It’s easy to see why AC is susceptible to demand shocks. The Atlantic City Convention and Visitors Authority released a survey that showed easy parking was the top reason customers chose to visit the city. Gambling, restaurants, nightclubs, retail, beaches; not as important. Pennsylvania, a smoking ban, high gas prices, and a tough consumer environment have all contributed to declining gaming revenue in AC. When parking is your top lure, you are defenseless in the face of these threats.

Parking the top draw? Not good enough

Goldman (GS): "For good and valuable consideration"

The early open of trading in Crude oil futures coincides with an extraordinary net-trading session for ISDA jurisdiction OTC derivative contracts to allow major banks to trade out of their Lehman Brothers exposures amongst themselves conditional on a bankruptcy. This could be a simple coincidence driven by the simultaneous less-severe-than-feared impact of hurricane Ike on coastal refineries and offshore drilling platforms. It could, however, also be intended to allow listed market participants the liquidity to adjust their holdings in the wake of major banks selling into the OTC oil and gas markets as they scramble to cut exposures across the board.

On one hand this second scenario makes some sense: people don’t sell what they SHOULD during a crisis – they SELL WHAT THEY CAN. Unwinding exposures in the oil market could potentially allow banks that are long commodities to raise quick cash to offset other exposures.

At this point it remains nothing but idle speculation on my part. There appears to be unusual volume in the early trading session.

PS -the title of this post comes from the second sentence of the ISDA Lehman Effectiveness Protocol

Keith has obviously been negative on Lehman and Merrill for months now. Note that he remains short Goldman (GS) in the Hedgeye Portfolio. He thinks that if the stock breaks down to his immediate target price of $147.43, the $100/share line comes into play. We are fully aware that few agree with our positioning here – that’s why the short interest in GS remains shockingly low at 3.5% of the float. Complacency is not an investment process, however.

Andrew Barber

(chart courtesy of

US Market Performance: Week Ended 9/12/08...

Index performance:

Week Ended 9/12/08:
DowJones +1.8%, SP500 +0.8%, Nasdaq +0.2%, Russell2000 +0.2%

September 08’ to date:
DowJones (1.1%), SP500 (2.4%), Nasdaq (4.5%), Russell2000 (2.6%)

Q308 To Date:
DowJones +0.6%, SP500 (2.2%), Nasdaq (1.4%), Russell2000 +4.4%

2008 Year To Date:
DowJones (13.9%), SP500 (14.8%), Nasdaq (14.7%), Russell2000 (6.0%)

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Ike Stinks

Very tough weekend for lots of good people in the Gulf States. I don’t intend to foolishly translate hurricane destruction to making money on stocks. That’s absurd. But to better arm you with insight as to whether or not companies you care about are exposed to the region, we ran the math and highlighted the outliers.
Click to enlarge.


I like Dale Black’s answer to The Question we posed to gaming companies a few weeks ago. As a reminder The Question was (and still is):

Cost of capital is rising across the globe and returns on investment in the gaming sector appear to be falling. How does this impact your long term view of the industry? If this is the new paradigm what are your long term options for capital allocation?

  • Rather than dismiss the current difficult environment, Mr. Black acknowledges higher cost of capital is here to stay. Future projects will be judged assuming a higher borrowing cost than those prevailing during last few years of easy money. ISLE’s recent goals have included improving financial flexibility and matching future expenditures with the flexibility afforded the company in the new credit facility. The focus will be on improving operations of existing properties while reducing the leverage ratio one to two turns over the next 18 months. Mr. Black’s assertions are borne out in the numbers in the first chart. I calculate ISLE could reduce leverage to 5x in 2 years.
  • This sounds a lot like the Argosy plan from the late 1990s. For the younger folks, ISLE’s current management team successfully turned around Argosy Gaming at that time. They are off to a solid start with ISLE, despite the difficult environment. Mr. Black has to be one of the most underrated CFOs in gaming as he restructured the balance sheet to effectively provide liquidity until fiscal 2013. Despite the very high leverage, ISLE has no significant debt maturities until that time. Leverage should consistently decline as capex is curtailed. See chart #2. Operationally, ISLE just reported its FQ1 ended July 31st which was the first decent quarter in some time. Margins were clearly a focus and it showed.
  • Management seems to be saying and doing the right things. Moreover, there actually could be some upside to the EPS estimates due to continued margin improvement. I see only downside EPS possibilities for most of the other gaming operators. While the ISLE story certainly has some potential, I’m not sure the stock does over the near term. Forward EV/EBITDA is around 7.5x which, while not expensive, historical precedent shows could go as low as 5x. At that multiple, I could buy PENN which maintains an underleveraged balance sheet at 2.5x versus ISLE at 7x.
ISLE's goal is to deleverage by 1-2 turns in 18 months. This looks attainable
CapEx story looks promising

Quantifying the Margin Cycle

Excess capital in the apparel supply chain freed up about 18% of the industry’s EBIT for EACH of the past 8 years. Let’s look at some unit margin math…

I think that the biggest issue facing the industry today is what I’ll call the ‘Margin Grab,’ or the sheer amount of capital that is being either consumed by, or freed up by the apparel supply chain. It sounds theoretical, but I believe that it is absolutely quantifiable.

I love when I hear someone tell me something like “that analysis can’t be done,” or “there’s no way to arrive at that number.” To no surprise, this usually refers to something where a management team, third part data firm or lobbying organization has not done the work and made it available to the free world. I’ve had several people argue that the apparel retail industry’s margin structure cannot be quantified. It might not be ‘easy’ to get, but the answer exists.

Let’s pull out our calculators for a minute and do some good ‘ol fashioned math. We know the following. a) apparel CPI, b) the change in import prices and raw material costs, c) import ratio, d) US manufacturing cost premium, and e) the delta in units sold by month. We also know the pricing algorithm for a garment – i.e. the percent of each dollar that goes towards factors such as raw materials, shipping, factory costs, selling, obsolescence, mark-up, shrink and promotions.

When I net it all out, I get the net consumer price change per garment, and then the cost input change per garment. Net those two against one another, and viola! That’s the margin. A mere $0.14 in added net margin per garment might not sound like a lot. But multiply that by 19 billion units per year and it’s a different story. In fact, the average trailing 12 month net change in capital freed up by the supply chain over the past 8 years in this industry was $2.8 billion (see chart below). For a $200bn industry with 8% margins, this equates to about 18% of annual operating profit. Yeah… Not good.

Here goes McGough the broken record again…but even if macro factors improve, there are still big issues here. Over this time period the industry went from a 72% offshore model to 99% (which it hit last year). At a 5 to 1 cost differential that will not recur, this is a massive consideration. Also, it is before the added raw material costs we’ll see next year, and the lack of any benefit from a weak dollar (and potentially FX going the other way).

Be careful what you buy here… Numbers are still largely too high.

With that, have a great weekend…

An average of $2.8bn annually over 8 years was pumped into the industry's supply chain. There's structurally no more ammo left in the tank.

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