China: Burning Both Ends of Supply Rope?

China has been gaining leverage in sourcing product – that is well known. But now we see an investment in US retail -- perhaps the first step to own both ends of the supply chain?

Here’s a scary thought. Gottschalks (troubled West Coast-based department store chain) announced yesterday that it has received a $30mm capital investment from Chinese based Everbright Development Overseas, to establish an ‘exclusive sourcing and sales partnership’.

So let me get this straight… Values on marginal US assets are justifiably falling due to inability to maintain margin in an environment characterized by weak spending and rising imported inflation. At the same time, factory dynamics in China are dramatically changing in a way that is limiting capacity and giving the large factories long-sought-after pricing power. Then we see the Chinese use this leverage plus stronger FX to invest in said US assets after the initial margin hit?

Under the terms of the deal, Everbright will be issued 5.6mm shares, 29% of the total shares outstanding, and a $20mm convertible secured note that convert at $1.80 per share. In addition, Everbright can acquire up to 60mm shares of Gottschalks common stock at $120mm in cash if shares trade above $6 for more than 60 day and performance thresholds are met. This would be another $300mm payday.

Morgan Stanley: Where are the Evil Doers today?

MS is down -7% from its intraday high and down -3% on the day to $27.11. The stock is being sold by someone, and since John Mack, Chris Cox and Lloyd Blankfein have the shorts banned from playing the game, this leaves the objective mind to wonder who these sellers might be.

From a quantitative perspective, the stock looks like it can easily trade down to $19.18 again. The scariest thing about the Street buying into this evil doer short seller narrative is what happens next.

Now we all know why Goldman Sachs was trading down prior to the short selling ban – they needed capital to survive!

As MLK said, “a lie cannot live”.

TED spread widening again today...

Below is a TED spread chart since beginning of August. This spread is widening this morning partly because Goldman Sachs is admitting that they need capital, and partly because the duration on the Paulson Plan fix is being pushed out to reality (i.e. not rubber stamped this week).

CNBC has this chart flashing on their screens more regularly now. From a sentiment perspective, this is a positive sign. The consensus fear associated with a psychological bottom is finally in motion.



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Eye on Resolution and Trust...

On February 9, 1989 President Bush the first announced his plan to deal with the mounting fallout from the Savings & loan crises. His stated goal was to have legislation passed within 45 days, but the Financial Institutions Reform and Enforcement Act was not actually enacted until August 9th.

Today Paulson, Bernanke and President Bush the second are attempting to get a much more extraordinary piece of emergency legislation passed within a matter of days. This will be a very hard sell, irrespective of the fear mongering you saw yesterday and will continue to see tomorrow.

Investors do not trust this leadership.

Keith McCullough & Andrew Barber
Research Edge LLC


Outside of Stanley Ho’s guesthouse and private marina where several boats and yachts looked to be in pretty bad shape, Macau appeared to escape the direct wrath of Typhoon Hagupit. Unfortunately, we cannot say the same thing for the Guandong province which took a direct hit. But back to Macau, the early assessment is that the casinos and the projects under construction suffered no major damage. I had indicated yesterday that the construction projects were most at risk, but my Macau contacts said the developments survived relatively unscathed. Now if they could just get the visa situation fixed.

When it Rains it Pours (Literally)

China got a wad of sand kicked in its face, which is likely to impact footwear manufacturing capacity, logistics, and pricing. Another bad development for US footwear margins.
Typhoon Hagupit triggered a ‘once-in-a-century’ storm tide in the Guangdong province, which sparked a rise in water levels to more than 5 meters above the normal tide. Authorities, who described Hagupit as ‘the worst to hit Guangdong in more than a decade,’ evacuated more than 100,000 people before typhoon Hagupit made landfall around dawn.

Not a good narrative in China this year. First it sees the most debilitating snowstorm in 100 years in 1Q. Then in 2Q it is hit by the earthquake – for which the death toll is still uncertain. Now the typhoon and ensuing flooding is impacting a key manufacturing province.

Remember that 86% of US footwear consumption is made in China. Nearly 3,000 footwear factories closed in 1H as raw material prices skyrocketed, government support for factory margins eased, FX pressured margins, and migrant workers simply did not show up for work due to the forces of mother nature (in addition to the ability to find better jobs in major cities for more money), and the storms exposed the weak transportation infrastructure that precluded US companies from shifting sourcing to central China.

It was already apparent to me that we’ll see thousands of additional factories close in 2H. Now there’s no doubt in my mind. Not good for footwear pricing throughout the global footwear supply chain as the economic balance shifts in favor of the survivors in China. I’d hate to be a marginal US brand or retailer right now (SKX, DSW, BWS, and even WWW). I’m incrementally of the view that this will lead to more consolidation and M&A.

Daily Trading Ranges

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Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.