A Whale Called Warren

“What counts for most people in investing is not how much they know, but how realistically they define what they don’t know.”
-Warren Buffett
These days this is easier for Buffett to say than it is for most investors. As Berkshire and the cash on its balance sheet expand, Buffett gets better information. That’s the way that Wall Street works. As a result, defining what Warren doesn’t know gets de-risked. After all, no one (including the US government), gets the preferred terms that Buffett has been getting in recent months. Preferential treatment has its perks.
Swimming alongside America’s value investing sage is another big whale these days – her name is China. Like that whale called Warren, she also has the enviable position of a cash full belly and preferential terms on investments. While chewing on Steve Schwarzman’s Blackstone stock wasn’t as tasty as some American bankers forecasted it to be, the Chinese whale has said goodbye to that $3B loss on her investment and, ostensibly, gone back to feed on her domestic shores.
The Chinese feeding at home is creating a rumbling sound in the stomach of Buffett, and American bond holders alike. US Treasuries have had one heck of a time in 2009, and the objective mind can’t help but wonder what it is that we don’t know. Has the largest customer of the Greenspan debt feedbag stopped buying Treasuries? Is she selling them?
Whale watching is what Wall Street loves to do. Whales like Schwarzman and Ackman come and they go. Across economic cycles, the visibility that our manic media provides us to these whales is always the same – these self purported genius navigators of the depths of the investment oceans never miss an opportunity to smile for the camera. Life in the world’s largest fishbowl has its perks, until these whales don’t “realistically define what it is that they don’t know.”
Buffett knows this all too well. He has spent the better part of his investment career feeding on the plankton and depressed prices that these bloated whales create. I wouldn’t be surprised if that whale called Warren isn’t running the math on buying himself some preferred shares in Target today. Everything has a price, and Warren loves to eat what forced sellers have on the offer. I just hope our national mammal of the investing oceans saves some of that cash in his belly for rainier days.
Those leverage sharks who get starved by not having access to cheap capital are in trouble. This is why Blackstone’s stock was down another -8% yesterday in an up tape for the US Financials. This is why poor Billy Ackman is blowing up another hedge fund, and “apologizing profusely” for it.
Whether we know or don’t know what the Chinese are doing with their American bonds is not the point – the fact of the matter is that a lot of people are selling them back to us, and even more people have stopped buying them. As a result, you see the cost of long term capital on the long end of US Treasuries increasing, as access to long term capital tightens.
Despite putting in its second consecutive up day yesterday, at $9.90/share, the US Financials Sector etf is down -22% for the year-to-date. The whales of leverage cycles past are still for sale, and I see another -13% of downside left in that exchange traded fund before we can wipe our hands clean of that fishy smell that we have to wake up to every morning. This is Darwinian, and it should be – Americans don’t invest in losers. That’s what these government state enterprises are going to be, regardless of what Tim Geithner says at 11AM EST this morning.
The SP500 closed at 869 yesterday. It is down -3.8% for the year-to-date (outperforming those nasty financials by a considerable margin) and now looking for direction from the US government. This Obama government is not the kind of whale that American capitalists want to be invested in – at least not yet. Last night, President Obama lacked clarity on the financial front – and that doesn’t work. Investors like it to be, as Jack Nicholson said in ‘A Few Good Men’, “crystal.” Confusion breeds contempt.
If we want to be long a government, just buy China’s. As unpatriotic as that may sound, that’s what is working. Last night, the Chinese printed fantastic inflation readings on both the producer and consumer price front of -3.3% and +1% year over year, respectively. Chinese stocks raced higher on the news, closing up another +1.8%, taking the Shanghai Stock Exchange Index to +24.5% for 2009 to-date. This massive mammal is cutting taxes, cutting interest rates, and chowing down on the world’s stock market league tables – this folks, is a WHALE!
Realizing that most of the masters of the hedge fund universe told you 18-24 months ago that they “don’t do macro”, be rest assured that they all will be today. Geithner is going to have to pull off a miracle of sorts to get the US futures to turn around from the weakness born out of Obama’s first press conference last night. If the SP500 closes below the 862 line, this market will be in trouble again. My support levels are 847, then all the way back down to 811, which would be a -6.7% drop from last night’s close.
With the political rhetoric dominating the market’s dialogue right now, the only thing I have left is hope. Hope, as you know, is not an investment process… but sometimes that’s all we have left. We better hope that whatever comes out of Timmy Geithner’s mouth this morning creates US Dollar weakness. Unless we break the buck below the line of support that it held yesterday (84.51), that big Chinese whale has no incentive to buy whatever it is that our bankers are going to try to sell them next. Like Buffett, this Chinese whale likes to eat lower prices.
While I wish we were all in the preferred investor position of that American Whale called Warren, that isn’t The New Reality. The reality is that many American investors are still locked in marked-to-model and illiquid investments that they “realistically don’t know.”
Best of luck out there today.


A Whale Called Warren - etfs021009


Everyone knows that room rates in Vegas have taken a big hit. However, we thought it would be interesting to attempt quantifying the effect of lower ADR rates on EBITDA for the WYNN, MGM, and LVS.

Unlike occupancy, change in ADR is a direct hit to EBITDA. In the table below we illustrate the flow-through to gross profit of a theoretical ADR decline. In addition to direct room expenses, there is also overhead (reservations team, back office, front desk management, utilities, etc) which we believe comprises of about 90% fixed costs. Realistically, casino operators will try to cut costs to offset some of this pain, but a 50% rate cut may render many properties unprofitable.

As a point of reference the average ADR for the Las Vegas properties of WYNN, LVS, and MGM for the last twelve months was $295, $235, and $151 respectively. On Wynn’s pre-announcement conference call (or whatever it was) management spoke about room pricing of $169/$199 post Encore opening. If Wynn is charging under $200 a night at their properties, a 35% YoY decline, this bodes very poorly for LVS and MGM, as WYNN’s property’s typically set the ceiling on pricing.

We estimate that at a blended ADR of just over $210, WYNN’s consolidated EBITDA in Las Vegas will fall to below $200MM from a peak of over $400MM in 2007. For LVS, we believe that a 35% drop in rate will translate into an aggregate Las Vegas EBITDAR of approximately $240MM, down from our $409MM estimate for 2008. For MGM, our best guess is that rates will be off 30% to an ADR of just over $100 night causing Las Vegas EBITDA to plummet to approximately $825MM (pre-condo rentals) for 2009, down from over $2BN in 2007.

Is there a scenario where profitability drops to zero for these companies? Without factoring in changes in casino and other spending, we’ve carried the analysis to the break-even point for each company. WYNN, LVS, and MGM would have to see a further 25%, 45%, and 50% decline, respectively, in YoY ADR beyond our estimate to drive EBITDA to zero. A highly unlikely outcome but the fact that we are even having this discussion is telling. The good news is that free and independent room rates on the Strip appear to have stabilized recently, down in the 20-25% range over the past several weeks. Not good, but a little better sequentially and offering an ever so small ray of hope.

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German Export data is one of the barometers of European economic health we follow closely; as of Q3 of last year exports totaled nearly 45% of GDP for Europe’s largest economy. Data released this morning showed total exports dropped a seasonally adjusted 3.7% month-over-month in December, rebounding somewhat from the -10.8% level registered in November, potentially signaling a higher low for industry in Europe’s largest economy. Exports increased 2.8% for the total year with shipments to countries outside the EU showing + 6% vs. +1.1% for intra-EU sales.

Imports slid by 4.1% M/M during the same period, with the total trade surplus tapering to €6.9 Billion from €9.9 Billion in November.

The clear trend emerging from German export data for late 2008 is a sharp decline in demand for manufactured products, particularly cars and engineered metals products, and a particularly strong drop off in intra-EU sales:


One signal that global confidence in the German economy is waning is being provided by the yield curve, which has widened to a spread of over 200 basis point between the 2 and 10 year bunds as capital continues to flow into short term German debt to the determent of long term paper, which faces pressure with a large auction later in the week –in the wake of last month’s cooling demand.

German leaders, after initial slowness, now appear to be proactively responding to the situation. Over the weekend two important policy changes were announced:

Following a Security Council conference in Munich over the weekend German Chancellor Angela Merkel issued a joint statement with French President Nicolas Sarkozy saying that they are working on ideas for a common European Union response to the economic and financial crisis. Merkel invited European leaders to meet in Berlin on Feb. 22 to discuss changes in the global financial system before an April 2 summit of Group of 20 government heads in London.

Also over the weekend Germans received the news that German Economy Minister Michael Glos has tendered his resignation, just seven months before national elections. By all accounts, Glos has taken a back seat in recent weeks to the increasingly popular Finance Minister Peer Steinbrück (a member of the SPD party) in handling Germany’s response to the financial and economic crisis. Glos, 65, garnered criticism for struggling to show a command of economics like his predecessor, Wolfgang Clement. He has made embarrassing references to Deutschmarks instead of Euros in speeches and was absent for a long trip to Asia during critical early stages of the crisis.

This morning Karl-Theodor von und zu Guttenberg of the Christian Social Union (CSU)—the Bavarian sister party of Merkel’s Christian Democratic Union (CDU)—was named in Glos’s place. Merkel, who leads a Grand coalition with the Social Democratic Party (SPD), is fighting for her party’s reelection in September. Glos’s poor performance and resignation in this environment cast a poor light in confidence for Merkel’s party in the wake of the CSU losing its decades-long absolute majority in Bavaria.

The hope for a CDU led coalition election victory now seems to lie in Merkel’s ability to resuscitate German leadership in EU economic policy making and to steer the ship forward again. The German economy contracted by 2% in the final three months of 2008 alone and consensus forecasts predict another 1-1.3% decline in 2009. Any further signs of indecisiveness could be politically and economically fatal for her party.

We continue to believe that the German economy is the strongest in Europe on a relative basis, but that strength will mean little if there is no confidence it its leaders. We will keep our eye firmly on the situation there.

Matthew Hedrick

Andrew Barber

The Line That Matters: US Dollar

Below we have outlined where I think the SP500 can either find her next up leg, or break it.

The white dotted line in the chart below is at $84.47. If the buck breaks that line (like it did in December), I think stocks breakout to test the December/January highs. Today, the US$ Index is down another -0.79% at $84.61, and the stock market likes it.

If we fail to break the buck, there is a massive wall of resistance at SP500 885 that I do not believe will be overcome. This is the line that matters.

Keith R. McCullough
CEO & Chief Investment Officer

CAKE – It’s been a long Time

Anybody can look at a map and read the news and tell you that a majority of CAKE’s units operate in some of the most economically challenged parts of the country. Even better than that, we can use Malcolm Knapp’s regional data for a very specific look at CAKE’s regional performance. While we don’t yet have December data, my guess it will look like November. For the November same-store sales data, there was not much movement among the best and worst performing regions of the country. The same regions of the country are still performing both above and below average so in November, CAKE still had 62% exposure to the worst performing regions of the country (third worst exposure behind only CPKI and MSSR). This is old news and consensus thinking.

The Research Quantitative Edge

The Research Edge quant models suggest that CAKE just turned bullish on both the “trend and trade.” On the trend line we see $8.51 as support and for a trade it broke the $9.26 shark line on Friday. If there is any turn in the fundamentals (see below), the stock looks like it’s going to $15.00. I would also note that the short interest is surprisingly low (6.3% of the float) relative to years past, and on balance that’s bearish. There has not been any insider buying recently, but there are no sellers for a while either. The composition of the shareholder list is a net positive – guys that probably buy more as fundamentals turn, plus you have the big slug owned by CEO Dave Overton that isn’t on the offer. Importantly, the high turnover hedge fund beta appears to have been drained from the top holders list.

Here are some of the fundamental aspects to think about when looking at CAKE over the next four quarters.

(1) EPS NEXT WEEK - I don’t expect the tone of the earnings call to be good next week. Same-store sales are an issue, but we know that. I do think that street estimates are low for the quarter and possibly for 2009, but that is impossible to tell right now. Less than toxic will be the tone from the call.
(2) LOWER COMMODITY PRICES - CAKE will benefit more quickly than most restaurant companies from lower food costs. Dairy prices have declined substantially over the past year and tend to have a more immediate impact on the P&L.
(3) CONTROLLING CONTROLABLES – CAKE’s capital spending has declined very quickly and now stands at less than 5% of sales, which is one of the lowest levels of spending in the industry. The significant decline in capital spending will make the company a more efficient organization, reducing its cost structure and allowing for sequential margin improvement, even with declining same-store sales.
(4) M.E.G.A. - Sticking with the Research Edge MEGA thesis on the consumer, if Knapp Track sales trends become less bad as we head into the spring, the leverage to EPS is even stronger in a company with a more efficient cost structure.
(5) NEW MANAGEMANT – CAKE recently hired Doug Benn as CFO. Traditionally, the role of CFO has been a revolving door at CAKE, and to be honest I don’t view Doug’s position any differently until proven wrong. First, rumor has it that it is a challenge to work for CEO Dave Overton. Second, Doug’s roots are in Atlanta, which is far cry from southern California. Having said that, Doug is a much respected CFO in the restaurant industry and brings significant credibility to the organization. In addition, last July, CAKE hired Mark Mears as CMO. Mark’s hire was the first time that CAKE has had a CMO.
(6) NO BALANCE SHEET ISSUES – CAKE recently entered into an agreement to amend its revolving credit facility, taking a proactive step to increase its financial flexibility in light of the uncertain economic environment.

At 5.3x NTM EV/EBITDA, CAKE is cheap, but who cares – there are a lot of cheap restaurant stocks. What matters to most investors is stability and smart decisions. The actions CAKE has taken to right size the company and add creditability to management will be reflected in the company’s stock price over the next six months.

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