KSWS: What Happened to Capitalism?

When I saw that KSWS announced a special $2/share dividend it made me scratch my head. Near-term payout trumped capitalism in a big way here.

During last week’s earning call, management stated that “the brand has slowed down and it needed to be ignited” – I agree. Utilize the balance sheet with $290 million in cash and drive growth by investing in new product initiatives -- or better yet put on the capitalist hat and go out and acquire one of the many troubled assets out there on the cheap. Instead, the Board paid out 24% of its cash in a special dividend. And the winner is… CEO, Steven Nichols.

As of June 30, the Nichols Family Trust owned 7.4 million shares or ~ 20% of the total shares outstanding making them the largest shareholder of KSWS stock (see table). As such, Steven Nichols would pocket ~$15 million. Nichols also owns substantially all of the class B shares (93%), which are super voting and account for ~70% of the total. How’s that for raising personal capital without sacrificing control of the company?

I don’t want to come across as too harsh here, because a rally in KSWS today will make some stockholders very happy. I like when stockholders are happy. But I like it more when management teams put the 5-year plan ahead of the 5-week plan.

Casey Flavin

Don't Stress

“Sharp downward movements do that… they focus the mind… like a good hanging used to in the old West.”
-Judge Roy Bean

After a sharp three day -8.5% hanging of the S&P500, those who have been staring at the trees for the last 12 months have their eyes wide open now, don’t they? They wake up in the mornings surprised that a company that makes ¾ of the world’s computer chips is seeing demand slowing (Intel). They are running around talking about Great Depressions. They are coming to the stupendous revelation that my calling Hank “The Market Tank” Paulson onto the accountability carpet had merit.

Today is just another day in my life. Feet on the floor at the same time; banging through the macro factors in my trusty investment notebook; and now dealing with the same disbelief that I had to fend off at this time in 2007 that the market could actually go down a lot, by suggesting it has upside! If you don’t take the time to laugh at yourself in this business, you may as well just lock your door, tell yourself how smart you are, and cry.

An American alternative to isolating yourself is to just go to the bar. Roy Bean was a good ole Western saloon keeper who was born in 1825 in Mason County Kentucky. He was also “Justice Of The Peace”, and we may have to revive the old legend’s court alongside the Rio Grande to deal with the pending crisis of fear on Wall Street. You see, a lot of people can only justify 2 and 20 when they can lever up in bull market tapes… when the piano players music stops, the finger pointing starts, and the guns of narrative fallacy emerge.

According to FBI figures, in the week of November 3-9 (Obama’s election week), the Bureau received 374,000 requests for background check on new American gun owner purchases. A 49% year over year increase is a lot of firepower! Roy, this fear stuff is getting serious… in the last 3 days of the Street’s typical “he said, she said” ramblings across the crackberry network, I’ve “heard” of some snarly looking “hedgies” who are locked and loaded.

It’s time for real investors to stop the panting and get real here. If you are liquid long cash, this is turning into your second chance in two weeks to buy yourself some of the Street’s wares on sale. Why is it that Wall Street’s manly capitalist savants like to buy everything else in life on sale other than stocks anyway? Maybe it’s because they fear their wives shopping disruptions more than fear itself? Maybe it’s just because they fear their investment process – shouldn’t they?

Not all “hedgies” are crackberry addicts – some of them are doing a fantastic job managing risk and making money for their clients in 2008 - John Paulson, Bruce Kovner, Peter Thiel, and Phil Falcone are some of the new leadership names to add to your notebooks. Today, the Hedge Fund industry’s elite will be testifying in Washington. Undoubtedly, on their breaks, they might just call into their respective trading desks and buy/cover a stock or two down here.

Not one of the 9 bullish macro factors that I highlighted in yesterday’s strategy note has changed materially enough in the last 24 hours for me to change. In fact, some of them have improved on a day over day basis. The yield curve has steepened further, and LIBOR rates are lower (2.13% 3 month rate). Commodity driven inflation dropped another -2.4% yesterday with the CRB Commodities Index hitting fresh lows and Oil testing $56/barrel. There were many days in 2008 where CNBC’s finest would trumpet $3/barrel drops in oil as “stimulus for consumer spending”… today, with oil -60% lower, and oil dropping $3, I hear nothing but crickets. Can someone send them entertainers a calculator and a Research Edge math challenge? (Question #1: Is $3 /$130 a larger % change than $3/$56?)

I know, I know… Keith, ‘you’ve been buying stocks this week and you’re buying them lower today – shame on you… don’t make fun of us… you suck too’… I have to admit, with all of the people out there proclaiming their mystery of investment faith that “at some point fundamentals will matter” and/or “I’m a long term investor”, buying in a 12 day window for the first time in 12 months is a little reckless… God forbid someone gave me one of them guns!

Although Asia sold off last night (Japan -5.3%, India -3.1%... we’re short both), China slapped the drunks upside the head and said “I’m your Huckleberry”… closing up an impressive +3.7% on the Shanghai Composite Index to 1927. If you have a technician in your saloon, wake him up and send him that chart – it’s breaking out. Was China’s export report worse than expected? Of course it was – ASIA HAS SLOWED – this is not new… and if I didn’t make that call on a weekly basis nine months ago, I would actually feel as bad as Goldman should today trying to tell you it’s time to buy the Japanese Yen (short that call).

More importantly, China’s economy is growing high single digits, and now its inflation rates have dropped to low single digits. Last night they cut taxes on almost 1/3 of their exports. Rather than getting freaked out by the Connecticut Cowboys and their guns this morning, tickle your fancy with this narrative reality: CUTTING TAXES, SPENDING $586B in STIMULUS ahead of a SEASONALLY STRONG Q1… no, this is not Ronald Reagan folks… nor is it Roy Bean… this is China.

I have taken our Hedgeye Portfolio Allocation model down to 45% cash… I have plenty of powder left to be firing up my troops with guns… but I’m more into the “Justice Of the Peace” thing these days – so I’ll pass on the fear mongering, and look forward to those Western blue skies of my trip next week to the office we are building in San Diego, California. Don’t stress, it’s time to invest.

Happy shopping,

Long ETFs

EWL –iShares Switzerland- Zurich Financial (EWL: 4.68%), the largest Swiss insurer, reported a 90% y-o-y Q3 earnings decline on write downs and US hurricane exposure and suspended a share repurchase program.

EWA –iShares Australia- Commonwealth Bank of Australia (EWA: 7.2%) shares lost 6% after the company announced that non performing debts will likely double to 0.52% of total portfolio.

EWG – iShares Germany –GDP numbers released today show the economy contracted by 0.5% q-o-q in Q3, the second successive negative growth quarter and the steepest decline since 1996.

FXI – iShares China – Industrial production for October increased by 8.2% y-o-y, the slowest rate of growth in 7 years.

EWH –iShares Hong Kong –The Hang Seng declined by 5.2% today to reach its lowest level since October 29 as selling pressure mounted for financials.

VYM – Vanguard High Dividend Yield ETF – Borrowers whose credit does not qualify for the Fed Window who still have access to emergency bank lines are choosing to access them instead of floating commercial paper driving CP volume to the lowest level in 2 years. Three month LIBOR rose for the first time in 24 days, increasing by 2 basis points.

Short ETFs

UUP – U.S. Dollar Index – Trade numbers today are expected to show a narrowing deficit.

EWW – iShares Mexico – The lower house of congress approved a Federal Budget that factors a deficit of 1.8% of GDP, the first budget deficit in 4 years if approved by the Senate.

EWJ – iShares Japan BOJ Board Member Seiji Nakamura delivered a grave assessment of long-term Japanese economic conditions at a speech in Matsuyama today.

IFN – The India Fund – The Wholesale Price Index declined to 9% y-o-y for the last week of October marking the most rapid decline in inflation in 18 years.

Keith R. McCullough
CEO & Chief Investment Officer

What A Croc

Classic case of cocky brand mgmt gone bad. But my bear case liquidation analysis blesses current $63mm EV even if the brand is worth zero. Barring major fraud, I think CROX will be bought.
The volatility in this stock over the past two weeks told us that something big was coming down the pike. In that regard CROX did not disappoint. I won’t drone on about sales weakness, downsizing or asset writedowns. Ron Snyder (CEO) summed it up with two of the weakest statements I have heard from a CEO – ever.

1) “After several years of rapid expansion, highlighted by triple digit sales and earnings growth, our business has slowed during 2008.” Gee, thanks for that insight Ron.

2) “Our performance was below expectations and continued to be impacted by the extremely challenging retail environments in the U.S. and Europe during the third quarter.” Are you kidding me??? How a company with the trend characteristics of Crocs has the audacity to mention a ‘weak retail environment’ simply blows me away.

Ok, I got that off my chest. Thanks for listening. The question from here is bigger than the quarter, the restructuring, etc… The reality is that after hours, this stock is trading at $1.13. With 82.8mm shares, and 31 million in net cash, we’re looking at a total enterprise value of $63mm.

The market is saying that the $312mm book value is nowhere close to being real. I’m inclined to agree. But assume the following…

1) All stated liabilities are fairly represented, but that they head 20% higher over 2 quarters as the business continues to erode.
2) All $40mm in intangibles are actually worthless.
3) PP&E is only worth 50% of stated value.
4) Only 75% of accounts receivable are collected.
5) Remaining inventory is liquidated at 50% off.
That all nets out to $50mm, or $0.60 per share in value. This equates about 53% of the market cap – which unfairly assumes that the brand goes away.

Don’t forget that Crocs is a brand. Do I wear them? No. I think they are hideous. But I am not the customer. Even customers that have moved on still remember the name – and the reality is that Crocs has had reasonable success extending into areas beyond the core product, and the name is worth something. At $63mm, we’re getting pretty dang close. Unless there is fraud, this thing will be bought.

PS: I think I just spent too much time analyzing a $100mm market cap company!

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 80.47%
  • SHORT SIGNALS 78.71%

EAT – What is plaguing EAT today?

In October 2008, Moody's and Standard & Poor's placed Brinker's credit ratings under review for possible downgrade prompted by the company’s revised earnings expectations for fiscal 2009. Standard and Poor’s has since left EAT’s credit rating unchanged at BBB- (investment grade) with a stable outlook. Moody’s review, however, is ongoing and is focused on EAT’s ability to improve operating performance and debt protection metrics over the next few years.
As a result, EAT’s availability under its $150 million uncommitted credit facility declined to $50 million. If the current rating is confirmed, the availability under this facility will return to $150 million. However, if EAT’s rating is downgraded by Moody’s, the company’s uncommitted credit facilities totaling $250 million will no longer be available. EAT has said it is committed to maintaining its investment grade credit rating and is taking actions to ensure its current investment grade rating is reaffirmed. The review and subsequent outcome will not have any impact on EAT’s availability under a separate $300 million revolving credit facility.

As of last week, EAT expects to receive net cash proceeds of $125.5 million from the sale of Macaroni Grill in fiscal 2Q09, excluding fees and expenses associated with the closing of the transaction, and will use the proceeds to pay down debt. In addition, EAT is significantly reducing capital expenditures for fiscal 2009, eliminating nearly all growth capital spending in fiscal 2010 and is suspending its share repurchase program.

Time will tell…

SP500 Levels Into the Close...

It looks like we may very well get by here by the hair of our chiny chin chin... provided that the S&P500 does not close below its prior closing low of 848, our macro model will register this as a positive data point, on the margin. Everything that matters in our models happens on the margin.

There is an immediate term “Trade” setup here of down -1% and up +10% (risk/reward) in the SP500. That's as good as I have seen it in well over a year. See levels and chart below:

Buy "Trade" = 850
Sell "Trade" = 937

Buying into capitulatory selling is what capitalists do. What "they" levering up and buying them at this time last year is their problem, not yours. Be patient. Deploy your hard earned cash at a measured pace.

Eye On Oil: Updating Our Research Edge...

Since we sent out our last update detailed update on, Oil a good deal has changed. Most notably, the price of WTI (West Texas Intermediate) is now trading at just over $56 per barrel. I made the following point in our last update on October 18th, 2008:

“On the production side, while I totally buy the long term supply constraint argument, in the short term and this is very simplistic, if OPEC has to cut production to maintain price than scarcity value should not be priced into Oil anymore (I think that was part of the argument that people were making when Oil was on its way to $140 i.e. there is a premium above marginal cost for scarcity), thus Oil should trend towards its marginal cost . . .$60 / $65?”

Since I wrote about the dangers of narrative fallacies this weekend, I’m not going to pretend that I called the decline in oil we’ve seen over the last few weeks, but I did want to highlight the point above because it is very important in understating the context of how Oil has traded.

Oil has traded down despite what are, ostensibly, bullish data points. Specifically, OPEC announced a 1.5MM barrel per day emergency production cut a week after my post on October 24th. Obviously this has done little to support the price of Oil as the commodity is down roughly another 10% since then. What this tells me is that the concept of Peak Oil, at least in the short term, is finally getting priced out of the commodity. And that, on the margin, suggests to me that the Oil bottoming may be beginning. Remember, bottoms are processes, not points.

On the demand side, despite consumer weakness, there is no doubt that the dramatic declines in gasoline prices we have seen in the U.S. and around the world will have, on the margin, a positive impact on demand. At a sub $2.40 per gallon price, gasoline is down by more than $1.70 from its July “Peak Oil” peak. Eventually this will have a positive impact on y-o-y demand comparisons, even if it is a quarter or two away.

The other key point I made above is that the marginal cost of production for Oil, according to many oil economists, is in the $60 per barrel range. Obviously this is a vast simplification and is subject to grades of oil and services costs, but, once again, on the margin this price level is important. At this price, many projects become less economic and at sustained prices below $60 per barrel we will see some mothballing of exploration and development projects. The excerpt below from an article in the Houston Chronicle today highlights these points:

“Oil prices closed below $60 a barrel, a level widely considered to be near the break-even point for multibillion-dollar deep-water projects that have been a key driver of Houston’s energy economy in recent years. If prices go lower still, oil companies could be forced to re-evaluate and possibly postpone deep-water projects, just as they have already done with less-costly land and shallow-water drilling plans, analysts said. At $50, they probably start canceling projects or slowing projects up,” said Eric Smith, associate director of the Tulane Energy Institute in New Orleans.”

We are not ready to call a bottom just yet, but after a ~20% decline since our last update and a 1.5 barrel production cut from OPEC, we are certainly getting interested.

Daryl G. Jones
Managing Director


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