Rumblings from Macau that the project might be back on. 



Maybe eSun Holdings and New Cotai have finally got their act together?  We’re hearing that is the case and there may be an announcement that the project will resume.  Industry followers may recall that MPEL was chosen to manage this Studio City casino on Cotai.  The project never got underway because of financing issues and partner disagreements.  The situation came to a head last year as eSun and New Cotai sued each other.


Our view is that any progress on the project would be a huge positive for MPEL.  As it stands now, MPEL will not commit any capital or be responsible for any expenses.  They will, however, manage the casino, contribute the subconcession, and receive a management fee.  The Studio City site is a good one on Cotai and if developed right, could be a very successful property.  We wouldn’t rule out some sort of equity contribution or financing from MPEL which makes the recent refinancing announcements timely but that wouldn’t necessarily be a bad thing.


No commentary on the timeline but it does appear that the forces are mobilizing.  Add Studio City to the positive MPEL catalysts which include a booming Macau and big April market share gains for MPEL, and a discounted valuation.  Somewhat offsetting these positives is competition from Galaxy Macau opening on Cotai in mid-May and potentially too aggressive whisper expectations for MPEL’s Q1.


BYI could’ve done a better job of managing expectations but at least they are now admitting visibility is pretty low. Still, the core earnings power of the company appears quite large.



BYI preannounced so there weren’t any huge surprises in their FQ3 announcement last night.  However, we did walk away from the call feeling pretty good about their 2 year outlook.  While product sales and margins were pretty miserable and the fact that BYI basically admitted that they have no confidence at the moment to forecast their systems business, there were plenty of things to get excited about.  Namely:  Canada, Italy, Australia and New Zealand, gaming operations, BYI’s tender and debt refinancing… just to name a few.


Just Italy and Canada can boost BYI’s EPS by $0.33 cents ($0.40 cents if we assume 45MM share post tender) in FY12 and by as much as $0.60 in FY13 ($0.70 cents if you assume 45MM post tender).  That’s before taking into account a pickup in replacements, market share growth and margin improvement from the maturation of the Alpha 2 platform, growth in gaming operations, iVIEW DM, and other new markets.

  • Italy:  $23MM in revenues in FY12 and $44MM by FY13 assuming BYI can roll out 4,500 units with gross margin contributions of $17MM and $33MM respectively, which amounts to $0.20 in FY12’ and $0.39 cents in FY13 of incremental EPS
  • Canada:  We believe that Canada’s system contract is worth about $100MM of revenues that will be recognized over the course of the rollout which should take 2-3 years. Assuming a 3 year rollout, that’s over $8MM of incremental revenues per quarter.   While we don’t expect this business to have +70% margins like the rest of BYI’s system’s business since new installations tend to have lower margins than upgrades, software and maintenance revenues, even if we assume just 50% margins, this deal is worth at least $0.60 or $0.20 per year, plus some recurring revenue thereafter (usually 20% of the deal price).



The most disappointing results of the quarter belonged to BYI’s Gaming Equipment segment.  Despite the pre-announcement, BYI’s gaming equipment sales revenue and gross margin still missed our estimate by $3MM and$5MM, respectively.

  • New gaming sales were $8MM below our estimate and margins were just terrible
    • New gaming machines were 700 below our estimate, with the entire miss on the international side.  Earlier in the year, the Company was pretty confident about growth in international sales
    • ASP’s were about 6% higher than we estimated
    • An obsolescence charge of $1.6MM impacted margins by 2.5%
  • Other gaming had its best quarter in 2 years, although we have little confidence that it’s a repeatable event since management didn’t provide a whole lot of color on the call aside from telling us that used sales and conversion kit sales were better this quarter
  • We estimate that BYI’s ship share of NA units was about 14%, the same as the last 2 quarters. We do feel pretty good that we will see their share tick up over the next 12 months by a few percentage points.  Once the platform is mature, we also believe that margins should get to at least the high 40’s.  Moreover, if BYI is able to get more traction in video slots with their new platform, this also presents a nice opportunity for them to grow their relatively small conversion kit business which carries margins in excess of 90%.
  • Systems sales continued to disappoint, despite the pre-announcement, but margins were fantastic… albeit a result of very few new installs and a higher mix of software and maintenance revenue. 
    • We estimate that next quarter systems sales should be at least $55MM vs. $47MM this quarter with the Galaxy Macau opening.
  • Gaming operations had a healthy quarter and great margins due to no jackpot payouts
    • The next two years should see some nice growth from this business
      • Acqueduct will have a partial opening in 1Q12 and add an estimated $10MM of revenues to BYI’s game ops business in F2012 and $16MM in F2013 which will benefit from a full year of operations with the entire facility open
      • We assume that Italian shipments will begin in F1Q202 and contribute $23MM of revenues in FY12 and over $40MM in F2013
  • SG&A was $5MM higher than we estimated
    • There was a $1.8MM bad debt charge in the quarter that was higher than normal for BYI

Supply, Demand, and Default in Muni Land

Conclusion: We are sticking to our call that a supply/demand imbalance will drive up muni bond yields as the year progresses. In addition, we believe a structural elevation of credit risk will continue to get priced into this market over the long-term TAIL.


Position: Short muni bonds (MUB).


It’s would be a severe understatement to say that the State of Illinois’ finances are in rough shape. Consider the following metrics when analyzing this Domestic Pig: 

  • Debt/Revenue: 141.3% vs. the national average of 90.2%;
  • Interest Coverage Ratio: 13.6x vs. the national average of 32.4x; and
  • FY12 Budget Shortfall as a % of FY11 Budget: 44.9% vs. the national average of 15.5%. 

After years of fiscal mismanagement and spending growth that has consistently outpaced income growth, the State of Illinois now finds itself sitting on top of 208,635 unpaid bills totaling $4.52B, which itself sits on top of an additional $3.8B in additional unpaid liabilities including withheld corporate tax refunds and skipped employee health insurance payments. Including these obligations, which current governor Pat Quinn proposes issuing $8.75B in debt to fund, Illinois’ Debt/Revenue figure jumps +2,064bps to 161.9%.


In addition to Piling Debt Upon Debt (Illinois was the second-largest municipal borrower in 2010), the State has already signed off on raising its corporate and individual income tax rates by +46% and +67%, respectively. With a three-factor model of aggressive debt buildup, tax hikes, and routinely skipping payments to vendors, municipalities, and nonprofit organizations, there’s no surprise the Illinois electorate disapproves of Governor Quinn’s performance by a factor of 2-to-1.


From an investment perspective, none of this is new-news, which is why Illinois CDS (5Y) continues to trend down, closing yesterday at 193bps from a peak of 358bps in early January. Over the intermediate-term TREND, we agree with the credit market’s conclusion here, as it is highly unlikely that the State of Illinois defaults on any of its debenture obligations within this window of time. Over the long-term TAIL, however, we expect the State’s mounting debt burden, pension funding requirements (a national-low 51% funded), and healthcare liabilities (0.1% funded) to become too much to bear (source: Pew Center on the States). One important lesson the credit market taught us about itself is that it doesn’t know what it doesn’t know – Lehman CDS (5Y) was trading at ~300bps mere days before it went belly-up. 


Supply, Demand, and Default in Muni Land - 1


Supply, Demand, and Default in Muni Land - 2


Illinois will, however, continue to default on many of its other obligations as it is currently doing, which will increase the amount of debt the State is likely to issue in the coming months. While Illinois may be the dog of dogs in this regard, a widening gap between hard-to-cut expenditures (see: WI, OH, IN budget debates) and consistently overestimated revenues on a national level will cause aggregate muni bond supply to accelerate quite substantially in the coming quarters, up from a record-low amount in the first quarter ($43.2B in total fixed rate issuance).


Supply, Demand, and Default in Muni Land - 3


On the revenue side specifically, a recent study done by the Pew Center on the States shows that States typically aggressively overestimate revenues coming out of recessions, meaning that State budget deficits are likely to surprise to the upside as the fiscal year progresses, especially given that their revenues have been bolstered by now-dwindling Federal aid over the past two years. Net-net, the results of national fiscal austerity being cheered on by muni bond fund managers as a reason to buy muni bonds right here and now could wind up looking like the recent upwardly-revised debt and deficit projections for Greece and Spain. If you didn’t know sovereigns could “miss” estimates, now you know. Lower revenues = more mid-year muni bond supply.


Supply, Demand, and Default in Muni Land - 4


On the demand side of the equation, hedge fund buying amid a relative lack of supply has supported the muni bond market in recent months – something we don’t see continuing. In 4Q10, Federal Reserve Flow of Funds data showed that “Households” (a category that includes domestic hedge funds and other investor pools) increased their investments in muni bonds by +$50B, amid a (-$18B) decline in Mutual Fund muni bond assets (retail investors). In addition, a slowdown in the rate of defaults was positive from a headline risk perspective (removes the “Whitney factor”); according to Distress Debt Securities Newsletter, nine muni bond defaults totaling $445M occurred in the 1Q11, down from 22 and $1B in 1Q10.


We question whether the hedgie crossover buyers that were gobbling up “mis-priced” muni bonds at the start of the year truly understand the potential supply/demand mis-match that looms on the horizon for this market. In 4Q11, “attractive yield spreads” relative to “historic averages” weren’t even enough to entice new sources of demand to absorb the market’s (albeit elevated) supply - +$50B in new hedge fund/“other” demand vs. +$86B in new supply (new issuance + mutual fund selling). We also question whether their revenue assumptions are accurate, given that GDP is likely to continue to coming in light over the coming quarters, which will effectively keep a lid on State tax receipts in FY12 – a call we’ve been making for several months.


All told, we are sticking to our call that a supply/demand imbalance will drive up muni bond yields as the year progresses. In addition, we believe a structural elevation of credit risk will continue to get priced into this market over the long-term TAIL. For a deeper dive into this thesis, refer to our February presentation titled, “Mayhem in Muni Land”.


Darius Dale


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Corn: A Hedgeye Staple

Position: Long corn via the etf CORN

We added a long position in corn yesterday in the Hedgeye Virtual Portfolio via the etf CORNWe entered this position on yesterday’s sell off at $44.38. Keith aptly summarized the opportunity, “Corn is getting smoked today, so we’ll buy back our longstanding intermediate-term bullish TREND case while it’s on sale. KM.”


With the US Dollar making lower-lows, corn continues to ride this currency crash higher, posting an inverse correlation to the dollar of -0.53 over the past three months and -0.88 over a twelve month span. While the US Dollar has fallen -7.5% year-to-date and -11.3% over the past twelve months, corn futures have risen +13.9% and +79.8% over the same durations. Along with a tight supply and demand situation, a major factor behind our bullish corn call continues to be US Dollar weakness and the subsequent run-up in commodity prices; the CRB commodity index has a -0.87 correlation to the greenback and is up +9.2% over the intermediate-term (3M) duration.


Global corn supply remains tight, particularly in North America, where cold and wet weather in the first half of April halted fieldwork and corn plantings in the US and Canada. According to the USDA, as of April 17th, only 7% of the US corn crop was planted, down from 16% at this time a year ago. The USDA has also reported that China is only expected to export 100,000 tons of corn in the 2010/11 season, down from 150,000 tons the prior year; and there is growing concern that China’s surging demand for corn may soon lead them to completely cut exports. Meanwhile, South Korea, the world’s third largest importer of corn, has initiated a grain trading venture in the United States which will boost corn and soybean exports to Korea to 2.15 million tons by 2015.


The big story on the demand side continues to be China’s surging appetite for corn and corn-related products, which, according to Shang Qiangmin, director of the China National Grain & Oils Information Center, “will grow faster than supply in the next 10 years on rising production of livestock feed and biochemicals.”  Corn used to produce biochemical products this year will increase to 50 million tons, up ten-fold from a year ago. Further, Oil World has reported that Argentina will export 1-2 million tons of corn to China in June and July, signaling China’s effort to diversify their imports. On a global picture—a bullish one indeed—corn demand is projected to outpace supply in the current season by 7 million metric tons.


On our quantitative set-up, CORN is bullish on the TREND duration, with intermediate-term support at $42.13 and no upside resistance.


Corn: A Hedgeye Staple - corn


Kevin Kaiser



Don’t look to the data points on the consumer to support the S&P 500 being at a three year high.  At best the numbers on the consumer this week point to sluggish underlying trends, but the reality is that government continues to prop up the overall consumer picture.  This has been the case for some time, and may continue, but potent cocktail of slowing growth and accelerating inflation – we call it Jobless Stagflation – is starting to muddle the thoughts of the Central Planners in Washington, D.C.  


THE JOBS PICTURE IS PUNK - Yesterday, Initial claims rose by 25,000 to 429,000 for the week ending April 23. The increase was noticeably above consensus expectations and follows the previous week’s 12,000 decline.  As our Financials team noted yesterday, reported claims are now at the same level they were in January 2010.  The consensus that “the jobs picture is getting better” may need to be revised back to “the jobs picture is not getting any worse”.   On the margin, this is a potentially bearish change in general expectations.  That being said, a number of temporary factors may have contributed to the rise in initial claims, including auto plant shutdowns because of Japanese supply-chain disruptions and the shift in Easter.  Initial claims have been above 400,000 for three consecutive weeks; the latest gain raised the four-week moving average from 399,250 to 408,500 (the highest since mid-February).  In terms of employment, the recovery story is on ice for now.


INCOME FOM UNCLE SAM - Income growth accelerated to 0.5% before adjustment for inflation from 0.4% in February.  The source of the improvement was the government as transfer payments grew far more rapidly than in recent months, led by increased unemployment compensation.  This situation is temporary and without an improvement in core fundamentals, like employment, there will be an increasing case for a pullback in spending – particularly as the buck continues to burn.


SPENDING WHAT WE DON’T HAVE - Consumers clearly have the income to spend and as I said the questions of where the income is coming from and how long it can be sustained are front and centre for investors today.  The High-Low society dominated 2010; consumer confidence by income is one chart that illustrates that idea vividly.  A chart of the total enrollment in the Foodstamps program is another image that hits home when one considers the broader economic picture in America today.  Overall, consumer spending moderated in March, despite a slight acceleration in income. Nominal spending rose 0.6%, down from 0.9% in February, while real spending growth slowed from 0.5% to 0.2%.


WITH LITTLE CONFIDENCE - While the headlines are showing an uptick in April consumer confidence the index gained back only 2.3 of the 10 points it dropped in March.  The index is up 25 points from the November ‘08 bottom and 29 points below its January ’07 high.  By contrast, the S&P 500 is a mere 4.6% off its close on 1/31/07.  The economic drivers of consumer sentiment (housing, jobs, inflation and income) remain very mixed, which are consistent with the low level of confidence.  The inflation of stock prices, a direct result of Ben Bernanke’s easy-money policy, remains the only significant positive influence on confidence at this juncture.  Below, I have a chart indexing consumer confidence by income bracket from January 2010.  I’m sure every investor could weave their own story into this chart but what I see is a sharp relative gain on the part of confidence among the $50k and above bracket following the announcement of QE2 and the stock market rip that followed.  Positive jobs data, it could be argued, bolstered other cohorts at the end of 2010/early 2011.  Even going back to our April Flowers/May Showers call, it is clear to see that the stock market was a huge driver of confidence at that point.   I believe it remains so today and, with earnings strong, many are assuming that it’s different this time.  The terrible trio of Accelerating Inflation, Slowing Growth, and Joblessness has not mattered to equity investors of late.  In our view, it is reckless to “keep dancing while the music is playing” while earnings are peaking and, like in 2Q08, the macro is not being respected.



Howard Penney

Managing Director









European Misery Charts

With a tip of the hat to economist Arthur Okun, who created the misery index which assumes that higher rates of unemployment and worsening inflation create more miserable economic and social costs for a country, below we show the three fundamental drivers of unemployment, inflation (CPI), and government bond yields across the Eurozone’s periphery. The main take-away that we continue to hammer on is that piling debt upon debt with inflation and unemployment rising is a recipe for disaster, or misery, as it perpetuates and extends slow to negative growth and inhibits government revenues to pay off grossly imbalanced budgets, essential requiring governments to take outside assistance. Over the intermediate term we expect the red arrows in the charts to push misery higher.


Matthew Hedrick



European Misery Charts - t1


European Misery Charts - t2


European Misery Charts - t3

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