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YUM – AS BOLD AS EVER

YUM continues to pursue an aggressive growth strategy.  Here is a recap of their analyst day that occurred this week in New York.

 

Chief Executive Officer, David Novak, and his team gave a detailed presentation today in midtown NYC and their overall strategy remains unchanged.  As they presented it, their four-pronged strategy is:

 

1) Build leading brands in China in every single category

Hedgeye take: An incredibly strong business and much of the future sentiment around the stock will be anchored on the performance of the China division.

2) Drive aggressive, international expansion and build strong brands everywhere

Hedgeye take: Herein is lies a risk for the company’s “aggressive growth” strategy.  Incremental international “growth” related capital is moving toward the lower return western part of Europe

3) Dramatically improve U.S. brand positions, consistency, and returns

Hedgeye take: Apart from the Taco Bell and the franchise revenue stream, the US business is not competitive and is in a continued, long-term, secular decline

4) Drive industry leading long-term shareholder and franchisee value

Hedgeye take: This significant growth profile will limit the amount of cash returned to shareholders relative to the past 5 years.

 

I have some thoughts to share on the respective segments, as they were discussed today, and then I will conclude with some thoughts on the company’s guidance and overall strategy heading into 2011. 

 

 

China


China’s performance remains impressive and management is as bullish as ever on prospects for that market.  YUM plans to further improve asset utilization in the near future with breakfast being rolled out in all stores, delivery being implemented and also 24-hour service on a limited basis (just over 1,000 stores).  KFC is opening in cities where no competitors exist and are currently in 650 cities in China.  Management was repeatedly citing a Euromonitor source outlining the projected 650m Chinese that will make up the Consuming Class in 2020 versus the 2010 total of 450m. 

 

Overall, the division is focused on its aim to continue growing aggressively in China.  The company is appropriately focused on cities and transport hubs.  It was interesting to see that the company breaks cities into six tiers.  While I was unable to find a specific definition for these tiers, it follows that Shanghai and other large, developed cities are Tier 1 cities and smaller cities such as Xinghua in the Jiangsu Province are Tier 5 cities.  In 2010, 15% of total builds were Tier 1, 33% were Tier 2, and 52% were Tier 3-6.  It is interesting to note that operating margins have stayed relatively flat versus nine years ago despite growth being more focused on lower tier (higher margin) cities in recent years.  This obviously implies that margins have declined for YUM in Tier 1 markets.  There is a 500-800bps difference between T1 cities and the balance of the country.  This was explained to us as being mainly attributable to higher rent expense in T1 cities.  Given that operating margins are so much higher in other cities the contraction is not overly problematic, but the trends are important to watch.

 

China accounts for 37% of the company’s operating profit and I think it is now unwise to be negative on YUM unless one is also negative on China.  YUM’s management team is “all in” as it relates to China and this is evident in their guidance for 2011.  The “ongoing” growth target remains 15% on an annual basis and embedded in that number are assumptions of double-digit percent unit growth, at least 4% of comparable restaurant sales growth, and moderate G&A leverage.  The 4% same-store sales imply a significant step up in two-year trends and I believe it may be slightly aggressive but top line trends remain robust.

 

Their earnings guidance also takes into account expected inflation levels of 5% on the Food & Paper line coming from 6-to-7% inflation in chicken (45% of mix) and 2% inflation for packaging.  Management’s projection of 12% inflation in labor due to ongoing government requirements is a double-edged sword for Yum since consumers have more money but labor costs go up for their China division.  Obviously one edge of that sword is sharper than the other and this will negatively impact earnings.  Management seemed confident that sales leverage and the scale that exists in China would enable them to overcome these headwinds in 2011.

 

 

United States

 

The United States is a relatively difficult market for YUM and the company is investing less and less (as a percentage of total) in the division as a result, preferring to increase their focus on China and emerging markets.  In 1998, 78% of YUM’s operating profit came from U.S. operations.  At present that figure is 35% and the company projects that it will shrink further, to 25%, by 2015. 

 

For now, though, the U.S. remains an important market and the company is struggling to stimulate the KFC business and readily admits that no silver bullet is forthcoming.   Taco Bell drives 60% of U.S. operating income.  For 2010, 376 (over 2x the 2009 number) remodels will be carried out and management are stepping up the pace of new unit growth for the concept.  The “Bold Goal” is to build 8,000 Taco Bells in the U.S.  The slide management presented to illustrate this point showed the number of Burger King restaurants in the U.S. as a comparison, which is roughly 7,300.  This is not an especially useful comparison given the intrinsically different natures of the two concepts and the fact that Burger King, many could argue, could stand needs to close many of its stores. 

 

In terms of guidance for 2011, the company is forecasting 6% operating profit for Taco Bell U.S. in 2011 and 3% for “Rest of U.S.”, which, if you take Taco Bell as 60% of operating income, implies overall profit growth of 4.8% for the entire U.S. Division.  Taco Bell’s guidance assumes “modest” unit growth, 3% comparable restaurant sales growth, and “modest” G&A leverage for the year.  Specific guidance for KFC and Pizza Hut within the U.S. Division were conspicuous by their absence.  The lack of disclosure doesn’t bode well for their respective performances in 2011.

 

Overall, I expect the U.S. business to continue to be a drag for YUM.  Despite best efforts, KFC is struggling and I do not believe any of the initiatives mentioned at the Analyst Day, such as increasing sandwich mix, will yield improved margins.  Again, comparisons of markets (in this case U.S. versus U.K.) may be interesting but do not necessarily offer a winning solution from a strategy standpoint.   The refranchising strategy that the company is pursuing with KFC should insulate the company’s bottom line from the weaknesses in that business somewhat, but alongside the bold (and brave) pronouncements that defined the other segments of the presentation, the management’s tone during commentary on the U.S. market was decidedly cautious.  Goal number 3, of the 4 pronged strategy outlined at the outset of the presentation, to “dramatically improve U.S. brand positions, consistency, and returns”, will definitely be the most difficult of all 2011 goals for Yum Brands.

 

 

YRI

 

This was an interesting part of the presentation.  YUM is aggressively pursuing growth opportunities in select emerging markets, such as Indonesia, Malaysia, Thailand, and others.  The thesis is similar to YUM’s China stance; the consuming class population is set to grow at an even faster rate in “YRI Emerging” markets than in China; set to grow to 2 billion by 2020 from 1.1 billion today versus 450 million to 650 million over the same period in China. 

 

Management was particularly enthusiastic about the prospects for growth via the Asia Franchise Business Unit.  There are 4,500 units in operation within these countries where six franchisees own 75% of the units.  GDP growth in many of these emerging markets in Asia, such as Malaysia, Thailand, Indonesia, and Vietnam is expected to greatly exceed that of the U.S./Euro area over the next 30 years and, as with the China thesis, it is not hard to understand the appeal.   This was truly a presentation of bold statements, from start to finish, and the YRI section held its own in that regard, showing the 7.5 YUM stores per million people in the Asia FBU division versus the 60 YUM stores per million people in the U.S.  Undoubtedly the Asia FBU number will grow, but I don’t understand the significance of the (probably over-saturated) U.S. number in this context.

 

 

Africa

 

One of YUM’s goals for 2011 is to “drive aggressive, international expansion and build strong brands everywhere”.  Apparently, they meant it.  Africa, putting the “A” in “BRICA”, is on the “ground floor of growth”, according to YUM.  This is a plan that is in its embryonic stages so it would be wrong of me to be hypercritical at this stage but the thesis certainly did not seem water-tight to me.  The GM of the Africa effort made some statements that alarmed me within an otherwise interesting and well-delivered presentation. 

 

One of these was that “Africa has good governance”.  I’m not an expert on Africa’s political economy but, merely by following the news, I know that the level of political stability in many African nations is far from good.  This is true for several of the nations cited by management as targets for unit expansion with stories abounding of political unrest regularly.  A simple news search online can illustrate my point. 

 

I don’t think that this will significantly impact YUM’s earnings power but there are certainly better uses of capital, in my opinion.  While the long term debt schedule included in YUM’s folder of slides that was provided for the presentation shows that the company has access to cheap capital, it may not last forever.  David Novak underlined the company’s commitment to “watch returns manically” but the company could rue investing capital in some of the African markets mentioned should their projections be overly bullish.  

 

Projections are only as useful as the assumptions implicit in them and I would submit that the estimate of Africa’s GDP hitting $2.6T in 2020 is not very useful given the length of time and the politically and economically volatile nature of African political economies.  Again, the extent to which the company will lever itself to the African markets is as yet unknown and can be assumed, for now, to be small.  Perhaps this new direction is allied with Chinese investment in Africa, given how important China is as a market for YUM, but I hope that they proceed with more caution than was communicated in the presentation yesterday.

 

 

Conclusion

 

At the end of the day, the strategy of “building brands everywhere” and “growing in China till the cows come home” works until it doesn’t.  I’m not suggesting that management won’t stay focused on returns but it will be important to monitor what they do more closely than what they say.  Bold statements have set great expectations and it will be important for the company to retain its discipline – something it purports to do – and not become married to a mantra of growing “everywhere”.  A change in the macro environment, pertaining to individual companies or to the company’s cost of capital, could be a future risk.

 

Overall, the company remains an impressive organization but the more it stretches itself, developing new brands and new markets, the more investment it will take to maintain current performance.  The 500+ person team employed in almost every province in China is just one example of the infrastructure YUM has built for itself in certain international markets.  All in all, no revelations were revealed during yesterday’s meeting.  Management was extremely positive and as bold as ever in their projections and outlook for the business.    Given the company’s significant growth profile, how the company invests its incremental cash is a vital determinant of the stock price.  By that score, as shown in the charts below, 2010 has been a very strong year for YUM.

 

YUM – AS BOLD AS EVER - china roiic

 

YUM – AS BOLD AS EVER - us roiic

 

YUM – AS BOLD AS EVER - yri roii

 

Howard Penney

Managing Director


THE M3: VENETIAN RAID; GALAXY BONDS; JUNKET COMMISSION TAX; CHINA; TIGER AIRWAYS

The Macau Metro Monitor, December 10th, 2010

 

VICE SQUAD RAIDS CASINO HOURS AFTER OWNER ADELSON FLIES IN SCMP

According to Macau police, a total of 110 mainland women believed to be prostitutes and 22 other people thought to be controlling them were detained at the Venetian.  A Sands spokeswoman said the Venetian had a policy outlawing sex workers on the premises.  She said  "His [Adelson's] arrival is not connected with any of the current issues happening. It's a regular board meeting that was scheduled."

 

A Macau insider said such raids on the city's casinos were not uncommon but were usually right before "sensitive" occasions such as the visits of state officials to the city.  "A police operation was carried out before the arrival of Premier Wen Jiabao last month and other casinos have been the subject of similar action. But everyone in Macau knows what sort of attention an action like this at the Venetian will attract," the insider said.

 

DIM-SUM JUNK BONDS LURE GALAXY YIELDING LESS THAN WYNN, MGM: CHINA CREDIT Bloomberg

Galaxy sold $1.38BN yuan of three-year notes yielding 4.625%--58 basis points less than similar- maturity investment-grade bonds in Shanghai.  The bond yield was also lower than that of MGM's 2016 notes (10.05%) and WYNN's 2020 first-mortgage notes (6.39%).  According to S&P, the bonds were the first speculative-grade corporate debt offered in Hong Kong’s yuan market.  A person familiar with the deal said Galaxy's sale attracted 14 billion yuan of orders.  Galaxy said it will use money from the bonds for non-gambling businesses and general corporate use.

 

MACAU GOVERNMENT TOOK MOP250 MILLION IN TAXES ON JUNKET COMMISSIONS IN 2009 macaubusiness.com

The government pocketed MOP250 million (US$31 million) in taxes on commissions paid by casinos to junket promoters last year, 4.4% more than in 2008.  A final withholding tax of 5 percent is levied on commissions paid by gaming operators to junket promoters.  The amount of tax collected last year implies that casino operators paid MOP5 billion in commissions.

CHINA RAISES BANKS' RESERVE RATIOS AGAIN Reuters

On Dec20, Required Reserve Ratios will increase by 50 basis points to 18.5%, a record high for the majority of the China's banks.


CHINA'S NOVEMBER PROPERTY PRICES RISE AT SLOWEST PACE IN A YEAR ON CURBS Bloomberg

In November, China's home prices in 70 cities climbed 7.7% YoY and increased 0.3% MoM.

 

BUDGET CARRIER TIGER AIRWAYS CARRIES 464,000 PASSENGERS IN NOV Channel News Asia

Singapore-listed budget carrier Tiger Airways said it carried 464,000 passengers in November, up 10% YoY.  However, the load factor edged down by one % point to 86% in the same period.


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - December 10, 2010

 

As we look at today’s set up for the S&P 500, the range is 35 points or -1.54% downside to 1214 and 1.30% upside to 1249.  Equity futures are trading above fair value in the wake of yesterday's financial-led gains. Trading in Asia and Europe has proved mixed.  To coincide with the start of China's Central Economic Work Conference, authorities have raised their bank reserve requirement.  Today's data highlights include Dec preliminary U of M Consumer Confidence and Oct Trade Balance.

  • Aastrom Biosciences (ASTM) to offer undisclosed amount of shares
  • Borders Group (BGP): 16 stores to be closed in 4Q, in talks to refinance
  • Capstead Mortgage (CMO) declares 4Q div 39c-shr
  • Cypress Sharpridge Investments (CYS) to offer 10m shrs
  • Esterline Technologies (ESL) sees FY11 EPS above est.
  • Green Mountain Coffee Roasters (GMCR) sees 1Q EPS below est.
  • National Semiconductor (NSM) sees 3Q rev. below est.

PERFORMANCE

  • One day: Dow (0.02%), S&P +0.38%, Nasdaq +0.29%, Russell 2000 +0.47%
  • Month-to-date: Dow +3.31%, S&P +4.44%, Nasdaq +4.47%, Russell +5.59%
  • Quarter-to-date: Dow +5.39%, S&P +8.04%, Nasdaq +10.47%, Russell +13.53%
  • Year-to-date: Dow +9.03%, S&P +10.57%, Nasdaq +15.31%, Russell +22.74%
  • Sector Performance: Financials +1.3%, Telecom +1.1%, Materials +0.4%, Consumer Spls +0.4%, Utilities +0.3%, Energy +0.3%, Industrials +0.2%, Healthcare +0.2%, Tech 0.00%, Consumer Disc (0.02%)

 EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 354 (+1039)  
  • VOLUME: NYSE 1004.27 (-8.10%)
  • VIX:  17.25 -2.76% YTD PERFORMANCE: -20.43%
  • SPX PUT/CALL RATIO: 1.33 from 2.05 -35.21%

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 16.83 0.102 (0.607%)
  • 3-MONTH T-BILL YIELD: 0.14% -0.01%  
  • YIELD CURVE: 2.59 from 2.63

COMMODITY/GROWTH EXPECTATION:

  • CRB: 316.09 -0.25%
  • Oil: 88.65 +0.10%
  • COPPER: 408.70 -0.33%
  • GOLD: 1,389.30 +0.53%

CURRENCIES:

  • EURO: 1.3222 -0.04%
  • DOLLAR: 80.069 +0.09%

OVERSEAS MARKETS:

 

EUROPEAN MARKETS:

  • European markets trade mixed to higher with peripheral markets lagging.
  • The FTSE100 mainly fluctuated in a narrow range either side of unchanged, while the DAX and CAC have extended early gains to trade near session highs.
  • Chinese trade data underlined the strength in its economy.
  • President Sarkozy and Chancellor Merkel are meeting to discuss the EuroZone crisis ahead of next week's EU Summit.
  • Germany Nov Wholesale Price Index +7.8% y/y vs prior +7.7%
  • France Oct Industrial Production (0.8%) m/m vs con +0.3%
  • UK Nov Core PPI +3.3% y/y vs con +3.5% and prior revised +3.2%

ASIAN MARKTES:

  • Most Asian markets went down today as strong trade figures from China exacerbated fears that the country will raise interest rates.
  • China rose on its trade figure, though volume remained tepid
  • China increased bank reserve ratios
  • Australia finished flat as gains in banks balanced out declines by miners.
  • Hong Kong finished flat, but Chinese property stocks fell on worries about interest rates.
  • Taiwan fell 0.40%              
  • Japan rose 1% early, but quickly reversed course on profit-taking, having reached a seven-month high.
  • McDonald’s Holdings (Japan) fell 2% on lower November comps
  • Japan November corporate goods price index +0.9% y/y. Q4 large-company sentiment (5.0) vs 7.1 seq. November consumer confidence 40.4, +0.9 pts y/y, (0.5 pts) seq.
  • China November trade surplus $22.90B vs $22.3B survey.

Howard Penney

Managing Director

 

THE DAILY OUTLOOK - levels and trends1210

 

THE DAILY OUTLOOK - S P 1210

 

THE DAILY OUTLOOK - vix 1210

 

THE DAILY OUTLOOK - usd 1210

 

THE DAILY OUTLOOK - oil 1210

 

THE DAILY OUTLOOK - gold 1210

 

THE DAILY OUTLOOK - copper 1210

 


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Rich Privileges

“One of the privileges of a rich man is that he can afford to be foolish much longer than a poor man.”

-Ludwig von Mises

 

This morning’s top global macro headline is ‘China raising rates on reserve requirements in order to fight inflation.’ This shouldn’t be new “news” to anyone who follows Chinese monetary policy closely. China is willing to give-up short-term stock market performance (the Shanghai Composite Index is down -13.3% for the YTD) for long-term price stability. Fancy that.

 

What is inflation? It’s when prices are breaking out to higher-highs over the intermediate-term TREND. In Ludwig von Mises 4th Lecture (“Inflation”, page 52 of Economic Policy) he reminds us that “the most important thing to remember is that inflation is not an act of God; inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.”

 

The Ben Ber-nank’s inflation policy has been crystal clear. Since his decision to engage in Quantitative Guessing part deux at the Groupthink Inc. meetings in Jackson Hole in August, here are the 3-month percentage moves of real-time market prices:

  1. Crude Oil = +18.2%
  2. Natural Gas = +20.8%
  3. Heating Oil = +18.2%
  4. Gold = +10.1%
  5. Silver = +41.2%
  6. Palladium = +38.3%
  7. Copper = +17.3%
  8. Cocoa = +12.3%
  9. Cotton = +52.4%
  10. Lumber = +19.8%
  11. Orange Juice = +16.5%
  12. Sugar = +35.5%
  13. Corn = +24.2%
  14. Oats = +27.9%
  15. Rice = +20.5%
  16. Soybeans = +23.6%
  17. Wheat = +10.3%

Now to be fair to the Fear-mongering Deflationistas who want me to believe that I should accept a ZERO percent rate of return in my savings account in perpetuity, the price of pork bellies was down -1% over the same time period. Maybe, in the short run, I should have stuffed my kids with rice-less, wrap-less, pork burritos for the last 3 months and have told them to like it… no guac.

 

Altogether, in the long run, the Keynesians like to say don’t sweat this short run stuff, because “you’re dead.” While that’s seemingly a convenient and clever answer to starving the world’s poor for a nice year-end US stock market “pop”, as von Mises said, “the fact is that, in the not very long run, inflation does not cure unemployment” either.

 

As the US stock market continues to hit higher-highs on light volume and negative breadth and skew, both global and local bond yields continue to ring the alarm bells of inflation concerns. That’s why the world’s largest bond fund, Bill Gross’ PIMCO Total Return Fund ($250 BILLION in assets under management), has lost 3% of its nominal value in the last 30 days. Inflation is a policy. Inflation is bad for bonds.

 

Every aspect of what’s going on in global macro markets right now makes sense to us other than US stocks going higher. No, that doesn’t mean that every stock market should be going lower. We have a 9% long position in the German stock market and that makes sense to us as countries like Germany and Australia have pseudo-sober monetary and fiscal policy that’s not equating to US style Jobless Stagflation.

 

As a reminder, our intermediate-term global macro outlook for the next 3-6 months is as follows:

  1. Global Growth Slowing
  2. Global Inflation Accelerating
  3. Interconnected Risk Compounding

As hyped up as a US stock market bull wants to get on buying the things that China, India, and Brazil want, is as disinterested as local stock market investors in all 3 of those markets have suddenly become. Two of the three are broken on both our TRADE and TREND durations (India and Brazil) and one of the three (China) is gearing up to release very hawkish inflation data this weekend.

 

In the Hedgeye Chart of The Day (attached) we have outlined this point with a picture of Brazil’s Bovespa. The situation developing in Brazil’s economy is a major global macro risk:

  1. Growth Slowing – Q3 GDP released yesterday showed Brazilian growth slow materially (on a sequential basis) to +6.7% year-over-year versus the +9.2% reported growth of Q2 2010.
  2. Inflation Accelerating – this morning, Brazil’s CPI (Consumer Price Index) jumped to +5.6% for the month of November versus +5.2% reported for October.
  3. Interconnected Risk Compounding – as emerging market debt in Brazil comes off one of its worst monthly performances since the late 90’s , Brazil’s stock market has all of a sudden dropped -7% since the beginning of November.

Remember, market prices don’t lie; politicians do. And think about what Ludwig von Mises said in his 4th Lecture, “Inflation” (in Argentina 1959) when he asked us to “remember that, in the long run, we may all be dead and certainly will be dead. But we should arrange our earthly affairs for the short run in which we have to live.”

 

My immediate term TRADE support and resistance levels for the SP500 are now 1214 and 1249, respectively.

 

Best of luck out there today and enjoy your weekend,

KM

 

Keith R. McCullough

Chief Executive Officer

 

Rich Privileges - BOVESPA


I-POKER BILL MAY BE DYING

While it appears that the I-Poker Bill may be dead for this session, it is likely to reemerge next year.  Here is our review.

 

 

 ‘‘Prohibition of Internet Gambling, Internet Poker Regulation, and Strengthening UIGEA Act of 2010” 

  • “Poker has long been part of the cultural and recreational fabric of the United States”

According to the latest conversations, it appears that the I-poker bill is dying on the vine and it may be a stretch for Senate Majority Leader Harry Reid to get his bill attached to the tax cuts.  However, we thought it might be helpful to summarize the latest and greatest draft of the ‘‘Prohibition of Internet Gambling, Internet Poker Regulation, and Strengthening UIGEA Act of 2010”.  Some of the key highlights of the bill include:

  • Timing:  at least 15 months after enactment (April 2012 at earliest)
  • Who can get licensed: Currently licensed US operators and suppliers that have been licensed for at least 5 years
  • Term and Terms: Initial 5 year term with renewal options with a license fee of 20% of poker receipts
  • Who can’t get licensed:  Anyone who owned (5% or more) or controlled a company that knowingly accepted illegal wagers from US players or any person that was a significant vendor to such person.  The acquisition of any Person also precludes a person from getting licensed
  • Down the road:  After 2 years, governing agency reserves the right to expand the universe of qualified licensees
  • What happens to unlicensed operators:  Unlicensed operators must cease operations within 30 days of the bill’s enactment and return any monies to customers or face fines of up to $1MM/day.
  • International players?  Can’t get licensed under this bill but there’s nothing in here that suggests that they can’t partner with land based operators to help them get up and running.

 

FULL SUMMARY

Part I:  PROHIBITION ON UNLICENSED INTERNET GAMBLING AND REGULATION OF INTERNET POKER

  • Basically lays out the argument of why Poker is different from other games of chance and how it’s legal to play poker in 15 states
  • Claims that since the US never intended to include Internet gaming of any kind within the scope of its commitments under the General Agreement for Trade in Services, and therefore, no WTO Member had any competitive expectation of access to the United States Internet gaming market
  • Licensees may not accept wagers from individuals located outside the US, unless the entity that operates that internet gaming facility is separate from the one that is licensed to operate an internet poker facility under this title
  • To the extent international wagers are accepted by a separate entity, there must be no commingling of funds
  • The Secretary may choose to remove the limitation of accepting international bets 3 years after licenses are first issued
  • Essentially bars former participants in the illegal US igaming market to be licensed and prohibits any licensee from purchasing former illegal operators (anything over 5% ownerships or control).  Prohibits issuing licenses to any Person who:
    • Previously owned an internet gaming facility that knowingly accepted bets/ wagers from persons located in the US
    • Was a significant vendor to the bets or wagers from persons known to be located in the US
    • Who purchased or acquired on whole or part an online gaming operator who knowingly accepted wagers from persons in the US or who was a vendor to sure operators
  • Licenses will only be issued to applicants who:
    • Own or control a company that operates a casino facility or a qualified track for  a duration of at least 5 years
    • Suppliers (who have been licensed for at least 5 years) of slot machines or qualified mobile gaming systems casino gaming facilities with at least 500 machines
    • After 2 years following the issuances of licenses, the Secretary may expand the definition of qualified licensees as deemed appropriate
  • Prohibits
    • Underage gaming (21 years old)
    • Wagers from States and Tribes that prohibit gaming
      • Although states that do not currently permit commercial poker may opt in to online poker and states that do permit commercial poker may opt out
  • Mandates collection or reporting of customer taxes
  • Safeguards against financial crime (money laundering/fraud/etc), compulsive gambling, privacy, and cheating
  • No licenses will be issued before 15 months after this bill is enacted
  • Operators running internet poker sites without a license would have up to 30 days to cease operations once this bill is enacted and return all monies in accounts back to players over 2 years , after which any remaining funds would be put in escrow with a financial institution for safekeeping
  • Penalties for unlicensed of not more than the greater of :
    • Amount of bets or wagers taken by the person from players in the US during the unlicensed period; or
    • $1MM per day that they person accepts bets or wagers from players during the unlicensed period
  • Licenses are issued for a term of 5 years with renewal options. Any transfer of a license or change in a control require approval by a qualified body.
  • All licensees will have to report all transactions to the regulatory body and provide annual reports
  • There will be regulations developed for exclusion of compulsive gamblers and other persons that want to opt into a self-exclusion program which each licensee will have to implement
  • Deems it illegal to operate a place of public accommodation (club or associations) in which computer terminals or devices are made available principally for the purpose of Internet gambling

Part II: STRENGTHENING OF UNLAWFUL INTERNET GAMBLING ENFORCEMENT ACT OF 2006 (UIGEA)

  • Financial transaction providers shall not be held liable for accepting bets or wagers permitted by the UIGEA 2010 unless they know or should know that the transactions are conducted in violation of Federal or State law
  • Identify unlicensed Internet gambling enterprises and within 120 days of the enactment of the Prohibition of Internet Gambling, Internet Poker Regulation and Strengthening of the UIGEA Act of 2010 submit a list of those companies to the Secretary.  The list will be updated every 60 days. Financial transaction providers will not be able to process transactions for any companies on this list.

Part III: INTERNET POKER REVENUE PROVISIONS

  • License fee to be paid no later than 15 days after the end of each month in the amount of 2% of the licensee’s Internet poker receipts
  • Fees include any commissions, tournament fee, or any other charges to customers
  • The fee/ penalty for unlicensed operators is 50% of poker receipts
  • Internet Poker licensee fee trust fund where all the I-poker revenues will go
  • Expenditures from the fund will go to qualified Indian tribes and States,  allocated on a pro-rata basis with the number of players within each jurisdiction

Mandelbrot Math

This note was originally published at 8am this morning, December 09, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“He doesn’t spend months or years proving what he has observed.”

-Professor Heinz-Otto Peitgen, on Benoit Mandelbrot

 

Benoit Mandelbrot was one of the most important contributors to my multi-factor, multi-duration, global macro risk management model. After publishing “The Fractal Geometry of Nature” in 1982, Mandelbrot eventually landed in New Haven as a professor in Yale’s math department. He finally earned his tenure as I was leaving campus for Wall Street in the late 90’s. Over time, he’s been recognized as one of the forefathers of fractal math.

 

On October 14th of this year, Professor Mandelbrot passed away in Cambridge, MA.  He was 85 years old. A few days later, one of our analysts, Matt Hedrick, sent me a nice tribute that Jascha Hoffman wrote for Mandelbrot in The New York Times. That’s where the aforementioned quote came from and it was followed by this one (which is taped on the insert of my notebook):

 

“But if we talk about impact inside mathematics, and applications in the sciences, he is one of the most important figures of the last 50 years.”

-Professor Heinz-Otto Peitgen (“Benoit Mandelbrot, Novel Mathematician, Dies at 85”, by Jascha Hoffman, NYT, October 16, 2010)

 

Amen Professor Peitgen. And thank you Jascha Hoffman. Benoit Mandelbrot was no one’s yes man. He wasn’t academically dogmatic either. He kept learning and re-thinking. As a result, I think the principles of Mandelbrot Math will be applied by global macro risk managers for decades to come.

 

I call this out this morning as I just got back from an investor trip that took me to Western Canada. The contours of the Rocky Mountain tops would most certainly fascinate Mandelbrot inasmuch as they would the fractal dimension of the Pacific Ocean’s coastline. Anyone flying across this world attempting to consider its deep simplicity from a top down perspective probably gets what I mean. It’s what make this game fun.

 

When you wake-up every morning trying to make a global macro market “call”, you need a place to start from. In order to attempt to know where you are going with that “call”, you most certainly need to know where you’ve been. By the time that market’s bell rings, you don’t have “month or years to prove what you have observed.” You have minutes. This is the game.

 

This morning’s global macro game is confusing. The US stock and bond markets are sending completely different messages as Asian stocks and bonds continue to break down.  All the while European sovereign risk premiums continue to fluctuate like twitter.

 

Let’s look at US markets first:

  1. The SP500 had its 1st up day in the last 3, making a bullish comeback from an outside reversal on the day prior, hitting a new YTD high at 1228.
  2. The SP500 is now up +81.7% from its March 2009 lows and down -21.5% versus its October 2007 highs.
  3. The immediate-term TRADE range for the SP500 moves to 1209-1245, with the daily downside risk being about equal with upside reward.
  4. Volatility (VIX) at 17.74 is testing a breakdown towards its April lows; while this is a bearish contrarian signal, the VIX could easily test 16.
  5. US stock market Volume and Breadth studies continue to flash bearish, despite higher prices, there is a very negative skew.
  6. In our SP500 Sector Studies, 2/9 sectors are bearish (XLV, and XLU) and 7/9 bullish from an immediate-term TRADE perspective.
  7. The US Dollar Index continues to flash bullish on both our TRADE and TREND durations, with intermediate term TREND support at $79.49.
  8. US Treasury Yields continue to boom to the upside with 2s, 10s, and 30s all busting out into what we call Bullish Formations.
  9. The Yield Spread (10s minus 2s) continues to widen at +10bps for the week-to-date, supporting the rally in Financials (XLF).

Overseas, the immediate-term game is much less confusing:

  1. Chinese equities were down another -1.3% overnight and remain bearish from an immediate-term TRADE perspective at -14.3% YTD.
  2. Indian equities got tagged for another -2.3% drop overnight as the BSE Sensex broke its intermediate term TREND line of 19,655.
  3. Japanese equities are the only bullish immediate-term TRADE market in Asia as the POSITIVE correlation to the USD reigns supreme.
  4. Australia’s central banking guru, Glenn Stevens, continues to prove that raising rates and seeing unemployment drop can work together.
  5. Germany, Russia, and the Netherlands continue to flash bullish TRADE and TREND signals in both stocks and bonds.
  6. Spain, Italy, and Greece continue to flash bearish TRADE and TREND in both stocks and bonds.
  7. Brazil looks like India, as stocks on the Bovespa are down every day this week and now bearish on both TRADE and TREND durations.
  8. The Euro continues to flash bearish on both our TRADE and TREND durations with intermediate-term TREND resistance = $1.34.

Global Commodities markets continue to confirm what almost every country’s central banker who has real-time quotes sees – inflation:

  1. The CRB Commodities Index closed at 316 yesterday = +21% higher than Bernanke’s decision in Jackson Hole to Quantitatively Guess.
  2. Oil is in a Bullish Formation with immediate-term TRADE lines of support and resistance of $87.17 and $91.47, respectively.
  3. Copper prices are testing ALL-TIME highs again this morning = +29% since The Ber-nank opted to sponsor inflation.

Gold, meanwhile, looks a little bit less-like most commodities all of a sudden. To a degree, if real-interest rates continue to push higher, the gold bulls will have to compete with that yield. That’s new. Tops are processes, not points, but Gold will need to get back above its immediate-term TRADE line of $1390/oz to get me interested in getting long it again (I sold our GLD position on Monday).

 

Altogether, if you take the beginning and end of 2010, you can draw plenty of conclusions that are now crystal clear. From my global macro model’s vantage point, the deep simplicity of all of these global macro factors and what they mean prospectively to the global markets remains as follows: Growth Slowing, Inflation Accelerating, and Interconnected Risk Compounding.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Mandelbrot Math - mandelbrot


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