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PENN: THE ONLY BUYER IN A BUYER’S MARKET

The analysis and research of the gaming sector keeps bringing me back to a few themes: liquidity, cost of capital, and return on investment. Excess liquidity kept borrowing costs artificially low, allowing most gaming companies to over earn for a long time. Meanwhile, the same excesses allowed these same companies to pursue lower ROI projects and over leverage their balance sheets. As the ROIC chart shows, lower ROI on incremental developments began to push down industry ROIC in Q4 2006. Obviously, this also impacted ROE which began to fall in Q1 2007. The problem for the industry is that ROIC will likely continue to decline with the double whammy of escalating borrowing costs. ROE should fall at a faster rate over the next two years. Not good for equity holders.
  • A bear might counter that falling industry ROIC should have the same impact on PENN. A surface analysis might indeed conclude that. However, PENN has the ability, liquidity, balance sheet, and a buyer’s market to actually improve its economic ROE, even if the negative industry ROIC trend continues. Why would an investor buy any other similarly valued equity when the economic ROE spread between PENN and everyone else is widening, not that it isn’t already wide. See the ROE chart.
  • Why do I keep referring to economic ROE? I’ll have another post on that shortly but for now, accounting ROE is likely to look worse for PENN following the termination of the merger agreement with Fortress and Centerbridge. The $1.25 billion zero coupon preferred equity investment will be treated as equity which is rarely a positive in the ROE calculation. On an economic basis, however, ROE should climb post deployment of those funds, again even in a declining ROIC environment for basically three reasons:

    • Given management’s track record, any acquisition will likely be ROE enhancing
    • It is a buyer’s market for gaming assets/companies and PENN should face limited competition
    • Additional debt will lever returns

  • PENN holds all the cards in a very trying time for the gaming industry. The environment appears ripe for management to do what it has always done: create shareholder value.

Timberland (TBL): Tick-ah-teee Booo!

Boot to the head if you're short McGough's bullish call here. I've never been accused of not celebrating big wins, and this was our biggest one today; TBL closed +11% on the day on takeout rumors. See Brian McGough's research for more. At 7x trailing cash float, with net cash on the balance sheet, and 9% short interest, this stock's run isn't over.
  • Breaking out of a big base, TBL's next stop is $19.18, before the shorts get some relief.
    KM
chart courtesy of stockcharts.com

SKX: Misery Loves Company

At least Skechers has good company in announcing announces capital investment in China AFTER a 20% run in the Yuan. The narrative here is scary…

I think Skechers’ announcement that it is expanding its Asian JV with the Onwel Group is another nail in the coffin for this story. Let’s add this to the narrative of its growth slowdown… A) Shift in fashion towards low profile propels margins from 0% to 9%. B) Low profile growth slows after four years. C) Takes next leg of growth overseas. D) SKX becomes more litigious, suing a smaller brand after years of fighting against economic harm from knocking off styles. E) Opens up more company-owned retail stores to get product to consumers despite less interest from retail. F) Broadening wholesale distribution to more marginal channels (Goody’s, Mervyn’s). G) Bids for Heely’s. H) Now it grows more aggressively into Hong Kong and Macao with a goal to triple sales there in 3-years. Maybe they should have thought of this 3-years ago before a 20% run in FX? FX moves are always hindsight 20/20, but this is another example of a poorly managed company in this space deploying capital reactively. Proactive always wins in my book.

The biggest plus is that its partnership could secure it better capacity in an environment where plant space is becoming extremely more difficult to find. But this is not a positive – it simply helps mitigate a potentially massive negative.

Also, it was announced within a day of Coke offering a 195% premium for Huiyuan Juice Group.

Maybe Skechers and Coke borrow each other’s Macro analysis….
Investing in China at the top!

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Unemployment Trends In Japan: Where's the next big move going to be?

The glass half full crowd got thrown a bone by a slight downtick in unemployment numbers in Japan this week. To better understand the employment environment in Japan you must factor in the “Haken” – a chronically underemployed class of young people created as the government introduced regulatory changes over the past decade that made it easier for employers to hire through temp agencies and short term contracts.

In 2007, the Ministry of Internal Affairs estimated that there were 3.3 million people aged 25 to 34 working as temps or contract employees – put in context that is over 4% of total working age population (15-64).

As major domestic employers like Toyota start to reduce capacity these workers will be the first to go, and even those lucky enough to stay employed will feel rising inflation faster and harder than the fully employed.

Andrew Barber
Director

An Ugly Chart Gets Uglier: Japanese Stagflation...

The scariest thing about this chart is that the US one can start to look a lot like it, soon.
Below we have overlaid Japanese inflation with their easy money interest rate policy.

KM
(chart by Andrew Barber, Director - Research Edge LLC)

Finally, A Fed Member Who Agrees With Me On Something!

From our friends at Street Account who do a great job intraday!

9/03/2008 12:21:27 PM "Boston Fed President Rosengren says US unemployment rate may rise above 6%"

I'm continue to be in print with an estimate for the US Unemployment rate to hit 6-7% by the end of 2008.

Stagflation remains, despite the selloff in commodities.
KM

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