Eye on Activists: Memo to Ivory Asset Management

Memo to Ivory Asset Management
Subject: Long only levered activism is dead

While we don’t know anyone at Ivory Asset Management, and we are sure they are great people, we do have some advice for them, activism is dead. If the only way you can get the stocks up that you own is to throw out hail Mary activism proposals, the market is more likely to look at that for what it is, a last ditch attempt to save a bad investment.

Back in the market mania highs of 2005/2006, these strategies worked. Unfortunately, the cheap money, private equity bubble has popped, like all bubbles inevitably do, and with it so has the long only levered activist model.

Microsoft CEO Steve Ballmer has said the idea of acquiring Yahoo is dead and while the idea of doing a search deal is still alive, the likelihood of anything getting done at Ivory’s proposed $24 - $29 is preposterous at best. Ballmer understands that he will get a real shot at Yahoo if he wants it, but it will likely be at a much lower price.

The days of long only activists actually mattering are long gone. We would use Ivory’s press release investment strategy, and any short term increase the stock price that come with it, as catalysts to sell positions.

Daryl G. Jones
Managing Director


Yesterday Wyndham had a call to discuss its announcement that it was going to self fund its timeshare development business given that the asset backed securitization market is essentially closed and showing no signs of improvement for 2009. Basically, WYN is reducing its sales velocity by approximately 40% from 2008 levels to get the business to a level where it can drive positive FCF and become self-funding.

Like other development businesses, timeshare is capital intensive and typically cash flow negative when the business is growing rapidly. There is no revenue recognized until the building is complete and over 10% of the purchase price has been collected. However, when the business is being wound down, it throws off a material amount of cash. The average duration of a timeshare loan is about 7 years currently.

Since 2000, the timeshare industry has grown at a 14.5% CAGR, driven by demand, abundant and cheap financing, exchange programs (RCI & Interval International) and introduction of new products (fractionals, condo hotels). Marriott, Starwood, and Wyndham have been beneficiaries of this trend, experiencing an average CAGR of 19% from 2003-2007 in their timeshare business.

According to our calculation the industry will need to contract by about 45% from peak levels in order to become “self funding.” Currently most sell-side analysts model some contraction for 2009, with a large rebound thereafter. If the industry needs to become self-funding, it will take many years to return to 2007 sales velocity.

We’re pretty sure we’re not going to see the same hockey stick growth in timeshare experienced earlier this decade. Timeshare growth will likely be constrained to funding availability and free cash flow generation. Investors looking for growth may want to look elsewhere.

For those focused on cash flow like us, the winding down of timeshare development is a positive event. The Street is likely to understate the potential cash flow generation of this business in the coming years. We’ll have much more to say on this soon. Also, the evaporation of the credit market might be a blessing in disguise by forcing companies to trim development activity proactively before demand falls apart as it has for most large discretionary leisure purchases. This cutting back should minimize the inevitable future write-downs and growing delinquencies as the value of inventory gets written down and the rate of defaults on loans accelerates.

We are not yet ready to pound the table on the lodging sector. However, despite the near term earnings drag from turning timeshare into a self-funding vehicle, the FCF picture for MAR, HOT, and WYN should improve dramatically.

Anna Massion


Missouri November gaming revenues climbed 9.2% in total and down only 2.2% on a same store sales basis. The 9% increase improved from October’s 3.7% gain and September’s 0.3% decline. November is a seasonally slower month than October yet revenues increased 5% sequentially. I attribute the improved performance to the removal of the $500 loss limit which was implemented in time for the second weekend of the month.

While most properties improved sequentially, PENN’s Argosy Kansas City property performed particularly well in the month, up 7.5%. PNK’s Lumiere Place posted gaming revenues of $14.4 million, its 2nd best month behind May, which is a seasonally stronger month.

November did contain an extra Saturday and Sunday versus last year, but was down a Friday. Even so, it looks like the loss limit removal is boosting revenues. I expect the favorable impact to increase with a full month of limitless gambling and increased marketing.

Revenue growth improving due to loss limit removal
Strong November at Lumiere Place despite seasonally slow month

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Czech Mate? Not So Much, Yet...

Market entertainers are always flipping around on TV with whatever narrative it is that suits the direction of the day. I heard someone rattle off something about a "depression" in The Czech Republic this morning. While Czech GDP has certainly fallen from its double digit growth graces... this is hardly a "Great Depression." Ask someone who lives there...

Czech Republic GDP came in at +4.2% y/y this morning (Q3 of 2008). This is another deceleration (see chart), but looks outstanding on a nominal basis versus countries that are swallowing themselves with leverage into the thralls of stagflation (Japan). Stocks in Prague are trading up +2.5% as they head into the European close. This is a positive divergence vs. the other countries in the region.

It will be very interesting to watch stock markets around the world reset their performance in 2009. Eastern Europe does have an interesting organic GDP growth story to tell. Romania just printed the highest growth GDP in almost the entire world last week.

Stay tuned into reality - we've got your back.

Keith R. McCullough
CEO & Chief Investment Officer

YUM – Initial Thoughts from Analyst Meeting

YUM’s senior management has a history of over promising and under delivering in the U.S. See below:

2007: At its December 2006 Investor Day, YUM provided 2007 U.S. operating profit growth guidance of 5%.

On its 1Q07 earnings call, the company revised this guidance and said that it did not expect to meet its 5% long-term growth goal but that operating profit growth should be positive.

2007 U.S. operating profit came in down 3%.

2008: At its December 2007 Investor Day, YUM again provided 2008 U.S. operating profit growth guidance of 5%.

On its 2Q08 earnings call, the company lowered this guidance and said that U.S. operating profit should decline about 3%.

U.S. operating profit year-to-date through 3Q08 came in down 11%.

2009: Today, at its December 2008 Investor Day, YUM provided 2009 U.S. operating profit growth guidance of 15% (9% from expected G&A savings).

2009 will come in ???

The company is obviously lapping an extremely easy comparison from 2008, but the company has been lapping easy comparisons (not as easy as 2008) for the last 5 years.

YUM is expecting to grow EPS by at least 10% in 2009. The company has been successful in achieving this goal in recent years with little to negative operating profit growth in the U.S. so positive growth in 2009 should help to make this an easy feat. However, YUM has also reduced its share count in the last 5 reported years and is on target to repurchase nearly $1.7 billion in stock in 2008. The company’s significant share buybacks have helped to support YUM’s annual EPS growth. Currently, the company does not expect to buy back any shares in 2009, largely because the company levered up significantly in 2008 in order to maintain its share repurchases in 2008.

SP500 Levels: Intraday Look...

It takes a bear to know one, and I think the bears are really struggling with this momentum change in the US market.

In the immediate term, I see a narrowing trading range developing (see chart). On balance, this is bullish. For now, the days of an 80 VIX are gone. From a short term momentum perspective, breaking and closing below 62.26 is negative for the VIX. Deflating volatility with accelerating volume on up days provides for a new range to trade the SP500 with an upward bias. If the SP500 can hold my new line of support at 878, I wouldn’t be surprised to see the VIX test 50-52 on the downside.

There are two very important macro calendar catalysts that I foresee the bullish narrative clinging to. First will be Friday’s bullish PPI report (inflation is dead will be ringing all over Barons this weekend is my guess), then we will have “Heli-Ben” come in and drop FREE moneys from the heavens next week at the FOMC meeting.

At a bare minimum, don’t be short these 2 catalysts.

My immediate term upside “Trade” target for the SP500 is 931.

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