Darden Restaurants has a significant amount of owned real estate (including buildings and Equipment) on its balance sheet ($3.0 billion) and have thought for years that equity investors do not assign the appropriate value to the Darden real estate holdings. As of May 28, 2008, Darden operated 1,702 restaurants (including 680 Red Lobster, 653 Olive Garden, 305 LongHorn Steakhouse, 32 Capital Grille, 23 and seven Seasons 52 restaurants). Of the company’s 1,427 restaurants open, 904 were located on owned sites and 798 were located on leased sites.

While owning a significant amount of real estate can provide a safety net to the company, removing the real estate can optimize Darden’s capital structure while improving investor perception and valuation on the core restaurant business. Traditionally, restaurant investor’s views real estate operations as a lower return proposition than the core restaurant business, thus creating an undervalued asset. Additionally, for the company to establish a permanent off-balance sheet capital financing vehicle for existing and future real estate capital needs would be extremely valuable for the entire enterprise.

  • In 1999, Darden formed two subsidiary corporations, each of which elected to be taxed as a Real Estate Investment Trust (REIT). Both corporations are currently holding certain restaurant real estate assets. Originally, the formation of the two REITs was designed primarily to assist the company in managing its real estate portfolio, reduce taxes, and provide a vehicle to access capital markets in the future. Upon a REIT spin-off, although we do not know if the tax implications would reverse, it is highly unlikely that the value of those tax implications would match the underlying value released as a result of the transaction.

  • In an attempt to determine the potential value of the stand-alone Darden REIT, it’s important to understand what the potential benefits and issues the company may face if it were to do a tax-free spin-off of its REIT. The Darden Real Estate Company would be an independent public company with its own Board of Directors and management team. A majority of the new company’s executives could be drawn internally from Darden, allowing the company to reduce its G&A costs. Further any additional property and leases would be negotiated on contributed property between Darden and the Darden REIT.

  • The following are some of the benefits that might accrue to the company if it were to spin-off its real estate business:

    Singular focus on the core restaurant business.

    Simplify balance sheet to include only core operations and a better valuation.

    Redeploy capital currently restricted by real estate in higher return restaurant business.
    Increase shareholder value with a significant share repurchase program.

    Reduce capital spending and significantly increase free cash flow.

    The Darden REIT will continue to aid Darden Restaurants in real estate solutions as new restaurants and concepts are added to the portfolio.

    Darden Restaurant will have Board level involvement at the Darden REIT.

    Darden Restaurant will be able to reduce depreciation expense

    Darden Restaurants will have the ability to transfer General and Administrative expenses to the Darden REIT.

  • The following are some of the disadvantages that we believe that Darden Restaurant might face:

    The company will incur lease expense on the currently owned properties.

    The Darden REIT will be organized with a master lease structure to allow for new properties to be added. Lease escalators are built in to future performance of the REIT.

    Darden Restaurants would lose flexibility associated with real estate ownership.

    Real estate is no longer available to pledge as collateral if needed.


“You been hearing about how bad I am since you were a little kid with mess in your pants! Tonight, I'm gonna whip you till you cry like a baby.”
-Muhammad Ali (1974, to George Foreman prior to the “Rumble In the Jungle” fight)

For the better part of this year I have been the annoying bear in some of the “hedgies” bonnets, and I am happy to be their little pet bull this morning, with a gun. One of our major investment strategy calls this year has been that 2008-2009 was going to most resemble the mid 1970’s. No, not a “mid cycle slowdown”; not the early 1990’s; and certainly not a “Great Depression”…

This brings me back to this day in 1974, when it was “global this time” and the entire world watched Muhammad Ali “Rumble In The Jungle” with George Foreman – he knocked him out in the 8th round. Sports fans will recall that it was the “Rope-A-Dope” strategy that Ali used to dizzy the dancing bear. Having been a growling bear for the better part of the last 12 months, I think I have learned a thing or two about dancing with them. You see, my Dad prepared me for this… but not by the avenue of his usual hockey lessons, rather by warning my sister Cheryl’s boyfriends that they “didn’t want to dance with the bear!”

Across the global macro risk factors that I grind through every morning, I have not had this many positive signals in my notebook since 2003. Everything that matters in my models occurs on the margin. While I am aware of consensus, I do not respect it for anything other than what it is – a leading indicator as to what part of the jungle I should be beating my own path down next. Bears don’t scare me. I know them well… and on nippy mornings like this, I get excited to dance with them.

So let’s dance… globally:

1. Asian Bears beware…
-China, Hong Kong, and Taiwan all cut rates
-“Heli-Ben” Bernanke dropped oodles of cash on Korea and Singapore, opening up $30B swap lines
-Hong Kong’s stock market closed up another +12.8%... pop, pop, bang! Rope-a-dope… pop!
-Korea, Japan, and Singapore closed up +12%, +10%, and +7.8%, respectively… pop, pop, bang!
-Asian currencies had their biggest up day in a decade… pop, pop, bang!

2. European Bears be worried…
-If prices close where they are trading now, this will be the 1st consecutive 3-day rally in Europe in October
-Germany is up another +4.6% after printing a NEW LOW in unemployment, coming in at 7.5% vs. 7.6% last month
-European “hedgies” are still whining about being run over by Volkswagens, or were those Porsches? Pop, pop, bang!@*%!
-Russian Bear hunters are back, putting up a +9.4% up day in their market; Russian stocks are +28% since 10/24… pop, pop!
-Russia’s Medvedev gives a state of the union address to the country today; fyi, it won’t be bearish!
-Eastern European countries like Hungary are getting bailout $ from the IMF and World bank; Hungary is +4% this morning… bang!
-France’s PPI inflation came in lower than expected for the month of September; deflation is taking hold globally…

3. Rest of the World Bears, you have a target on your heads…
-Middle Eastern stock markets (who have lost ½ of their value since May08’) are vying for their 3rd consecutive up day… pop, pop, bang!
-Oil is up +13% in 3 days post the “Heli-Ben” dropping of cash on emerging markets… if there is one thing that these countries like, it’s oil up!
-Copper and Nickel have had +12-14% moves to the upside since US rates were cut to 1%; beware of Peruvian bear hunters with guns!
-Brazil and Canada put in +4% up days; with the CRB Commodity Index +6% yesterday, you can’t be short them here…
-The Canadian Loonie has picked up +7% in 48 hours and we are long it via the FXC; I am Canadian, and I support hunting season!

This dancing is global folks. The US Dollar is down another -0.65% this morning, taking its 48 hour decline to -4.2% (we are short it via the UUP). You can thank the USS “Heli-Ben” for that! Pop, pop, bang! That’s the sound you’re going to hear in your newfound genius “short book” of “ideas” if you don’t recognize that being in 96% Cash (like we were in September) is the last thing you do when governments are giving away money for free!

I don’t have to agree with Bernanke, Paulson, or Foreman on much at all here. What I have to do, is be right. One of the toughest things for investors, boxers, and hunters to do is keep the mind focused when opposing thoughts enter the brain. Maintaining balance and sobriety under these emotional circumstances is the key. Otherwise, you are going to get “Rope-A-Doped”… pop, pop, bang!

I think there is at least another +9% left in this S&P500 rally. Our call on being net long China and Germany is starting to play out. Allow me to borrow John McCain’s calling card: “My friends”, the bears, I am calling all of you out of the bushes - let’s get ready to rumble!

Have a great day,

Long ETFs

FXC – Currency Shares Canadian Dollar Trust – The “Loonie” has rallied sharply in the last week, up +7.1%, on the back of a U.S. interest rate cut yesterday and strengthening commodity prices.

EWG – iShares Germany – The DAX is a positive outlier in Europe up +4.6%. Positive earnings reports from Deutsche Bank and Metro, a retailer, are highlighting this action. Unemployment fell slightly more than forecast for October coming in at 7.5%.

FXI – iShares China – The Hang Seng was up ~12.9% overseas and the largest gainer in Asian markets this morning.

EWH - iShares Hong Kong – The Hong Kong Monetary Authority cuts its key interest rate by 50 basis points, to 1.5%.

VYM – Vanguard High Dividend Yield ETF – This is a fund of the U.S. largest, blue chip companies and currently pays a dividend yield of ~3.7%. We like Dividends.

Short ETFs

UUP – U.S. Dollar Index – As we expected and noted yesterday, on the back of a U.S. interest rate cut, the U.S. dollar had its largest one day decline against a basket of currencies (based on ICE’s Dollar Index), since 1998.

EWU – iShares United Kingdom – The Nationwide Building Society reported that average cost of a home fell -14.6% y-o-y, the largest decline since the survey started in 1991. According to the Bank of England’s Blanchflower, “Interest rates do need to come down significantly – and quickly.”

Keith R. McCullough
CEO & Chief Investment Officer


The hedge fund strategy du jour in the gaming space is to go long bonds and short equities. Even the sell side has jumped on board, in typical fashion. A little chirping in the ear of the naive sell side community is all it takes.

Today alone, this strategy could’ve KO’d an aggressive hedge fund. Gaming operator stocks increased in the 20-30% range today with a few outliers like LVS up 80% and PNK up 60%. I’d like to think it my note this morning, “A SHORT SQUEEZE COMMETH”, had something to do with it. In fact, I will think that. I need the ego boost.

We also had that inconsequential (sarcasm) MGM earnings release today. Business is pretty bad in Las Vegas but MGM was able to show the market a bit more liquidity than expected. That was also my call this morning on PNK ahead of next week’s earnings. Moreover, PNK’s fundamentals are a bit stronger than for MGM.

So we got our short squeeze, a bit quicker than I expected. Where do we go now? Yes the moves were huge but they were off such a low base. The short interest may be lower after today but most of the other catalysts I pointed to this morning are still intact. The trade is still higher, potentially much higher.

Buy bonds/short the equity? Not a good strategy in my opinion. Not that gaming bonds aren’t attractively priced. They are. But gaming equity has a long way to go until it’s shortable again.

Aside from potential 50% moves in the stocks daily, the other problem with this strategy is interest rates. Yes, higher interest rates are bad for stocks too but they are a direct input into bond pricing. At the current low level, interest rates are likely to go up. Inflation is a big risk with the current Greenspan Fed Fund rate in place. Inflation is very bad for bonds.

Besides, even gaming companies are buying bonds, their own and each other’s, and not buying stock. Given their track record on investing: share repurchases at the top (MGM, IGT), other stock purchases (PNK buying ASCA stock), and the horrible ROI on recent new casinos and expansions, the actions of these guys look like a solid contrarian indicator to me.
I personally own shares of PNK

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

Today's Trivia ...

Q: Was it volatile at the lows?

A: Over the past 10 trading sessions the average change between the intraday high and low in the VIX has been 22%.

Uh, yeah...

Don't be short that.

Confidence: How Wrong Could The Bears Be, From here?

It’s always easier to see a market bottom in the rear view mirror…

A subscriber responded to our post on consumer confidence with a few follow up questions regarding which data series tended to have the strongest correlation. I sent him a quick note along with consumer confidence charted vs. unemployment and told him that it seems that the strongest correlation was to employment, and that a bottom in confidence tends to lead the unemployment spike slightly –something of a tautology (most see the writing on the wall, know that layoffs are coming and stops spending before the pink slips actually arrive). In his follow up note he said that he expected “the stock market should in theory be acting similarly to prior periods entering recessions although w/more voracity this time b/c of housing”.

The part that I stumbled on was “acting similarly to prior periods entering recessions”. I charted confidence vs. unemployment since the Consumer Confidence Index was created in 1967 to arrive at a channel to gauge points of maximum pessimism. In the year following each of the five inflection points the S&P had positive returns. What’s more, four out of five realized double digit gains greater than 15%.

This is pretty intuitive stuff. From a market psychology standpoint, looking at the convergence of consumer pessimism and unemployment as an indicator may provide a valid rear view mirror indicator. In each of these historical periods an investor that took long positions in the quarter subsequent to improving confidence numbers was rewarded.

Andrew Barber

"Heli-Ben" Flies Again!

Bernanke just cut the funds rate to the level that the crowds were crying for. He is polarized and politicized – sad, but true.

Now that we have an effective Greenspan free money 1% Fed Funds rate, I think we’ll see enough cash deployed in November to keep this short term "Trade" rally alive. Consensus is on the other side of that idea. The bulls have guns, and the bear shorts are on the run. This is all good for stocks.

Bernanke has acknowledged that the economy has slowed "markedly" and that "risks to growth remain"… gee, thanks. Since he has been looking for inflation to slow for well over 2 years, I don’t think what he thinks on inflation matters.

At 1% interest rates, I don't get paid to be in cash. Every asset class has time and a price. Look for us to continue to decrease our position in US Cash, and increase our exposure elsewhere. The US Dollar is getting whacked again today. We remain short it via the UUP etf.

Our immediate "Trade" target for the S&P500 remains 1016.

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