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CBRL – Changes to management’s compensation metrics in 2009

In the CBRL’s proxy filed last week, the compensation committee changed the key financial metrics for management’s compensation. According to the proxy “We seek to align the interests of the named executives Named Executive Officers with those of our shareholders by evaluating executive performance on the basis of key financial measurements which that we believe closely correlate to both near-term and long-term shareholder value, including increases in operating profit, revenue growth and operating margin.“ In 2008 the key metrics included operating profit, revenue growth and return on investment.

Why would management not want to include ROI in 2009? One thought would be to make it easier for management to get a bonus since they did not hit the key metrics in 2008

For management to get a bonus in 2009 total revenue are to increase approximately 4.5% to 5.5% over 2008 and operating income margin to be approximately 6.0% to 6.3% compared with 6.3% in 2008. All of this translates to operating income growth of approximately 6.4% in 2009.

Currently, the Reuters estimate for revenues growth is 3%, flat EBITDA and earnings declining slightly.

US Market Performance: Week Ended 10/24/08...

Performance:

Week Ended 10/24/08:
Dow (5.4%), SP500 (6.8%), Nasdaq (9.3%), Russell2000 (10.5%)

October 08’ To Date:
Dow (22.8%), SP500 (24.8%), Nasdaq (25.8%), Russell2000 (30.7%)

2008 Year To Date:
Dow (36.8%), S&P (40.3%), Nasdaq (41.5%), Russell2000 (38.5%)

Eye On Our Network: The "Stockdale Paradox"

We have been hammering on our RE Investment Theme "Eye On Leadership" for most of this year. To some, say 9 months ago, that was a little too “soft” of a Theme … to those who get it now, leadership is going to be a driving factor in solving this financial crisis. Finally, we are seeing consensus fall onto our side of the moral compass balance sheet.

This is a very good thing, for both America, and the next generation of capitalists that this crisis will give opportunity to.

Below is an excerpt from one of our avid readers, who captures the "Stockdale Paradox" from the penmanship of Jim Collins:
KM
---------

Keith,
"The author is Jim Collins who wrote the book Good to Great. I thought it would be interesting reading for you at a time when great leaders and companies in the Business World are faltering , the economy is believed to be in a full Recession and FNM is no longer as we knew it."
Regards,
-RE Subscriber
---
The Forum
A man in his early 20s recently asked me, "So, what's a recession like?" It's an entirely alien concept to him; he'd grown up during the greatest economic boom in modern memory. His question drove home the fact that we haven't faced a severe, protracted economic setback for nearly 2 decades, leaving us terribly unpracticed at dealing with tough times.

With this recession -- long in coming, perhaps long to stay -- now officially upon us, it is imperative that corporate leaders relearn a key lesson about how great companies (and great people) deal with difficult times differently from how they deal with merely good ones. That lesson is the "Stockdale Paradox," a peculiar psychology shown by those who emerge from tough times not just intact, but stronger.
Adm. Jim Stockdale was the highest-ranking U.S. military officer in the Hanoi prison camp during the Vietnam War. Tortured many times during his 8-year imprisonment, Stockdale lived without any prisoner's rights, no set release date and no certainty as to whether he would ever again see his family.

He shouldered the burden of command while fighting an internal war against his captors and their attempts to use the prisoners for propaganda. At one point, he beat himself with a stool and cut himself with a razor, deliberately disfiguring himself so that he could not be put on video as an example of a "well-treated prisoner." He exchanged secret intelligence information with his wife through their letters, knowing that discovery would mean more torture and perhaps death. After his release, Stockdale became the first three- star officer in the history of the Navy to wear both aviator wings and the Congressional Medal of Honor.

You can understand, then, my anticipation at the prospect of spending part of an afternoon with Stockdale, who happened to be at the Hoover Institution across the street from my office when I taught at Stanford. In preparation, I read In Love and War, the book he and his wife wrote to chronicle their experiences those 8 years.

As I read the book, I found myself getting depressed. It just seemed so bleak -- the uncertainty of his fate, the brutality of his captors. And then it dawned on me: Here I am sitting in my warm and comfortable office, looking out over the Stanford campus on a beautiful Saturday afternoon. I'm getting depressed reading this, and I know that he gets out, reunites with his family and becomes a national hero. If it feels depressing for me, how on earth did he deal with it when he was actually there and did not know the end of the story?

"I never lost faith in the end of the story," Stockdale said when I asked him. "I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life that, in retrospect, I would not trade."

I didn't say anything for many minutes, and we continued the slow walk toward the faculty club, Stockdale limping and arc-swinging his leg, still stiff from repeated torture. Finally, I asked, "Who didn't make it out?"

"Oh, that's easy," he said. "The optimists."
"The optimists? I don't understand," I said, completely confused.
"The optimists. Oh, they were the ones who said, 'We're going to be out by Christmas.' And Christmas would come, and Christmas would go. Then they'd say, 'We're going to be out by Easter.' And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart."

After another long pause, he turned to me and said, "This is a very important lesson. You must never confuse faith that you will prevail in the end -- which you can never afford to lose -- with the need for discipline to confront the most brutal facts of your current reality, whatever they might be."

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Volatility: Echoes of LTCM

"History Doesn't Repeat Itself, But It Rhymes"
-Mark Twain (attrib.)

The term “relative value” can at times be slippery. Distinct from directional investing and arbitrage, the term is loosely defined as an investment designed to capture a contraction or expansion between the market values of two instruments that are not directly related but which share common economic drivers.

Earlier this week we purchased the Canadian dollar (FXC), in part, because of the relative value play between it and the US dollar (i.e. Canada and the US are both stable North American democratic economies that share(d) a high degree of financial integrity by international standards). The deficit driven US economy is facing the grave consequences of exploding levels of debt and slowing personal consumption, while the smaller and surplus driven Canadian economy ‘s only major negative is slowing GDP growth spurred by declining commodity prices.

The massive spikes in volatility levels this week appeared to be driven by indiscriminate buyers willing to pay up no matter what the price. Recall that on Thursday that we speculated that some of this buying was due to a large player (or players) being forced to liquidate short volatility positions rather than investors trying to hedge risk.

Market chatter has been full of speculation that several large players (including one particularly large fund based in Chicago) have been whipsawed in a “relative value” volatility transaction. Details are sketchy but my guess, based on this frenzied buying, is that the trade in question was a play on the relative level of volatility of small caps vs. large caps. Whether making a straightforward wager on the VIX vs. the RVXK (the Russell 2000 equivalent) or a more complex dispersal transaction spanning individual names –anyone who was counting on large cap equity volatility to revert to its historical low levels relative to small caps has been in a world of pain.

This brings to mind the demise of Long Term Capital. This of course occurred only a decade ago when the masters of bond arbitrage gambled on an equity volatility mean reversion with disastrous results. Then, the LTCM traders were undone when the VIX levels held out at anomalous levels for much longer than they anticipated. This time around not only have volatility levels sustained at highs for a prolonged period, the relative spread between the VIX and the RVXK has swung wildly, providing stresses that exceed any historical comparison. As such, any model based approach is suffering for lack of context.

Simply put, I saw the wild action in the VIX this week as the capitulation of hedge funds who were betting on a mean reversion, rather than a broad market capitulation signaling a bottom.

Andrew Barber
Director

BYD: JUST A TOUCH OF CONFIDENCE PLEASE

BYD reports Q3 earnings on Tuesday morning. The stock has acted like it will be ugly. In this case, looks probably won’t be deceiving. I’ve included a chart below that details management guidance and consensus estimates. They will all be too high, but I don’t care. I care about two things: 1) free cash flow per share will be at least $1 next year and 2) BYD can get into 2009 without busting the leverage covenant.

It looks to me like the 2009 consensus EBITDA estimate is too high by 5-10%. Even if I knock it down by 20%, BYD still generates $1.35 to $1.50 per share in net free cash flow and still doesn’t violate the leverage covenant in 2009. For those of you who haven’t looked in awhile, BYD is trading at $4. That is a yield of 34-38% on very conservative numbers. Pretty ridiculous I must say.

BYD benefits from an escalator in its leverage restriction covenant to 6.5x in 2009 from 6x in 2008. There is some risk of a Q4 covenant bust but BYD would have to see its EBITDA decline 30% below the current consensus estimate of $116m. Again, I think there is probably 10% downside to that number but certainly not 30%.

Anyone expecting a near term inflection point in business fundamentals need to look elsewhere. But BYD shouldn’t be lumped with the rest of the gamers. Liquidity is very good and free cash flow has the potential to be off the charts compared to the stock price.

Guidance and estimates are too high but $1.50 in net FCF is very doable

Charting the Chinese Yuan: Bullish "Trend" Remains...

In terms of our ‘Hedgeye Asset Allocation’ model, if there is one thing that 2008 has proven, it's that cash is king. All cash in this increasingly inter connected global marketplace of factors is not created equal, however...

The US Dollar's resurgence from the thralls of forever is pretty well known at this point. The Japanese Yen tacked on another +7% this week, making it one of the more impressive cash stories of the back half of the year. But the 2008 stability MVP in the currency market remains the Chinese Yuan (see chart below).

Given China's well publicized slowdown in economic growth this year, you have to be impressed with their currency's resilience. The new world order of economics and balance of power are changing. If you refuse to acknowledge that, your headache will not abate. China has $1.9 Trillion in currency reserves. Amongst the few kings that remain, their cash (and its valuation) seems to depend on the rest of the world, the least.
KM

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