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Quote Of The Week: The Chinese Are Coming!

“Chinese property hunters to raid US”
By Geoff Dyer in Beijing, Financial Times, December 5, 2008

This quote was a beauty. The only thing better than “Heli-Ben” and Bushy dropping moneys from the heavens is the idea that hundreds of Chinese men and woman are going to descend on Floridian property gluts and rescue American homeowners from their levered up losses.

Geoff Dyer’s article was inspired by “SouFun”, which is the largest dot com site in China for real estate. Apparently some 300 Chinese “expressed interest” in soaking in some of fun in the foreclosure sun of California. Oh how times have changed folks. The Chinese are liquid long cash, reminding the USA what being a capitalist means. Buying low, not high.

Since the first week of November, the Chinese Capitalists have plenty of their own “Re-flating” moneys to count. Inclusive of a +6.7% three-day rally to close out this week, the Shanghai Stock Exchange Index has put on a +18% move. This stands in sharp contrast to the depression in some of the homes of levered long American wanna be capitalists who saw the SP500 close down another -2.3% this week, taking the US market’s performance over the same period (from the 1st week of November) to down -13%.

CNBC’s “Fast Money” literally used to get away with espousing strategies of “buy high and sell high-ah!”, while Larry Kudlow used to proclaim his mystery of market faith by having his group thinkers say “free market capitalism is the best path to prosperity.” Watch what these American entertainers do, not what they say. Begging for bailout moneys and government sponsored help is no definition of capitalism. Neither is the notion that buying low and selling high is passé.

Capitalists are called capitalists, because they own themselves and their process… and they capitalize on opportunities to buy low. They don’t need government supports. They don’t need to ask for permission. They are liquid long cash when the lemmings are levered. They may be coming to a neighborhood near you, knocking on your door… looking to mark your home to market!

Just as readily as American Capitalists were 100 years ago, the Chinese are coming.
KM

Eye on Employee Productivity

Employee productivity always matters, but I’m increasingly interested in the investment base to sustain such levels. The numbers suggest that some companies are more at risk than others.

With pressure on profitability mounting and the outlook for 2009 increasingly uncertain, cost control matters more than ever to buoy profitability. What many people fail to remember is that 70% of discretionary (non-COGS) costs in this business relate to headcount – both directly (# people) and indirectly (T&E, IT, etc…).

So how best to peek inside a company to gauge whether cuts are coming from fat or muscle? I think a fair way is to plot each company’s productivity versus total SG&A ratio. This is by no means a way to make blanket statements about which companies are behaving better than others as it relates to capital deployment – especially given that there are differences in business models (wholesalers, retailers, and vertically owned manufacturers). But it definitely helps us put the data in perspective, and ask the appropriate questions about where one company stands relative to another.

There are 2 major buckets of companies.
1) High productivity, high SG&A ratio. These are companies I am least worried about. They have mostly healthy productivity levels, and have either a) given employees the proper tools to maintain such productivity (R&D, marketing, technology, etc…) – such as Nike, UnderArmour, Ralph Lauren and Coach, or b) are just flat-out fat and/or poorly run with room to cut (Timberland, Quiksilver, Liz Claiborne). That’s not great for the here and now, but certainly leaves a nice call option.

2) Low productivity, low SG&A. First off, I fully acknowledge that this group includes several retailers and the two vertically operated manufacturers, who have more of their respective investment bases captured on (or near) the balance sheet in the form of equipment or leases. But it’s impossible to look past some massive gaps in SG&A spend on like-for-like businesses. FL, DSW, and GIL bad; FINL PSS and HBI good. You get the idea.

See chart below, and/or contact my office for additional color.

Chart Of The Week: Global Rates

From the heavens they came, dropping free moneys on all of those who are still allowed to trade the futures. Our holiday greetings and many thanks go out to “Heli-Ben” and his global air force of Japanese B-52 cash money bombers. Ben, you have inspired us all to take this baby right back up to 10,000 feet again. Never mind the naysayers calling ole Greenspan the “Grinch”… let’s deck the halls with 0.01% three-month US Treasury rates and “Re-flate” some of them Bushy bubbles!

All the while, lumps of cost of capital coal have seemingly found their way to Russia and Pakistan. Both were forced to actually raise rates in recent weeks. This has been horrible for Russian equity investors, and a non-event for the folks in Karachi, where they just keep the stock market closed, rather than get “stoned” by their populous.
KM

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US Market Performance: Week Ended 12/5/08...

Index Performance:

Week Ended 12/5/08:
DJ (2.2%), SP500 (2.3%), Nasdaq (1.7%), Russell2000 (2.6%)

Q408’ To Date:
DJ (20.4%), SP500 (24.9%), Nasdaq (27.9%), Russell2000 (32.2%)

2008 Year To Date:
DJ (34.9%), SP500 (40.3%), Nasdaq (43.1%), Russell2000 (39.8%)

DIN – Reality vs. perception

On Friday DIN rose 30% on the back of a 13D filing by the company’s largest shareholder, Southeastern Asset Management, and a strong market. Southeastern says that it is converting its ownership filing to 13D from 13G “in order to be more active in corporate governance and management matters, and to have the ability to enter into discussions with third parties concerning proposed corporate transactions of a significant nature. In this situation, Southeastern has talked to the Issuer's management, and will have additional conversations with management and/or third parties, regarding opportunities to maximize the value of the company for all shareholders.”

The filing goes on to say “Southeastern is engaged in the business of investment management of its clients' assets and pursues an investment philosophy of identifying undervalued situations and acquiring positions in undervalued companies on behalf of its clients. In pursuing this investment philosophy, Southeastern analyzes the operations, capital structure and markets of companies in which its clients invest and continuously monitors the business operations of such companies through analysis of financial statements and other public documents, through discussions with knowledgeable industry observers, and with management of such companies, often at management's invitation.”

The part that say’s “often at management invitation” is interesting given the current situation at DIN. Given the current economic crisis facing every casual dining operator DIN is in crisis mode, or should be. The company is leveraged at 7x EV/EBITDA and has been operating with an interim CEO since the end of September. The company desperately needs to sell assets to relieve the burden of excess leverage to give the company breathing room. In addition, management is cutting costs thru layoff’s, significantly reduced bonuses and reduced vacations, which is not an environment that will foster significant goodwill with the company’s employee base. Lastly, the Applebee and IHOP franchisees are faced with P&L inflation, lower traffic and increased discounting resulting in lower store level cash flow.

So what can DIN do to create long term value for shareholders? Let’s remember this is a restaurant company so the options are limited. To start, the stock is not undervalued relative to its peers. Using a NTM EBITDA range of $330-$350 million, DIN is trading at around 7.5x EBITDA versus its peers at 5x. The most effective way to build value for shareholders is to get more customers in the door paying full price, but that’s not likely anytime soon. The only real option the company has is to sell assets beyond what has already been announced. Given current sales trends and limited access to capital assets sales in this environment is nearly impossible. Additionally, no person in his right mind would pay more than 3-4X EBITDA for Applebee’s assets. Needless to say, with the stock selling at 7.5x EV/EBITDA selling assets at those prices would be dilutive to DIN and would not create shareholder value.

My guess is that Southeastern could act as a buffer between an angry franchise community and company management. Southeastern’s track record is impressive and they own stocks for years, but the change in to a 13D from a 13G is a defensive move not offensive. DIN is going to need miracle to save this ship.

THINK LOCALLY

The gaming industry’s problems are wide and varied, but unemployment is certainly one of them. As we’ve highlighted in past posts, unemployment has been a key macro indicator in explaining gaming revenue changes in most markets with the exception of the Las Vegas locals market where it’s all about housing.

We can see on the map which metropolitan areas are seeing above U.S. average unemployment rates. St. Louis, Memphis and Chicagoland are enveloped in red on the map (above national average unemployment). However, as depicted on our chart, the trends in these markets are less negative than those in the Las Vegas, Texas, and Louisiana. The situation in those areas is quickly deteriorating.

This is especially true in Louisiana with both Shreveport-Bossier and New Orleans seeing a degenerating situation. Moreover, trends in Dallas and Houston, the big feeder markets into Louisiana, are also negative sequentially. This is potentially troubling for a company like Pinnacle Entertainment which generates approximately 75% of its EBITDA in Louisiana and has been posting some of the best operating results in gaming.

Turning to Atlantic City, this market receives a large proportion of its visitors from the NY and Philadelphia metropolitan areas. The AC market is one we have been negative on for quite some. While the October yoy unemployment figures are not bad, the trend is getting worse, as can be seen in the chart. TRMP, BYD, and MGM are public companies with exposure to AC. Harrah’s Entertainment on the private side is also at risk.

In the Las Vegas locals market, it is no secret that Boyd and Station Casinos have faced grim prospects. We’ve expounded on the housing situation at length and determined that housing has been the only statistically significant macro factor in driving gaming revenues for the LV locals market (LV LOCALS: HOUSING TRUMPS EVERYTHING, 11/30). In line with this, to the extent that unemployment and economic malaise affects the already deflated housing market, unemployment is a factor worth monitoring. Next to Los Angeles, the unemployment picture here is the worst in the country.

The national trend is important for the Las Vegas strip, which depends largely on tourist dollars. November’s national unemployment trend affirms the October sequential and yoy negative trend. In 2007, 88% of visitors to Las Vegas were from the United States. 25% of all visitors came from Southern California. Unemployment in California is rampant and the attached chart shows that LA and San Diego have seen a dramatic increase in unemployment. San Diego and LA have both seen a sequential increase in the yoy change of unemployment rates from the third quarter to October. The national and SoCal statistics bode badly for MGM, a company highly invested in the Strip. MGM has committed a vast amount of capital to expanding its Las Vegas Strip exposure with project CityCenter.

Rory Green
Junior Analyst


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