Reuters / Shannon Stapleton
Bill Ackman would be right to be worried about his Herbalife short following the company's decision to do a Dutch auction.
First and foremost, the company's surging stock - up 11% over two days after a report that it held talks to go public - has cost the Ackman-led Pershing Square Capital Management roughly $115 million on a mark-to-market basis, according to data compiled by financial analytics provider S3 Partners.
And Ackman personally could be in for more pain due to Herbalife's decision to execute a so-called "modified Dutch auction," through which the company will buy back $600 million of shares at $60 to $68 a pop. Beyond that, all shareholders who sell back their stock will get an addition cash payment if Herbalife is acquired at a higher price than the auction range sometime in the next two years.
The buyback of 8.8 million to 10 million shares could actually end up squeezing Ackman out of some of his shorts, which he started accumulating five years ago while accusing Herbalife of operating as a pyramid scheme. S3 estimates that if the Dutch auction is fully tendered, Ackman could face 3 million to 5 million share loan recalls. After all, he makes up roughly 75% of the company's short interest.
But it doesn't end there. Once the number of Herbalife shares available to be loaned plummets following the auction, the cost to borrow the company's stock will "increase dramatically" from around 2% into the 10% to 40% area, according to S3.
So to what extent will that hurt Ackman's wallet? He currently pays about $63,000 a day in financing costs, but that could skyrocket to $300,000 to $1.2 million a day once the auction is complete, S3 says.
Long story short, the Dutch auction will hit Ackman from two angles: loan recalls and financing costs.
Your move, Bill.
Short interest in Herbalife is up 28% this year, but bearish speculators have lost roughly $150 million over the past two days.