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R3: Uniqlo, Crocs, Gilt Groupe, GCO

R3: REQUIRED RETAIL READING

November 2, 2010

 

 

RESEARCH ANECDOTES

  • Private sale pioneer, Gilt Groupe, is said to be exploring an apparel line of its own.  No word yet on whether the line will be private label or an exclusive collaboration with another designer.  Clearly a tightened supply chain and lower quantities of closeouts are taking their toll on the availability of compelling, fashion product.
  • While not the first teen focused retailer to use the smartphone as a promotional “carrot”, Journeys is offering teens a choice of devices for free if they try on a pair of shoes.  The iPhone is not amongst the listed choices.
  • The holidays are here!  According to Responsys, 57% of major retailers have already begun their holiday email campaigns.  A surge emails alluding to the holidays came in the final week of October, outpacing efforts observed in both 2008 and 2009.
  • Add Crocs to the list of brands now participating in the toning category. The shoes are aesthetically consistent with what consumers have come to expect from Crocs with the addition of an Easy Tone Reebok-like sole. Importantly, the shoes sell for $49.99 and $59.99 and well below the industry average, which is now hovering around an ASP of $77 compared to $95 at the start of the year.

OUR TAKE ON OVERNIGHT NEWS

 

Uniqlo Comps Down in October - Fast Retailing Co. Ltd. said Tuesday that Uniqlo’s same-store sales slid 1.1 percent in October, regaining some stability after a steep drop the month before."Temperatures were high until the middle of the month, but fell in the latter half, helping drive sales of winter items," the company said in a release. The figures are a vast improvement on September's comps, which slid 24.7 percent.  Fast Retailing blamed that drop on unusually hot weather. Uniqlo currently operates 799 stores across in Japan after having opened 11 new locations and closed two in the month of October. The chain’s comps refer exclusively to its stores in Japan and exclude its international operations. Uniqlo announced separately that its first store in Malaysia, which is set to be the company's location in Southeast Asia, will open its doors on November 4 in Kuala Lumpur's Fahrenheit 88 mall. To mark the opening of the 23,000-square-foot megastore, Uniqlo is planning to offer customers limited-time bargain prices on popular products such as graphic t-shirts, UJ jeans, and fleece jackets. <WWD>

Hedgeye Retail’s Take: Recall that last year’s launch of Heatech drove substantial comp increases across the globe only to result in disappointment a few months later when the product ended up in short supply.  Clearly Heatech round 2 isn’t helping with warm temperatures across the globe.

 

China Key Market for Ermenegildo Zegna Group. - In the almost 20 years since the Italian luxury men’s wear company entered the market, China has grown to represent some 25 percent of Zegna’s annual sales of 797 million euros, or $1.11 billion, last year, Ermenegildo Zegna, chief executive officer, said during a presentation Monday. The country may eventually account for as much as 50 percent of sales. From 2005 to 2009, sales in China rose 33 percent, and the brand now operates 62 stores in 33 cities in the country. Those stores, which include a Peter Marino-designed flagship that opened in Shanghai last summer, “have to be big and create a wow effect,” Zegna said, because shoppers there seek excitement and exclusivity. The most important products to the Chinese consumer are luxury sportswear and leather accessories, he said, revealing sportswear accounts for 50 percent of the business there and leather accessories 20 percent. Executives at the top of their fields don’t feel the need to wear suits, opting for high-end casualwear instead. “An owner of an enterprise wears what he wants,” Zegna said. <WWD>

Hedgeye Retail’s Take: A rare example of a “first mover” in China while the majority of western brands are looking at the largest population on earth for the first time. 

 

PE Head Forecasts Active M&A Environment - John F. Megrue Jr. is looking at retail and likes what he sees. “Right now is really a unique time,” Megrue, chief executive officer of private equity firm Apax Partners U.S., said Monday. “There is a dislocation in the market,” with retail debt financing coming back as some stock valuations in the sector lag. “We are going to see a much more active period in the next six to 12 months than we have historically.” That assessment from one of the key players in Apax’s sale of Tommy Hilfiger to Phillips-Van Heusen Corp. merits attention. Just where all the action will be is unclear. There has been rampant speculation through the market that retailers across a spectrum might be in play. So far, there have been only a few deals. Private equity firms like Apax are expected to drive much of the action. As a group, the firms have tons of money ready for retail deals — $100 billion according to McKinsey & Co.’s reckoning — as well as access to debt markets. Megrue sketched out some of the attributes that draw the interest of the investing giant, which manages $37 billion and focuses on deals worth more than $1 billion. Apax owns British fashion retailer New Look and another of its holdings, Rue 21 Inc., went public in November. In addition to searching for “well-positioned” brands, Megrue is focusing on online businesses, which he described as an “underinvested” category. “We are huge believers in this,” he said. “There’s a lot of low-hanging front in terms of scaling this business.” On the other hand, Megrue said businesses that are made up of a portfolio of brands are prone to distraction and take time to figure out. Niche brands are also a problem. “They tend to be too small to be confident we can take them internationally,” he said.

 

He also highlighted some of the difficulties faced by publicly held retailers. For more mature stores, “It is a lousy idea to be public,” Megrue said. “Wall Street stops appreciating how core the brands are.” Public companies also face difficulties making high-risk moves. Megrue urged boards to think about going private. “Do it at least once a year,” he said. In addition, he noted: “We pay big premiums. That’s the business we’re in.” <WWD>

Hedgeye Retail’s Take: Recall that M&A within the retail and apparel space was on our top 10 themes for 2010.  Looks like we are now getting confirmation from the horses mouth that this should continue into next year.  We wonder however how a weakening consumer may factor into buyouts of companies with peak margins and minimal growth prospects.

 

RFID Adoption Gaining Momentum - The apparel industry is moving to adopt radio frequency identification at retail to reduce out of stocks, a group of retailers and brands said Monday. Wal-Mart previously said it will move to item-level tagging, and retailers such as American Apparel and Nine West have revealed they are testing the technology, but this is the first time an industry group has publicly said it plans to use RFID tags in stores for tracking individual items of apparel. The technology can reduce out of stocks by as much as 50 percent. “We believe it is time for the industry to come together to advance the use of this technology throughout the retail supply chain,” said Peter Longo, president of logistics and operations at Macy’s Inc. “We are excited about the business improvement and customer satisfaction opportunities that this industry-led initiative affords us.” Retailers and brands participating in the initiative include Macy’s Inc., Dillard’s, Kohl’s, Wal-Mart, J.C. Penney Co. Inc., Conair, Jones Apparel Group Inc., Li & Fung, VF Corp., Jockey and Levi Strauss & Co. American Apparel, Bloomingdale’s and Banana Republic have previously said they are testing the technology. Marks & Spencer, Tesco, Metro, Carrefour, Misukoshki and Throttleman’s also use RFID. Adoption has come more slowly than anticipated, partly because of the way the initial Wal-Mart mandate was crafted, and also because of public misperceptions about privacy risks posed by the technology. In 2003, Wal-Mart required suppliers to tag every pallet and case, but it had not yet tested the business case for the technology. That approach proved less useful than tagging certain key individual items, such as jeans, for a variety of reasons, including that Wal-Mart already had a sophisticated system in place for tracking every shipment, and RFID does not work with metal and liquid. Consumer groups have raised concerns the tags could be used by the government or others to track people at any time and in any place. But the tags contain no personal data, are difficult to read from a distance and can easily be disabled by removing them or covering the tags with tin foil. <WWD>

Hedgeye Retail’s Take: RFID has long been thought to have potential to be the biggest technological breakthrough in retailing since the POS, but costs have kept mass adoption at bay.  If successful, WMT’s lead here could force the hand of the supplier community to begin broader adoption. WMT however will still have to produce goods that consumers actually want.

 

Initiatives Underway to Grow & Maintain NYC Fashion Leadership - The Bloomberg administration plans to unveil six initiatives today to bolster New York’s $55 billion fashion industry and secure the city’s status as a global fashion capital. City Hall’s efforts will tackle the future on two fronts: Playing up New York as a hub of innovation for specialty and chain stores, along with helping to develop the next generation of designers, managers and merchants by insuring they have the business know-how to succeed. With 165,000 jobs, the fashion industry accounts for 5.5 percent of the city’s workforce, generating about $2 billion in tax revenues and $9 billion in wages annually. City officials aim to shore up those figures. Just last month, designers and union officials rallied in Midtown because of frustration about stalled talks with the city over rezoning the Garment Center to keep its manufacturing core. “The industry obviously is changing significantly, both in terms of production and the sales model,” Seth Pinsky, president the New York City Economic Development Corp., said Monday. “Production, as we all know and have seen in the last several years and past decades, has moved outside the city and the country. There has also been a change in the sales model. A lot more is being sold online instead of just brick-and-mortar stores. In the new global paradigm — whatever that turns out to be — we want New York to remain the fashion hub it has been for the past several decades.”  The program is expected to get rolling next year and each element will have a manager and corporate partner. The individual annual initiatives are: the NYC Fashion Fund and Institute, Project Pop-up, New York City Fashion Draft, Fashion Campus NYC, New York City Fashion Fellows and Designer as Entrepreneur. <WWD>

Hedgeye Retail’s Take: With costs in NYC presenting substantial hurdles for small, under capitalized brands and designers, it will be key for the Mayor to offer tangible incentives to keep the industry alive and well here.  If not, it will ultimately become too expensive to call NYC the fashion hub of the world.

 

Footwear News Power 100 of 2010 - After the tough times of 2009, when most footwear executives cut costs, slashed inventories and braced for the worst of the recession, this year was a different story. Corporate leaders began to regroup, restrategize and return to finding innovative ways to conquer the retail market. It’s no wonder footwear has been a leading category, rebounding much faster than apparel and, oftentimes, saving the bottom lines of department stores. As in every year, new players earned their places on the list, such as Scott Savitz, who has grown Shoebuy.com into an e-tail force, attracting 6.5 million monthly visitors and chalking up $180 million in sales. J.Crew’s Mickey Drexler also joined the industry’s elite this year, after making footwear a larger focus for the company and teaming with Alden, Minnetonka and New Balance for interesting collaborations. And Tony Post, too, made the cut after turning Vibram’s FiveFingers style into a footwear movement. To measure the market heft and influence of each executive on the list, Footwear News studied all sides of the industry — from discounters to luxury houses — to determine who is having the biggest impact on the shoe industry. Sales figures and earnings, of course, factored into the decision process, but so did new store openings, line extensions, collaborations, fashion clout, innovative product, revamped business strategies and, of course, the all-important buzz factor. What follows is a ranking of the industry’s most powerful influencers — those who not only survived the recession but are shaping the footwear landscape in its wake. <WWD>

Hedgeye Retail’s Take: With innovation behind several new additions to this year’s list, Christian Louboutin (#2 from #5) and Wes Card & Richard Dickson of The Jones Group (#9 from #13) represent the most notable moves in the Top 10. Among the factors behind Louboutin’s ascension is an aggressive growth in retail stores to 32 in 2010 from 21 last year while Jones’ stake in Stuart Weitzman in June has provided a significant boost to JNY’s profile in footwear circles beyond Nine West.

 

R3: Uniqlo, Crocs, Gilt Groupe, GCO - R3 1 11 2 10

 

Internet Flash Sales Surge in Popularity - While competition has dramatically increased over the last year, insiders said there is still growth potential. That is in large part because established leaders, such as Gilt Groupe and Rue La La, are upping the fashion quotient, adding new features and partnering with key brands on collaborations. “[The category] is here to stay,” said Larry Joseloff, VP of content for Shop.org at the National Retail Federation. “The hype will die down as with any new tech or business model, but retailers will fine-tune their best practices.” The key for retailers, said observers, is to address new areas of the market with their models. “There are tons of sectors that haven’t been touched, so there is definitely room to grow, ” said Krista Garcia, research analyst at Emarketer.com. Shoplikekings.com, an all-men’s site featuring contemporary and upscale brands, was also founded to serve an untapped consumer. According to CEO Jordan Rosen, while the flash-sales category as a whole is crowded, the men’s market is not as well represented. “We’re trying to be a place that’s all for men,” said Rosen. “I don’t know if I would feel comfortable shopping at a place geared toward women.” His site, which debuted in September, stocks brands such as Creative Recreation, Circa and Osiris, and showcases one or two sales per day that last about 48 hours and offer anywhere from 55 percent to 65 percent off retail value. Fifteen percent of the site’s mix is footwear. Another new entrant in the category, Ahalife.com, is taking a different approach, focusing on high-quality products rather than price. Larger retailers are getting in on the action, too. At Jcrew.com, merchandise from the outlet stores is being sold in an exclusive online flash sale on the weekends. And last month, discount retailers TJ Maxx and Marshalls announced they were considering adding a flash sales section to their websites. Despite the influx of new competition, existing players such as Gilt Groupe — which is often credited with creating the flash category in the U.S. — said they are continuing to see growth. <WWD>

Hedgeye Retail’s Take: In addition to a lower quantity of closeouts as noted above, increased involvement from larger more established retailers will  begin to squeeze out marginal players.

 

Weakness in Golf Rounds Persist - According to Golf Datatech, golf rounds played for the US were down 3.6% in September and were also down 3.6% on a YTD basis. Public access play was down 3.8% for the month and private course activity was down 2.9%. A total of 3960 courses are represented in the report. The biggest decline in September came in West North Central, 9.0%; followed by East North Central, 7.8%; New England, 6.2%; Mid Atlantic, 3.2%; Mountain, 1.6%; South Atlantic, 1.0%; and Pacific, 0.5%. The one positive region was South Central,  up 3.4%. <SportsOneSource>

Hedgeye Retail’s Take: Not much changed here – rounds have been down LSD all year as evident with both September and YTD down -3.6%.

 

E-Commerce Sales Remain Robust in Q3 - U.S. online retail sales increased 9% in the third quarter, comScore reports today, calling it “a fairly positive indicator for the upcoming holiday season.” That follows 9% year-over-year growth in the second quarter and 10% growth in the first quarter, according to comScore, which makes its estimates based on the activity of some 2 million consumers who agree to have their online behavior tracked. Total U.S. e-retail sales were $32.133 billion in Q3, comScore says. It was the fourth consecutive quarter of year-over-year growth in e-retail sales, following four quarters of flat or negative growth during the recession, according to the web measurement firm. Despite what he calls solid growth in the third quarter, comScore chairman Gian Fulgoni says, “We continue to preach caution due to the continuation of high unemployment, which is creating very divergent spending patterns between the 'haves' and the 'have-nots.' Even Americans who do have jobs still aren't confident enough to spend freely and many are still pained by their loss of wealth since the financial crisis struck in 2008. The top-performing online product categories were Books & Magazines (excl. digital downloads), Computers/Peripherals/PDAs, Computer Software (excl. PC Games) and Consumer Electronics, indicating a higher willingness of consumers to spend on in-home entertainment.  41 percent of online retail transactions included free shipping, down marginally from last year. <internetretailer>

Hedgeye Retail’s Take: Not surprisingly, online sales continue to outperform. Interestingly, the top 25 retailers accounted for 70% of sales this year up nearly 6 points yy suggesting accelerating growth at the top end at the same time the bottom 30% of the industry becomes increasingly more fragmented.

 

Mobile Couponing Slow to Take Hold - According to some predictions in 2009, mobile couponing was ripe for takeoff. While relatively few mobile users had redeemed a coupon through their phone, many were interested, and Yankee Group predicted an increase in the number of mobile coupons redeemed in North America in 2010 from 200,000 to 2.3 million. But consumers have been slow to climb on board. According to a September 2010 survey conducted by OnePoll for mobile transaction network mBlox, fewer than 15% of US mobile subscribers have redeemed a mobile coupon. This is about twice the penetration Yankee Group found in 2009. Also in September, research from the In-Store Marketing Institute found 12% of US shoppers had used a mobile coupon, and 34% were interested in doing so. mBlox found even greater interest, at nearly 42%, but both these numbers were significantly down from the 73% of US consumers who told Yankee Group last year that they wanted mobile coupons. Overall, respondents to the mBlox survey still preferred to clip coupons the traditional way—receiving them by mail. Email was popular with nearly a third, and a combination of email and text message with nearly 11%. <eMarketer>

Hedgeye Retail’s Take: What’s not captured here is the quality of couponing in the study (as in brands participating) – a key component of true underlying consumer demand. Additionally, the conversion from an email to mobile coupon requires that consumers enable retailers to push content a function that has been historically labeled as a four-letter word.

 

R3: Uniqlo, Crocs, Gilt Groupe, GCO - R3 2 11 2 10

 

 


QUANTIFYING QE2'S EFFECT ON CONSUMER SPENDING

The following is a post written by our Hedgeye Financials team, led by Josh Steiner, on the impact of QE2 on consumer spending through 2011.  The analysis shows that the modest impact on consumer spending resulting from QE2 may not be worth the significant opportunity cost (for savers) associated with longer term rates.

 

When $2 Trillion Buys You $3 Billion

We think it's conventional wisdom that when long-term rates are low it drives high volumes of refinancing activity, which puts significant incremental disposable income back into consumers' pockets. While this was true back in 2003, we think investors will be surprised to find out just how little it will add this time around, especially when comparing 2011 to 2010.

 

Low Long-Term Rates (i.e. Refinancing) Are Not the Elixir the Market Thinks They Are

In the table below we've mapped out precisely how much additional money consumers will have from refinancing opportunities. We've used MBA estimates, which, to be fair, have generally overestimated activity in the past. The takeaway is that based on their estimates for refinancing volume over the remainder of this year and throughout next year, we expect a very modest increase in disposable personal income of $5.9 billion in 2010 (roughly 4 bps of GDP) and an even more modest boost of $3.1 billion (2 bps) for 2011.

 

Considering that QE2's only direct stimulative property for consumers is in boosting the housing market and consumer spending through refinancing activity, we were somewhat surprised to see just how paltry the benefit would be ($3 billion) especially when juxtaposed against the rumored cost of QE2 (~$500 billion to $2 trillion).

 

For those who think the MBA's rate forecasts and commensurate refi volume assumptions are overly conservative in light of the rumored scale and scope of QE2, consider that in 2010 mortgage rates fell 40 bps and drove only $6 billion in incremental disposable income. If we assume that 2011 sees mortgage rates fall another 40 bps, averaging 4.3% for the whole year, this would drive roughly $6 billion in further disposable income, only $3 billion higher than our $3.1 billion estimate. In other words, we just don't see how QE2 can drive enough incremental spending power to either move the needle on GDP or justify the profound cost.

 

QUANTIFYING QE2'S EFFECT ON CONSUMER SPENDING - refi table


Our Methodology

We've used MBA forecasts for refi volume and 30-year mortgage rates, and we've even used their home price assumptions (basically flat), which are in sharp contrast to our own (down). Based on this, we show there being 2.2 million mortgages being refinanced in 2011, down from 5.5 million in 2010 leading to a total annual payment reduction of $3.1 billion in 2011, down sequentially from the $5.9 billion boost it gave to 2010. We've assumed, based on Freddie Mac data, that, on average, people save 90 bps on their rate when they refinance. We've also assumed that everyone is in a 30-year fixed rate mortgage and that everyone is refinancing at 80% LTV.

 

It's worth pointing out that there is a not immaterial opportunity cost associated with lower long-term rates. Namely, the savers in this country are earning lower returns on their deposits. While it's difficult to quantify precisely what this opportunity cost is, we estimate that it is in the billions of dollars and likely exceeds any aggregate savings from refinancing activity.

 

We recognize that the goals of QE2 are twofold: to inflate asset prices by crowding out whatever asset class the Fed decides to monopolize for the next 6-24 months and to transfer lower borrowing costs to the consumer. The point of this note is to call out how small the actual transfer will be.


MPEL: THE HOUSE OF DANCING EBITDA

The new CoD show may or not be a success but MPEL’s turnaround has been impressive. However, the catalysts we’ve been waiting for are already on the table and this one may take a breather.

 

 

The MPEL thesis was two pronged:  strong market share gains punctuated by a strong bottom line quarter – finally.  MPEL certainly delivered.  Street estimates still need to go up.  To be fair, although we knew hold percentage would be high, it did come in above what we were looking for, so some of this upside may not be sustainable.  We may want to keep a trade a trade.  Here are some takeaways from the quarter:

 

CoD net revenues were $7MM above our estimate while EBITDA was $9.6MM better

  • We know that the company said that direct play was 20% but we think it was actually a little north of 13% with the addition of 3 more junket rooms in the quarter.
  • VIP gross table win was $7MM above our estimate
    • RC was actually $600MM less than our estimate, but hold was 20bps higher as a result – which also helped margins even more since 50% of their junkets are paid on a fixed % of RC
    • At a normal 2.85%, net revenues would have been about $76MM lower and EBITDA would have been about $83MM (about $32MM lower than reported results)
  • Mass win was $1.5MM higher than our estimate, with drop $22MM lower but hold rate 1.3% better
  • Slot win was $5MM light
  • Non-gaming revenues net of promotions were $2MM below our estimate
  • Fixed costs were $5MM below our estimate and were essentially flat to last Q at $55MM.

Altira net revenues came in $10MM below our estimate although EBITDA came in $8MM above

  • RC was $100MM better than we modeled, which we attribute to a small increase in direct play which is also why the reported hold of 2.7% was 10bps below our estimate.
  • VIP gross win was $7MM below our estimate
  • Mass win was $500k better than we estimated
  • Non gaming revenues, net of promotional expenses were $2MM above our estimate
  • The real story seems to be lower junket commissions and controlled fixed costs.  All-in, junket commissions were $9.5MM below our estimate while fixed expenses look to be only $15MM

Other stuff:

  • Mocha Slots was $0.7MM ahead on revenue and $0.6MM ahead on EBITDA
  • D&A was $3MM below our estimate
  • Pre-opening expense was $5MM higher but it looks like they took it all in the Q vs. over the next 2 Qs
  • Interest expense was $8MM higher

 

MPEL: THE HOUSE OF DANCING EBITDA - MPEL 11


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MPEL 3Q2010 CONF CALL NOTES

They finally beat and it was a blockbuster. No buying of business here. Margins were great. Here is the transcript of the conference call.

 


"We are pleased to report record net revenue and record Adjusted EBITDA during the third quarter of 2010. These milestones are driven by continued progress in expanding our mass market gaming volumes and by further success in our already robust VIP business, along with a favorable rolling chip hold percentage in the third quarter of 2010."

- Lawrence Ho, Co-Chairman and Chief Executive Officer of Melco Crown Entertainment

 

HIGHLIGHTS FROM THE RELEASE

  • CoD: Net revenues of $504MM and Adjusted EBITDA of $115MM
    • "Year-over-year improvements in both net revenue and Adjusted EBITDA were driven by increased rolling chip volume, an improved mass market win rate, and higher mass market table games drop"
    • Hold was 3.4%
  • Altira: Net revenue of $186.8MM and Adjusted EBITDA of $28.8MM
    • Hold was 2.7%

CONF CALL NOTES

  • Feel like the operating team has begun to gel and that they can now start producing more consistent results
  • They are gaining market share
  • VIP benefited from 3 new junket rooms at CoD
  • The House of Dancing Water show is sold out through the end of the month; HDW is helping drive increased visitation to the property.
  • Mass market drop per day increased 35% YoY
  • The improvement in their Mass market hold is sustainable as they are providing a better guest experience and people are staying and playing longer
  • Have 450,000 members in their database and hope to hit 500,000 by year end
  • Organizational restructuring that they announced on September 1st is already helping them improve results
  • Will continue to look to improve margins as their mix of Mass increases
  • 4th quarter is off to a good start with record business levels in October
  • Non-operating 4Q guidance
    • $84MM of D&A
    • Interest expense: $29MM
    • No pre-opening or capitalized interest

Q&A

  • 2012/early 2013 Ferry Terminal Pac On opening
  • No Singapore impact
  • Focus over next 12 months is on improving existing operations
  • They are interested in Macau Studio City if it ever opens - their management contract still stands
  • They are also quietly looking at other opportunities in Asia
  • CoD increasing VIP rooms. They have some extension plans on the second floors. Hopefully they will add another 2-3 junket operators in by Chinese New Year.
  • More likely than not, they will only have a hotel, not an "apartment hotel." Once their occupancy and ADR ramps up, they can decide whether to build the additional tower on the land they have.
  • EBITDA normalized for 2.85% would have been just north of $100MM
  • House of Dancing Water cost is just over $100,000/day
  • FCF in the Q was just over $100MM
  • They believe that the Galaxy opening will move the center of gravity in Macau to Cotai and will be good for them
  • Claim that premium direct volume was still in the 20% range, but we believe it was around 13% based on our proprietary database
  • No change in the junket commission environment for them
  • CoD - 50% turnover based commission, at Altira - the majority are on a turnover basis (ie 1.25% vs. Rev Share)
  • 165 VIP tables and 240 Mass tables at CoD
  • Want to cross market Altira and CoD. They will try to have some premium direct at Altira
    • I also see a small increase of direct VIP play at Altira this Q to 2%
  • Have done some work on Japan and Taiwan and are interested.
  • There are Taiwanese elections coming up - so anything that happens on the islands would occur after that

Compliance: Vic or Treat

Put simply, the new rules don’t create a wide enough net.

-         Vikram Pandit

 

Just because Vikram Pandit says something, doesn’t mean it’s wrong. 

 

 

Compliance: Vic or Treat - Vikram Pandit

 

 

We were spooked as we saw the entire world financial system going down the tubes.  America had fomented a housing disaster.  The traditional Manufacture and Distribute model of American finance had found a golden egg-laying goose, courtesy of our elected officials who, outdoing our Third World brothers and sisters, promised Americans not merely a chicken in every pot, but a kitchen to house the pot, and a four bedroom house – complete with two-car garage, trash compacter and satellite dish (in-ground pool optional) – to surround it.  Americans of every stripe – from the criminal, to the gullible, to the hard-working hopeful Believers in the Dream – lined up clutching their worn bank deposit books and three years’ worth of tax returns to get their piece of the American pie. 

 

Never mind that most Americans realized they were going to have to uphold their end of the bargain by staying employed, putting in an honest day’s work for an honest day’s pay.  If, as our Hedgeye watchword has it, everything important happens at the margin, the margin of homeowner finance soon swelled like a rampant tumor.  Fraudulent financings became increasingly the order of the day as bankers and their administrative minions actually coached people on how to lie on their mortgage applications.  We get that there are gullible, vulnerable and dishonest people out there who leapt at the chance to get something for nothing.  And there is likely a significant number of failed homeowners who allowed themselves to believe that lying on your mortgage app is like cheating on your taxes: everyone does it, no one is hurt by it.  I can get away with it.

 

For a moment it looked like the banks were actually the Greater Fools, about to be brought low by their own greed.  What a relief, then, when Secretary Paulson stepped in and spread our cash over the crisis like oil upon the waters.  We were wrong.  The homeowners did get flushed away like so many troublesome small turds.  The banks were made whole, and then some, and it was, after all, we who were the Greater Fool of Last Resort.

 

Speaking at a conference sponsored by The Economist magazine, Pandit said the legislative changes to date could give rise to a new shadow banking system.  “Could,” Mr. Pandit?  Nay, must.  Quoth the Pandit, “Any time the amount of capital required by regulation exceeds the levels judged necessary by the market, opportunities for arbitrage arise.”  Pandit is noting something a fact approximately as obvious, and as rarely remarked upon, as the sun’s rising in the East.  And he made the useful distinction that “the banking system is not synonymous with the financial system as a whole – and Basel only affects the former.” 

 

As always, the money has done all the talking, though we are not sure exactly who has done its bidding.  Dodd-Frankenstein, as observed by NY Times chief financial correspondent Floyd Norris (http://norris.blogs.nytimes.com/ 25 October, “Return of the Shadow”) “does give regulators authority to oversee the next AIG – a huge financial institution that is systemically important even if it is not fully in the conventional regulatory system.”  However, observes Norris, “Congress rejected proposals to let regulators go after shadow sectors,” those being precisely the marginal areas of activity that will take up the slack.  As our neighbor’s bumper sticker reads: “If they outlaw guns, then only outlaws will carry guns.”  And you can bet that if they outlaw mortgage-backed CDS… well, you get the idea.

 

We are intrigued that Pandit is so afraid of this that he felt the need to speak about it in a public forum.  We are not sure whether he is saying it prophylactically, to prevent being taken to task next time the banking system implodes, or as a way of marking his territory and calling for pre-emptive regulatory approval of his future actions at the helm of Citi.

 

One thing, though.  He’s got it right.  The regulated banks played with a will into the morass of the unregulated marketplace, extending lines of finance and credit far beyond what the foreshortened horizon of their own regulations permitted them to see.  It is, of course, a fallacy to say that there was not already sufficient regulation in place to prevent the latest disaster.  There was, rather, a lack of will on the part of the regulated marketplace to exercise the caution and diligence required of them by their fiduciary brief.  The fact remains that no bank analyst – and no analyst from the rating agencies – ever visited any of the vast housing developments that were being sold off like hotcakes, all on no-documentation mortgages.  The banks rolled up these same mortgages and sold them to overseas investors, to Orange County – indeed, to one another, and even to other divisions within their own entity. 

 

One obvious answer is for Congress to force regulators to drop an iron curtain between regulated and unregulated activities, allowing the unregulated market to bear all the risk – with the recognition that they will also reap the profit, while the banks continue to plod along.  For our money – and in your Humble Scrivener’s case, Mr. Pandit has most of it in his tottering institution – plodding is just fine.

 

But it’s not just fine for the shareholders.  Despite Jack Welch’s recent disavowal of Shareholder Value as “the stupidest idea” to come along in years, bank executives want their institutions to prosper because Dodd-Frankenstein does nothing to undercut Wall Street’s compensation model.  The problem is, as far as the regulated banking system is concerned, there’s no such thing as safe sex.  As has been observed again and again, that first dip into the unregulated world creates instant addiction.  And, like the addict who sells his grandmother’s jewelry and clock radio, the banks will stop at nothing once they are hooked.

 

On the other hand, we recognize that it is in the unregulated world that all the truly creative ideas are hatched.  Let the word “unregulated” be divorced in the public mind from the word “criminal.”  Indeed, by definition it is easier to violate the rules in a market that has many, than in a venue where there are none.  If this seems cynical, please recognize that many of the greatest advances in all areas of human endeavor have come from outsiders working on their own, and often against the opposition of the institutionalized mainstream.  We need only point to examples such as Galileo and Darwin.  Or if you prefer, Moses, Jesus and Mohammed.  You get the point.

 

Far from holding the regulated and unregulated markets apart from one another, Dodd-Frankenstein appears to leave the door wide open for the next round of Minskian boom and bust as these two incompatible species attempt once again to produce viable offspring.  Many in our industry gaze despairingly on the micro-meddling going on in Washington and wish the Austrian school of economic theory had more influence in our system, with its notion that “creative destruction” creates fecund soil from which future economic success will sprout.  Does no one in government have the moral courage to stand by and allow significant economic failure to ensue?  If you want destruction, we remind you there is at least one Austrian in government in this land: Arnold Schwarzenegger.

 

Moshe Silver

Chief Compliance Officer


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - November 2, 2010

As we look at today’s set up for the S&P 500, the range is 9 points or -0.54% downside to 1178 and 0.22% upside to 1187.  The futures are higher as the Republicans are poised to retake the House and narrow Democrats’ margin in the Senate. 

 

Earnings today are reported by companies including Emerson Electric, Pfizer, MasterCard and Kellogg.

  • Anadarko Petroleum (APC) 3Q adj. EPS missed est. 
  • Cognex (CGNXS) sees 4Q rev. above est.
  • Corporate Executive Board (EXBD) 3Q adj. EPS beat est.; raised  full-year forecast
  • Ironwood Pharmaceuticals (IRWD), Forest Laboratories (FRX) companies reported positive results from Phase III trial of linaclotide 
  • MEMC Electronic Materials (WFR) 3Q adj. EPS, rev. missed ests, suspended 4Q forecast
  • NutriSystem (NTRI) raised 2010 EPS forecast 
  • RightNow Technologies (RNOW) raised year sales, profit forecast *Rogers (ROG US) 3Q EPS missed est.

 PERFORMANCE

  • One day: Dow +0.06%, S&P +0.09%, Nasdaq (0.10%), Russell (0.68%)
  • Month-to-date: Dow +0.06%, S&P +0.09%, Nasdaq (0.1%), Russell (0.68%)
  • Quarter-to-date: Dow +3.12%, S&P +3.78%, Nasdaq +5.75%, Russell +3.32%
  • Year-to-date: Dow +6.68%, S&P +6.21%, Nasdaq +10.39%, Russell +11.7%
  • Sector Performance: Energy +0.12%, Technology +0.08, Financial, +0.01, Industrials 0.00%, Healthcare 0.00%, Materials (0.06%), Consumer Discretionary (0.20%), Consumer Staples (0.42%), and Utilities (0.98%)
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Baker Hughes +4.40%, Cabot Oil & Gas +4.07% and M&T Bank +3.64%/First Horizon -6.74%, Marshall & Ilsley -4.57% and Avon -4.56%.

 EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 146 (-428)  
  • VOLUME: NYSE: 959.57 (-7.39%)
  • VIX: 21.83 +2.97% - YTD PERFORMANCE: (+0.69%) - THE VIX IS UP FOR THE LAST 6 DAYS
  • SPX PUT/CALL RATIO: 2.57 from 3.37 -23.66%  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 16.73 -1.725 (-9.347%)
  • 3-MONTH T-BILL YIELD: 0.13% +0.01%    
  • YIELD CURVE: 2.32 from 2.32

COMMODITY/GROWTH EXPECTATION:

  • CRB: 301.53 +0.29%
  • Oil: 82.95 +1.87% - BULLISH
  • COPPER: 378.50 +1.38% - BULLISH
  • GOLD: 1,352.68 -0.37% - BULLISH

CURRENCIES:

  • EURO: 1.3901 -0.33% - BULLISH
  • DOLLAR: 77.296 +0.04%  - BASING

OVERSEAS MARKETS:

 

European markets:

  • FTSE 100: +0.90%; DAX: +0.44%; CAC 40: +0.30%
  • European markets are trading higher, having quickly reversed slight opening falls that saw CAC down (0.3%) and FTSE100, DAX (0.1%).
  • Continuing M&A activity and generally well received results from European heavy-weights, particularly in the UK, was countered by caution ahead of the US Federal Reserve policy decision on Wednesday and additional capital raisings announcements by banks.
  • Advancing sectors lead decliners 5-4, with banks and utilities amongst the leading fallers, travel & leisure and personal & household products the leading gainers.
  • France Oct final Manufacturing PMI 55.2 vs preliminary 55.2
  • Germany Oct final Manufacturing PMI 56.6 vs preliminary 56.1
  • EuroZone Oct final Manufacturing PMI 54.6 vs preliminary 54.1

Asian markets: 

  • Nikkei +0.06%; Hang Seng +0.1%; Shanghai Composite (0.28%)
  • Asian markets traded in a tight band today, with many investors choosing to stay out of action ahead of today’s Federal Open Market Committee meeting.
  •  A surprise decision to raise interest rates in Australia pushed regional markets down in the early afternoon, though most recovered before closing. Australia raises cash rate 25bp to 4.75%.
  • India raised interest rates for a sixth time this year, hiking the Repo Rate and the Reverse Repo Rate by 25bps each.
  • China ended down slightly, as investors sold financials and carmakers. 

Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER



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