When the Wolves Bite

by Scott Wapner

  Hughes tried to reassure his customers that despite the growing criticism, the business would survive.

  “There are going to be a whole lot more articles that are going to come out about this company,” Hughes told his loyalists. “And they’re not all going to be positive. Some are going to be very negative. They’re going to take some shots at us. They’re going to say some things are wrong with our products. They’re going to say some things are wrong with the ingredients.”

  On October 16, 1986, Herbalife settled with the state of California. The company agreed to pay an $850,000 fine and to stop some of its controversial marketing practices. The company didn’t admit any wrongdoing, and after the settlement Hughes claimed victory.32

  “I’m pleased to announce that after a year and a half, with many many discussions with the Food and Drug Administration, the California Attorney General and the State Department of Health, that all three of these agencies have independently determined that Herbalife have been, and still are, safe for the American public—and that all of our claims, products and marketing materials are now in complete compliance with the letter of state and federal law,” he said.

  Just one week later, on October 25, 1986, Hughes took Herbalife public on the Nasdaq exchange, making himself enormously rich.

  Hughes continued to expand Herbalife, focusing on overseas markets. In 1990, Herbalife opened in France and Germany, then, in 1992, in Italy, Japan, and Hong Kong. By 1996, Herbalife was in Greece and South Korea and spreading quickly. Hughes was earning $17 million a year, making good on his promise “to take Herbalife around the entire world.”33

  In February 2000, during the company’s five-day twentieth-anniversary celebration at the Los Angeles Forum, a video highlighted the company’s history—its rise from the back of Hughes’s car to global powerhouse. Hughes handed out million-dollar checks to top sellers, while tears rolled down his cheeks. Hughes seemed overwhelmed by how far Herbalife had come.

  Just three months later, he was dead.

  At the time of Hughes’s death, Herbalife had one million distributors in forty-eight countries and $1.79 billion in annual sales.34 Investors, though, seemed unimpressed, as Herbalife shares underperformed. A Los Angeles Times story documenting his death said that in the months prior Hughes had tried and failed to buy out the company himself, unable to raise the necessary financing. Herbalife shares had slipped to nearly $10 a share.35

  With its patriarch gone, it wasn’t long before Herbalife began to suffer.

  After sales grew 18 percent from 1996 to 1999, they rose just 7 percent in the first quarter of 2000. Shares dropped 40 percent after hitting a fifty-two-week high that January.36 Herbalife’s bottom line was suffering, and things weren’t much better at the top. Herbalife went through four CEOs in three years. Distributors were essentially doing whatever they wanted, even if it meant pushing the legal limits. One especially questionable practice involved a business opportunity called “Newest Way to Wealth,” which was run by a handful of powerful distributors who pushed an opportunity to “work from home.” Ads were pitched on the radio and cable television by popular personalities. People who answered the spots were asked for their contact information, which was then sold to distributors. The distributor would then call the prospective recruits, who would have to buy thousands of dollars’ worth of products if they decided to join. These dubious business practices would eventually force Herbalife to close the Newest Way operation, but not before facing a class-action lawsuit.37

  Plus, there were doubts as to whether Herbalife could survive without Hughes at the helm.

  Then, in 2002, JH Whitney & Company and Golden Gate Capital, two West Coast–based private equity firms, took Herbalife private for less than $350 million and began a search for a new CEO—someone to lead the twenty-three-year-old company back to prominence.

  On April 3, 2003, the firms announced who they’d found. He was a confident, smooth-talking fitness buff named Michael O. Johnson, and he was then president of Walt Disney International. “A proven winner” is how the official press release described Johnson’s hire.

  “I basically sat with the private equity guys in my Disney office and we talked from 6 p.m. to 11:30 p.m. and talked about what the potential could be,” Johnson said.

  Though he had no MLM experience to speak of, Johnson seemed the perfect fit for Herbalife. He’d done triathlons and was an accomplished cyclist who looked like he could give Lance Armstrong a run for his money. “I felt a kindred spirit with the product.” Johnson said after being hired.38 Johnson was also just the kind of leader Herbalife figured it needed. He was a type-A talent, a spark plug of enthusiasm who was active and aggressive.

  “I think I’ve always been that way,” Johnson said. “That’s the way I operate best.”

  They were traits, Johnson said, that came from his father, who ran a successful manufacturing business in the family’s hometown of Jackson, Michigan. The elder Johnson made crankshafts for diesel trucks, and his company had become the largest maker of the products in the world. He was a Depression-era man who was as tough as nails.

  “He was a very aggressive, successful guy,” Johnson said. “I probably get a little of that from him.”

  As a young man, Johnson seemed destined for his own slice of success. He had good grades in high school, played sports, and had plans to go to the University of Michigan. But in Johnson’s junior year of high school, tragedy struck. His brother—one of five siblings—was killed in a skiing accident in Taos, New Mexico. Johnson’s life went into a spiral.

  “We grew up in two’s,” Johnson said, meaning they were often paired with the sibling closest in age to themselves. “And my brother and I were really close.”

  Johnson’s grades suddenly fell apart, leaving his dream of the fabled university in shambles. Johnson ended up at the local junior college, and in 1973 he moved to Dillon, Colorado, to work at a saloon with a friend. He would end up running the place.

  “I carried around a business card that read, ‘Bus Boy with Keys,’” Johnson said. “I learned more about business there than anywhere.”

  With his life back on track, Johnson enrolled at Western State College of Colorado, majoring in political science with minors in business, history, and English.

  “I took a lot of classes,” Johnson remembered.

  There were stints in sales, and one company offered a transfer to Los Angeles. Johnson jumped at the opportunity and moved to California in March of 1980. He soon grew bored with the new job though, and enrolled at UCLA, taking classes in marketing, script writing, and film.

  “I didn’t know anybody in LA,” Johnson said. “I slept at a friend’s place.”

  Johnson took a series of jobs to make ends meet, selling light shows to the big-name musical acts of the day and working in magazines before finding his way to the more glitzy and glamorous world of entertainment. After several interviews and offers, Johnson chose Disney, where he settled in to the company’s home video department.

  Johnson would spend seventeen years in Burbank, and was considered a marketing whiz. He’d engineered the expansion of Disney’s video business, growing it from thirty-four markets when he took over to more than eighty by the time he left. Johnson had succeeded future Disney CEO Robert Iger in the unit, and he helped turn Disney into the number one distributor of home entertainment in the world.

  At Disney, Johnson was known as the “shake guy” because of his love for smoothies with a blast of protein powder, and he burst with energy.39 He sounded like a motivational speaker when he talked, and he still loved the University of Michigan, frequently flying back to Ann Arbor on Saturdays for the football team’s home games.

  Still, the messy MLM business was a far cry from the wholesome home of Mickey Mouse. Johnson knew it and initially declined the job when approached by the search firm Heidrick and Struggles. “A woman approached me and I said, Herbalife? Are you kidding me?” Johnson said. “I looked at it much in the same way
others did at the time.” Johnson didn’t know much about Herbalife or its business, but had heard enough about its checkered past to pause. “The image was a little, let’s be honest, challenged,” he told an interviewer.40

  Johnson had thought about leaving Disney before but had always passed, even turning down big jobs at AOL and Hertz. “I even got a reputation in the recruiting business as the guy who’d never leave Disney,” Johnson said.

  But the Disney gig had started to develop its own issues. “I had a huge title that didn’t have the proper authority to go along with it,” Johnson said. “I was getting increasingly frustrated.”

  Before accepting the Herbalife job, Johnson did his own research, hoping to dispel any of the concerns he had about the company’s past. “I snuck into an Herbalife meeting in the Bonaventure Hotel in Los Angeles and saw the people in there, and I saw a highly motivated sales force,” Johnson said. Johnson’s recon went a step further, even signing up as an Herbalife distributor to see for himself what the products were all about.

  “I had my trainer do the same thing,” Johnson said. “We would share notes. I got a case study on the lawsuits the company had faced. I looked at the company and just didn’t understand all of the machinations of how the company worked.”

  The private equity shops that owned Herbalife offered Johnson a piece of the business, and he ultimately caved, sensing he could do for Herbalife what he’d done at Disney—expand the brand’s international presence. He also realized he’d never be Disney’s top dog, since Iger had been bumped up to president and seemed the heir apparent to its current CEO, Michael Eisner.

  Johnson figured he could be a positive influence on Herbalife’s rank and file.

  “My personal enthusiasm for fitness and wellness gives me a special attraction to Herbalife’s mission,” Johnson said in a press release announcing his hiring. “Herbalife is a well-established organization with terrific products and a powerful world-class sales network comprised of more than one million distributors.”41

  Herbalife’s powerful distributors welcomed their new, well-established leader after years of unrest.

  “I’m extremely pleased to welcome Michael Johnson to the Herbalife family,” said longtime distributor Leslie Stanford, who was also on the company’s board of directors. “His entrepreneurial spirit and personal passion for wellness is an ideal match with the legacy of this company and will allow him to work well with distributors.”42

  But Hughes’s death—and the chaos that followed—revealed just how powerful Herbalife’s top distributors had become. After he died, fourteen top distributors led Herbalife sales meetings—a testament to their influence.43

  Johnson had no idea what he was getting himself into, which became clear fairly quickly. Shortly after taking the job, Johnson tried to introduce a new product without first consulting distributors. It failed. Distributors didn’t trust him, and they wondered whether he was the right guy for the job.

  Johnson wasn’t sure either, and figured he’d made a mistake taking the job.

  “It was very, very rough,” Johnson told Fortune of the transition from Disney. “There were a lot of issues I didn’t understand. A language was spoken that I didn’t get.”44

  After only a few months, Johnson was ready to quit.

  “There were practices that were taking place that were legal, but I’m not sure they fit what we wanted to be as a company,” Johnson said. “I had some ideas in my head that maybe I wasn’t right for this job.”45

  Ready to walk, Johnson called a mentor, who pushed him to stay. Johnson went home, wrote a business plan that night, and decided to stick it out.

  One of Johnson’s immediate goals was to downplay the shady sales pitches some distributors had been making during the Hughes years. Herbalife had already banned the sketchy “Newest Way to Wealth” lead-generation practice, and in early December 2004, Johnson settled the class-action suit against the company for $6 million, figuring it was time to move on from the past.

  Nearly a week later—and a year and a half after Johnson was hired—Herbalife, which now had $1.4 billion in annual sales, went public again, this time on the New York Stock Exchange, offering 14.5 million shares for $14 apiece. The company raised $200 million.46 Johnson hoped the IPO would help the company move beyond the scrutiny of years past. He also had even bigger aspirations—to turn Herbalife into a truly global powerhouse.

  He outfitted soccer icon David Beckham and his Los Angeles Galaxy team in Adidas jerseys with “Herbalife” emblazoned on the front, knowing the sport was part of the fabric of Europe and Latin America and was growing in popularity in Asia.

  “Adidas produced more than 600,000 Galaxy jerseys in its initial run, and everyone on every one of those is a mobile Herbalife billboard,” said Johnson during an earnings call.47 A few years later, Johnson upped the ante by cutting a deal with another of the game’s legends—Lionel Messi, whose professional club, FC Barcelona, is one of the most successful and popular in the game.

  Johnson was also intent on pushing Herbalife as a life brand—a place to make money in the business opportunity and save it too for when times got tough. On December 16, 2008, during the middle of the Great Recession, and with Herbalife’s stock price tanking along with the rest of the market, Johnson and his executive team went to the New York Stock Exchange for an Investor Day event. Inside an NYSE conference room, Johnson threw to a video, where a narrator pitched Herbalife as a safe port in the now gathering financial storm.

  “Why Herbalife?” the voice asked.

  Well, now is the perfect time. I mean, you’ve seen the news. Let’s face it. It’s a scary time. The economy’s in trouble. Gas prices are at an all-time high. Everybody needs money. Markets are crashing. People are losing their homes. Their jobs. People can’t buy groceries. People are looking for something they can depend on. A better life. Herbalife has the perfect, inexpensive, healthy meals. We have the best nutrition products in the world. Changing people’s lives. A better life, that’s why. Why Herbalife? Herbal-nomics. It’s recession proof.48

  Though Johnson had tried to downplay the role of recruiting—or, at least, the shady methods of recruiting used by some distributors to attract new members—he made it clear to the group what the practice meant to the company’s growing bottom line.

  “We’re focusing on recruiting and the growth of our distributor base,” he told the meeting. “This is absolutely foundational to us. It is making sure that we get our message to distributors, that this company stands 100 percent behind them, that we are confident that you can create an income working at Herbalife, that you can build a business, that you can build an opportunity for part-time or full-time income and for generations to come.”49

  Johnson’s strategy seemed to be working. From 2008 to 2011, total shareholder return in Herbalife stock rose 870 percent as sales soared.50 Not even the Belgian pyramid-scheme lawsuit, brought against Herbalife in November 2011, could derail its growth. That year, Herbalife had $3.45 billion in sales.

  Then there was Johnson’s own incredible success. In 2011, he was the highest paid CEO in America, taking home a whopping $89 million, including stock options, a testament to Herbalife’s meteoric growth under his guidance.51

  By mid-2012, Herbalife had operations in ninety countries and an envious track record on Wall Street. It had turned in eleven straight record quarters, with shares quadrupling over the prior two years. The steady performance led CNBC’s Jim Cramer to once proclaim during an interview with Johnson, “This is arguably the greatest stock we have ever talked about!”

  Johnson seemed on top of the world. Herbalife was humming, and investors had taken notice.

  5

  THE PHONE CALL

  Michael Johnson climbed atop his $3,000 Bianchi mountain bike and set out for the office from his Malibu home. It was May 1, 2012, and in just a few hours, Johnson and his team would run through the previous quarter for sell-side research analysts on Wall Street.

&
nbsp; Cycling the thirty or so miles down the Pacific Coast Highway to Venice Boulevard, then onto Olympic, where Herbalife’s headquarters were located, was a chance for the CEO to clear his head—to break from the routine and get ready for that morning’s somewhat mundane earnings call with analysts.

  Johnson was a grinder. Besides being a regular on the triathlon circuit, he regularly competed in one of the most grueling events in the country—a bike race called the Leadville 100 MTB, a hundred-mile trek through the Rocky Mountains, including frequent climbs, some as high up as 12,600 feet.1 Those who finished the race in less than twelve hours—after managing to wind through the uneven and dust-covered backcountry—got a buckle for their efforts, and a lifetime’s worth of pride. Johnson had scored the brass bounty every time he’d competed and viewed anything less as unacceptable.

  Quarterly conference calls weren’t nearly as grueling or rewarding and had become a formality. Johnson expected nothing different this time around as he pulled into L.A. Live, the complex downtown where Herbalife’s headquarters was located and headed upstairs to his desk with his bike in tow. Once upstairs, Johnson cleaned up, then ran through the prepared remarks he’d read for analysts in a matter of hours.

  At just before 8 a.m. local time, Herbalife’s executives gathered in a conference room to get things going. Seated side-by-side at the long rectangular table was Johnson, President Des Walsh, Chief Financial Officer John DeSimone, and Chief Operating Officer Richard Goudis, along with legal advisor Brett Chapman and a few others. It was expected to be an upbeat affair, as the night before Herbalife had reported strong numbers for the prior three months.

  Johnson began with a few minutes of prepared remarks—a typical run-through of the quarter that was and what the Street could expect from future quarters to come:

  Our financial and business trends continue to be strong. Yesterday, we announced a 24 percent increase in earnings per share, driven by a 24 percent volume point growth. Each of our six regions experienced strong volume point growth in the quarter. Five of the six regions had double-digit volume increases. Four of our regions—Asia, North America, China, South and Central America—exceeded 20 percent growth. Mexico had a 16 percent increase in volume points and Europe, Middle East, and African markets were up 6 percent. Before I elaborate on the quarter, let me say thank you to our distributors, employees, and vendors around the world. The consistency of our growth and financial results is due to your dedication and hard work.2