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Do You Believe?

This note was originally published at 8am on October 26, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“All money is a matter of belief.”

-George J.W. Goodman


If he was writing today, George Goodman would have thrived as an “economist” of The People. The competition in the land of Market Practitioner (money manager) turned Author is light. I think he would have crushed Paul Krugman, like a bug.


Best known for his writings under the pseudonym of “Adam Smith” when he first published one of the all-time greats on my bookshelf  “The Money Game” in 1968, Goodman went on to write “Supermoney” in 1972 and “Paper Money” in 1981. The similarities between the times of his writings (US Dollar Debauchery, US Debt Monetization, and Big Keynesianism) and today are glaring.


Let me re-state that – they are glaring to the non-willfully blind who would, of course, have to accept some level of responsibility in their recommendation. Much like history has forced Nixon, Carter, and their Fed Chief (Arthur Burns) to in the 1970s.


Do You Believe?


“Credit derives from the Latin, credere, “to believe.” Belief was there, the factories functioned, the farmers delivered their produce. The Central Bank kept the belief alive when it would not let even the government borrow further. But although the country functioned again, the savings were never restored, nor were the values of hard work that had accompanied the savings…” (Paper Money, 1981)


In that excerpt, Goodman was talking about The German Hyperinflation of 1923. Obviously a lot has changed since then, but the idea of the world’s largest man-made Money Printing Bazooka (ever) will be as alive as ever in the next 24 hours.


If you want to believe that the Swedes, Russians, and British aren’t already feeling the anticipated inflation associated with the centrally planned destruction of the Eurozone’s common currency, just go there… and ask them…


In the US, it’s already here. Only from the artist formerly known as an “economist” from The Goldman Sachs (NY Fed Head Bill Dudley) would you hear that talking up QG3 for a +9% one-day energy rip in the price of oil isn’t inflationary for those of us driving somewhere to eat something for our American Thanksgiving.


Thanking God’s Work for that…


Back to reality, what do The American People believe?


1.   US Consumer Confidence: after the biggest 21 day stock market and commodity inflation almost ever (which is a long time), US Consumer Confidence for the month of October plummeted yesterday to 39.8 versus the 46.4 reading when inflation toned down in September. To put that print in context, US Consumer Confidence in October of 2008 was 38.8! (see chart)


2.   US Institutional Sentiment: if there’s one certainty grounded in the Uncertainty of 2011, it’s that institutional investors are forced to suspend disbelief, often. BEFORE this 3-week, +13% inflation of the oil price, the II Bullish to Bearish Survey had a Bearish Spread of minus -12 points (bulls minus bears). AFTER the move, we have a Bullish Spread this morning of +2 points (40% Bulls versus 35.8% last week and 37.9% Bears versus 41% last week).


3.   Hedgeye’s Moves: we made the “Short Covering Opportunity” call on October the 4th and the “Shorting The SP500” call on October the 24th. Back-check, Fore-check, Time Stamped.


But never mind what we did when few wanted to pull the trigger … or what went on in Germany in 1923 … or in the USA in 1978. Those were lessons that history has offered to us – and our said leaders can ignore them at their own risk. The American Zeitgeist that no one can simplify is actually really simple – The People no longer believe that stock and commodity market inflations are good. Period.


Our 2011 Strategy: Growth Slowing. The Keynesian 2011 Strategy: More Policy.


The difference between our views and theirs is not that complicated. What is complicated is having The People believe in these ridiculous acronyms (TARP, EFSF, etc). So now, in the spirit of simplicity, the Obama Administration is mixing it up with ones that commoners and journalists alike can pronounce – like HARP (Home Affordable Refinance Program):


HARP is the next Policy Idea coming out of Washington that’s had the US Housing Index (ITB) trading with what The Bernank would call The Price Stability (ie +3% daily price moves in the stock market).


If you read into this Policy Idea, it’s effectively a short-term subsidy for losers, which will serve notice to the American Dreamers that their deadbeat neighbor can afford a shiny new car lease with his government handout. Or will they?


Our resident Financials and Housing gurus, Josh Steiner and Allison Kaptur, have boiled down the HARP 2.0 as follows:

  • It doesn’t really help consumers much at all
  • Consumers will be pressured into shortening the duration of the loan
  • Net-net, monthly payment flat when principle and interest is taken into account

OK. So what do you do with that?


The conservative, head down, American saver gets even more upset because every Policy Idea we come up with rewards leverage and losing. Meanwhile the policy itself doesn’t help the most delinquent Americans anyway!


Nice. Really nice. Can we get some more of that?


As the pretend American Capitalists of Adam Smith’s Invisible Hand spend the next 24 hours hoping and begging for the Heaviest Keynesian Hand offered to Global Markets ever, I’ll leave you with Goodman’s summary of what I think Americans Believe:


“… yet they had lost their self assurance, their feeling that they themselves could be the masters of their own lives if only they worked hard enough; and lost, too, were the old values of morals, ethics, and decency.” (Paper Money, 1981)


My immediate-term support and resistance ranges for Gold, Oil, German DAX, and the SP500 are now $$1670-1715, $88.62-93.67, 5698-6144, and 1222-1254, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Do You Believe? - Chart of the Day


Do You Believe? - Virtual Portfolio

Licking Gravity

“We can lick gravity, but sometimes the paperwork is overwhelming.”

-Werner von Braun


The only problem with last week contributing to the best month for stocks since 1974, is the 1970s. This morning, between German Retail Sales falling to flat year-over-year and Eurozone inflation (CPI) remaining at +3%, European Stagflation remains.


Most of last week’s fanfare can be boiled down to one solid gravitational factor that underpins all of the math behind what we’ve been calling The Correlation Risk – the US Dollar. If you get the US Dollar Index’s direction right, you’ll get most other things right.


The US Dollar Index is up +1.3% so far this morning. That’s a good start to my week because my being long it last week was nasty. Inclusive of a -1.7% week-over-week drawdown, the US Dollar was down for the 3rdconsecutive week, and down -4.6% since the week ended October 7th, 2011.


Since that 1stweek of October (after the Cover of Barron’s said “Watch Out, Mr. Bull” – this weekend it said “Not So Fast, Mr. Bear”?), this is what other major moves in Global Macro have looked like:

  1. Euro/USD = +6.1%
  2. CRB Commodities Index = +6.6%
  3. Oil = +12.5%
  4. Copper = +14.9%
  5. Volatility (VIX) = -32%
  6. 10-yr US Treasury Yield = +12%

So what was this all about – Growth or Gravity?


We’ve had plenty of rallies since the start of 2011 where consensus has been convinced that this has been all about growth. The only problem with that is that there is a big difference between growth and inflation. That’s why the legitimate calculations of GDP growth apply a legitimate “deflator” to the nominal growth estimate. It’s called the purchasing power of money.


Remember in Q1 of 2011 when Sell-Side and Washington “economists” had +3-4% 2011 GDP and 1450 SP500 targets? We do. We also remember that the price of oil was tracking upwards of $110/barrel – and that had a big impact on global economic growth slowing.


After it was revised -81% to the downside versus the “preliminary US government estimate”, US GDP growth in 1Q11 was only 0.36%. That was using a “deflator” that we’d consider accommodative to the Big Government Interventionist camp that it’s not Policy, Stupid.


That was then – this is now. What does this economy need from here?


A)     More US Dollar Debauchery

B)      Higher Oil prices

C)      Stock market cheerleading based on A) and B)


Alex, I’ll take a restroom break and the other side of Jon Corzine’s long/short book for $1,000.


Obviously most people whose compensation isn’t solely tied to stock market inflations are allowed to get the point here. Not surprisingly, amidst last week’s generational squeeze, a few not so funny things happened on the way to the Europig Forum:

  1. European PIIG Bond Yields (Italy most specifically) hit new 3-year highs
  2. TED Spread (measures global banking counterparty risk) hit a new 2011 YTD high
  3. US Financials (XLF), The Russell 2000 (IWM), and the price of Copper (JJC) all failed at their long-term TAIL lines of resistance

Now that last point is probably the most interesting – because, essentially, it ties back to the aforementioned point about growth. It’s a question really. The Question this morning (as in what you do with your money right here and now): is Global Growth “back” OR was that just another Dollar Down reflation of asset prices?


Longer-term, I think the only way to recover real US economic growth (adjusting for inflation) is to:


1.       Strengthen the US Dollar

2.       Deflate The Inflation

3.       Strengthen Employment


In the Chart of the Day, you’ll see this quite clearly across US Presidential terms. Someone running for President in 2012 really needs to use this picture. Going all the way back to when Richard Nixon abandoned the Gold Standard (1971) and embarked on today’s Euro-style debt monetization scheme, a Strong US Dollar = Strong America.


To be sure, looking back at the last 18 days of the biggest move ever in stock prices (ever is a long time), Licking Gravity’s  short-term political resolve has its Month-End Markup perks, for some of us…


But, for most of us, the long-term TAILs of Global Growth are still broken.


My immediate-term support and resistance ranges for Gold (bullish TRADE and TREND), Oil (bullish TRADE; bearish TAIL), German DAX (bullish TRADE; bearish TAIL), and the SP500 (bullish TRADE and TREND) are now $1, $90.19-93.86, 6098-6455, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Licking Gravity - Chart of the Day


Licking Gravity - Virtual Portfolio

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The Week Ahead

The Economic Data calendar for the week of the 31st of October through the 4th of November is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - 1. cal

The Week Ahead - 2. cal


Lani Kane-Hanan (Chief Growth and Inventory Officer)

  • Inventory Management
    • Have several resorts under development in North America
    • May buy back inventory from existing owners or buy distressed inventory from 3rd parties
    • Other ways of getting inventory:
      • Build
      • Buy turnkey inventory for a management fee
      • Manage someone else's inventory
    • Will not develop new resorts anytime soon.
  • Current Inventory
    • North America
      • Completed: $320MM spend or $840MM of contracted sales - 18 months at their current sales pace
      • Under construction: $230MM spend on B/S, which would yield potential contract sales of $930MM
      • Future phases to complete (land at adjacent resort): $275MM spend, which would translate into $4.23BN of potential contract sales
      • Total: $6BN of potential future sales
    • Asia Pacific strategy
      • Complete existing projects
      • Reacquire inventory
      • Turnkey projects
      • Co-located property
    • Europe Strategy
      • Sell existing inventory by 2015
      • Opportunistically reacquire inventory
      • Ongoing resort mgmt, rentals and customer service
    • Luxury Strategy
      • Ongoing sales of existing inventory; leveraging the existing distribution challenges
      • Bulk land dispositions
      • Future growth through asset light strategy
    • Optimization for Sale
      • Offering incentives to existing owners like MAR Rewards
      • Since 2008, cost of sales is greater than real estate inventory spending
      • In 2010, they had 10,810 VOI units flying the MAR flag - 6% were unsold
        • This translates into 5.5MM available keys in 2010. In 2010, 75% of those units were used by owners, 14% were rented to transient guests,2% was used towards marketing and packages, 2% was getting refurbished, and only 7% went unused.
        • Their occupancies have consistently been over 90% (91.6% in 2010, ~92% in 2008, and 91.4% in 2009)
    • Opportunities for growth
      • Capital efficiency
        • Offer new experience to owners that aren't capital intensive - safaris/ cruises/ tours/ outside of their systems for new points
        • Recycling inventory: buying back owner inventory which is cheaper than new construction
        • Cross brand utilization
        • Selective asset light deals: Turnkey developments with 3rd party owners, fee for service arrangements, affiliation arrangements, co-development deals
      • Recurring income streams:
        • Exchange fees


Joe Bramuchi (VP Capital Markets, Treasury and Financial Risk Mgmt)

  • $700MM of non-recourse debt on balance sheet
  • $40MM of preferred stock
  • Has a warehouse facility and revolver
  • Profitable consumer financing business
    • Typically 45% of their customers take MAR financing at the point of sales at an 80% LTV
    • They use their warehouse facility to fund the loans and accumulate them in the warehouse for about a year before packaging them into an ABS deal and securitizing the receivables in a loan sale.
    • Their loans are 10 year, fixed fully amortizing loans at 12.5-13.5%
      • No prepayment penalty
      • Low monthly payment: $315/month
      • FICO: 737 average
      • 10% down is a minimum downpayment
    • High coupon and FICO score provide them with a large spread.  Before 2007, they would incentive customers to take financing by offering extra points/ etc. When the ABS market weakened, they stopped offering those incentives.
  • At any point in time, they hold some of the notes receivable because they are not securitizable for one reason or another.  Expect their loan receivable balance to level off in 2014 and then begin to grow as sales grow.
  • Note Securitization terms
    • Year 2010-2011
    • Gross note sales volume: $229MM
    • Advance rate: 95%
    • Weighted average coupon: 13.2%
    • Investor return: 3.6%
    • Excess spread: 9.6%
  • Their worst deal was in 2009-2010
    • Only a 72% advance rate and 3.4% excess spread (they repurchased this deal)
  • Timeshare paper has had similar performance to credit card and auto performance  - and was much better than home equity loan.  The performance of MAR paper tends to lead the industry.
  • Other sources of liquidity
    • $300MM warehouse line of credit
    • R/C: $200MM (undrawn at spinoff)
    • Expect to access the ABS market regularly going forward
    • Rated: BB- by S&P (similar to HST and HOT at BB+)


John Geller (CFO of MVCI)

  • Enhance cash from sales of land in Luxury segment
  • Their base management fees are very stable
  • Contract sales: accurate measure of demand trends
    • Require a 10% down payment by customer
    • In 2010, volume declined 8% (weak economy, start up impact of point program, and closure of sales office). They have been focusing sales to existing owners rather than pursue new buyers.
    • Believe that pricing and volumes going forward will exceed 08' levels
    • Will monetize Luxury inventory. Going forward, they will focus on affiliations.
    • Europe - sells weeks based program. Expects that contract sales will decline as they wind down their inventory.
    • Asia Pacific - contract sales should continue to improve; Total contract sales in 2011: flat YoY but better in 2H
  • Cancellation allowance (many luxury customers canceled their purchases)
    • This should go away going forward.  When they sold projects based on week programs, they couldn't recognize many sales as some projects were still under construction.  Currently, that is less of an issue, however, they must have 10% net of promotional allowances before they can recognize a sale and they must surpass a recision period of 7-10 days. So on a 10% down financed sale, it takes a few months to recognize the sale.  As they recognize revenues they reserve for about 11% of financed sales (5% of total sales).
  • Product costs (Cost to build/acquire inventory)
    • In 2011, it was 38-40%, down from 42% in 2009 given the higher promotional environment then.  Going forward, construction costs have moderated and luxury sales are de-emphasized, so cost of sales should improve.  Their luxury sales have much lower margins as they carry much higher cost of sales.
  • Marketing and sales costs
    • Going forward they are targeting a return of 42-46% after marketing and sales costs.  Currently 49-51% in 2011.
  • Expect that financing revenue will continue to decline in 2014 and then grow steadily thereafter with sales volumes.
  • Rental revenue: $205-215MM in 2011 ($175-180MM in NA); net of expenses: loss of 7-12MM and +15-20MM in NA. Maintenance fees on unsold inventory totaled $68MM in 2010 and estimated $58-60MM in 2011.  25% is from luxury inventory.  Intention to sell out luxury inventory and elimination of those associated expenses will save them $10MM or so per year
  • Management fee revenue:
    • 10% of maintenance fee by owner
    • 2500 point purchase: $1000/annual mgmt fee; In 2011: $63MM of estimated fees
  • Reduced SG&A expenses since 2008 - past years were adjusted for the MAR royalty fee and approx $12MM of standalone company expenses.  SG&A of $140-145MM in 2011
  • Forecasts for 2012:
    • 2011E: $95-105MM EBITDA
    • Flat contract sales: $116MM
      • 5% growth: $127MM
      • 10% growth: $138MM
      • 5% decline: flat with 2011 levels
    • Assumes $66MM of fees to Marriott International, and $134-135MM of SG&A
    • Expect $150MM of proceeds or so on the land sales
    • Expect to only have 5 projects under construction vs. 20 in 2008.  Will be focused on maximized FCF.



  • Their compensation policy is yet to be determined. They will make sure that the management team is impacted by the performance of MVW.
  • ROIC: high points were 15% or so.  Their business was dragged down by the luxury segment. Points based program is also more capital efficient since you don't need as much under construction inventory and they can adjust construction appropriately based on demand.
  • Management fees of $63MM are net of all expenses
  • Why does rental P&L lose money?  It carries the unsold maintenance fee, marriott reward expenses, costs of advertising and rental expense of the inventory.  In 2009 they carried a lot of the Luxury inventory; they are also unable to rent out some of that inventory due to zoning restrictions.
  • Historically, financing propensity was in the 40-50% range; however, around 2007, they incentivized their buyers to take financing in return for MAR reward points.  So when they were no longer getting 100% advance rates, they went back to the historical norms.
  • Bringing over the securitized note balances, $40MM of preferred stock at a 12% coupon, 10 year redeemable callable in 5 years.
    • Also $800MM of debt and cash in working capital to run the business ($25-30MM day 1)
  • Timeframe for lowering their marketing and cost of sales from 50% now to 42-46%: NA is running at 47% today, luxury and Europe are dragging up the cost today so once those segments are wound down, costs of marketing will improve. Part of it will depend on volumes improving.
  • Focus on consumer confidence the most as a general proxy for the health of their business since this is a large discretionary purchase
  • Interval International provides their weeks program customers with the functionality of exchanging their weeks
  • In Form 10, they have a $1.4BN servicing portfolio.  The delinquencies in the Form 10 are $104MM over 150 days.  Foreclosure process can take up to a year so they are seeing a build up there.  Still seeing the work out of loans from 2009 - their $104MM still reflects a lot of the 2009 overhang.  For financed contract sales, they include in their inventory some amount of foreclosure units (which they estimate).
  • Their priority today is to sell down their existing inventory.  As they look to develop new units they will consider asset light strategies (cruises/tours/fee for service deals/distressed condo acquisitions/ engaging 3rd parties to build product for them to take in as they need it)
  • Brands: they may develop a new brand or acquire an existing brand.  Right now, they have been solely focused on the spin. They aren't so focused on new brands right now. 
  • Where can contract sales go?  You can look historically; they used to be at $1BN back in 2007.  Today only 8% of eligible people in NA own timeshare.
  • Their priority is to maintain a 4.5-5x leverage ratio (includes securitized notes) to keep their rating so that they can maintain access to the ABS market.
  • Marriott is 65 out of 2500 II resorts - so maybe they are 100/2500 II resorts.  They have spoken about starting an exchange business.  Their points based business enabled the start of their own exchange based business; so they are just in their infancy in that business.  Right now, they are really focused on converting their existing ownership base.  Don't see their business with II going away.
  • They don't really view sites as VBRO as a threat


Here is part one of our notes



Timing of timeshare spin-off:

  • 11/8: Trading of issued shares begins
  • 11/7-11/17: Roadshow
  • 11/22: Regular trading begins


Carl Berquist (CFO of MAR)

  • This is not a way for them to exit the timeshare business but rather a way to grow it faster
  • Why do the spin-off?
    • In 1996, they spun off their owned real estate to Host Hotels
    • Having a company with a singular focus makes it easier to implement strategies faster which will grow their value
    • Allow them to roll out more products
    • MVW will have ample inventory and a good capital structure that will allow them to grow successfully and MI will benefit from this growth through their management fee
    • In 1984, they were the first hotel company to enter the vacation ownership business
    • Have 64 resorts and 400,000 owners
    • Once the spin-off is executed, MVW will become the largest publicly traded timeshare company


Steve Weisz (President and CEO of MVW)

  •  What do they do?
    • Sell timeshare products, manage resorts, provide services for owners and members, finance consumer purchases, rent vacation ownership inventory
    • 45% of their customers finance with them
    • Have exclusive use of the Marriott and Ritz Carlton brands
  • Life cycle of a buyer:
    • Initial purchase, finance income, rentals, additional purchases, and referrals
    • Recurring revenue: club dues, management fees, on-site spending, and interest income
  • Strategic priorities:
    • Drive profitable sales growth and focus on their existing owners and guests
    • Expect to opportunistically dispose of excess land.  They do not intend to develop new projects in the near term.  When they do need to develop new projects, they will seek to do it through capital efficient asset light deal structures
    • Look to pursue new opportunities such as enhanced amenities on site and adding new partnerships
  • Strategy:
    • NA:
      • 80% of the business is NA driven ($530/705MM)
      • Expect to enhance their points program by adding new partnerships
    • Plan to expand their Asia ownership base ($68MM); plan to sell out their European inventory base and no longer develop new inventory there ($63MM) In the Luxury segment; they are selling excess inventory as they have recently been doing ($44MM)
  • Why do the spin now?
    • Success launch of the points program
    • Have a large amount of finished inventory
    • Transaction will open more doors for them, allowing them to pursue new business opportunities that they could not do as part of MI
    • Seamless from a customer standpoint
    • Allows for greater future growth 


Lee Cunningham (COO of MAR)

  • They refurbish their rooms about every 5 years
  • Have seen higher satisfaction service ratings from points owners vs. deeded ownership
  • Points based program was introduced in June 2010:
    • Allows customers to buy into a portfolio vs. a location
    • Allows MAR to sell product from any of their location irrespective of inventory in NA
    • Have 365,000 NA owners that own 550,000 weeks of vacation.  More than 83,000 owners have enrolled in 153,000 weeks in the points program thus far. They have made $46MM in 1x enrollment fees thus far.
    • Point program users have access to a pool of properties: they can bank/borrow points, trade them for MAR Timeshare/Rewards/ II and other Global vacation opportunities.
  • Various MAR collections - access to these are 2500 points:
    • Marriott collection gives access to MAR branded hotels and resorts WW
    • Explorer Collection is provided by partners which include exotic tours, adventure travel,cruises and packages for sporting events
    • World Traveler Collection: access to 2500 affiliated resorts in 75 countries, II, and a wide range of experiences
  • Annual cost of ownership:
    • 60%: resort operations; 20% towards FF&E reserves, 10% to property taxes and insurance, 10% mgmt fees


Brian Miller  (Sales, Marketing and Service Operations EVP)

  • Marketing efforts are highly directed
  • Their biggest competitive advantage is the trust behind the brands of Marriott and Ritz.  Marriott.com is the 8th largest e-commerce site in the world.
  • Also use various Marriott Rewards and travel packages when they sell points
  • Baseline demographic target: Homeowners with household incomes > $100k, college educated, married 35-65 with kids
  • Average owners: 95% are homeowners, 150k income, 80% college educated, 75% married, 56 yrs old
  • Have a proprietary database with 25MM prospect households
  • Various marketing channels mix:
    • In house sales (54%) (on site during a stay)--costs them 9.3% of sale
    • Direct sales (11%): 7% cost of sales
    • They use central marketing previews during shoulder seasons which is their most expensive marketing channel (28% cost of sale)
    • Their average cost of sale is 12% and commission expenses represent 10% of costs.  Think that they can lower costs by being efficient and driving total sales and marketing costs to the low - mid 40s.
  • Have a talented sales force sourced through testing - 1 in 11 are hired;  Have effective sales tools that pre-screen all prospects to make sure that almost all prospects qualify for financing
  • Average contract price was $27k in 2Q2010 before switching to weeks.  Then when they switched to points which allowed customers to buy add-ons, the sales price dropped to $17k due to mix. Last quarter the price increased to $24k as they sold more to new customers and less add ons.
  • Since 2008 owner reloads have increased from 35% to 53%of total sales.  The good news is that this is the most efficient sales channel.  It's not so much that new owners are purchasing so much more but rather the absence of new purchasers.  In 2010, 4.6% of owners bought more product.  In 2012 they are launching a new owner referral program.  1 in 3 new buyers are owner referrals.
  • The points program allows them to market to customers that live locally making the selling process more efficiently.  They are having great success in select international markets: Latin America, Dubai, and some Asian destinations


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