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Great combinations don’t happen often. Reese’s Peanut Butter Cups were created in 1928. Also in the 1920s, a Milford, Connecticut restaurant brought lobster to the masses by sticking the meat in a hot dog roll and presto, the lobster roll was born. Nobody knows exactly when, but at some point a Frenchman decided to pair up Bordeaux and Ribeye. So good. I’ve got to stop writing these posts on an empty stomach. Maybe I’ll go grocery shopping instead.

I’m not quite ready to put a PENN/PNK combination up there with those classics, but boy if there was ever a time for PENN to ignite its dry powder, now would be it. I’m thinking bear hug, a la PENN/AGY, not that long ago. PNK management may not want to sell at $10 but who cares what they think. Those guys own an immaterial amount of stock. You live by an option based executive compensation structure, you die by one.

So why is this a good combination?

• Very accretive to free cash flow – even assuming a $10 per share bid (75% premium), the deal could be accretive to PENN Free Cash Flow by 20-30% in 2010. PENN is underleveraged, maintains significant borrowing power on the credit facility, and should preserve a cost of capital significantly below the rest of the industry and certainly lower than PNK.
• Calculated accretion does NOT include likely cost savings and debt refinancing.
• Better management – PENN are better operators, pure and simple. Look for higher EBITDA margins under PENN ownership
• Better stewards of capital – no gaming company has created a larger % increase in shareholder value over the last 5 (except Wynn), 10, and 15 years than PENN and Peter Carlino.
• Asset sales – PNK won’t sell its boardwalk land. PENN would. Boardwalk property values are going lower. Bader field and the Marina district is where the value is. Look for a quick sale even with the tax bite. AC costs PNK $1m a month and the equity markets give ascribe no value to the development opportunity nor the land value itself. Sell it.
• Development opportunities – Investors are also not ascribing any value to PNK’s potential growth projects in Lake Charles and Baton Rouge. Nor should they. PNK’s management is not as ROI focused as PENN. PENN’s management would downscale the cost of these projects and drive a much better ROI. The option value is much higher under PENN’s stewardship.
• Bigger is better – Not always, but in this case bigger is better. Significant purchasing leverage could be generated along with cross marketing benefits, particularly if PENN were also able to secure a Las Vegas property (MGM?).
• Diversify market exposure – PENN is underexposed to the stronger regional markets servicing the east Texas population.
• Big step up in Baton Rouge – Baton Rouge is a growing and attractive market but PENN’s product is weak. A PNK acquisition gives them the opportunity to develop the right product for the market and jettison its existing assets.

At $10 per share, the acquisition price would be about $1.6bn, including 2009 capex and the assumption of debt. Following the receipt of the remaining $775 million from Fortress two weeks ago, PENN maintains about $1bn in cash and is net leveraged only 2.75x. A cash buyout of PNK would raise leverage to just under 4.0x, still well below industry average, and barely putting a dent in PENN’s liquidity situation.

Investors, don’t miss this one. I’m pretty sure PENN won’t.

Financial metrics of a PNK acquisition are compelling

Remembrance Day

“Rules are not necessarily sacred, principles are”
-Franklin D. Roosevelt

Roosevelt was a lot of things to many people. To some, he was simply a regulator … to others a calmness. His “fireside chats” are often looked back on by historians not for their economic resolve, but for their tone. He had a wonderful temperament. He was a man of principle.

These, of course, are not the kinds of leadership qualities that you have been waking up to in the early mornings of 2008. I spend most of my reading time these days studying Hoover and Roosevelt, their economic policies, and the respective successes and failures associated with their decisions. There is always much to glean from history, and as Santayana said best, those who have not learned her lessons “are doomed to repeat them.”

While I have been a resident bear for some time now, I am not in the “Great Depression” camp… certainly not here and now. I continue to hold the line that 2008-2009 will be much more like the mid 1970’s than any other period – but let me be clear, no economic point in this country’s history is a carbon copy of another. Today’s unique differentiation lies in the interconnectedness of global market factors. This is not 1974. This is 2008. This is a world where global information and asset classes trade hands real time. This complex system of markets waits for no one. It is always on.

Today is Veteran’s Day in the US. Today is Remembrance Day in my homeland. Today is Independence Day in Poland. Today is a day to reflect and be thankful for the men and women of principle who have served their countries.

Michael Bloomberg is an American capitalist who is now serving his country. He built an iconoclastic American company that continues to provide the world with the faster and cheaper investment tools that quickly delineate fact from fiction. Bloomberg left Wall Street after the 1970’s meltdown and started his business with what he knew best – his principles.

Those who don’t respect duration in investment modeling probably dismiss what they usually do when endowed with an investment tool like Bloomberg – context. Bloomberg’s business didn’t even exist until 1981… and now, 27 years later, we have the weaponry at our fingertips that allows us to traverse the global plains of market data as fast as you can click and read.

This morning, a top 3 Bloomberg story headline is “Bonuses for bailed-out Wall Street Should Go To Zero” – this is sad. When America came out of the “Roaring 20’s”, President Hoover was in a compromised position of over-seeing a society that had lost its moral compass. The “Trend” was first and foremost for financial wealth. The “Trade”-off was the Great Depression. Today we don’t have that – but we do have much to fix.

Whether or not the folks at “Investment Banking Inc” pay themselves the bonus pool they have allegedly allocated to themselves or not this year is very much looking at the tree. The forest is being ‘You Tubed’ by Americans in their investment savings and portfolios. Every day that they are misled, America votes and sells these stocks lower. Chris Cox and his cronies can’t stop gravity. These over-geared financial firms have disintermediated themselves via short term compensation compromises. Now the process is in motion to replace them.

The US stock market is paying less and less attention to these horse and buggy whip “Investment Banks”, and starting to look beyond them. Goldman and Morgan Stanley can lose 5-10% of their value, daily, and people in this country are no longer surprised. Americans are a people of progress and change. They are done with the conflicts, the compromises, and the constraints of a financial system that lost its way. Old rules and said leaders of American financial institutions “are not necessarily sacred… principles are”… and if it wasn’t for that, I wouldn’t have my feet on the floor early every morning, charging our business forward.

Bottoms in markets are processes, not points. The change needed in this country will take time. That’s what investing has always been about. Take your time this morning. Read and reflect. This is not my gospel. These are the principles that great American Capitalism has always been built upon. God bless America’s families today, especially those who have lost loved ones serving our countries’ principles.

Keith R. McCullough

Long ETFs

JO – iPath Coffee –Vietnam and the Central African Republic have officially established diplomatic ties with a statement signed on Nov. 10th in Hanoi. Coffee is among the agricultural staples that is encompassed in the plan for economic cooperation.

EWL –iShares Switzerland- Julius Baer fell over 6% to a decline of 56% YTD. The largest remaining independent private Swiss bank announced a decrease in AUM due to outflows as well as investment decline.

EWA –iShares Australia- Australian business confidence reached a record low of -29 in October, down 21 points since September to the lowest recorded level.

EWG – iShares Germany – The ZEW survey of German investor confidence rose to -53.5 in November from -63 in October, an unexpectedly bullish move.

FXI – iShares China – Customs data shows exports increased 19.2% y-o-y in October, down from 21.5% in September. Imports rose just 15.6%, the lowest level since June 2007 bringing the trade surplus for the month to $35.2 billion. Industry group leaders expect tax rebates on copper and aluminum exports to be re-introduced in the near term,

VYM – Vanguard High Dividend Yield ETF – Revised AIG bailout terms spurred the Markit CDX North America Investment Grade index to decline slightly by 1 basis point to 186.5 in anticipation that carmakers may also receive capital injections.

Short ETFs

UUP – U.S. Dollar Index – The dollar rose against Latin American currencies as yields for the region declined.

EWW – iShares Mexico - Consorcio Ara SAB received authorization from regulators to proceed with its 26,000 home Citara project despite financing concerns.

EWJ – iShares Japan - The Economy Watchers index, a survey of sentiment among small business owners dropped to 22.6 for October, the lowest level since the survey began in 2001.

EWU – iShares United Kingdom – Leaders from the three primary political parties called for tax cuts to soften the recessionary blow. The pound reached 82.15 pence per EUR, an all-time low.

IFN – The India Fund – -- Stocks of state controlled refiners rose on news of a 4.6 billion infusion of government bonds to compensate them for losses created by subsidies. The Rupee fell 0.5% percent to 48.12 for the largest single day decrease in a month.

Keith R. McCullough
CEO & Chief Investment Officer

RRGB – Clarifying Conference call rhetoric

The impact of advertising;

Optimistic outlook from the conference call - “While the last of our 24 weeks of national advertising ends this--next week, we are very pleased with how guests have responded to our cable advertising this year. The economy may be tough right now, but the guests are telling us more than ever how much they love Red Robin, so we believe that our brand building efforts overall are working.”

In the 10Q things are less clear – “While we believe our brand health and sales are being positively impacted by this media, it is increasingly difficult to judge the effectiveness of advertising in an environment where consumers are pulling back on retail and restaurant spending.”

Looking at Cost of Sales;

On the conference call the company said “Our cost of sales increased by 80 basis points in the third quarter compared to last year. The increase was primarily due to higher raw materials costs in almost every category, somewhat offset by menu price increases, favorable produce and beverage costs, and some mix shift to higher margin menu items.”

In the 10Q the explanation for the increase in COGS was a little different; “cost of sales increased as a percentage of restaurant revenues over prior year due to higher raw material costs in almost every category and a slight shift in the mix of food versus beverage sales, with a decline in the sales of higher priced menu items and beverages, partially offset by menu price increases.”

I see things a little differently; RRGB reported that in 3Q08 same-store sales decreased 2.2% with traffic declining over 6%. Relative to the comment s in the 10Q, the same-store sales decline was also driven by people trading down to lower priced items. On the conference call, management indicated that consumers had shifted to higher margin menu items. For reference, the highest margin items on the menu are in the specialty beverage section so I find these two comments to be somewhat contradictory. How are consumer purchases shifting toward higher margin items, but also shifting away from higher priced menu items, including the high margin beverages?

Increasing rents;

Lastly, the 10Q mentioned that “many of the restaurants acquired from franchisees are ‘build to suit’ locations that typically bear a higher occupancy cost as a percentage of restaurant revenue.” As you can see from the chart, higher rents are going to be an issue for the company in a declining sales environment!

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SP500 Levels Into the Close...

This market is hardly for the faint of heart. As we head lower, I'll be positioning to proactively prepare for the SP500 to make a lower high than that of October 27th (848). See chart and levels below:

BUY “Trade” = 888
BUY “Trade” breakout line (dotted green) = 951
SELL “Trade” line = 1007


Hats off to Kovner and Paulson!

John Paulson, that is...

According to the Bloomberg hedge fund performance article this morning, both Paulson's Advantage Plus Fund and Bruce Kovner's Caxton Global Fund are having fantastic years.

When we talk about "hedgies", we are not referring to the PM's out there who know how to manage risk. Paulson and Kovner are amongst those who are profiting from the "hedgies" groupthink.

Well done gentlemen, well done!

Deflating the Chinese Inflation Chart...

Today's Chinese producer price inflation report was somewhat lost in the shuffle of the media's daily dance on the data point coals... but it shouldn't have been. On the margin, this was a material release.

China's PPI came in at +6.6% y/y (see chart). This is down materially from the +9.1% reported in September, and what now looks like it was a 12 year peak in August at +10.1% year over year.

If you are going to invest in equities, we suggest you do so globally. Combined with the $586B stimulus plan that the Chinese instituted this morning, decelerating inflation is a positive macro factor. This puts owning the Chinese etf (FXI) at the top of our global macro country investment list.

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