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Bill Ackman
The Canadian Press via AP/Pawel Dwulit
How do I make this not look like I’ve lost?

Bill Ackman is scaling back his anti-Herbalife bet, so why has the stock price fallen?

Famed hedge fund manager Bill Ackman is scaling back his much-watched bet against vitamin king Herbalife. Normally, news that a big investor like Ackman was pulling back on a massive short position—he famously short-sold shares worth an estimated $1 billion late last year—would be a boon for the company’s share price. But instead, the share price has fallen more than 7%. How come?

Ackman, who maintains that Herbalife is a pyramid scheme, revealed last night in his quarterly letter to investors in his Pershing Square funds that he was curbing his bet on the health shake, vitamin and supplement peddler. His view has pulled him an unseemly spat with high-profile Herbalife shareholders including Carl Icahn, Dan Loeb and George Soros about the company’s legitimacy.

Wednesday’s share price fall comes after a sharp run-up, thanks in part to the company’s strong performance. The doubling of the stock price in 2013 (it rose 55% in the last quarter alone) is also partly due to Icahn and Loeb’s opposition to Ackman, which has forced Pershing to stomach big losses.

But arguably a bigger force at play has been the market expectations of an epic “short squeeze” in the stock, based on the amount of Herbalife shares outstanding and the size of Ackman’s short position. A “short squeeze” is when short-sellers desperately scramble to buy back shares to cover their short positions, creating a virtuous circle of share buying, which in turn lifts the stock price. And the squeeze has been fueled by another rumor: that Herbalife was poised to buy back up to $2 billion of its own shares.

On top of that, the company’s stock is largely held by long-term shareholders, such as the company’s own executives, which likely created a shortage of stock accessible to short-sellers to cover their positions, driving share prices up further. That undoubtedly made it harder for Ackman to get hold of Herbalife shares in his latest move. He managed to cover 40% of the shares he sold short—and likely paid a big premium to do so.

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