Ackman Cuts Herbalife Short

Oct 3 2013 | 3:25am ET

Sitting on a paper loss of $500 million on its $1 billion short bet against Herbalife, Pershing Square Capital Management is cutting back on its risk.

The hedge fund told clients yesterday that it had reduced the size of its short against the nutritional supplements company by 40%, replacing it with long-term put options. The move leaves Pershing Square poised to reap the full reward of a Herbalife failure while protecting it against further losses if the stock, which has more than doubled this year, continues to rise.

"If the company fails within a reasonable time frame we will make a similar amount of profit as if we had maintained the entire initial short position—while mitigating the risk of further substantial mark-to-market losses because our exposure on the put options is limited to the total premium paid," Pershing Square founder William Ackman wrote in Pershing Square's third-quarter letter. The hedge fund lost 5% on the quarter and is up 0.5% on the year.

Ackman made clear that he hasn't lost faith in his thesis that Herbalife is a pyramid scheme that will be shut by federal regulators. He said the move from short interest to put options protected Pershing Square against a potential short squeeze.

"While we have endured mark-to-market losses on this investment as Herbalife bulls have promoted the stock and downplayed the probability of government intervention, we believe it is only a matter of time before the company is shut down and prosecuted by regulators." Ackman said he had not seen "a less attractive risk-reward ratio than a long investment in Herbalife common stock at current levels."

Pershing Square's out-of-the-money options expire in 2015 and were obtained on the cheap, due to Herbalife's surging share price.

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