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WHERE’S ELMO?

I write this as I jet toward Hong Kong on route to my final destination, Macau. This needs to be short because I’m in a bad mood. I’m too tall for coach, especially on a 17 hour flight, yet as a partner I need to set a good example. I’ll be sending around a petition to ban reclining seats in coach, please sign. Two hours into the flight and my knees, neck, and computer are all breaking down. Maybe one leg of the flight will be example enough.

My itinerary is top notch, set up by my Macau consultants who are also top notch. These will not be the run of the mill Macau investor meetings. I’ve got junket operators, mid-level casino employees, government officials, development guys, and of course corporate and casino management on the schedule.

This may be a bit unorthodox but I’d like to invite clients to send me questions you would like answered. I will do my best to find concrete answers to those questions and post them for you on my portal. Please email all questions to:

Stay grounded. Flying sucks.

THE DIFFERENCE BETWEEN THEN AND NOW

It was a glorious time. The Red Sox and Yankees were both on their way to the playoffs and the New York football Giants had just wrapped up the preseason before their Super Bowl season. Jets fans still had a clean slate in front of them and oh yeah, the stock market was on an upward trajectory toward the October 2007 high. August 2007 was also the last month the riverboat gaming markets generated positive same store sales.

I use win per day per gaming position (WPD) as a proxy for same store gaming sales as shown on a trailing twelve month basis in the chart. We’ve now had 12 straight months of declines in WPD and 19 out of the last 20. Ouch. As bad as that looks, it was even uglier in 1. WPD declined 13 straight months, averaging 17% down per month. Now that was pain.

Regional gaming stocks got crushed beginning in mid-1996. It’s probably no coincidence that my first day covering the gaming sector was also in mid-1996. Maybe that’s why I’ve always been good on the short side. But stocks rebounded strongly beginning in late 1998 and lasting a decade, interrupted only by 9/11.

So why shouldn’t we be loading up on regional gamers? Valuations are 5-6x, in-line with those prevailing in the mid to late 1990s and WPD trends are similar if not better. Let’s go to the video tape, actually the chart, to answer this question. The difference between now and then is that while WPD declined in 1, total revenues increased dramatically. Markets were still growing. The pie was getting bigger. New casinos were just cutting the slices smaller, temporarily. Fast forward to present time and we see that the markets are contracting along with WPD. Gaming is cyclical after all.

Unlike the late 90s, the market is not growing

JBX – SIGNIFICANTLY UNDERVALUED?

I woke up this morning to read that Western Sizzlin (WEST) is going to commence an exchange offer for up to 680,500 shares of JBX. The offer values JBX at $22.66. For reference the market capitalization of WEST is $38 million and JBX is $1.1 billion. If all the shares are tendered it would represent only about 1% of the outstanding shares of JBX.

The CEO and controlling shareholder of WEST is Sardar Biglari. Mr. Biglari holds a 35% interest in WEST through The Lion Fund L.P., a private investment partnership. Mr. Biglari is the general partner of The Lion Fund L.P., which is an activist hedge fund. WEST and The Lion Fund have bought positions in a several public restaurant companies that were perceived to be value plays. In the past, Mr. Biglari has been very public about putting pressure on senior management of these public companies to unlock shareholder value. Until WEST files its S-4, Mr. Biglari’s intentions are unknown.

JBX’s management is one of the more impressive management teams in the restaurant industry. That is not to say that they are managing the business perfectly and that there are no levers to pull that could create shareholder value, but in this environment not much is going to get done. JBX is clearly a value stock trading at 5.0x NTM EV/EBITDA.

So what could Mr. Biglari be thinking?

First, JBX operates and franchises Jack in the Box restaurants and Qdoba Mexican Grill. In the past, many have speculated that the company should spin-off Qdoba to create vales for shareholders. I am not sure how that scenario would work in this environment. The company also operates more than 60 proprietary convenience stores called Quick Stuff®, which include branded fuel stations. While the Quick Stuff’s are developed adjacent to a full-size Jack in the Box restaurant, it is not a core competency of the company. This would be a clear target for any investor looking to sell off non-core assets.

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US Market "Trade" Getting Bullish Down Here...

I just started covering and buying. I have a downside support level in the S&P500 of 1030.93 (see ‘Hedgeye Portfolio’ for security specific moves).

After patiently sitting on a 96% Cash position since the initial Paulson ‘bail out my friends’ announcement, I have moved to 93% Cash this morning.

Treading into the water, slowly.
KM

"Trend" negative: Obama extends his lead...

As we review the polls and political futures markets from this past weekend, Obama seems to be expanding his lead.

Despite Governor Palin’s “better than expected” performance in the Vice Presidential debates last week, McCain has received no bounce. The current Real Clear Politics national poll average shows Obama up +5.9 and Intrade Market show a 65.5% chance of an Obama victory. In addition, on an electoral college basis Real Clear Politics has Obama up by an astounding 168 electoral college votes.

We have been writing since August that an Obama victory is likely and that his victory will be negative for the equity markets in the intermediate term. As a result, we have been positioned very conservatively (96% Cash, 3% Gold) and will be positioned conservatively from here through November 4th subject to the facts changing.

Daryl Jones
Managing Director

PNRA – Wheat Price Favorability

Wheat prices declined nearly 14% last week and are down 50% from the peak levels seen back in March. For PNRA, a $1 change in the price of wheat impacts the company’s full-year costs by $3.25 million, or about $0.06 per share. PNRA offsets some of these rising costs with price increases, however, so the company does not typically feel the full impact of that increase on the bottom line. Earlier in the year, PNRA locked in its full-year 2008 wheat costs at $14/bushel and has since then contracted 95% of its 1H09 requirements at $10/bushel (versus the average $15/bushel paid by the company in 1H08). Based on the 1H09 cost of $10/bushel, the $4 of wheat price favorability versus 2008 represents about $13 million of lower commodity costs in FY09.
  • With wheat prices having recently fallen to below $7/bushel, PNRA could see even more substantial savings in the back half of 2009. Management said back in June when it announced that it had locked in its wheat requirements for 1H09 that part of the benefit from more favorable YOY wheat costs would be offset by higher commodity costs, notably proteins, dairy, packaging, and the increasing cost of gasoline, but that was when wheat was trading closer to $9/bushel.
  • Also, PNRA has not seen the demand destruction experienced by other restaurant companies. The Panera Bread concept is able to attract customers at multiple day parts, which is a clear advantage in difficult times. Helping to drive sales is a new breakfast sandwich which is driving incremental customers in the critical morning meal period. If top-line trends continue to hold up in FY09, I would expect PNRA to see incremental benefit to its bottom line as the company finally experiences some relief on the wheat cost front.

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