The Macau Metro Monitor, October 5, 2011




Macau lawmakers are urging the government to disclose when it will remove gaming facilities out of residential neighborhoods, a promise first made in late 2007.  Secretary Tam had said at the time that the government would not grant more licences to lottery houses and slot machine venues in residential areas, explaining that it wanted to “gradually” remove gaming facilities from neighborhoods.  However, almost four years have passed and the government has yet to announce a timetable.


But Tam revealed that the new legal system for the construction and location of casinos, slot machines and lottery houses will be ready in the first half of 2012. “Slot machines and lottery houses are banned in residential buildings and those that already exist will be relocated,” he reassured.



RWS said they have a 13,000-strong workforce; about 70% are locals.  They remain committed to hiring Singaporeans.  MBS said out of the nearly 9,000 team members, nearly 70% are Singaporeans.  In some departments such as entertainment, facilities and security, the percentage of locals is as high as 94%.



Ongoing concerns surrounding economic growth coupled with the strengthening dollar are pressuring commodity prices.  Week-over-week, most of the commodities we track declined significantly.





Declining grain prices are bullish for restaurant industry margins and bearish for protein prices.  This is a positive for food processors such as TSN and SAFM in particular, particularly as beef prices continue higher.  Rising beef prices are a concern for WEN, TXRH and many others in the restaurant industry.


Coffee prices have continued to drop sharply, making it less likely that additional price raises from coffee retailers such as SBUX, DNKN, PEET, GMCR, CBOU and THI are imminent.  As we said last week, we expect high retail prices to take some time to adjust, given the need to clear inventory purchased at elevated prices.


Chicken wing prices continue to gain, which is a concern for BWLD.  See our note (10/4) for more detail on our short BWLD thesis.  We believe coming margin pressure could be expedited and exacerbated by soft sales in the fourth quarter.  Furthermore, from a sentiment perspective, the Street is more bullish (60% Buys) on the stock than it has been in some time.


Dairy prices have been moving sideways over the past couple of weeks, and cheese prices remain down year-over-year.  This is a positive for CAKE, DPZ YUM and PZZA, especially considering the level cheese prices were at just a few weeks ago.





Lean hogs, chicken wings, live cattle and cheese were the only commodity prices in our monitor that gained versus last week.  The declines in our weekly monitor were again larger than the advances.  Rice, chicken broilers, sugar, coffee, milk, soybean, wheat and corn all saw sizeable declines.  As we have been writing of late, declining commodity costs are generally a positive for restaurants but it is worth noting that much of the softness in commodity demand is related to softening economic conditions and this implicitly means a drop in demand for consumer goods and services. 


Gasoline prices continue to toe the 2008 line, declining as the dollar continues to strengthen and economic concerns mount. 









Corn has been declining sharply as demand has been slowing and stockpiles rising.  This is a positive for protein producers that can enjoy much needed relief as feed prices decline.  The U.S. Grain Council, according to Bloomberg, has said that China – the world’s second-largest corn consumer – won’t have enough supplies to meet rising demand even as farmers there harvest a record crop. Despite this, and concerns about a smaller U.S. crop, demand concerns seem to be catching the eye of investors as grain prices drop high-single digits week-over-week.




Below is a selection of comments from management teams pertaining to grain prices from recent earnings calls.



PNRA (7/27/11): “Just to note on the cost of wheat, in 2011 overall, the per-bushel cost will be about the same as 2010 due to our laddering purchasing strategy.”


“We are going to take price in the fourth quarter. This price will offset dollar for dollar the per-bushel inflation of wheat of approximately $3 a quarter that we're going to see in the fourth quarter of this year and then across next year”


“We do continue to expect significant inflationary pressures in 2012, 4% to 5% food inflation, $10 million of unfavorability on wheat costs, which means that we don't expect operating margin much better than flat to full-year 2011 in 2012.”


HEDGEYE:  Weak global demand and a stronger dollar are currently trumping the adverse impact on supply due to weather and fires in the U.S.  Slowing demand may also mean lower sales for PNRA, so it remains to be seen if margins improve from this effect, even if high wheat costs come down.



DPZ (7/26/11): “We're fairly locked in on our chicken, locked in on our wheat into – partway into next year.”


PZZA (8/4/11): “We're actually covered through Q1 from a contract standpoint. So from a supply chain disruption or even significant price impact we don't anticipate anything between now and the end of the year.”





Beef prices continue higher despite the free-fall in corn prices over the last week.  Feedlot inventories shrinking and demand for meat increasing globally are two factors being cited for the continuing strength in beef prices.  The U.S. cattle herd totaled 100 million heads on July 1st, the lowest for that date since at least 1973, according to the Department of Agriculture.  Strong demand for U.S. beef overseas is spurring the price gains that are illustrated on the chart below.




Below is a selection of comments from management teams pertaining to beef prices from recent earnings calls.


RRGB (8/11/11): “We're still buying ground beef on the spot market… If you recall, we said 5% to 6% commodity inflation on the last call and we dropped that to 5 to 5.5. Again, that's mainly ground beef driving that.”


HEDGEYE:  Live cattle prices are up 22% YoY and, we believe, will continue to be a negative for RRGB’s P&L going forward.


WEN (8/11/11): “That's one of the reasons why as we've talked about our margin guidance, we do not expect to see much relief on beef cost this year.”





Chicken wing prices continue to go higher, signaling a likely end to the massive headwind BWLD has enjoyed from a margin perspective over the last couple of years.  We believe that this change is coming at a difficult time for the company as sales trends have been softer in 4Q in recent years and consumer confidence is waning. 


WEEKLY COMMODITY MONITOR - chicken wing prices 104



Howard Penney

Managing Director


Rory Green




Here are some tidbits from our Konami meeting at G2E


  • There is more focus on video products by having a 3 reel product and a new Dynamic 5 reel product transferred to KP3 platform for all video slots
    • Dynamic 5, a duel-reel steeper that is not transmissive, has a skill stop on bonus and will be a participation product in 2Q12
  • The new slant top machines have a nice backlog
  • Fortune Chaser - Progressive product to be released in 1H12'.  Fixed fee per day of $50-60.  Konami doesn't want the game to compete on the WAP side.  Also, the game may drive their participation base.
  • Lot-A-Bucks, a 3D software-based game, has a skilled-based button on side.  Konami is learning how to use 3D in collaboration with their Playstation division.  Lot-A-Bucks will be available on a limited basis as a direct sale product.
  • Aside from Fortune Chaser, base games are all for sale unless they are linked to a progressive
  • 5 reel market is somewhat falling off.  3 reel market is approaching a replacement cycle so they are enhancing their 5 reel with lights, music, and sound.
  • Konami will have games that if you bet more, the payout increases.
  • Their iView versions go on all devices when you get a Konami system.  Senia, Grand Falls, Ohara property, Evil Mountain, and Echo Entertainment in Australia are all new systems projects.
  • 75% of their offering is sales based.  The balance is participation.
  • Through June, Konami has 15.2% of the market.  This quarter is very strong for them. Most of the video products have already met their plan of YoY growth.  They also have a nice backlog. 
  • Konami ran a volume-based discount promotion from last week of August through last Friday
  • "Trade, no trade" is a program that pays people to take things off the market.  They sometimes don't want the box back.
  • Lots of industry folks felt like WMS was too aggressive. Konami and most other suppliers will not raise prices this year.  It is not the time to anger your patrons.

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Weekly Asia Risk Monitor


Recent trends in Asian financial markets are certainly cause for alarm over the intermediate term.



***Note: wk/wk price action is from the five trading days ending on 10/4. Additionally, we’ve moved the price tables to the end of the note to increase ease of reading.***


From a wk/wk perspective, Asian equity markets are largely in negative territory, closing today down -2.9% on a median basis and -3.4% on an average basis. Hong Kong, which we’ve been explicitly bearish on since late May, closed today down -10.4% on a wk/wk basis and is now down -29.5% for the YTD – leading all other Asian equity markets to the downside over this timeframe.


Asian currencies continued their recent string of declines vs. the USD, as the global Flight to Liquidity trade ensues.  The Aussie dollar (AUD) led the way to the downside (-4.6% wk/wk vs. the USD) largely due to the RBA’s hint that it could potentially cut interest rates at some point over the intermediate term – a view we authored in early 2Q. Australian 1yr interest rate swaps acted on the news, falling -25bps wk/wk and are now trading a full -83bps below the RBA’s 4.75% target cash rate. On three-month basis, the AUD is down nearly -12% vs. the greenback – tops amongst all Asia-Pacific currencies over this duration.


Far beyond individual currencies, we’d like to call your attention to one of the more noteworthy moves in Global Macro in a very long time. Specifically, Asian currencies, as measured by the Bloomberg-JPMorgan Asia Dollar Index, just wrapped up their worst month since December 1997 (falling -4% in Sept). This is particularly meaningful given that Dec ’97 was mid-way through the Asian Financial Crisis! In recent months, we’ve been keen to flag the risks associated with the rapid buildup in external debt we’ve seen out of various emerging market debtors over the past 2-3 years and we continue to do so now.


While we haven’t yet done enough work to feel comfortable making a call for AFC 2.0, we do have conviction in suggesting that a stronger U.S. dollar (vs. debtor currencies), a rising cost of capital for global corporations, and a contracting European banking sector will combine to create meaningful liquidity headwinds for many developing Asian debtors. Email us for more detailed analysis on this subject; we’ve been circulating a compendium of notes on the subject on a one-off basis to clients and we’d be happy to send them your way.


Looking to Asian credit markets, the key moves we’d like to flag are the backup in yields across India’s sovereign debt curve and the jump in Chinese CDS. Indian interest rates – which are being dragged higher by the combination of hawkish commentary out of the RBI and the market coming to the realization that the government is quite likely to miss its FY12 deficit reduction target (a view we authored in late February) – backed up +11bps, +22bps, and +16bps on 2s, 10s, and 30s, respectively.


China, whose banking system is coming under increasing international scrutiny, saw its 5yr CDS widen +45bps wk/wk (+29.2%) to just shy of the 200bps mark. Beyond mere Sovereign Debt Dichotomy speculation, credit investors are indeed starting to sniff out the possibility that the Chinese government may have to dramatically expand the public balance sheet to help recapitalize ailing banks at some point over the long-term TAIL.



***In an effort to make this piece more easily digestible, we’re simply going to flag key data points and our analysis in bullet point format and offer only our [brief] thoughts at the end of each country capsule. We’re always happy to follow up in greater detail; simply reply to this note to open up a dialogue on anything you see below.***



  • Dollar-denominated debt of property developers rated below investment grade fell -19.9% in 3Q11 – the steepest quarterly decline since 4Q08.
  • Unable to refinance through more traditional sources of funding, property developers have turned to private trust companies for loans costing around 16-25% per an official at Beijing National Trust. Such financing has accounted for roughly half of the total amount of credit extended to developers YTD, per a recent Credit Suisse report. In addition to being deprived of commercial bank credit, property developers have been shut out of international bond markets since May, per Bloomberg data.
  • AAA corporate credit spreads widened +46bps in 3Q11 to close the quarter at 221 bps wide – just shy of the 5yr+ high 226bps registered on 9/26.
  • Chinese corporations have issued only 494 billion yuan of bonds in 3Q11 – down -17% YoY and down -14.1% QoQ.
  • Twenty-eight percent of local government financing vehicles have negative cash flow, roughly 22% of them have debt/asset ratios north of 70%, and their average ROE is only 4.4% (vs. an average of 8% for Chinese corporations at large), making it hard for them to access new capital for refinancing, per a study published by the country’s official bond clearing house.
  • Dim-sum bonds, or yuan-denominated notes traded in Hong Kong, fell -4% MoM in September, driving yields up +105bps on average.
  • Savings deposits at Chinese banks are nearing their first quarterly decline since 1992, which threatens to exacerbate the liquidity headwinds currently squeezing the Chinese economy. Through the first half of September, deposits for China’s four largest lenders fell -420 billion yuan; through August, deposit growth for the banking system at large was running at a -98% YoY clip. Negative real interest rates (-270bps currently) are a key contributor to this issue, which may ultimately limit the scope of any monetary easing the out of the PBOC  – if any – over the short-to-intermediate term.
  • Slowing deposit growth and plunging equity prices (down -20.5% over the last six months) has forced Chinese banks to debt markets for sources of liquidity. In 3Q11, the sector issued 388 billion yuan of debt – up over +57% on a YoY basis! The glut of supply has contributed to a predictable backup in borrowing costs; 5yr commercial bank bond yields backed up +69bps in 3Q11 to 5.92% – the highest level since Sept ’07. Spreads over similar-maturity sovereign debt widened +49bps in 3Q – largest quarterly jump on record – to 216bps.
  • Manufacturing PMI ticked up in Sept to 51.2 vs. 50.9 prior.
  • Non-Manufacturing PMI ticked up in Sept to 59.3 vs. 57.6 prior.
  • The 21stCentury Business Herald reported that nearly 80% of China’s rail projects have been put on an indefinite hold as banks concerned about loan repayment have stopped extending credit to the industry. They are reported to be awaiting further clarification of the government’s updated policies for the industry in the wake of late-July’s fatal bullet train accident.
  • Senator Chuck Schumer (D-NY) and 18 of his endowed colleagues have introduced a bill designed to force the Treasury Dept. to issue a biannual report identifying currency manipulators, as well as authorizing the implementation of protectionist measures towards those countries found guilty. The bill is being vehemently opposed by over 50 U.S. business groups, including the Chamber of Commerce, the National Retail Federation, and the Financial Services Roundtable. The bill is expected by some to eventually become bottled up the House Ways and Means committee, which has authority over trade legislation.
  • In response to Schumer’s bill, the PBOC issued a stern rebuke on its website today, saying, “Passage of the legislation may lead to a trade war that we don’t want to see… The [legislation] won’t solve U.S. problems of insufficient savings, a trade deficit, and an elevated jobless rate.” The PBOC, which boasts claim to the largest currency appreciation vs. the USD of any other emerging market nation over the past five years (+24%), per Bloomberg, supports opposition claims that punitive legislation towards China won’t contribute at all to U.S. employment growth. Rather, job losses in China will likely be offset by job gains in other low-cost developing market producers.

Hedgeye’s take: In terms of having concrete numbers to crunch or floated policy recommendations to analyze, it’s too early to wrap our heads around the true size and scope of the headwinds facing the Chinese banking system as a result of property developer and local government financing vehicle credit quality. That said, however, this is an acute risk we will no doubt continue to monitor closely going forward…


Elsewhere, we see that Chuck Schumer and his political cronies are at it again attempting to infuse their dogma on the U.S. economy – despite a bevy of key business groups and actual industry players speaking out against it. Big Government Intervention continues to: a) shorten economic cycles and b) amplify market volatility. A marked and expedited yuan revaluation would spell short-term economic disaster for the U.S. economy in the form of import price inflation for a bevy of key consumer goods.


Hong Kong:

  • Export growth came in flat in Aug at +6.8% YoY.
  • Import growth accelerated in Aug to +14.1% YoY vs. +10.2% prior.
  • Trade Balance growth slowed in Aug to -HK$22.9 billion YoY vs. -HK$5.4 billion prior.
  • Retail Sales growth slowed in Aug to +20.7% YoY vs. 22.4% prior.

Hedgeye’s take: Though stale (it’s Oct), Hong Kong’s August economic data does continue to support our bearish view of the economy insomuch that growth is continuing to slow.



  • Small Business Confidence ticked up in Sept to 47.2 vs. 46.4 prior.
  • The ruling DPJ party proposed at ¥9.2 trillion ($120 bil.) “temporary” tax increase to help fund the third post-quake “stimulus” package of about ¥12 trillion. The bill, which is now being negotiated with opposition LDP lawmakers, calls for corporate tax rates to be raised in the next fiscal year (starting April 1, 2012) for three years and income tax rates to be raised in January 2013 for a full 10 years. Additionally, tobacco levies will increase in October 2012.
  • Retail Sales growth slowed in Aug to -2.6% YoY vs. +0.7% prior.
  • Overall Household Spending growth slowed in Aug to -4.1% YoY vs. -2.1% prior.
  • Japanese corporations issued ¥2.7 trillion ($28.4 bil.) worth of debt this quarter – up +17.5% QoQ after 1H11 brought on the lowest level of issuance on six-month basis in five years. The surge in supply is not being met with a commensurate backup in yields, as demand from Japanese banks (holders of ~50% of the nation’s corporate debt) increased as a result of deposits outpacing loans by ¥163.3 trillion in August – just shy of the record ¥166.7 trillion spread recorded in June.
  • Manufacturing PMI ticked down in Sept to 49.3 vs. 51.9.
  • Unemployment Rate fell in Aug to a 33-month low of 4.3% vs. 4.7% prior. We continue to point out that Japanese employment is being overstated on a relative basis to other economies, given that the Japanese labor force is shrinking aggressively and is now at lows last seen since October of 1987.
  • Industrial Production growth accelerated in Aug to +0.6% YoY vs. -3% prior. MoM growth also accelerated: +0.8% vs. +0.4% prior.
  • The Finance Ministry unveiled plans to raise the issuance limit for bills to fund intervention in the FX market by +¥15 trillion to ¥165 trillion total, as well as extending the monitoring of FX positions through year-end (from an initial plan until the end of 3Q).
  • Tankan Quarterly Business Survey came in better on the margin, but still below the pre-catastrophe levels of 1Q11: large manufacturer sentiment and outlook improved to 2 and 4, respectively (from -9 and 2); large non-manufacturer sentiment and outlook improved to 1 and 1, respectively (from -5 and -2). On a sour note, the All-Industry CapEx Guidance component dropped to +3% from +4.2% – signaling a tempering of corporate intentions to act upon the improved sentiment.
  • Japanese corporate 5yr CDS, as measured by the Markit iTraxx Japan Index widened to 209bps yesterday – the highest since July ’09.

Hedgeye’s take: It’s clear from recent data that expenditures on quake reconstruction are eating into the everyday consumption patterns of Japanese consumers. Natural disasters are, at best, a zero sum game – a point we strongly stressed in the face of consensus buying Japanese stocks on hopeful expectations for rebuilding in 2Q11... Alas, the Japanese economy – awash with corporate cash like its U.S. counterpart – remains mired in a classic liquidity trap as a result of a dim long-term outlook for the economy.


Japanese officials continue to completely miss the boat as it relates to why the yen remains at elevated levels, saying recently that, “There’s no reason for the Japanese yen to be targeted as a safe-haven currency or flight-to-safety currency.” As long as Japanese policymakers continue to fundamentally misunderstand the mechanism by which the yen trades (a mechanism imposed by the BOJ’s ZIRP, btw), expect more misguided FX intervention upon JPY exchange rates.



  • RBI governor Duvvur Subbarao unleashed a string of hawkish commentary at recent press events: “Inflation has been fairly stubborn.”… “Above a threshold, you can’t accept high inflation to have higher growth. The price limit is as much as 6% for the nation.”… “A premature change in the policy stance could harden inflation expectations, thereby diluting the impact of past policy actions (+350bps of rate hikes since March ’10 – the fastest round of tightening since the central bank was established in 1935).”
  • Manufacturing PMI ticked down to a 2.5yr low of 50.4 vs. 52.6.
  • Despite the rupee’s region-best -9.5% YTD decline vs. the USD, Subbarao stated plainly that “intervention in forex markets brings unexpected consequences”, suggesting to us that central bank aid to support the rupee might be limited going forward.

Hedgeye’s take: Subbarao’s latest statements underscore our view that Indian inflation will remain sticky enough to keep the central bank from cutting interest rates in a proactive manner to stem the tide of slowing growth – as evidenced by the PMI data.


South Korea:

  • Consumer Confidence came in unchanged in Sept from Aug at an index level of 99.
  • The Korean government, citing fiscal woes in Europe, plans to cut its fiscal deficit by ½ in the next year to 1% of GDP (~12.25 trillion won). It also will seek to balance the budget by 2013 and post a surplus of 0.3% of GDP by 2015.
  • Manufacturing Business Survey reading came in flat in Oct at 86.
  • Non-Manufacturing Business Survey reading increased in Oct to 86 vs. 83 prior.
  • Industrial Production growth accelerated in Aug to +4.8% YoY vs. 4% prior.
  • Service Industry Output growth accelerated in Aug to +4.8% YoY vs. +3.8% prior.
  • Trade Balance growth slowed in Sept to -$3 billion YoY vs. -$727 million prior.
  • CPI slowed meaningfully in Sept to +4.3% YoY vs. +5.3% prior.
  • Manufacturing PMI ticked down in Sept to an 11-month low of 47.5 vs. 49.7 prior.

Hedgeye’s take: As we’ve outlined in our work on the Korean economy in the YTD, Korean economic growth remains resilient. On balance, Korean economic growth is flat-to-down, but still hanging in there much better than most of its Asian counterparts.


While we certainly admire the Korean government for recognizing an global phenomenon and attempting to strengthen its already-pristine balance sheet (debt/GDP = 22.7%), we do question their ability to achieve next year’s target given that it relies on the aggressive assumption of +9.5% YoY revenue growth and roughly a tenth of the deficit reduction coming in the form of revenues from state asset sales. As we saw in India this year, state asset sales get canceled when capital markets are under duress – which they very well could be in 2012. 



  • HIA New Home Sales growth accelerated in Aug to +1.1% MoM vs. -8% prior.
  • Building Approvals growth accelerated in Aug to -5.5% YoY vs. -14.3% prior.
  • Manufacturing PMI ticked down to a 27-month low of 42.3 vs. 43.3 prior.
  • TD Securities unofficial CPI gauge slowed in Sept to +2.8% YoY vs. +2.9%.
  • Trade Balance growth accelerated in Aug to +A$757 million YoY vs. +A$270 million prior.
  • Corporate borrowers in Australia have cut bond issuance to the least since 4Q08 (A$16.5 billion), driven lower by reduced demand for debt capital out of Australian banks who saw term deposits surge to record A$469.5 billion as recently as July.
  • 10yr sovereign bond yields fell -15bps in September to close the quarter at 4.22%, capping the longest stretch of monthly declines on record (dating back to 1978).
  • The move in the Aussie bond market coincides with the RBA keeping the benchmark policy interest rate on hold at 4.75% for the 10th-consecutive month – the longest pause since a 13-month hiatus ended in May ’06. In accordance with the policy announcement, RBA governor Glenn Steven’s commentary came in noticeably dovish on the margin relative to recent months: “An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.”Stevens also admitted to weakness in the Aussie labor market and the potential dousing impact that would have on labor costs – a key area of concern for the central bank as it relates to the long-term outlook for inflation.
  • Treasurer Wayne Swan, perhaps in response to the -600bps decline in his boss’ approval rating over the last two weeks, stated that policymakers are discussing ways to alter the tax code to address the country’s two-speed economy. Per Swan, nothing will be “off limits” at the two-day tax forum (starting today in Canberra).

Hedgeye’s take: The Aussie housing market, which remains under substantial duress, has exhibited a classic dead-cat bounce off the lows. We continue to think the trend in this market is one that is negative over the long-term TAIL – particularly if Stevens continues to remain stubbornly hawkish on interest rates. Australia’s economic growth continues to slow alongside a waning of inflation pressures out of the once-tight Aussie labor market – which is exactly why the interest rate swaps market is pricing in a full -161bps of cuts to the benchmark rate over the NTM (per a Credit Suisse index)… We don’t have any edge on this tax meeting, but any growth-negative fiscal policy in the form of higher taxes might be incrementally bearish for the Australian economy.



  • Indonesian CPI slowed in Sept to +4.6% YoY vs. +4.8% prior.
  • Thailand CPI slowed in Sept to +4% YoY vs. +4.3% prior.

Hedgeye’s take: As our theme of Deflation the Inflation continues to play out across key commodity markets, we continue to expect that reported inflation trends down on a global basis – particularly in emerging markets. At a price, this will be a very positive development for global consumer stocks. Timing, however, remains the key factor to solve for – particularly on the emerging market front, given the potential for FX headwinds to erode the profits of foreign-based investors.


Darius Dale



Weekly Asia Risk Monitor - 1


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Buffalo Wild Wings remains one of our favorite names on the short side. 


As detailed in the Hedgeye Restaurants Alpha, which describes our three best long and short ideas, there are several factors turning against BWLD as we move through the last few months of 2011 and into 2012.


Firstly, the fourth quarter traditionally tends to be a seasonally difficult period for the concept from a traffic perspective.  While the company is planning on implementing marketing initiatives around the football season in the back half of the year, we believe that a softening macro environment could impact BWLD’s fourth quarter comp.  The company has been successfully taking price even as wing prices have gone lower and lower; whether or not further price increases can be taken without stymieing traffic growth is the key question going forward. 





Connected to this issue of price is the fact that the relationship between restaurant operating margins and wing prices has, we believe, reached an inflection point.  Wing prices have begun to climb and the substantial tailwind that the company has enjoyed is dissipating.  Protecting margins from this point will require even more aggressive pricing than before and could prove difficult in this macro environment. 







Our conviction remains strong on this name.  Given the strong outperformance versus the S&P 500 and the XLY consumer discretionary ETF over the past three quarters, we would expect the reversal in the commodity tailwind and (possible) top-line issues to have a sizeable impact on BWLD’s stock price.





In conclusion, the valuation and sentiment set ups for BWLD are only supportive of our bearish stance.  In terms of valuation, BWLD trades at the third highest EV/EBITDA multiple of casual dining.  Some of the premium it enjoys is undoubtedly due to its growth profile and expansion into new markets.  We believe that growth is good but it does come at a price and contributed to the company’s EPS miss in 2Q.  From a sentiment perspective, as the second chart below shows, the street has not been as bullish as it is now in quite some time.


BWLD CONTINUING TO LOOK GOOD ON THE SHORT SIDE - BWLD historical sell side sentiment



Howard Penney

Managing Director


Rory Green



The markets have been melting down over the past 5 day with the S&P 500 down 5.5%, while COSI is up 11.8%.  I would argue that the stock is not reflecting the bunker mentality that management and the board has adopted, but the realization that there is a real plan in the market place that suggests COSI has a bright future.   


Yesterday, the WSJ revealed that there was a war of word between the management of COSI and Brad Blum.  It appears that management hurled the first diatribe in a memo to employee’s and Franchisees.  Which begs my first question; why did management leave out shareholders in communications about the issues its has with Mr. Blum?


What I’m asking is really a rhetorical question, because its unlikely that management has many shareholders on their side and, more importantly, their shareholder base is not naive enough to believe the rhetoric implied by the WSJ article. 


Management may be able to rally the troops internally but doing so externally is a different proposition.  I believe that COSI shareholders hold management to a high standard of accountability.  Finding the right solution will hinge on the financial performance of the company and, on that score, management gets a failing grade.  


Given current trends and management’s lack of a cohesive plan, COSI seems somewhat like Greece at this juncture: one cannot rule out the possibility of outright failure of the company.  Should the company meet that fate, it will not be entirely due to the poor economic environment; some of Cosi’s peers are managing through, and even thriving in, the current malaise.  In my view, the most significant threat to Cosi going forward is management neglecting to recognize the real issues facing the company: the need for leadership and additional capital.


The company continues to make progress on several fronts, including the new catering menu, online ordering, and a remodeling initiative but, as yet, sales have not rebounded as strongly as many had hoped. 


COSI IS LIKE GREECE - cosi comps



What is management doing to enhance shareholder value?


The Board of Directors recently engaged The Elliott Group to work with the search committee towards the goal of finding a new CEO.  I would question the wisdom of this decision.  Alice Elliot, founder and Chief Executive Officer of The Elliot Group, has extensive experience in the restaurant industry and is surely aware of the credentials of one person – Brad Blum – that is actively seeking the job and willing to work for $1.  Maybe that low salary is somewhat of a disincentive for the search firm, but irrespective of that, the company will find it very difficult to find a candidate as well-suited for the CEO position as Mr. Blum.


I would doubt that the Elliot Group can find another candidate that has done as much research on the company, has as comprehensive a plan to reinvigorate the business, will work for free and – as a bonus – has access to capital that the company desperately needs.  Additionally, Blum is a major shareholder of the company.  As things stand, the company is not facing a bright future.  This is despite the tremendous potential of the brand; I would think that a solution as offered by Blum would be a blessing for the interim CEO and the board.


Instead of this obvious solution, the company is going to pay money that it doesn’t have to a search firm to find a CEO when a highly qualified, major shareholder of the firm is willing to do the job for free.  Blum owns 6.75% of the shares out while the board (collectively) owns less than half of that percentage.  What shareholder would not want a CEO with Blum’s credentials and strong financial interest in ensuring the firm’s future success?


Time is ticking for the current management team.  If decisive actions are not taken immediately, by June 2012 the market will have determined the future of the company and it will not look good for the current management team.  Based on the assumption shown in the chart below, the company’s cash cushion will be worn thin in early 2013 unless some capital is injected into the company.  If sales soften, the process could be shortened.  Additionally, our assumption does not factor in the company’s need of $5-7mm of additional to remodel the company's restaurant base. 





Even if a quality CEO not named Bradley Blum is found in the near-term, it seems likely that the first order of business for that individual will be raising capital.  Unless the person in question has similar access to capital that Blum has, it is likely that the capital raising process will be time-consuming and costly, and perhaps extremely dilutive to current shareholders.


Yet, another conversation that management does not want to have with its shareholders!


Like Greece, Cosi needs capital fast.  The $8mm of cash on the balance sheet looks like a net positive but the company needs a significant level of reinvestment; the asset base has been starved of capital for the last three years.


COSI IS LIKE GREECE - cosi capex



If I were to the strip out the $0.16 of cash on the balance sheet, the stock price is currently valuing the company at $30.2 million.  Given that the company has no assets on the balance sheet, has not made money in years and is on schedule to lose money again in 2011, the $30.0 million would appear to represent a fair value for the goodwill in the COSI brand name. 


The company’s contention that Blum is making a low-ball offer for the company may not be entirely accurate when considering the scenario described above.  


There is no guarantee that Mr. Blum will be successful but he has a better shot than most, in my view.


One really has to wonder what the discussions are like in the COSI boardroom today.  While not an ideal scenario for management and the Board, Mr. Blum has offered multi-pronged solution to fix the company.  Any objective outside observer of this situation is surely wondering if management and the board is putting their interests ahead of employees, franchisees and shareholders.



Howard Penney

Managing Director




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