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MGM: MANAGEMENT NOT PESSIMISTIC

MGM management has met with a lot of investors as of late in addition to trying to raise $3bn for CityCenter. The company has been pretty consistent with its commentary that Q3 is a lot like Q2 and Q4 looks better. Of course, it depends on what metrics are used for the comparison. When times get tough, gaming management teams tend to focus investors on occupancy rates to give the impression that Las Vegas is still in demand. Unlike other hotel markets, Las Vegas casino hotels cut rates to sustain occupancies so occupancy is a poor measure of the underlying demand. I believe the decline in Q4 room rates will look worse than Q2.

The other major focus is gaming revenues. July’s 15% decline in Strip revenues was horrendous. The only August data to be release thus far was the McCarran Airport passenger data which actually deteriorated from July (-9.9% vs. -8.6%). However, the comparison breakdown is completely different: The 2008 July table hold percentage came in well below 2007. August gaming revenue may only fall low to mid single digits as table drop in August 2007 was abnormally low and slot hold percentage was also low. Given the investors’ reaction to the airport data (MGM down 13% in a down market), I would expect a positive reaction to any Strip gaming revenue decline less than the airport traffic decline. These numbers should be released between October 8-10th.

The August gaming revenue release may be the last positive data point for Las Vegas for some time, however. The trend is firmly in negative territory. Room rates are likely falling at a faster rate. Table drop and slot volume trends are declining, even though the near term trade is better (but still negative). Gaming revenue comps may be where MGM is getting its Q4 optimism. Sequential Q2-Q4 comps last year were 4%, 6%, -1%, respectively. However, with less airline capacity and higher airfares, already pinched consumers, and slowing global economies, my money would be on a weaker Q4, not a stronger one. And I am a betting man. As discussed in my 8/06/08 post “MGM: SOOTHSAYERS OR HOPEFUL AGNOSTICS”, MGM management actually has about as much visibility as we do on the Q4. We’re data dependent here at Research Edge and the data is certainly not making me feel better about Q4.


Easy Aug comps could be near term catalyst but underlying metrics are in decline

Primary Insights Efforts – BKC Discounting

Our “primary insights efforts,” which included a survey of various Burger King restaurant managers/employees, showed that 78% of the restaurants surveyed are currently offering some type of corporate promotion/incentive. According to restaurant employees, these promotions include “buy one, get one free,” the Value Menu, and various meal coupons distributed primarily through newspapers and the mail. Most respondents agreed that the incentives have helped to generate more sales. We did not ask, however, how these discounts are impacting margins. On a more positive note, a handful of the BKC employees did highlight that the corporate office has introduced new and different sandwiches which are helping to drive sales.
  • As I have said before, discounting has become more prevalent across the QSR industry as restaurant operators attempt to drive increased traffic (often at the expense of margins), so BKC is not alone. Recent NPD trends also show that BKC’s percent of visits on deal has continued to tick up. The same can be said for the entire QSR hamburger category which has seen its level of discounting climb rather significantly since mid-2007.
  • We will follow up with other primary insights efforts results, including a look at BKC’s current sales trends.

Eye On Leadership: Volcker As Bailout Czar!

As Congress works over the weekend attempting to overcome partisanship and presidential election year maneuvering to pass the financial bailout bill, we continue to question the lack of leadership in Washington D.C. According to the Associated Press this morning, the bailout bill which was three pages in length a week ago now totals 42 pages, so the bill has increased in its length and complexity by 14x. In that period, Washington Mutual has gone bankrupt, which is largest bank failure in United States history.

We have reservations about government led bailouts in general, but our analysis of global credit markets continues to indicate that credit markets are tightening and the crisis will continue without some form of intervention. So our issue is not with the concept of intervention, but rather the leadership of the intervention. We have one suggestion - Paul Volcker.

In our opinion, the 6’7, cigar chomping Princeton graduate is the best hope for leadership in this crisis and both parties should come together to name him “Bailout Czar” with the role of managing the disposition of the $700BN+ mortgage securities that the U.S. government is about to take on its balance sheet.

As we have said repeatedly, facts don’t lie, people do. And the facts in regards to Volcker’s ability to manage through a prior fiscal crisis with integrity and against popular opinion speak for themselves. Volcker is rightfully credited with ending the United States’ stagflation crisis of the 1970s. Chairman Volcker abandoned interest rate targeting and adopted policy to limit the growth of money supply. His policies led to a sharp recession and were widely unpopular, but inflation which peaked at 13.5% in 1981 was 3.2% by 1983. Volcker was decisive, unpopular, but ultimately more right than any economic leader has ever been.

The only real issue with this proposal is that Volcker is as an advisor to Presidential candidate Barak Obama; so the Republicans would likely be reluctant to approve Volcker for the position. We would just remind partisan Republicans that the Democrat Volcker was appointed by President Carter in 1979 and reappointed by Ronald Reagan in 1983, an election year. As Treasury Secretary, Donald Reagan, said at the time of Volcker’s reappointment: “He’s the right man at the right time.”

While Hank Paulson getting down on both a proverbial and actual knee to ostensibly pander for bipartisan support for the “Paulson Plan” is an interesting image; and while we have no doubt Paulson is a “good man”, we just think it is once again time for “the right man”.

Daryl Jones
Managing Director
Research Edge LLC

Early Look

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EGREGIOUS EXPLOITATION OF EASY MONEY

One would be hard pressed to find a sector that benefited more from the easy money era than gaming. Unfortunately, for investors in many of these stocks we’ve come to the end of an error. Throughout most of the decade, gamers exploited the low interest rate environment to over invest and over leverage. Wall Street loved it. Long term IRR and ROI? Who cares? Growth and EPS accretion, where do I send the check? Gaming stocks outperformed the S&P by a wide margin over the past decade. As the chart shows, the level of outperformance correlated very closely to the inverse of the US corporate bond yield. In fact, the level of interest rates explained 62% (R Square=0.62) of the spread between gaming stocks and the S&P.

It should come as no surprise that gaming stocks have been pummeled by the recent credit crisis. Gaming management teams left their companies with super high leverage and significant debt maturities in an environment where cash flows are declining. As these companies refinance over the next year or two, it will become crystal clear how much they’ve over earned the past few years.

Of course, there are exceptions. There are companies on the right side of this liquidity trade. BYD, PENN, and WYNN all maintain low relative leverage and tremendous liquidity. The rest of the gamers have had religion crammed down their throats by the credit markets. BYD recently found religion on its own and suspended Echelon. WYNN and PENN never lost it.


Gaming stocks outperformed the S&P during the easy money era

Japanese Stagflation Remains Reality...

Japan reported another 10 year high in their consumer price inflation number this morning. At +2.4% y/y, the August report remains as elevated as it was in July (see chart).

You do not want to be long an economy with a socialist government bailout policy. You do not want to be long an economy experiencing stagflation. Sound familiar?

We remain short Japan and the US via etf's (EWJ and IWM).
KM

Please Ignore The 2:19pm FL Post

In my infinite wisdom, I entered FL instead of FINL in the headline. All other info is the same.

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