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Finding Nemo: Key Takeaways from the Bloomberg China Conference

Conclusion: Anything but conclusive.

 

Virtual Portfolio Positioning: Long Chinese equities.

 

On Wednesday, we had the great pleasure of joining well over a hundred distinguished investment professionals at the New York Academy of Sciences for the Bloomberg China Conference. All told, there were 13 unique discussions on various topics ranging from China’s economic outlook to its real estate market to the opportunities/challenges facing China’s growing consumer sector.

 

Before we share with you the “best of” version of our notes, we just wanted to briefly reflect upon something that struck me us quite odd: with the exception of NYU professor Ann Lee, none of the 28 panelists were: a) from China or b) Chinese-Americans with valuable connections to the mainland. In fact, the vast majority of the seven-plus hours of discussion centered on the opinions and beliefs of American PMs, professors, and policymakers. Not that this is an issue prima facie – as each of presenters was highly accomplished, well-deserving, and thoughtful – but the general lack of Chinese voices on issues pertaining specifically to China is particularly bizarre in our opinion.

 

That speaks volumes to what we thought were my two greatest learning points from yesterday’s conference:

  1. While the general tone is grounded in apprehension, there is no discernable consensus on China. In fact, China appears to be a very difficult economy to reach consensus on because so much of what takes place there is just fundamentally misaligned with the patterns we've been trained to recognize through studying other economies; and
  2. It's clear that U.S. based investors analyze China from a far too Western point of view, imposing potential avenues for reform and structural economic changes that would ultimately serve China to become more like us. But does China want to be more like the U.S.? There was a sense that perhaps the speakers knew all too well what was best for China – perhaps even more so than the Chinese…

KEY TAKEAWAYS

Below is a collection of paraphrased notes that we found helpful to expanding the scope of our own internal debates regarding the world’s second-largest economy (sorted by topic of discussion):

  • GROWTH
    • Francisco Blanch: There aren’t enough natural resources or additional scope for productivity gains to keep China growing at +8-10% per annum. The law of large numbers would tend to support this conclusion as well.
    • Daniel Rosen: There’s trillions of dollars in low-hanging fruit the Chinese government can spend to support near-to-intermediate term growth: building schools and hospitals, social safety net expansion, etc.
  • PROPERTY MARKET
    • Axel Merk: High net worth individuals in China own 3.3 residential real estate properties on average. Most go unrented, as maintenance costs dramatically outpace any potential rental yields.
    • Michael Shaoul: The utility of real estate in China has changed from “shelter” to “speculation”.
    • Sonny Kalsi/Bhaskar Chakravorti: The median home price in China is 20x the median income – more than double the U.S. ratio. That said, however, there is very little in the direction of low-income, commodity housing in China; as such, a great deal of the homes that are being quoted for prices aren’t exactly being marketed to the median consumer. Thus, household affordability isn’t quite as poor as the headline metrics suggest.
    • Bhaskar Chakravorti: Commercial real estate – particularly high-end retail and hotels – is in oversupply across many municipalities in China, due to the incentive of mayors to seek rent-paying tenants. Thus, a nationwide residential property tax might actually return the supply side of the market towards equilibrium as those distortions are mitigated.
  • CREDIT
    • Axel Merk: The PBOC’s regulation of the cost of credit throughout the economy limits the supply of credit that is available to less creditworthy borrowers, such as small-to-medium-sized enterprises (SMEs).
    • Axel Merk: Cheap credit isn’t necessary to get/keep an economy going. What economies need, rather, is a market-based system for pricing of risk. Financial repression actually slows growth in the velocity of money, as certain borrowers are crowded out of the credit markets.
    • Michael Shaoul: The demand for real estate investment leads the demand for credit in China.
  • BANKING SYSTEM
    • Michael Shaoul: Since 2007, the Hang Seng Financial Index overlays quite well with the equity prices of Japanese banks in the four years post 1989.
    • Joseph Taylor: The deposit rate ceiling acts as a subsidy to the state banks. Thus, the #1 problem with removing the floor is that [largely] unprofitable state-owned-enterprises (SOEs) will see their weighted average cost of capital increase as bank funding costs rise.
  • CONSUMER
    • Daniel Rosen: The Chinese consumer is stronger than meets the eye. Since 2003, nominal household consumption has doubled; there’s $500B-$1T in “grey consumption” (i.e. large propensity to spend abroad, unrecorded cash transactions, etc.); and Chinese consumption has grown faster, in real terms, than any other economy over the previous decade.
    • Daniel Rosen: China desperately needs to further develop consumer vs. producer rights and establish intellectual property guidelines to reach a higher plateau of value-added consumption.
    • Daniel Rosen: China must embrace regulatory reform in order to expand the market for higher-wage, white collar labor.
  • CHINESE YUAN
    • Robert Kapp: The RMB can’t ever become a free-floating currency without first liberalizing interest rates – which are ultimately a function of the liberalization of cross-border capital flows.
  • CAPITAL FLOWS
    • David Rubenstein: The U.S. invests about 5x as much money in China as the Chinese do in the U.S.
    • Robert Kapp: Many Chinese investors are cynical towards their investment opportunities in the U.S. due to political resistance at the federal level, thus limiting the two-way flow of both foreign and portfolio direct investment. On the State and municipal level, however, many U.S. governors and mayors are welcoming of Chinese capital with open arms.
  • DOING BUSINESS IN CHINA
    • Robert Hormats: Intellectual property is an enormous problem in China. For example, to establish a joint venture in China – which is key form of FDI – a multi-national corporation essentially has to give away any/all its R&D and intellectual property, which ultimately gets pirated by “competitors”.
  • CHINA vs. U.S.
    • Robert Kapp: As China grows larger in economic and military might, it will seek to impose its own set of rules upon multinational organizations and international best practices. That said, Chinese international agents are very well aware of how certain systems benefit them and will no doubt seek to uphold those structures.
    • Robert Kapp: Chinese policymakers are aware that it is in their best interest to keep the peace on the geopolitical risk front. Furthermore, there are certain stances that they are likely to ultimately choose to not defend – such as sanctions on Iran – if the alternative was to engage in international military conflict.
  • POLITICAL LEADERSHIP TRANSITION
    • Consensus among panelists: 2012 will be the “year of the status quo”, as China will seek to avoid any major changes ahead of or shortly after “handing off the baton” to the new leadership.
    • Tim Adams: It would be surprising to see aggressive monetary easing in 2012. In fact, as Beijing has alluded to the entire way down, the State Council’s goal is to take the air out of the real estate industry. Further, they wouldn’t mind seeing consolidation in the over-supplied property development sector.
  • REFORM
    • Robert Kapp: The economic/market liberalizing reforms of the last 20-30yrs have essentially ground to a halt. It’s unlikely that China reaccelerates the pace towards Western-style capitalism in the near-term after witnessing the near collapse of the Western economic system in 2008/09.
  • SOCIAL UNREST
    • Robert Kapp: It appears that Beijing’s strategy in regards to dealing with social unrest is equivalent to “stomping out small fires” rather than enacting sweeping reforms to prevent such conflicts in the first place.

Darius Dale

Senior Analyst


Short Selling Opportunity II: SP500 Levels, Refreshed

POSITION: Long Energy (XLE), Short SP500 (SPY)

 

Am I a day, week, or month early? I don’t know. Being early is called being wrong. Been there, done that.

 

If you’re not right and the fundamental framework of your position changes, you should change. Today’s lagging indicator (US Employment Report) is a January number that reflects a lot of why I was bullish for the 6 weeks running into last week’s US Dollar Debauchery.

 

From here, I think inflation expectations continue to rise and growth expectations continue to slow. If that changes, I will. But like February of last year when I made this call, you don’t get the February slowdown data in the January numbers.

 

Across all 3 risk management durations, here are the lines that matter to me most right now: 

  1. Immediate-term TRADE overbought = 1343 (that’s where I shorted SPY again this morning)
  2. Immediate-term TRADE support = 1321
  3. Long-term TAIL support = 1267 

With the long-term TAIL intact, you should naturally be asking me why Newt and the SP500 can’t fly from here to the moon from here. I tend to get these questions after rallies, not before them. It’s just human nature.

 

Provided that the US Dollar’s immediate-term TRADE remains bearish and we keep making lower long-term highs on lower and lower volume studies in the SP500, I’ll stay with this call.

 

Long inflation, short growth.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Short Selling Opportunity II: SP500 Levels, Refreshed - SPX


BWLD: TRADE UPDATE

Buffalo Wild Wings is reporting next week and the CEO, Sally Smith, just appeared on CNBC sounding bullish about Superbowl weekend.  We think 4Q numbers will be strong but we are looking for the forward looking guidance and earnings call commentary.

 

Keith shorted BWLD in the Hedgeye Virtual Portfolio. We know 4Q is likely going to be a strong quarter.  We are concerned about FY12 and believe estimates need to come down.  This is not a consensus call; zero analysts have sell ratings on this stock.

 

Buffalo Wild Wings, along with the rest of the space, is trading higher today as jobs data for January indicated that the employment situation continues to improve in the U.S.  The CEO of BWLD also appeared on CNBC this morning and her commentary on Super Bowl Sunday was bullish.  Smith saying that the company “has dealt” with chicken wing prices does not convince us that expectations for FY12 are appropriately aligned. 

 

Traditional wings make up ~20% of sales for BWLD and wing prices are at extremely elevated levels.  This morning, Smith said that the company has “dealt with” wing prices in the past.  This may be true but our view is that the Street’s expectations have not dealt with the impact of wing prices on BWLD’s earnings very well in the past.  Our view is that FY12 EPS remains high and the growth story is not as secure as the stock’s high multiple suggests.

 

BWLD: TRADE UPDATE - bwld levels

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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CZR IPO INVESTOR CALL

Second time's a charm?

 

 

CZR's IPO INVESTOR CALL 

 

DEAL HIGHLIGHTS

  • Ticker: CZR
  • Range: $8-$10
  • Offering: 1.8M Shares (100% primary)
  • Deal Size: $16MM
  • Over-allotment: 15% all primary
  • Pro-forma Market Cap: $1.125BN
  • Pricing: February 6th 
  • Apollo/TPG not selling any shares in IPO/ subject to a 270-day lockup
  • Selling primary shares equal to 1.4% of the total will facilitate the listing of 29% of the shares
    • The 1.4% of the shares issued in the IPO and 18.8% of the shares will be immediately tradeable post IPO
    • 8.9% of the share will be subject to a 180-day lockup (Company & 50% of Co-investor shares)
    • All of Paulson's shares (9.9%) will be listed concurrently with the IPO and not subject to lock up


INVESTOR CALL NOTES

  • Going public will allow them to deliver
  • Investment in CZR's will give investors exposure to:
    • Recovery of CZR's existing facilities
    • New CZR's development
    • Expect to get Baltimore license and a casino there in 2013/2014
    • Option on online poker
    • Option on Asia development (If and when new markets get approved and if CZR wins a license in those markets)
  • Launched an amend and extend proposition yesterday, which will extend maturities from 2015 from 2018. Listing of equity itself would help them deliver as well.
  • Core business recovery:
    • What has changed since 2007? 
      • Total of $2BN of investments
        • Added CZR's Palace expansion
        • New Horsheshoe Hammond
        • Planet Hollywood
      • Competitive changes (increases)
      • New projects/ developments
    • Bottom line they think that they can get to $3BN
  • Las Vegas recovery is well underway with positive momentum across all the key metrics
    • CZR's cash room rates troughed at $85/night and was $92 in 2011 and still improving
    • Occupancy troughed at 90% and improved to 96% in 2011
  • Atlantic City has been a very tough market and just reversed 39 months of declines in December.  They are continuing to work on efficiencies there.  Believe that they can get their $1.5BN business to a 20% margin
  • Regional market results have been generally stable to slightly improving.  
  • The Back To Peak slide...yes if you only they had a 40% increase in ADR they could get $200MM of EBITDA in Vegas... IF.... 
  • Anticipate adding $250MM of EBITDA from their pipeline efforts opening from 2012-2014 with little balance sheet impact
  • WSOP & US Online Poker opportunity
    • Have taken advantage of markets where gaming is legal in UK and France. When Poker Stars and Full Tilt were shut down, it benefited them
    • They also acquired a social gaming platform to distribute their brands - Playtika, developer of social gaming applications on Facebook 
    • Slotomania is on Facebook, 4 Russian social networks, iphone and ipad. IGT payed $500MM for Double Down. They have 2x as many users and monitize their users just as well as Double Down. They are launching their platforms on ipad and iphone. Slotomania is one of the top grossing apps across all mobile platforms and Facebook.
    • Launching CZR's casino application within a week (currently in beta testing) and it will linked to CZR's rewards
    • Party.BWIN's stock pop based on the their MGM/BYD announcement boosted their market cap by $600MM and they think that they deserve a similar option value that Party is getting. 
    • While they are confident of the prospect of federally legalized online poker, it is already happening at the state level
  • Real difference between this IPO and last one is that there are two real comps for the value of their options
    • IGT/Double Down for their mobile gaming business
    • Party.BWIN stock move based on their option to enter US
  • Amend and extend underway
    • Did an amend and extend for $1,2BN last year on their term loan
    • This current deal is seeking to extend at least [$2.4BN] of their term loans through 2018 from current 2015 maturities

THE HBM: JOBS, MCD, PEET, SBUX

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Unemployment

 

We will have a more detailed post up on employment data pertaining to the restaurant group later this morning.  Nonfarm payrolls came in at 243k versus 140k consensus.  The unemployment rate came in at 8.3%, below consensus 8.5%.  This is a positive for consumer confidence, since the unemployment rate is the most often cited labor statistic in mainstream media, but there are a lot of moving parts behind the final print. One worth monitoring is the Labor Force Participation Rate.  In January, it fell to 63.7% from 64%.  This may not seem material but, as the second chart below shows, adjusting the LFPR to the ten year average (January ’02 through January ’12) implies a much higher unemployment rate for January.

 

THE HBM: JOBS, MCD, PEET, SBUX - lfpr

 

THE HBM: JOBS, MCD, PEET, SBUX - Urate LFPR adj

 

 

Commodities

 

Coffee prices in Brazil, the world’s largest producer, declined this week as growers sold after holding onto beans in a bid to boost prices, according to sources quoted by Bloomberg.  Prices are declining on speculation that global supplies will improve with large crops in Brazil and Vietnam.

 

SUBSECTOR PERFORMANCE

 

THE HBM: JOBS, MCD, PEET, SBUX - subsector

 

 

QUICK SERVICE

 

PEET: Peet’s coffee was upgraded to Outperform by Baird.

 

MCD: McDonald’s paid a record low on 30-year bonds – just 3.7% - as it tapped the debt market for $750 million in a two part offering.

 

SBUX:  “Starbucks can follow Satan if they want to”, says USA Christian Ministries head Steven Andrew in a statement addressing the company’s support of gay marriage in Washington State.  If Christians unite behind his cause, he predicted, Starbucks would lose 80% of its clientele.

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

GMCR: Earnings short squeeze.  High level of short interest in this stock and yesterday was a painful day for the shorts.

 

COSI: The CEO bought stock a couple of days ago.   This stock is up over 27% over the past week.

 

WEN: Gained yesterday after a strong sell off after the Analyst Day. 

 

YUM:  Besides news in the media about the salmonella incident in Oklahoma that media reports are attributing to Taco Bell, there was no news on YUM.

 

CMG: EPS just was not good enough for this priced-for-perfection stock.

 

BAGL: The Chief Marketing Officer left the company.

 

 

CASUAL DINING

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

BWLD: This stock is trading well into earnings next week.  4Q results are likely to come in strong but, in our view, the forward looking commentary needs to bring FY12 expectations lower.

 

KONA:  Management changes are disruptive to operations.

 

THE HBM: JOBS, MCD, PEET, SBUX - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


WYNN: THE INTERNET? IS THAT THING STILL AROUND?

Sorry to quote Homer Simpson but you know Wynn’s stock is in trouble when Steve starts the call raving about their new website.


 

WYNN is clearly not a hedge fund favorite right now and normally, we’d love to take the other side of that.  But really, what is the positive catalyst?  High short interest and low expectations may limit the downside to pretty much where the stock traded up from yesterday or maybe a little worse.  Q4 was not great but where we go from here is the real question.

 

Last night, WYNN held an uncharacteristically boring conference call.  Where was the political rant?  Where was the unbridled optimism?  Where were the dumb analyst questions?  Oh wait, there were plenty of those.  Anyway, the uninteresting nature of call was probably a preview into the next few years at Wynn.  Without any new projects underway, WYNN will be an operations and cash flow harvesting story.  The stock is probably priced that way too which makes it uninteresting to us, long or short. 

 

Wynn is a terrific operator and a value creator, no question.  Right now, he is a little bit of a victim of his own success in Macau until Wynn Cotai opens.  Wynn Macau/Encore is running close to full capacity now and is likely to continue to lose share and generate subpar and subdued growth in the coming years.  Vegas should have some nice growth, but it’s just not that material to the overall results of the company.  In the meantime, the catalysts are external:  Government approval of Wynn Cotai, potential legalization of gaming in Japan or Korea, and the RFP process in MA.

 

 

Q4 Details:


Wynn reported net revenue of $1.34BN and Adjusted EBITDA of $381MM (post corporate but before stock comp), missing consensus by 1% and 4%, respectively.  Macau missed by 2% despite holding well across both VIP and Mass, while Vegas EBITDA missed by 9%.  After the snoozer of a conference call, we’ll spare you the boring line by line and skip to the more interesting tidbits/non-obvious observations.

 

Macau

  • Hold boosted net revenue by $71-89MM and Adjusted EBITDA by $22-32MM
    • If you assume theoretical hold of 2.85%, the hold benefit to VIP was $69MM on net revenue and $20MM on EBITDA.  Using Wynn’s average hold since opening (ex 4Q11) of 2.94%, this gets you to a hold benefit of $50MM on net revenue and $10MM on EBITDA.
    • Mass also held well at 30.4% vs. the 27.4% TTM average.  We estimate that the incremental 3% of luck helped net revenue and EBITDA to the tune of $21MM and $12MM, respectively.
    • Direct play was 11% and rebates were 95bps or 30% of win
    • Single-digit midget growth as the property hits up against capacity constraints
      • VIP RC: 7%
      • Mass drop: 4%
      • Slot handle: 8%
      • Estimated 14% increase in fixed operating expense

Vegas

  • This is only time, aside from 2008, since opening where 4Q table drop decreased QoQ
  • Slot handle was disappointing which is surprising given the strong reported Strip results
    • Wynn could be losing share to MGM
    • Lower occupancy likely hurt the slot performance
    • Rebates/Casino discounts were 19.7% of gross casino win, compared to 17.3% in 4Q10 and 17.4% in 3Q11
    • Occupancy actually decreased YoY and RevPAR only increased 2.7% and was the lowest since the property opened.  On the positive side, it looks like promotional allowances/ comps decreased $44MM or 30% of net casino win from 32% last year.

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