explore some reasons why a company would want to make the
switch from public to private. Herbalife serves as the company of choice as the company is in
the middle of different scandals and is pondering a possible return to private status. Public
companies go private in order to gain full control of their company without having to deal
with the constraints set by both Securities and Exchange (SEC) and SOX.





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Motivations to Go Private
Companies go public and private for a wide variety of reasons. The motivating factor
depends on the company itself. Herbalife is an interesting company because it initially started
off as a private company that went public and is now considering a return to being private.
The little-known company that sells meal supplements and other health related products (via
distributors through a multi-level marketing structure) has seen many changes since its
founders death in May 2000. Darmiento (2003) stated, In 2002, an investor group that
wanted to revitalize the brand took the company private. Doing this allowed them to focus
on growth instead of quarterly expectations. They were able to expand the product line from
shakes to vitamins, teas, and protein bars. When former Disney CEO Michael O. Johnson
took over, the company went public for the second time in 2004. Holman (2004) said that,
The company filed with the SEC on October 1, 2004 to raise up to $345 million in an IPO
on the New York Stock Exchange. In theory the move was sound because the company was
not only able to grow, but become the sponsors of high-traffic events like the Los Angeles
Galaxy soccer games and the Latin Grammy Awards. The company was able to boast billions
in revenue and appeared to dominate their industry. Unfortunately their multi-level marketing
structure is under attack by prominent hedge fund manager Bill Ackman.
Ackman has accused the company of running a pyramid scheme that benefits off of
the enrollment of distributors instead of the actual products. Distributors receive an automatic
25% discount on all products they wish to purchase. Ackman claims that the revenues are
primarily from enrolled distributors who mainly purchase the products for personal use. The
more distributors a person has on their team the more profitable they become since they
receive royalties off of their recruitments. Ackman is selling the stock short and hopes to see
the company go bankrupt, as he will see a large profit should this occur. Herbalife insists that

The Switch from Private to Public and What to Expect from Herbalife

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their model is effective and in compliance with SEC regulations. This is not the first time the
company has dealt with fraud allegations. Darmiento stated that, Similar accusations
plagued the company in the mid-1980s that resulted in an injunction by Californias
Attorney General that set guidelines on how the company would be allowed to operate their
multi-level marketing method. Herbalife is not the only organization to benefit from this
type of marketing. The Pampered Chef and 31 Gifts are also companies who benefit off of
distributor-only sales. Pfeifer (2013) stated that, Prominent businessman Carl Icahn bought a
significantly large amount of stock making him a highly invested owner of the company.
Icahn believes he can salvage the reputation of Herbalife by delisting the stock and going
private once more. His motivation is growth and freedom from Wall Street.
Ladika (2004) said that, Companies choosing to go private weigh factors such as
cost and strategic freedom in order to help support their decision. Cost of being a public
company can outweigh the benefits, especially for a smaller company. Ladika also stated that
companies with annual revenue of less than $1 billion saw their costs of maintaining their
public status double between 2001 and 2003 (after SOX was implemented). The Catalyst
Journal staff (2004) said, The added costs of compliance associated with SOX have caused a
dilemma for the small to mid-sized companies. In order to continue as a going concern, a
company cannot have expenses exceed their revenue. Kahn (2003) stated, Although SOX
was designed as a safeguard to shareholders against corporate fraud, it can cost $1 million a
year in additional auditing and legal fees. For a small company, $1 million can be
overwhelming and keeping up with the fees can be stressful. If the costs of being public
exceed the benefits, it may be in an organizations best interest to become private and avoid
unnecessary expenditures.


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Costs of Switching and the Culprit Known as SOX
Holman mentioned that when Golden Gate and Whitney took Herbalife to its private
status, the related fees were $685 million. Kesterson (2003) had stated that, The process of
going private can take 24 months or longer because the consent of stockholders and the
mandatory filing of paperwork with the SEC is required. The finances involved ensure that a
company that switched from private to public will stay committed to maintaining their public
status with the SEC by complying with the regulations and periodically submitting required
paperwork. If the fees were minimal or non-existent we would see constant switches from
public to private, which would shake investor confidence and allow companies to constantly
find ways to get creative with accounting. The markets would not be consistent and it would
be difficult to compare companies in similar industries.
SOX regulations and the costs of compliance has been a major force in the shift from
public to private. Kesterson believes that costs associated with SOX is scaring smaller
companies. Kesterson is not the only author that sees a correlation between SOX and the shift.
Ladika believes that SOX is to blame for the switch by noting that some corporate leaders do
not feel that the company is not getting its moneys worth by being public. This does not
necessarily relate to the fees; when a company is public they are not longer able to make
decisions involving growth or expansion because the investors are now in charge of which
direction the company will go in. Being public can stunt growth and creativity. A company
may feel that going private will allow them to make better business decisions instead of
focusing on quarterly results and answering to outside investors who may not understand the
hard work required by management to keep the business afloat.



The Switch from Private to Public and What to Expect from Herbalife

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Conclusion
With the growing frustrations of SOX, society may continue to see public companies
flock to the private sector. Kesterson feels that the regulations are becoming more
burdensome and overwhelming. Not all companies can benefit from the costs associated with
maintaining their once desired public status. Making the choice to go private should not be
taken lightly as there pros and cons to this. On a positive note, a switch means more favor for
management decisions. The company can grow product lines, expand their locations, or go
global without having to seek approval from outside investors. The potential for growth is
unlimited. A major disadvantage to being private is the fact that the investor pool is limited
and finding new sources of capital can be tricky. When a company is traded on the stock
exchange, it is easier for an investor to provide funds that will help a company become a
dominant figure in their industry. In the end, size and costs will determine what is in the best
interest of an organization.
It is too soon to determine the fate of Herbalife as they have not made any formal
announcements of their public status. Inquiries by the SEC have been rumored to occur, but
nothing has been released in relation to it. Time and investigative efforts will reveal if the
company is in fact running a pyramid scheme under the guise of a health conscious company.
Herbalife is having a difficult year thanks to the fraud accusations, the shorting of stocks by
Ackman, and the resignation of their external auditor KPMG due to insider trading on the
accounting firms behalf. According to Alden (2013), the company has selected
Pricewaterhouse Coopers as their new auditor. Alden stated that, Pricewaterhouse Coopers
performed payroll and administrative services and that PwC determined that these services
would not affect the auditors objectivity or its impartiality. This can be seen as a red flag
since PwC was providing them non-auditing services during the years KPMG was the

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auditor; the financial statements for that period must be verified by PwC and that can be seen
as an independence breach since they will be auditing statements that they had an influence
on as advisors. Could the motive behind this be to assist in covering up any fraud that has
occurred or could it be that Herbalife feels comfortable working with a familiar firm?
In an effort to downplay the negative press it has been receiving since January, CEO
Michael Johnson recently announced that Herbalife is the official nutrition sponsor of world-
renowned soccer star Cristiano Ronaldo of team Real Madrid. The five-year partnership with
Ronaldo should help solidify their status as a reputable nutrition company since it is not an
easy task to get an exclusive sponsorship contract with a World Cup winner. Based on the
information that has been released, it is safe to assume that they will most likely go back to
their original statusa privately held company. Switching will result in less compliance fees
and more revenue as well as product expansion. Changing from public to private is not
always a sign of failure or defeat. Going private means the company wants to take care of
itself without any strings attached to the SEC and outside investors. In the end, it could be the
best decision a company has ever made.










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References
Aldean, W. (May 21, 2013). Herbalife Hires a New Auditor. Dealbook. Retrieved from:
http://dealbook.nytimes.com/2013/05/21/herbalife-hires-pricewaterhousecoopers-as-
auditor/.
Anonymous. (Mar/Apr 2004). Ohio Public Company Going Private to Avoid SOX? Catalyst
Journal by Ohio Society of Certified Public Accountants. Retrieved from:
http://search.proquest.com.ezproxy.snhu.edu/docview/219314088.
Darmiento, L. (November 24, 2003). New Herbalife CEO Seeks Return to Glory Days. San
Diego Business Journal. Retrieved from:
http://search.proquest.com.ezproxy.snhu.edu/docview/226933550.
Holman, K. (November 11, 2004). PE Firms Cash in on Herbalife IPO. The Deal. Retrieved
from: http://search.proquest.com.ezproxy.snhu.edu/docview/220356963.
Kahn, J. (May 26, 2003). The Burden of Being Public. Fortune. Retrieved from:
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Kesterson, M. (June 20, 2003). Public Companies Weigh Benefits of Going Private. St.
Louis Business Journal. Retrieved from:
http://search.proquest.com.ezproxy.snhu.edu/docview/228361224.

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Ladika, S. (December 2004). Going Private. HRMagazine. Retrieved from:
http://search.proquest.com.ezproxy.snhu.edu/docview/205137275.
Pfeifer, S. (April 25, 2013). Herbalife to Reassure Investors AT Its Annual Meeting the Firm
Is Expected to Say Its Strong and Healthy. Los Angeles Times. Retrieved from:
http://search.proquest.com.ezproxy.snhu.edu/docview/1346711990.
Rieger, J. (October 2006). Should Your Company Go Private. AFP Exchange. Retrieved
from: http://search.proquest.com.ezproxy.snhu.edu/docview/225992972.