Stupid Easy

“It’s not supposed to be easy. Anyone who finds it easy is stupid.”

-Charlie Munger


That’s one of the quotes Howard Marks uses to introduce his thought about what he calls “Second-Level Thinking” in his book that I just finished reviewing – “The Most Important Thing.”


People on Old Wall Street really don’t like being called stupid. They don’t like being called monkeys either. Both on the ice and in this Globally Interconnected Arena of risk management, I’ve been called plenty of names. It’s what gets me up in the morning.


Name calling isn’t nice. Neither is lying to people or blowing up their money. In some conflicted and compromised research report, this game looks gentlemanly. On the front lines though, this game is far from polite. It isn’t easy either.


Managing risk isn’t about getting a guy to call you with a whisper about this morning’s unemployment report. Neither is it about assuming we all know what we don’t know. It’s about embracing uncertainty, then considering scenario analyses, probabilities, and ranges. You don’t have to be a contrarian all of the time – but, some of the time, you need to play this game to win.


“Of course, it’s not that easy and clear cut … if your behavior is conventional, you are likely to get conventional results… Only if your behavior is unconventional is your performance likely to be unconventional.” (Howard Marks, The Most Important Thing)


Back to the Global Macro Grind


This morning’s setup across Global Macro is much more concerning to me than the one we were staring down the barrel of on Tuesday morning. Given that most of Asia and Europe was crashing and the S&P futures were trading at 1078 in the pre-market, that probably sounds like an unconventional thing to say.


Unconventional is as unconventional does. Covering shorts and buying that opportunity was too.


Today, after 3 consecutive days of The Pain Trade (short covering), all of Asia, Europe, and the US have rallied between +5-10% “off the lows.” The S&P futures are +5.9% from the YTD closing low (Monday, October 3rd 2011 = 1099), and if I had a Canadian Loonie for every email and tweet I’ve had that this US unemployment report is going to be “better than expected”, I’d pay myself for once.


I know. It’s unconventional for generals in this industry to eat last. It’s unconventional to be yourself instead of who you are supposed to be. It’s also been unconventional to have said Growth Slowing would be the 2011 call that needed to be made. If my behavior has sounded too “confident” or whatever it is that mediocrity calls success in this country these days, so be it.


Looking across my Global Macro factors this morning, here’s why I say start selling again today:

  1. Japan’s Nikkei’s 3-day rally failed at TRADE line resistance of 8777 and remains in crash mode
  2. Hong Kong’s rally failed at TRADE line resistance of 18,918 (Hang Sang) and remains in crash mode
  3. South Korea’s squeeze failed at TRADE line resistance of 1797 and remains in crash mode
  4. British banks are breaking down again and the FTSE remains in a Bearish Formation (bearish TRADE, TREND, TAIL)
  5. Belgium and Switzerland have taken over Europe’s negative divergences for this morning (big bank exposures for both)
  6. Russia’s Trading System Index rallied to another lower-high and is down -39% since April when US stocks peaked
  7. Oil prices remain in a Bearish Formation despite another bounce to lower-highs
  8. Copper prices remains in Bearish Formation despite a big short squeeze from a very newsy September oversold low
  9. Gold is now bearish TRADE and TREND for the 1sttime in forever with TREND line resistance up at $1673
  10. SP500’s TRADE, TREND, and TAIL lines of resistance (Bearish Formation) = 1182, 1237, and 1266, respectively

So that’s just the Top 10 unconventional calls you could have been making for the last 3-6 months. If you back this up to when we bought the Growth Slowing Trade (Long the US Treasury Flattener (FLAT) in February) you’ll see a lot of Global Equity prices put in their 2-year cycle peaks in February of 2011, not April.


And while its conventional to call out the SP500 as having “staved off a bear market” this week (because it didn’t violate the -20% crash signal; it was down -19.4% on Monday’s close), its unconventional to remind the bulls that Financials (XLF), Industrials (XLI) and Small Caps (Russell2000), have all crashed already in 2011 anyway.


Can the market rally on hope? For sure. It just did. But what do you do right now? If this unemployment number is better or worse than expected, my Stupid Easy hockey head answer will remain the unconventional one for 2011 – sell.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $75.92-85.11, and 1101-1172, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Stupid Easy - bearish formation


Stupid Easy - virt. port


BYI was probably the standout – at least relative to expectations.  Not much to cheer about yet but slot sales should pick up next year.



General Takeaways 

  • The pricing environment was going to be more sensitive this year so even if manufacturers raise prices they are going to give away more discounts/ promotions in the form of aggressive rebates.  We heard that IGT was running a 3 day promotion where if you turned in an old IGT machine, they would give you a $7k credit towards an MLD.  Konami and ALL aren’t raising prices this year.  Konami is running a trade-in promotion where you get $2,500 either by turning in the machine or just removing old machines from the NA market.
  • Everyone has wheels and the participation market is going to remain hyper competitive; this is not good for IGT despite their good content. On the bright side, IGT is becoming much more efficient in repurposing existing participation real estate.
  • Everyone is focused on iGaming down the road and the 500 pound gorilla issue of how to attract a younger player to the slot floor.  Almost everyone had some sort of “skill” based element built into their bonus rounds on the progressive games.
  • Video Poker is gearing up for a replacement cycle and WMS intends to compete.  Either way, a replacement cycle will be good for IGT – over 100k of their Video Poker games are on the 8960 platform which is over 9 years old.
  • 3 Reel Spinners are also coming up for a replacement cycle so there is more attention on the R&D front there from several manufacturers- BYI, IGT and Konami
  • WMS isn’t broken per say but will take a few quarters to get back on the right path
  • Greece will be a good opportunity for the US manufacturers but not in Phase 1 since OPAP is highly likely to pick Novamatica and LTO as their 2 suppliers for the first 16k games
  • A few small guys continue to make traction – ARUZE and AC Coin
  • A pick up in the replacement cycle of any material magnitude remains illusive although that’s offset by the likelihood of good news coming out of new jurisdictions like IL and MA by year end



We walked away from the conference feeling a little better about WMS.  That said, they have a tough 2 quarters ahead of them and may miss expectations.  


What went wrong?

  • WMS got carried away with putting 'too many apps' in the box without considering the tough environment.  They looked too far out and not at what clients want now.
  • WMS developed games without consideration for regulatory approval and therefore, shot themselves in the foot since they had already built investor expectations on meeting certain release dates.  By getting stuck in the regulatory cogs, they had no product to refresh aging and waning game ops titles.
  • As they got larger, they experienced growing pains in logistics by taking their eyes off what they do best–game R&D
  • In the meantime, the economy got worse, customers got more price sensitive, competition got more fierce and WMS had no new product.
  • Delays delays delays:  IL VLTs, Italy, Portal Apps, Game Ops approvals


However, WMS has simplified their products and is much more focused on delivering gaming ops content over the next twelve months. Also, WMS has a new cabinet in the works that looks like a pinball machine with just a flat screen.




Leveraging their platforms with lots of new content has saved them a lot of money on R&D.  The cost to refurbish some of the game ops boxes dropped a few hundred from $4,500.  IGT is basically just sticking with what they do well – developing good product and taking advantage of developing content for an aging install base of 3 Reels spinners and Video Poker.


Their message was "expect more" – offering a lot of core for sale product with lots of new titles.  New G23 cabinets with the new MLD that has sharper graphics (photo realistic images) has been out since Feb 2011. They have 55 titles, many of which clone math models which already work well on their top games.  Other ones have new game and play mechanics.  85% of their content is available on MLD formats.


IGT has been refocusing on 2 markets that haven't had new content in a while – 3 Reels and Poker. They have an install base of 130,000 video poker games, 100k of which are on the old 8960 platform.  IGT is also introducing a premium for-sale product where they sell the base game and then charge $10/day for each device linked to the bank.  This looks like a response to WMS's portal applications.




BYI has been making good use of their iDeck to introduce new skill like components to bonus rounds.  By leveraging their systems with more software products, it looks like they may finally get some traction with iVIEW DM which would be great for growing their recurring revenues.  BYI is also the leader in TableView technology.  They are addressing the issue of investors being concerned that they are too dependent on reels with more video product and the Pro-Curve product.



Aristocrat is focusing on delivering a lot more content to the Verve content on the Game Ops side.  They have a new reel product called Hybrid Steppers, which has transmissive like functionality during bonus rounds.  ALL's pricing on for sale products is likely to be static aside from paying more for some new features like the LED buttons.



Konami is putting more focus on video and not raising prices.  They expect to see an increase in sales YoY again this quarter but sees no general pick up in replacements.

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Simple: SP500 Levels, Refreshed

POSITION: Long Utilities (XLU)


Einstein said that “everything should be made as simple as possible, but not simpler.”


Put simply, this is called a Short Squeeze from an immediate-term TRADE oversold low. You either recognized the Short Covering Opportunity when you should have or you didn’t. No matter where you go right here and now, this short squeeze isn’t over, yet…


Where could it end and what could end it? As a Chaos theorists, I’ll have to go with time and space.


In my model, space is usually simpler (but not simple) to solve for. How fast we travel across a price range is often determined by explicit or implicit markets catalysts. In terms of space to the most relevant line of immediate-term TRADE resistance, the SP500 is 13 points (or +1.1% away) from a very consequential TRADE line of resistance up at 1171.


In terms of time, the next big catalyst is the September US Employment report (830AM EST tomorrow morning). While I think the Sell-Side’s expectation for the payroll number is too high (+50,000 adds), I’m not going to have to make a call on that. Mr. Macro Market personally does not care about what I think.


So, I’m going to let the market tell me what to do. If it tests 1171 and fails: A) there’s plenty of space that opens up on the downside to 1099-1101 support and B) the reflexive nature of our minds will undoubtedly call that employment print out as to why.


Simple is as simple does.



Keith R. McCullough
Chief Executive Officer


Simple: SP500 Levels, Refreshed - SPX


Positive conference call, particularly the commentary of RevPAR relative to GDP. Confirms our belief that hotels are in better shape than consumer sectors in this environment.



"After reaching targeted debt levels in mid 2010, we have been investing in growth while also returning substantial cash to our shareholders.  In the last 12 months, we have opened 33,000 new rooms while returning $1.4 billion to our shareholders through share repurchases and dividends.  Third quarter share repurchases alone totaled $550 million. The spin-off of our timeshare business is on track and we expect to conclude the transaction in the 2011 fourth quarter. We are cautiously optimistic about 2012 and are well-positioned for continued growth.  We expect to add approximately 30,000 rooms in 2012, most of which are already under construction and included in our 105,000 room development pipeline.  While there is considerable economic uncertainty, assuming worldwide systemwide REVPAR growth of 3 to 7%, our earnings per share could total $1.48 to $1.68 per share and return on invested capital could increase substantially."


-J.W. Marriott, Jr. MAR chairman and CEO




  • WW REVPAR comparable systemwide properties increased 6.9% (+8.7% in actual dollars).  Ex ME and Japan markets, WW comparable systemwide REVPAR rose 7.4% (+9.0% increase in actual dollars).
  • International comparable systemwide REVPAR rose 6.9% (+15.8% increase in actual dollars), including a 4.9increase in average daily rate (+13.6% in actual dollars). Ex ME and Japan, international comparable systemwide constant dollar REVPAR increased 9.2% (+18.7% increase in actual dollars).
  • NA comparable systemwide REVPAR increased 6.9%
  • Adjusted EBITDA: $240MM; Adjusted EPS: $0.29
    • Adjusted results exclude $352 million pretax ($251 million after-tax and $0.73 per diluted share) of non-cash other charges.  Other charges include $324 million pretax of impairment charges, which Marriott previously disclosed, related to the timeshare segment.  Other charges also include an $18 million pretax impairment charge on an investment in equity securities due to a recent decline in the market price of these securities and a $10 million pretax write-off of both deferred contract acquisition costs and an accounts receivable balance related to one property whose owner filed for bankruptcy.  Adjusted results also exclude $32 million ($0.09 per diluted share) of tax expense recorded in conjunction with the write-off of international deferred tax assets related to the timeshare segment that Marriott determined were impaired, which the company also previously disclosed.
  • Marriott added 38 new properties (5,969 rooms), including the Ritz-Carlton Oman, the Boscolo Palace Roma, Autograph Collection, in Rome and the Courtyard Pune City Centre in India.  Five properties (1,234 rooms) exited the system. At quarter-end, the company's lodging group encompassed nearly 3,700 properties and timeshare resorts for a total of more than 638,000 rooms.
  • The company's worldwide pipeline: 650 properties with over 105,000 rooms at quarter-end.
  • NA profit margins increased 130 bps, primarily reflecting higher occupancy and rate increases.  House profit margins for comparable company-operated properties outside NA increased 40 bps, challenged by lower REVPAR in the Middle East and Japan.
  • Owned, leased, corporate housing and other revenue, net of direct expenses, increased from $7MM in the 2010 third quarter to $35MM, largely reflecting $13MM of higher credit card and residential branding fees, $8MM of higher termination fees and improved operating results at leased hotels.
  • Timeshare segment contract sales: $179MM; 43% of timeshare contract sales came from new customers compared to 37% in the year ago quarter.  Average contract price improved 45% YoY while volume per guest increased 10% in the third quarter.
  • Adjusted G&A: $170MM
    • Adjusted general, administrative and other expenses also increased due to higher costs associated with growth in international markets and incentive compensation increases.  The increase in adjusted expenses was partially offset by $6 million of lower legal expenses.  The quarter-over-quarter variance also reflected the unfavorable impact of the$4 million reversal in the 2010 third quarter of an accrual related to a tax settlement on a European asset.
  • Interest expense: $39MM
  • Debt: $3.103 BN, including $830MM of debt associated with securitized Timeshare mortgage notes, and cash balances totaled $220MM
  • Diluted Shares: 356.8MM 
  • Share repurchase: 18MM shares for $550MM
    •  Remaining share repurchase: 12.4MM shares.
  • Guidance:

MAR 3Q2011 CONF CALL NOTES - guidance

  • 2011 Capex: $500-600MM ($50-100MM maintenance)



  • Reportability issues impacted timeshare segment results by a penny but FX and better RevPAR more than offset that
  • Transient demand was very healthy
  • NA systemwide RevPAR was down 2% in DC this quarter. Better group bookings in an increase in ADRs should help DC in the 4Q
  • Courtyard will be fully renovated by YE 2013
  • Ritz had a great quarter - WW luxury incentive fees almost doubled in the quarter. Their pipeline is 6,000 rooms - largely international
  • Marriott brand group business and catering revenues were up 2%. Impacted by DC and slow return of association business.
    • Group bookings are running up 7% YoY
    • Group bookings made in the quarter are up 30% YoY
  • Group Business booked in the in first 3Q represented 900,000 rooms or 7% of all business booked in regions outside of their own regions. Other sales metrics also show improvement due to their new system.
  • Signed a distribution agreement with -allowing them to pay commissions to after the guest stay
  • Renegotiating their Expedia contract which is scheduled for renewal at end of year
  • Japan is recovering faster than expected
  • Incentive fees were strong in Barcelona, Amsterdam and HK
  • Stronger sales at a JV project helped contracted timeshare sales, however, there were Hurricane Irene costs, ADA compliance costs and lower reportability negatively impacting their numbers
  • G&A would have been $162MM excluding the cost of the spin off
  • Their international RevPAR growth will slow in the 4Q due to tough comps and comparability issues. RevPAR in London will remain strong but provinces are expected to be weaker.
  • Little evidence of slowdown in NA.  Group attendance is running a bit higher than expectations. Cancellations and attrition are at normal levels.
  • Lower segment timeshare guidance is due to timing of more banking options on the new points based program, lower interest income on a smaller mortgage book and more deferred revenue
  • Total cash transaction costs for the spin off: $40-50MM, already expensed $13MM of the costs. Not all the costs will be expensed in 2011 as some will be capitalized.  Spin off will occur prior to YE. S&P has rated MVW at BB-. The new warehouse facility has closed and funded.  There will be an Investor Day in late October. DB will lead a roadshow in November with expected spin off occurring in late November.
  • $325-350MM in cash tax benefits through 2015: $70-80MM cash tax benefits in 2011 and $120-130MM cash tax benefits in 2012.  Already realized $55MM of tax benefits YTD.
  • MAR should receive a $150MM cash distribution in the 4Q prior to the completion of the spin off
  • Timeshare net of the transaction costs will contribute $0.10-$0.11 to 2011 earnings. Once the spin off is complete, they will provide pro-forma financials.
  • Expect to slow their share repurchase pace in the 4Q
  • Outlook for 2012
    • Not seeing any weakening of their business but seeing the same headlines as the rest of us.
    • 3% RevPAR growth assumes 1% GDP growth and is likely too conservative while 7% assumes 3% GDP growth which is likely too aggressive
    • Even with no GDP growht they still expect some modest RevPAR growth in NA. Supply is only expected to grow .5% in 2012.  They think it's highly unlikely to see RevPAR decline.  There has never been a single month of RevPAR decline when supply growth is less than 1% since the 1980's.
  • Their pipeline is growing and it's largely international.
  • MAR's openings have represented 25% all new NA opening [this past quarter]
  • Autograph RevPAR rose 12%.  Expect to have 60-70 properties opened/signed by 2012.
  • Return to peak 2007 RevPAR is on the horizon and more importantly, a return to fee revenue is on the horizon. 
  • Expect to open 5,000 in the 4Q11 and 30,000 in 2011 and 2012
  • Expect to grow their system wide rooms with minimal capex
  • Expect another $500-$1BN for stock buyback or opportunistic investment. Expect some buyback activity for 2012 even under the 3% RevPAR growth scenario
  • Prior peak earnings - ex timeshare in 2007 would have been $1.51 - so they should exceed peak EPS in 2012 even if they see a weak RevPAR environment (ex timeshare spin costs)
  • Group revenue on the books is up 7% for 2012 and government per diem rates is up 4%


  • Group bookings color for 2012:
    • Group revenue on the books is up 7% for 2012.  August group bookings made for 2012 were up 14% despite market turmoil.  Even after August, group bookings in the works, aka "funnel", were up 17% YoY
    • Feel really good about their group bookings going forward - partly due to their sales transformation. 
  • Sales Force One
    • $100-150MM of business in 2011 from bookings pitched to one city made to another
    • Feel like they are continuing to make progress with Sales Force One
  • Expect that Sales Transformation will help them take further market share as it continues to develop and improve
  • In a growing economic environment, Transient will outpace Group
  • UK Provinces is the one meaningful region for them where they are feeling the impact of austerity measures. Only have one hotel in Greece so can't really comment.  Rest of Europe is still strong for them.  Their guidance for 2012 assumes more modest RevPAR in Europe than rest of world given a difficult comp schedule and the economies there
  • 90% of their rooms in the pipeline in China are under construction. They often sign hotel contracts for hotels already under construction in China.  Despite difficult Shanghai Expo comps, RevPAR in China is still very strong and showing no signs of slowdown.
  • 2012: Excess FCF of $500MM-$1BN. Assumes that investment activity in 2012 will be up YoY; likely moderately higher than 2011's $500-600MM. May acquire some hotels for repositioning but there is nothing in the works on that front today.
  • Does their guidance include some leverage increase?
    • They will maintain 3x leverage but with growing EBITDA, that gives them capacity for more debt. 
    • So yes, it includes more debt commensurate with maintaining 3x leverage
  • 2012 will also benefit from the share activity already done, which isn't really reflected in 2011.  So 2012 guidance really doesn't include a big benefit from buybacks. Any buybacks they do include assume a much higher stock price
  • International house profit margins would have been up 70bps excluding ME
  • Total fee performance for 2012 should be a little higher than 2007 levels but comprised of higher quality fees (i.e.less incentive fees) and the base and franchise fees will be more diversified across international geographies. 
  • Think that corporate rates will be up in 2012. September occupancies domestically were exactly in-line with 2007 levels. Record demand occupancy is one of the positive attributes to the upcoming negotiations.
  • Incentive fees from the select services brands are computed largely on a pooled basis vs. on an individual hotel basis. So it will take a little while longer for those to come back.  Refreshes should help RevPAR and incentive fees get back to being in the money.  Some of their largest Courtyard portfolios (50-100 hotels) aren't paying fees in 2011 and they don't assume that they will pay fees in 2012.
  • Their current valuation strikes them as highly compelling today. However, if they believed that there was a large risk of a meaningful RevPAR decline that would change their view on buybacks, but they just have good comfort that they are still in the early innings of what should be a long recovery. Therefore they think it's a good time to use the capacity they have to buy back stock.
  • They will increase the buyback authorization when they need to. 
  • Possibility of corporate rates being flat or negative?
    • Thinks it's unlikely given the occupancy rates today
  • Commission rate with Expedia?
    • Will not disclose. The contract expires at the end of this year. 3% of their total business comes from OTA's including Expedia. Expedia is about 1% of their system.  So negotiations will not have a significant impact on their business next year.
  • Corporate negotiated rate increase vary market by market for each large group
  • In September, they are not seeing any slowdown in their business and feedback from meeting planners is still that they will spend more in 2012 than 2011

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