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Your Greatest Victories

“Never forget that sometimes your greatest victories can come from your greatest defeats.”

-Drew Brees


Last week was a great week for global macro risk managers. By week’s end, with correlation risk to the US Dollar running at all-time highs (Dollar UP = stock, bonds, commodities, etc. DOWN), a gigantic global mean-reversion trade captured victory.


With the US Dollar Index recouping +1.9% of its value (week-over-week), here were some of the major correlation moves:

  1. SP500 = -2.1% (the market’s worst week in the last 3 months)
  2. Russell 2000 = -2.3% (we covered our short position last week)
  3. Euro = -2.9% (we shorted the FXE on 11/4 and remain short it)
  4. Commodities (CRB Index) = -3.2% (intra-week we moved up our asset allocation from zero to 3%)
  5. Oil = -2.3% (no position – we sold our oil on 11/3)
  6. Gold = -2.2% (no position)
  7. Copper = -1.3% (no position)
  8. Volatility = +12.9% (we sold our long VXX position on strength last week)
  9. 2-year US Treasury yields = +13 basis points or +35% to 0.50% (we remain short SHY)
  10. 10-year US Treasury yields = +26 basis points or +10% to 2.79% (we remain long PPT)

Putting price moves in context is always critical. Having been short the Burning Buck from June 7th to November 2nd, I get the bear case (DEFICITS + DEBT = CONGRESS). Inclusive of the US Dollar closing UP for the 2nd consecutive week, it’s important to acknowledge that the Debauched Dollar is still down for 19 out of the last 24 weeks and has plenty to prove before it regains any semblance of credibility.


That said, THE risk management question this morning is: Can a TRADE higher in the US Dollar become a TREND?


TRADE, in Hedgeye speak = 3 weeks or less. Whereas a TREND = 3 months or more. Global macro TRENDs back-test with much higher batting-averages in our risk management model than TRADEs. However, all TRENDs start as TRADEs, so you have to be Duration Agnostic.


I bought the US Dollar (UUP) in the Hedgeye Portfolio on November 4th and I remain long of it this morning. Consensus is still short the US Dollar and I can assure you that consensus is not comfortable with that position.


Here are the lines that matter in my model for the US Dollar Index:

  1. TRADE = $77.11
  2. TREND = $80.69

What that means is that what was immediate-term resistance for the US Dollar ($77.11) is now support and there really is no significant resistance (provided that the USD Index continues to make higher-lows) up to the TREND line of $80.69. In other words, there’s another +3.2% upside from Friday’s closing price of $78.08 and, consequently, plenty of correlation risk over the intermediate term for anything priced in US Dollars.


So what can keep an immediate-term bid to the Debauched Dollar?

  1. The Euro going down on legitimate sovereign debt risks rising (Ireland, Spain, Greece, Italy, Portugal, etc.)
  2. Fed Heads continuing to get hawkish on the margin (Jeffrey Lacker joins Kevin Warsh and Tom Hoenig this morning)
  3. US Treasury Yields continuing to breakout to the upside (2-year yields charging higher again this morning to 0.53%)

I’m not looking for bullish catalysts – these simply are bullish USD catalysts - particularly when you consider the “Bye-Bye, Bear” cover story that Barron’s was running on November the 1st. Bernanke’s QG (Quantitative Guessing) experiment has been YouTubed by the entire free and communist world at this point. If you didn’t know that QG = inflation, now you know. US inflation reports (PPI and CPI) will accelerate again sequentially when reported this week.


It’s a mathematical fact that Dollars are priced as a basket of other currencies, so I don’t think I’ll get much pushback on the Euro DOWN trade equating to US Dollar Index strength. I’ll definitely get pushback on the Fed Head thing – after all, the cornerstone of the Bull case on US Equities is built on Begging Bernanke for free moneys as insiders make their highest levels of sales since December.


On that not so little squirrel hunting signal that the world calls Mr. Bond Market however, it will be very difficult for people to ignore these immediate and intermediate-term breakouts in US Treasury Yields. This is very new. And the risks in the Treasury market are very real.


The 30-year bond has been breaking down, big time, since mid-October. Long-term interest rates breaking out in the US as sovereign yields spike in Europe were 2 of the main risk factors associated with my getting out of stocks and commodities altogether in late October. While some of my greatest 2010 defeats came in the first week of November, the greatest victories in global macro risk management are potentially on the come.


My immediate term support and resistance levels for the SP500 are now 1188 and 1211, respectively. I remain short the SP500 (SPY).


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Your Greatest Victories - USD


TODAY’S S&P 500 SET-UP - November 15, 2010

As we look at today’s set up for the S&P 500, the range is 23 points or -0.93% downside to 1188 and 0.98% upside to 1211.  Equity futures are trading little changed to fair value in the wake of last week's post QE2 pull back. Today we have October Retail Sales and September Business Inventories in what will be a busy week with Fed Chairman Bernanke's speech at the ECB conference on Friday looking like a key highlight.

  • Aastrom Biosciences Inc. (ASTM) filed $75m mixed securities shelf
  • Accelrys (ACCL) said it will buy back as much as $6m in shares by March 31
  • Fortune Brands (FO) may work on a breakup plan with Pershing Square Capital Management, WSJ reported Nov. 12
  • Naugatuck Valley Financial (NVSL) and Southern Connecticut Bancorp (SSE US) mutually agreed to terminate merger deal
  • Novartis (NVS) may rise to $65 by 2013 as new drug portfolio overcomes expiration of existing patents, Barron’s says
  • Vale (VALE) may rise to the mid-$40s due to economic growth in China, increasing commodity prices, Barron’s reported


  • One day: Dow (0.80%), S&P (1.18%), Nasdaq (1.46%), Russell (1.68%)
  • Month-to-date: Dow +0.67%, S&P +1.35%, Nasdaq +0.43%, Russell +2.26%;
  • Quarter-to-date: Dow +3.75%, S&P +5.08%, Nasdaq +6.32%, Russell +6.38%;
  • Year-to-date: Dow +7.33%, S&P +7.54%, Nasdaq +10.98%, Russell +15.01%
  • Sector Performance: Consumer Staples (0.49%), Utilities (0.82%), Consumer Discretionary (1.04%), Industrials (1.17%), Healthcare (1.25%), Energy (1.47%), Tech (1.40%), Financials (1.65%), and Materials (2.23%)
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Fortune Brands +7.76%, NVIDIA +5.32% and Disney +5.27%/CF Industries -6.34%, DR Horton -5.42% and Office Depot -5.08%.


  • ADVANCE/DECLINE LINE:1977 (-1108)  
  • VOLUME: NYSE - 1013.04 (+6.69%)
  • VIX: 20.51 +10.57% - YTD PERFORMANCE: (-4.94%) - BEARISH TREND
  • SPX PUT/CALL RATIO: 1.22 from 1.64 +25.42%  


  • TED SPREAD: 16.67 0.710 (4.448%)
  • 3-MONTH T-BILL YIELD: 0.13%
  • YIELD CURVE: 2.25 from 2.21


  • CRB: 303.60 -3.57%
  • Oil: 84.88 -3.34% - BULLISH
  • COPPER: 389.80 -3.26% - BULLISH
  • GOLD: 1,365.15 -2.89% - BULLISH


  • EURO: 1.3691 +0.27% - BEARISH
  • DOLLAR: 78.082 -0.17%  - BULLISH



European markets:

  • FTSE 100: (0.33%); DAX: (0.08%); CAC 40: (0.22%)
  • The Irish Independent reported that Ireland is considering asking the EU for funds for its banks, avoiding State funding.
  • Mining shares were amongst leading fallers on economic growth concerns and a broadly stronger US dollar.
  • There were limited EPS results and no major regional economic data is scheduled today, with the focus on US retail sales later in the session.

Asian markets:

  • Nikkei +1.06%; Hang Seng (0.81%); Shanghai Composite +0.97%
  • Markets closed mixed.
  • Banks led Japan higher, as the market was boosted by a weaker yen and stronger-than-expected 3Q10 economic growth.
  • Hong Kong declined even though it got some support from mixed outcomes for property stocks.
  • China closed +1.0% higher reversing earlier losses after bank shares rallied late in the session
  • Japan Q3 real GDP +0.9% seq vs +0.6% survey. Annualized real Q3 GDP +3.9% y/y vs survey +2.5%. September revised industrial output (1.6%) m/m vs (1.9%) initial reading and (0.5%) seq.  September capacity utilization index (1.1%) m/m vs (0.9%) seq.

Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends














Notes from the IGT presentation yesterday at G2E


General Commentary

  • Best game content ever in IGT's history
  • Reduced leverage from 3x to 2.4x
  • Centerstage games are doing well
  • Core products - Reel Edge product (combo or skill and chance) will appeal to younger customers - had an order during the demos
  • Hot releases included: Dark Knight, Ghost Busters, etc
  • 2nd competitor in the biz only has 55% of the breadth that IGT has in products
  • Grew global biz 21% this year, which was one of the best growth years. 11% CAGR over the last 10 years. They are deciding to focus on where the growth is - not in NA replacements
  • Despite flat R&D, they increased their product output

Chris Satchell, CTO

  • Increasing leverage of their R&D dollars.  Moved from 11 cabinets to 7 cabinets 
  • Down to 1 production technology
  • Increase leverage of 3rd party technology
  • Improve quality of products and platforms
  • They have increased the pace of bringing games to market by leveraging 3rd party resources.
  • Systems story
    • Finally leveraging their investment by focusing on applications
    • Side games through sbx, tax application, connecting the online and landbased casino worlds
    • Increasing their addressable markets by not having to go to full ethernet.

Patti Hart, CEO

  • Goal is to reduce reliance on NA replacement cycle by improving game ops yield and improve and broaden systems offerings
  • International is growing faster, so it just makes more sense
  • Focused on driving higher ROIC by listening to customers and sharing in efficiencies and leveraging new content distributions
  • Online gaming and mobile gaming opportunities- recently formed a new stand alone division


  • How are they going to grow international biz if they keep exiting businesses?
    • Those businesses weren't contributing to the bottom line. Allowed mgmt to focus on better businesses. Australia did very well; Asia and Latin America and South Africa all did well this year.
  • In the systems business, they are focused on leveraging their sbx capabilities. For Europe, they are looking to build a lighter version of sbx for that market. Have 20-25% of the international market.
  • R&D - 63-65% is spent on applications and games; 30% of the rest is on systems, rest is on online, etc. Allocation hasn't changed but efficiency has improved.
  • Expect growth in all international regions. They are decentralizing their salesforce to be closer to their customers. Improving localization piece to make it faster and less costly. Business is moving more into an RFP process too - so they are trying to systematize that too.
  • Thoughts on US shipshare? Aren't taking their eye off the ball in the US. They are just trying to move away from being so US focused. They're just saying that they have the biggest opp to grow internationally.
  • Room to improve: ROIC, game ops, international growth, systems wins, operating margin/cash generation improvement
  • Interactive division
    • Focused on making money in the UK.  Businesses are so separate that US customers don't even know that they have online games.
    • When the UK legalized online gaming, the market grew from $0.4bn (2004) to $3.3bn in 2010
    • Italy - from $1bn in 2008 to $2bn in 2010
    • Partially legal/in process of legalizing: Canada, Italy, France, Australia
    • Potentially legal within 3 yrs: Spain, Denmark, S Africa, Belguim, Czech, Greece, Netherlands
    • Early stage discussions: US, Mexico, Argentina, Brazil, China, Germany
    • Expect 5x growth over the next 3 years in their addressable market
    • UK online demographics: 58% 18-35, 23% 36- 45; 12% 45-55; only 7% over 55 vs. 61% being +55 in the land based slot biz
    • Wagerworks : 10 yrs online and 8 years mobile. Over 10bn wagered since 2005, over 1.5bn transactions in calendar 2009. Have run over 3000 tournaments and contests for their customers. Registered 2mm players. Have over 100 online /mobile patents. Most importantly, they have the best online games.
    • As of 12/09, they provide most of the top 10 games in the UK online casinos. Have 120 online games. Do business with: Unibet, Gala Group, Betfair, 888, Party Gaming, Rank, Paddypower, Virgin Casino, Sky Vegas, Victor Chandler, William Hill, etc
    • Compelling growth drivers
      • Lots of upside in bringing their land content to mobil apps; most of their casino land customers are thinking about developing an online presence; legalization of new markets- incremental profit of new markets should be high bc localization isn't expensive; entry of their casino operators 
    • Thinks that land entrants would be very successful bc they already have brands and large databases
    • Have 200 dedicated online staff
    • How do the economics work? Revenue share is the norm and this is in the game ops business - in other revenue - so you can cap it at least - it's really small.
    • They have online video poker products
    • In Canada - they are leaning towards legalizing everything
    • Incremental set up expenses as this business grows over the next few yrs?  They have 200 people today - mostly in San Fran and UK; looking for personnel to grow to 300 over the next year. US not expected to legalize in the next year.
    • They derive most of their revenues from content, not platforms.
    • UK online casino market is $800mm and as a supplier, they are one of the largest
  • Game demos:
    • Skill games (for sale w/ 10 fee). Rollout in mid-Jan. Expect GLI approval. Mid-Jan field trials start in Nevada.  Have preorder already.
    • Game ops: ghost busters, dark knight(3q)
    • Puppy stampede - and a host of new mld games.
    • Hangover game on the Sex&City-like cabinet. Will come out in Q3 with the sequel release.


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Our notes from BYI's pre-G2E Sunday presentation.


Management Commentary

  • Alpha 2 platform and first alpha 2 games
    • Uspin technology
    • iView network/sale pipeline
  • BYI preliminarily selected by the British Columbia Lottery Commission and Ontario Lottery Gaming Corporation as the systems provider - 20,000 games (3,500-4,500 per game); still going through the procurement process. If they are contracted, installations would begin summer 2011 at the earliest and would take a few years to deploy.
  • Systems:
    • In the last few years, systems hasn't grown much : 206, 212, 218, 220-235mm in FY2011. Although, the economy has been challenged as well.
    • Average of 2.4 new customer sites added per month. Have about 615 clients now.  This is equivelent to 1,700 slot machine additions per month. Customer slots - 418k connected worldwide through BYI systems.
    • Top peforming casinos use BYI:
      • LA: 13 of the top 17
      • IN: 8 of the top 12
      • NY: 6 of 8
      • PA: 6 of 9
  • For FY2008-2010, BYI has had 149 major new installs ,201 upgrades, and 245 add-ons
  • Core products:
    • Multi-property (few companies have this function)
    • Universal card (few companies have this function)
    • Offline ticketing (will continue to print even if system goes down)
    • Live floor view
    • Smart card
    • 2 way downloadable credits
    • Game reservation (allows customers to lock games for 30 minutes so no one else can play them)
    • High limit jackpot
  • Table View:
    • Have over 80 sites and almost 4,000 tables connected. Sold more table views last year than all the years combined (won all of PA); added 2,500 tables.
    • Only system where casino doesn't need to replace chips or tables - Optical chip recognition and automated bet tracking - not RFID
  • Revenue generating products:
    • iVIEW DM only floor-wide solution
    • Supports all protocols (which their competitors' windows can't do)
  • On 1,200 devices at Pechanga - with iView.  Wheel allows them to market to customers at the point of play.  Virtual racing app: carded play, rated play and card requested all increased.
  • The virtual racing--will come out in a series of games
  • Drink ordering tool allows them to advertise certain alcohol and make money that way
  • Also can send customer rewards right to the game instead of mailing stuff to their house
  • Also allows them to market perishable inventory (food/hotel rooms/show tickets)
  • New casinos: 70k slots--3500 per game--is 245MM opportunity
  • WMS's bonusing only works on their own devices.  WMS's bonusing isn't integrated into the casinos' systems. Today, WMS's systems are approved as gaming devices, not systems.



  • 70% of their systems revenue has been generated from their existing customer base. Canada is obviously new.  It's been 70% for the last 3 years. When an existing customer has a new opening, they count that in the 70%.
  • The $3,500-4,500 price in Canada doesn't include maintenance revenue.  Maintenance starts 90 days after go live.
  • 3 of the top Konami salespeople joined them over the last few months.
  • Canada RFP for units:  doesn't think that winning the system will help with slots. Alberta was awarded to IGT and Speilo 50/50.
  • IL - still see it as a large market but it can slip into the Dec '11 quarter.  Think that they have a good product there. Time frame of IL roll out - best guess is 6 quarters.
  • Acqueduct timing: plan to open April/May 2011 at 50%.  Numbers should be better than Yonkers.
  • Part of what they did to improve their video product was open up lots of studios - former ALL guys, WMS guys and Atronic deal no deal guys. Alpha 2 is also a better platform. Have 50% more studios.
  • Australia - expect it to be breakeven, maybe a penny this year, but after that, they expect it to contribute 5 cents per year. But they also expect to be able to export the successes they have there back to the USA.
  • Thinks that WMS's lawsuit is about Cash Spin.  BYI just filed a response to WMS's suit.
  • IGT anti-trust and bonusing still left - not expecting any news on that for 6 more months.
  • Feel like iView DM pipeline is pretty exciting.
  • Can put it on a competitor's system but are staying away from that now. Applications will be initially licensed but can switch it to recurring revenue.
  • Out of the 420k slots connected - 100k can't do bc of economics and then half don't have high speed internet; so about 150k slot opportunity for iView DM. Marketing department limitations for customers are also a barrier.
  • Cool new games:
    • Love Meter
    • Cash Wizard
    • Golden Pharoah - has a horizontal wheel
    • Alpha 2: 4 screens, speaker system, emotive lighting, hot zones, iDeck.
    • 260 games at show


Conclusion: I walked away from a recent meeting with management with a very clear impression that things are mending and the consensus is taking the “wait and see” approach.   


As measured by our Casual Dining sentiment monitor, EAT is at the bottom of the pack.  As I told this to Brinker’s CFO, Guy Constant, I noted that all the great concepts in the restaurant space have been there at one time or another: MCD, SBUX, WEN and DRI to name a few.


His response was that the sentiment around Brinker’s stock is like a “badge of honor.”  I thought this was a positive indication, given the context, of how this CFO thinks.


A major component of the EAT thesis I outlined in my Black Book earlier this year was the company’s focus on operations with the aim of expanding margins and improving the guest experience.  Soft sales trends in recent quarters are adding a sense of urgency to improve both the front and back of the house from an operational perspective.  The 187 bps improvement in restaurant level operating margins in the past quarter was evidence that those efforts are taking hold.


The Street’s wait-and-see approach is clearly focused on the top line.  There is some evidence of improvement in September, with Chili’s same-store sales declining only 0.8% when adjusting for the one week calendar shift that resulted from the fact that fiscal 2010 was a 53-week year relative to 52 weeks is fiscal 2011.  The real evidence will be seen when we turn the calendar and begin to focus on the second half of Brinker’s fiscal year 2011.


As we head into 2HFY11, an acceleration of the sales will be evident for the following reasons:


(1)    Chili’s is lapping the introduction of menu changes that caused sales to decline last year

(2)    “2 for $20” is to become permanent menu item; this will be incremental to sales in 2HFY11

(3)    In January, Chili’s will be rolling out a new lunch menu focused on gaining traction in a day part that has been challenging for the company.


By the time sales trends start to improve (3Q of FY11), management expects to have fully implemented the margin initiatives across the entire Chili’s system.  The prospect of a combination of improved sales flowing through a more streamlined restaurant suggests that Brinker should begin to enjoy positive sales trends in conjunction with positive operating margin growth.  On a quarterly basis, I track the operating status of companies depending on their sales and margin growth and divide the space into four quadrants.  The top right of the chart – what I call “Nirvana” – is where I see Brinker in 2HFY11.  As an aside, my last examination of the “Nirvana” group indicated that, on average, companies operating at that level trade at approximately 9.5x NTM EV/EBITDA. 


Currently trading at 6.1x EV/EBITDA, EAT is trading at a multiple just slightly above RRGB at 5.9x.  The difference between the companies, and their respective prospects, couldn’t be any more clear.  RRGB’s management team has no control over their business trends.  Additionally, EAT is trading at a discount (on an NTM EV/EBITDA basis) to RUTH, CPKI, MRT and RT, all of which lack the size, scale, and brand presence that Chili’s has.  The strength of Brinker’s balance sheet and their cash flow generation are two other strong differentiators.  I am not surprised that Brinker’s CFO relished the company’s lowly standing in the sentiment stakes; he knows that the only way is straight up.


EAT - A BADGE OF HONOR - eatsent


EAT - A BADGE OF HONOR - eat matrix


Howard Penney

Managing Director


Management strikes out in attempting to pitch a 14x multiple deal at an 8-10x valuation.



A bird in the hand is worth two in the bush, or so the medieval phrase goes.  Unfortunately, Caesars’ management wants you to buy $3.32 billion worth of EBITDA in the bush versus the $1.77 billion of actual EBITDA in the hand.  With significant negative free cash flow and 11.5x leveraged, where do I sign up?  We call ball four on this deal so the prudent thing would be to take a walk. 


At the midpoint of the $15-17 offering range, the valuation looks to be around 14x 2011 EV/EBITDA.  We use the face value of the debt rather than book value which is over a $3 billion difference and a 1.8x EBITDA turn. 


This must be a Macau stock, right?  We think there should be close to zero value ascribed to Macau.  What about other development opportunities and hidden assets?  Even if they could find the money, Japan would be a long shot for them, and Texas, PA, and Ohio would cannibalize existing CZR properties.  Finally, while we do think World Series of Poker has brand equity, internet gaming in the US just took a major step backward with the Republicans taking over the House.


While we do agree that current EBITDA levels are close to trough, there is a lot of Kool-Aid to drink for one to believe in $1 billion in incremental recovery EBITDA.  Here is the Kool-Aid recovery scenario:



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