THE HEDGEYE EDGE
Broken Business Model
Multi-Level Marketing (MLM) companies should not be public companies. NUS can only grow its revenues by recruiting new distributors into the system. This requires either growth in new markets, and/or new products in order to attract new distributors.
At market saturation, all this is really illusory: there’s not enough addressable market left, and not enough margin so that a new distributor can actually make a profit. It all falls apart when a light is shone on the company’s business practices. In our view, Nu Skin’s questionable business practices have been a part of the company's since it was founded.
VitaMeal Hiding in Plain Sight
Selling VitaMeal as a charitable donation is a genius idea! Unfortunately, it appears those days are over, or we should say, are nearly over. Until recently, VitaMeal has been the secret weapon of NUS: the ultimate pyramid scheme within a pyramid scheme, and presented as a charity. The unwinding of this product could have significant implications for NUS financially.
SEC Investigation and the Lack of Disclosures
NUS is under investigation by the SEC. Given how significant VitaMeal is to the earnings of the company and the significant conflicts of interest that it appears to present, we think it’s just a matter of time before the SEC expands its investigation into the company’s business practices. Any new allegations of improper behavior will be financially devastating to the company on the heels of the ongoing 2014 scandal in China and the already challenging financial statements.
INTERMEDIATE TERM (TREND)
The SEC is already investigating NUS for charitable giving the company made in China. With the SEC already under the hood, what else might they find? We believe that there is a high likelihood that they will uncover more than they were expecting.
The increased level of scrutiny surrounding VitaMeal, combined with how the company/distributors promote the sale or “donation” of the product, cannot be overlooked. If, in fact, the SEC brings the hammer down on NUS regarding actions in China and they are required to change the way they represent VitaMeal, it could greatly diminish their ability to recruit new distributors. This is key because distributor growth is the only way that NUS revenues really grow, as revenue per distributor has been in a precipitous decline since 3Q12.
LONG TERM (TAIL)
If what we think comes to fruition in the intermediate term, there won’t be a long-term for NUS. However, if we are wrong we still predict a precipitous deterioration of the company fundamentals. As the company continues to burn through cash, it will be hard to maintain their share buybacks to prop up the stock, especially while under immense pressure from regulators. Additionally, the allegations of the DOJ against USPlabs, among others, specifically called out anti-aging regimens as a focus for current and future investigations. The dietary supplement industry is under enormous pressure from regulators, and MLM’s add an additional layer of risk to the equation.