Nu Skin Shares Drop Sharply on China Probe

Communist Party Paper Alleges U.S. Company Is Operating Pyramid Scheme

The Wall Street Journal/January 16, 2014

By Lilian Lin and Carlos Tejada

Beijing -- Shares of Nu Skin Enterprises Inc. NUS -2.68% dropped sharply Thursday after Chinese officials said they would investigate accusations that the company is operating an illegal pyramid scheme.

China's State Administration of Industry and Commerce said it was taking seriously a report in Wednesday's edition of the People's Daily newspaper that made the allegations. "If the situation proves to be true, the commerce agency will deal with it according to the law and regulations," the agency said.

The People's Daily, the Communist Party's main propaganda organ, had said the U.S.-based company uses direct-marketing methods "akin to brainwashing." It called the company's bonus and worker-management systems "pyramid schemes" and said distributors were selling more types of products than are allowed by Chinese regulators. In a pyramid scheme, salespeople are rewarded by recruiting additional salespeople.

Nu Skin, which makes skin-care and nutritional products, said Thursday that there likely would be a negative impact on its China revenue but that it was is too early to know whether its previous forecast would be affected.

China is Nu Skin's biggest market. Mainland China accounted for $667.4 million, or 31%, of the company's $2.16 billion in total revenue for the nine months through September. In the Greater China region, which includes Taiwan and Hong Kong, the company had 57,780 so-called sales leaders, more than half its global total. The company defines sales leaders as Nu Skin sales employees, contracted sales promoters in mainland China and independent distributors that meet certain sales goals.

The company, which is based in Provo, Utah, in November forecast a 22% to 25% increase in revenue for this year and an increase of 25% to 30% in earnings per share.

Nu Skin's shares were down as much as 39% on the New York Stock Exchange shortly after the company released its statement. The stock closed down $30.43, or 26%, at $84.80. The decline followed a 16% drop Wednesday.

Nu Skin said it would communicate with Chinese regulators to address any questions and had begun its own review of business practices in the country. "Given the substantial growth in our China sales force over the last year, we are also taking additional steps to reinforce our training and education efforts," Nu Skin said.

The company said Wednesday that the People's Daily report "contains inaccuracies and exaggerations that are not representative of Nu Skin's business in China. The reporters did not attempt to verify any information with Nu Skin. We do not believe that the article was the result of any particular government inquiry."

In most places, Nu Skin sells its products through direct marketing. The company has said that in China it sells through physical stores, as well as through direct sales where permitted, to adhere to local regulations.

The Nu Skin probe sent Herbalife Ltd.'s stock tumbling. Shares of the nutritional-supplement maker, which operates entirely through direct marketing, fell $7.75, or 9.8%, to $71.63 on the Big Board. Shares of the two companies typically trade in tandem.

"We are confident in our consumption-based business model in China," said Herbalife spokesman James Golden.

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