“I was just saying on that particular play, I would have played it different.”
-Roberto Luongo (Vancouver Canucks)
If you’re going to get paid to play this game at the highest level, whether you like it or not, you will be held accountable to both your words and performance. I’m not just talking about the Stanley Cup Playoffs. I am talking about the Future of Finance.
Last night in Boston, the Bruins chased Vancouver Canucks’ goalie Roberto Luongo to the bench within the first 10 minutes of the game (to chase de goalie means to pull him from de net – and make him feel shame). At that point, the score was already 3-0 en route to a big Bruins’ Game 6 win. Boston goalie Tim Thomas played the 1st period “differently.”
I played against Tim Thomas in college. He was at Vermont. I was at Yale. They were a national powerhouse. We were in the dog house. I’ll never forget coming onto the ice for the warm-up in their barn. I was like a Thunder Bay deer in headlights facing a full student section of kids clanging cow bells and playing some version of the Smurfs song while I tried to pretend they weren’t there.
You can pretend your competition isn’t there, but you’ll have a really big problem if they’re really good and Proactively Prepared to beat you. From Boston last night to Vermont in 1995, that’s what winners do – they wake-up every morning expecting to win.
I don’t expect to be Bullish inasmuch as I don’t expect to be Bearish. I expect my teammates and I to execute on our research and risk management process to the best of our ability every day. When we fail, we learned. When we win, we expected to.
This morning’s economic data and, more importantly, the market’s reaction to it, is bullish:
- Chinese Data – Growth Slowed at a SLOWER RATE as Inflation Accelerated at a SLOWER RATE (May data)
- Deflating The Inflation (Q2 Hedgeye Macro Theme) – oil prices falling to a 1 month low deflated the CRB Index by 1.1% yesterday
- Stock Markets – after 6 consecutive down weeks, around the world, they stopped going down
But can you be a Bullish Bear?
Yes We Can. Our risk management task every morning isn’t to be either Bullish or Bearish – it’s to be right.
That’s the American (and Canadian) Optimism we’re looking to champion. That’s the winning attitude we can believe in.
Are there bearish data points in my notebook this morning? You bet your Madoff there are:
- United Kingdom Stagflation – continued in May with Consumer Prices (CPI) remaining in-line with April’s print of +4.5%
- Hong Kong Property Bubble Popping – in motion now that HK Industrial Production has dropped to 3.5% (versus 5.7% last quarter)
- Spanish/Greek Piggies Don’t Fly – both countries issued more Pig Paper (fiat debt) this morning at higher yields than last auction
But what trumps what? In the aggregate, are these 6 bullish and bearish data points more bullish or bearish? Do you have an investment mandate to be bullish or bearish, regardless? Or are you tasked with neither being a Perma-Bull nor a Perma-Bear?
My answers to these questions are already in print. I think this morning’s Global Macro Grind flushes out as bullish as last night’s Bruins win. That doesn’t make me un-Canadian. Neither does it pigeon hole me into not being able to change my mind within the next 24 hours. The only rule in this game is to say what you think – take your position – and be accountable to it.
Across our 3 core risk management durations, the Bullish Bear’s view of US Equities from yesterday’s closing price is as follows:
- Immediate-term TRADE upside in the SP500 to 1290
- Intermediate-term TREND upside in the SP500 to 1320
- Long-term TAIL upside in the SP500 to 1377
Wow. Maybe on The Kudlow Report tonight (I’ll be on with Larry at 7PM EST) I’ll pretend I am Don Luskin and only be bullish. Maybe not.
Across our 3 core risk management durations, the Bearish Bull’s view of US Equities from yesterday’s closing price is as follows:
- Immediate-term TRADE downside in the SP500 to 1259
- Intermediate-term TREND downside in the SP500 to 1223
- Long-term TAIL downside in the SP500 to 1223
You see, if you are Duration Agnostic, there are two sides to every market debate – and, not surprisingly, two sides to every bid-ask spread across different times and prices. Sometimes durations converge (my intermediate and long-term support levels are the same right now). Sometimes they diverge. Sometimes you should be bullish; sometimes bearish.
Sometimes your competition is sleeping. All of the time we need to keep changing our positioning as the market’s time, price, and expectations do. As my great hockey Coach and mentor at Yale, Tim Taylor, taught me – you have to keep moving out there.
My immediate term support and resistance ranges for Gold (bought more yesterday), Oil (we remain bearish; Goldman bullish), and the SP500 (we have no long or short position here) are now $1, $97.60-100.03, and 1.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
CAKE was sold short today in the Hedgeye Virtual Portfolio.
The Cheesecake Factory is one of our favorite short ideas in the restaurant space at the moment. Keith sold it short today in the Hedgeye Virtual Portfolio based on his quantitative levels and our fundamental analysis which has highlighted significant risk of CAKE missing numbers this year. Specifically, Keith wrote that we are “bearish on Cheesecake’s intermediate-term TREND and the stock is immediate-term TRADE overbought today”. We published two posts, last Thursday and Friday, detailing our fundamental view.
As a recap, the main tenets of our fundamental thesis are as follows:
- Management’s commodity guidance is likely too low for 2H11. As we outlined on Friday, a chart of cheese or milk shows the current level of dairy costs are far in excess of those seen in 4Q10, a period management recently highlighted as a period that will offer easier comps from a dairy perspective. While a significant leg down is possible, especially given the volatility in dairy costs for the year-to-date, we believe that the likelihood of still-significant dairy inflation in the fourth quarter is not adequately baked in to management’s guidance. CAKE only has 60% of its food commodity basket locked.
- The Cheesecake Factory is a concept with an average check problem and management’s constant increasing of price helps protect margins but does not help mix or traffic. We believe that the concept must retain its relative value over time and it seems that management is – for now – steadfast in its belief that taking price consistently is its optimal strategy.
- Sentiment around this name is bullish and has only become more so over the last several months. The street’s ratings are as follows: 41% Buy, 59% hold, 0% sell.
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Conclusion: The consumer’s State & municipal government tax burden is headed north on a nationwide basis starting in FY12. Additionally, we are of the view that the “G” component of US GDP (~20%) will continue to weigh on the economy over the intermediate-term TREND and we detail why in the report below.
As outlined in our recent presentation on US interest rates, we are of the view that the “G” component of US GDP (~20%) will continue to weigh on the economy over the intermediate-term TREND. While we certainly do not support the tired Keynesian Dogma of textbook “countercyclical government spending”, we do agree that fiscal retrenchment throughout the economy will auger bearishly for near-to-intermediate term economic growth. On a long-term basis, however, we welcome a much needed dose of fiscal austerity and would view that as positive for the confidence that ultimately drives consumer spending and corporate investment alike.
From a Federal perspective, we continue to believe that the negotiations centered around the Debt Ceiling Debate are likely to result in reduced levels of spending in the FY12 budget, as well as some groundwork laid for entitlement reform – though the tough decisions will likely continue to get punted to future Congresses. That said, however, any austerity at the Federal level is a sharp reversal from what certainly looks and feels like permanently enacted stimulus spending. Refer to Daryl Jones’ 4/20 Early Look titled, “The Case of the Missing Stimulus” for more details. This is one of many potential positive catalysts for our long DXY position in the Virtual Portfolio.
From a State & Municipal perspective – which is the real focus of this note – we continue to highlight their fiscal stress as a headwind to 2H11 and 1H12 GDP growth. According to the National Association of State Budget Officers Spring 2011 Fiscal Survey of the States report, an aggregate $75.1B budget gap must be closed with the enactment of FY12 budgets (starting July 1st in all but four States). Furthermore, the $75.1B is likely to be revised higher in coming weeks, due to additional States’ completions of official forecasts (17 States remaining). That $75.1B-plus number is on top of a cumulative $12.1B in mid-year budget gaps from the FY11 budget that must be closed by June 30th. All told, assuming a constant budget gap-to-State ratio for the 17 States which have yet to report and the additional $12.1B in mid-year FY11 deficits, a budget gap of roughly $126B must be rectified via legislation in the coming weeks (with the exception of Vermont, all States have balanced budget statutes).
Perhaps the most noteworthy way in which States are prescribing to close their deficits is tax and fee increases. On a net basis, States are proposing tax and fee increases to the tune of $13.8B – a YoY gain of +122.6% vs. FY11’s $6.2B tax hike (-74% YoY). From a breadth perspective, the tax and fee increases are more concentrated in FY12 budget proposals (12 States) vs. last year’s 24 States. Still, the aggregate sum of taxation on a national level is what matters to the overall economy and, on both a nominal and sequential basis, State tax and fee hikes are an additional headwind to the economy over the intermediate-term TREND. Some States are even hiking taxes in arrears; CT, which just increased taxes and fees by a record $2.6B is applying the changes on a retroactive basis to January 1, 2011.
Below we detail the proposed FY12 tax and fee hikes on a national basis per the aforementioned NASBO report:
- SALES TAXES: Seven States proposed increases while three States proposed decreases for a net gain of $6.1B;
- PERSONAL INCOME TAXES: Six States proposed increases while seven States proposed decreases for a net gain of $5.9B;
- OTHER (including alcohol, tobacco, motor fuel, fees, etc.): 18 States proposed increases while eight States proposed decreases for a net gain of $2.4B.
As the chart below highlights, sharp accelerations in proposed State level tax and fee increases have been reasonably shown to lead 100bps-plus slow-downs in the rate of Real GDP growth by 6-12 months on average (likely due to the timing of State fiscal years, which typically begin six months prior to the start of the corresponding calendar year).
One positive callout amid this plethora of rising taxes is the net decrease of $537.2 million from corporate income taxes. To the extent a -1.2% reduction in aggregate State corporate income taxes stimulates job growth rather than mere earnings preservation in a slowing economy remains to be seen. Still, it’s a positive development nonetheless.
From a municipal government perspective, the most notable change to taxes and fees come in the form of property tax hikes. Simply put, as property appraisal values continue to decline on their typical 2-3 year lag to national real estate prices, city and county financiers have taken to gradually increasing property tax rates to offset any declines from this important source of revenue (~26%). As to be expected, property tax appeals have risen sharply on a national level. From our gathering of recent anecdotes, municipalities from Westchester County (NY), to Maui County (HI), to Hernando County (FL) are seeing record levels of property tax appeals that amount to doubling, tripling, and even quintupling of pre-crisis levels. The sheer volume of new cases is creating backlogs across the nation that may eventually amount to incremental hundreds of millions added in arrears to municipal budget deficits – at a time when funding from both the Federal and State level is set to decline dramatically. Still local government officials carry on with their “accounting tricks” for lack of a better solution:
“New Rochelle has seen its tax roll drop by 2 percent or 3 percent a year, so just to get the same revenue, you need to raise tax rates by that much.”
-Howard Rattner, New Rochelle Finance Commissioner
The net result of these gimmicks means homeowners get plugged with higher tax rates amid falling home prices. While payments on a net basis are likely to remain sticky, the psychological effect of higher property tax rates in an environment of ever-falling appraisal values is not one that is bullish for consumer confidence on a national level. Neither is a $13.8B increase in the consumer’s State tax burden. To the extent State and municipal tax and fee increases are offset by Federal tax cuts into and out of the Debt Ceiling Debate and FY12 Budget Debate remains to be seen – though likely at least to some degree. Still, any resulting spending cuts are likely to be an additional drag on the economy in the near-to-intermediate term that is likely to be eventually offset by higher levels of consumption and investment over the intermediate-to-long term due to [anticipated] tax cuts.
Macau Studio City, a new junket, and a blowout Q2 makes us wonder why the valuation discount remains so big.
We’ve updated our model for the accretive refinancing and we shake out at $0.32 for 2011, much higher than the Street at $0.21. MPEL trades at a 25% discount to Wynn Macau, yet there appears to be more positive near-term catalysts for MPEL.
- Neptune will open at City of Dreams hopefully by the end of June. Neptune is one of the largest junkets in Macau and they are shooting for HK$3-4 billion on monthly roll. We calculate that translates into an incremental US$6-8 million in EBITDA or a 5-10% increase in the current company-wide EBITDA run rate. This is not in anyone’s model, including ours.
- A blow out Q2 – we are currently estimating $172 million in Q2 EBITDA or approximately 25% above the Street and that’s after accounting for a softer June for the market.
- A Macau Studio City announcement – We think a resolution between the two principals in his JV could be announced soon. MPEL will likely take a sizeable equity stake and retain its management contract. We estimate potential value accretion around $3 per share at the low end. See analysis below:
Conclusion: A bigger deal than VFC was initially looking to swallow, but this one makes sense on many fronts. It’s rare that we’re positive on an acquisition, but this definitely changes our longer-term outlook for VFC.
Its rare that we say this about an acquisition, but this VFC/TBL deal makes perfect sense to us.
A few considerations…
1) It gets each company what they need. In the case of TBL, it puts the company in a portfolio that allow it to regain a shred of credibility – not to mention extremely good management which will, no doubt, be leveraged across a perennially poorly managed TBL. For VFC, it takes up footwear mix from roughly 15% of sales to greater than 20% -- and broadens international exposure to 35% pro-forma vs 30% today (VFC is 30% Int’l, and TBL is pushing 60%) representing significant progress towards achieving the company’s goal of 40%.
2) The timing was ideal as well. Think about it… TBL was faced with a class action lawsuit last week for allegedly misleading investors, where TBL blew out 4Q numbers, issued very bullish forward looking statements, and then missed meaningfully one quarter later (just after management sold stock at an increasing rate). The evidence is compelling (see chart below). This deal won’t make the lawsuit go away – but for the shareholders who stuck it out over six months, it gives some relief by valuing TBL close to where it was around the bullish 4Q print.
3) This suit will be VFC’s problem to an extent – but the scope will be greatly diminished – and if anything, more focused on the individuals at TBL as opposed to the company.
4) This deal happened FAST. It was very quiet in the market without any meaningfully suspicious trading activity (while TBL mgmt continued to sell stock). What gives us comfort is that VFC had literally been doing due diligence on it for the better part of 10 years. It knows TBL better than most people at TBL do.
5) One area we caution is that TBL’s SG&A is actually down by about 8% over the past 5 years. Yes, there are some moving parts with the closure of retail stores and the shifting of the Apparel business to PVH. But we never like to see premium-branded companies that shrink SG&A, We’d far rather see the company be a better steward of capital allocatioin, and invest in its content. Hence, our lingering concern here is that TBL actually needs more capital (talent/R&D/Marketing) before sales and margins have to remain robust.
6) Chance of competing bid? Very unlikely. The 10.8x EBITDA multiple is steep – though it’s closer to 8x 2 years our if we give credit for 10% top line growth (which we’ll front them) as well as slight margin improvement, we get to a multiple closer to 8x – which is fair. In addition, Adidas and Nike are the two most likely suitors – and neither has a good track record of buying companies that need to be fixed. VFC has a better track record in doing so. Also, the fact of the matter is that the valuation on current year’s numbers is rich. If anyone were to step in with another bid, it’d need to assume an unreasonable level of synergies.
We’re making the following changes to out model:
Revenues – we’re assuming the deal closes mid-September, with Timberland adding $690mm in revs in F11 and $1.71Bn in F12 accounting for 9% growth in ’11 and 11% in ’12.
Margins – we don’t expect significant synergies to be realized in F11 given one quarter with which to work, but do expect VFC to realize substantial synergies of roughly 150bps primarily in F12. We're usually not fans of gifting high expectations for synergies either. But in the grand scheme of what VFC can add as it relates to top line, Gross Margin, and to oan extent, SG&A, we're really not talking big numbers here.
Interest Expense – with the deal financed by $500mm in cash, $700mm in commercial paper, and $800mm in term-debt, we are layering in $28mm in interested expense in F11 and $75mm in F12.
EPS – based on the our calculation, we expect $0.30 of accretion in F11 (assuming roughly $30mm in 1x charges) and approximately $0.75 in F12 assuming 150bps of margin expansion in the TBL business bringing our earnings estimates to $7.45 and $8.75 in F11 and F12 respectively. While we're above management's guidance for deal accretion, unfortunately we are still slightly behind in assumptions for its other core businesses. Net them all out and our sense is that consensus estimates will shake out ahead of ours. If not, we'll likely change our near-term tune on the stock.
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