The reality is a spin may only be a split/sale which could benefit enterprise value but not necessarily shareholder value.



Despite the fact that roughly 95% of CZR’s EBITDA comes from its core casino operations, most of the focus remains on the company’s interactive division.  This division currently comprises online gaming operations in the UK and social gaming through Playtika’s platforms.  Speculation (dare we say “spin”?) is that CZR’s unencumbered interactive assets will be spun off to shareholders.  Under this scenario shareholders would hold stock in 2 companies – “bad company” consisting of highly leveraged core gaming operations and “good company”, essentially an option on a huge growth business comprised of online and social gaming.  Sounds good, but doesn’t really mesh with reality.


As we wrote about in “SPIN-OFF OF CAESARS INTERACTIVE? NOT SO FAST….” on 2/28, a spin-off of CZR’s interactive assets presents several challenges:

  • A spin-off poses material tax consequences for both Caesars Entertainment and its shareholders unless they can effect a tax-free spin under Section 355
  • While it is true that Caesar’s Interactive has no debt, that doesn’t mean that it is truly “unencumbered.”  CZR’s secured lenders at the operating company and CMBS entity have upstream guarantees secured by stock in Caesar’s Entertainment Corporation (CEC) and thereby an indirect claim to anything that CEC owns.  If a spin-off occurs and debt holders don’t receive consideration for their stake, they have a strong case of fraudulent conveyance should CZRs eventually file.  Even if no filing occurs, there are likely to be lawsuits brought by debt holders to either prevent a spin or get a piece of the proceeds.
  • Federal legislation now looks a lot less likely than a few months ago since the “Barton Bill” did not get tacked on to payroll tax extension as many hoped.  There is still hope that HR 2366 will get tacked onto a piece of must pass legislation this year (e.g. Highway Bill), but the odds look slim.  An online gaming market developed through the State route will take longer to develop and be smaller in size.
  • Without the exciting growth opportunity of social gaming and the option on US online gaming legalization, the core business is a collection of a over-leveraged Regional/ Las Vegas/AC assets with a lot of deferred cap ex and a sky high interest expense bill where every cent of FCF will go towards interest service for the foreseeable future.

We recently obtained some clarification to some of these issues.  The company confirmed to us that if they decide to monetize CZR’s interactive assets in a separate entity it would likely have to be in form of a split-off or sale where the proceeds would go back to Caesar’s Entertainment.  While this may seem like a subtle clarification, for an entity that is over 11x leveraged, an accrual of proceeds from any sale back to the enterprise vs. shareholders makes huge difference.  Essentially, with a monetization of Caesars Interactive, shareholders would be left holding the bag of a highly leveraged portfolio of Caesar’s casino holdings where proceeds of any sale would likely go towards debt reduction.  This is not necessarily a bad thing but on a $22BN pile of debt, it’s hard to move the needle enough to create material equity value.


CZR’s also needs to consider the synergies of keeping the company intact:

  • State by state legislation will likely require having physical assets in each state in order to get a license. This means keeping CZR Interactive in-house maybe a necessary reality for the foreseeable future
  • Co-branding opportunities for the social gaming site
  • Question of whether a split-off of the assets would create value in excess of what investors are currently assigning to the interactive business.  A split-off of the interactive company would also introduce a second set of reporting and public company expenses as well as a fee payable CZR’s would also diminish the standalone entities’ value.

We believe that the vast majority of CZR’s $1.6BN equity cap largely reflects the value of the Interactive division and an option value of a major recovery on the core.  Without a tax free spin, the equity value of the Interactive division may be less than investors perceive.

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VRA: Demand, or Doors?


Estimates still seem too high. People should focus on Demand, not Doors. In the end, consumer demand always prevails. There’s too much Hope baked into this story.



Our  take on VRA following Q4 results hasn’t changed, we’re still negative on the name. People seem overly focused on doors, and not on end-demand. Demand will always win that battle. There still appears to be a substantial “trust” factor associated to 2H expectations. Hope, as we say here at Hedgeye is not a risk management process, we prefer to stick to the math. Here are some key takeaways from the quarter:

  • Let’s start with the good news. The Direct segment came through better than expected. Comps up +9.3% resulted in a more modest deceleration in the 2yr trend than expected while e-commerce remained solid up +28% (but down sequentially from +50% in Q3). In addition, VRA’s sales/avg. sq. ft. productivity continues to climb up to $1,290 from $1,150, which is to be expected as stores mature on such a small base (now 56). However, our concern hasn’t been the retail business per se, which we expect to grow 32% in 2012, it’s the wholesale business that we think is at risk.
  • In that regard, indirect sales were down -0.7% for the quarter on top of the easiest compare of the year. While management points to not having “those breakout patterns that we traditionally do” and how we should look at revenue growth trends on a full-year basis not quarterly, the reality is that sales across VRA’s network of 3,300 small independent retailers slowed meaningfully.
  • Our sense is that VRA’s efforts to aggressively fill its uncharacteristically fragile wholesale channel with product headed into the holiday season has left little appetite for anything but modest reorders headed into the 1H.
  • As expected, management discussed the 60 new doors at Dillard’s this year (~20% penetration) and also noted how they are “starting discussions” with other department store accounts. As noted in our prior note, this could certainly proved upside to sales growth in the channel, but we aren’t baking it into our model.
  • This actually highlights a major piece of our call. People focus too much on door growth and not enough on product relevance and desirability. Additional retail stores and major department store accounts on top of its 3,300 existing doors does very little to impact end demand for the product. Yes, it will get more eyeballs on it. But it has an inverse impact on scarcity value. Retailers are not stupid. If they see product in a store at the other end of the mall that is identical to what is sitting in their stockroom collecting dust, they’re not reordering.
  • VRA is ramping to nine new patterns in 2H compared to the historical 6-8, which helps address the issue, though the company is now extending some older successful patterns into new styles, something VRA has not typically done. Delaying the retirement of these patterns appears to undermine confidence in the current run if not indicate uncertainty/concern regarding current demand.
  • In addition, Indirect segment margins were down sharply -580bps in Q4 due to higher fixed expenses (i.e. a larger sales force). It’s worth noting that the Indirect business needs to grow revenues MSD-to-HSD in order to leverage this new investment. Perhaps it should come as no surprise then that management’s full-year guidance for the business is…you guessed it, up mid-to-high-single-digit.
  • This guidance for the Indirect business implies that when you strip out the contribution from another 60 Dillard’s doors accounting for roughly 3% revenue growth and incremental shop-in-shops in Japan, it assumes a modest contraction in the core channel. We don’t think that’s conservative enough. We have Indirect sales down 4% for the year reflecting cannibalization from company-owned stores and more conservative ordering to work down inventories. At this point in VRA’s growth cycle we shouldn’t be seeing the wholesale business rolling like this if there strong underlying demand in the market.
  • As for margins, we expect operating margins down -275bps in Q1 and -215bps in Q2 and down -50bps for the year. We expect higher costs and the likelihood for higher promotional activity to weigh on gross margins in the 1H in addition to higher SG&A investments made in the 2H that we don’t expect to lever until Q4.
  • Inventories at quarter end were one of the highlights of the quarter up +11% compared to +23% sales growth. As a result, the sales/inventory spread improved substantially after five straight negative quarters (see SIGMA below). This is bullish for gross margins on the margin, but we don’t think enough to offset the aforementioned pressures.
  • Lastly, the DC expansion underway will moderate VRA’s typically strong FCF. With $36mm in CapEx budgeted for the year, we expect FCF margin to come in at 3% compared to 13% and 7% in each of the last two years. While we expect FCF margin to return to a HSD rate next year, this will limit VRA’s balance sheet flexibility near-term

All in we are shaking out at $0.27 for Q1 and $1.58 and $1.64 in EPS for F12 and F13 respectively 19% below Street expectations next year (F13). We continue to think the Street is missing the structural risk in VRA’s wholesale account base as it rolls out its owned-retail stores more aggressively. Despite a 9% hit to the stock today, we think there is more downside ahead as expectations head lower.


Casey Flavin



 VRA: Demand, or Doors? - VRA SIGMA



Shorting Greece (GREK): Trade Update

Positions in Europe: Short Greece (GREK), Short Spain (EWP)

Keith shorted Greece in the Hedgeye Virtual Portfolio today with the Athex trading comfortably below its immediate term TRADE and long term TAIL levels (see chart below).


Shorting Greece (GREK): Trade Update - 11. GREK


Greece remains the poster child for Europe’s sovereign debt excesses, of which its banks are highly levered. While many expect the ECB’s two 36 month LTROs liquidity injections to put Europe’s sovereign debt and banking crisis to bed, we’ll take the other side, and take advantage of price swings across the PIIGS equity indices, as growth expectations should continue to decline throughout 2012.


At a bare minimum, we think the assumptions from Troika that Greece can reduce its public debt to 120% of GDP by 2020 are overly optimistic, which implies the need for yet another bailout.  But aren’t Eurocrats wishing for more bailouts ahead in artificially supporting an uneven union of countries, some of which should default and consider returning to their own currency?


In addition, we expect social unrest to erupt in Spain on the near horizon over unemployment and fiscal consolidation, which will further pack this already topped-off Eurozone powder keg.


Matthew Hedrick

Senior Analyst


Following a disappointing February sales release, MCD spoke at the UBS Global Consumer Conference yesterday and added some perspective to the long term outlook for the company.  In particular, investors are asking if momentum is going to be maintained whether or not there are measures the company can take to counteract the negative impact of austerity in Europe on its top line. 


COO Don Thompson spoke to the audience at the conference and the standout comment from him was that “globally, breakfast is a huge opportunity”.  Looking at the proportion of sales that breakfast represents in different geographies as a percentage of sales, it is clear that some markets are not leveraging breakfast as much as others.





Below we highlight some of the key topics that were discussed during the McDonald’s presentation yesterday along with our thoughts on several issues for the company.





MCD:  “In the U.S., breakfast continues to be strong.  Keep in mind as well, in breakfast, we've done a lot of things to make sure that breakfast continue to be a very viable strength for us, everything from operational changes and organizational changes in the restaurant to the products, to the breakfast value menu, even to the percentage of products relative to McCafés that are sold at a breakfast timeframe, albeit lower, still accretive to the overall sales at breakfast.”


HEDGEYE: The biggest issue facing the breakfast day part for all operators is employment.  Increasing frequency in the breakfast day part on a global basis is important for the continued growth of the company.  In the end, cultural differences may limit the ultimate potential of breakfast in international markets and the levels seen in the U.S. may not be an appropriate yardstick to measure success.  However it is clear that the company is seeking to export its success in breakfast to other markets where possible.





MCD: “When gas prices become elevated consumers do some things we call ‘travel bundling’… so rather than go out four or five times, one to go to the grocery, one to go to the cleaners, one to go someplace else, they tend to do a bundle and they'll make one travel path and get all three or four of those things done.”


HEDGEYE: Consumers are stretched and behavior is changing to better enable navigation of inflation, stagnant wage growth, and economic uncertainty.  MCD’s stock performance is not as tightly correlated to initial jobless claims (inversely) as other restaurants but breakfast, especially, would be aided by employment gains and consumer uncertainty would be assuaged by a continuation of positive macro-related headlines.  For the company’s side, management is focusing on the marketing message and paying close attention to its consumer’s behavior.





MCD: “Some consumer confidence issues clearly around the world based up on the economies, but you have variances around the world.  When you are in the U.S., we typically say whether U.S., Europe, Asia, well there is no country called Asia or Europe and so when you look at the various markets you see different things. So as an example in Europe, if I looked at a markets like the U.K., markets like Russia, tremendous growth, the GDP is solid, I mean we're just, we're rolling along. You go to a market like France, markets like Germany, these are markets that now we see consumer confidence weighing in the scales and there is a lot more trepidation.


HEDGEYE: Four companies that we follow have used the word “austerity” in describing risks to their businesses: YUM, MCD, SBUX, and DPZ.  Clearly, any consumer-facing business with exposure to Europe faces this risk but on March 8th, MCD became the first company that we cover to state that austerity is having an impact on income growth.  Don Thompson including Germany in his commentary above was incremental to our conversation with management following the February sales release.  Perhaps Germany is somewhat on the fence but we left the conversation with management last Thursday under the impression that Germany was performing well.





MCD: “There were two adjustments made in two of the major markets yesterday and the day before yesterday.  And by adjustments what I mean, for us what an adjustment means is an opportunity we get with the franchisee base to talk about where we position in the marketplace and what lever we may need to pull more … So but some adjustment may be we've got bring in this new platform because things are bad now it just means we may do a little shifting … crank up certain messages a little bit more. We may focus a little bit more on P&L optimization efforts at a restaurant level as we stress value a little bit more in certain markets.”


HEDGEYE: Given that Don Thompson met recently with operators in Italy, Spain and France, we would be confident that those two markets mentioned above are two of the three he visited.  All three markets have been struggling of late and McDonald’s needs to crank up the value message to improve traffic trends. 





MCD: “We have 50% of our exteriors done in the U.S. versus 90% in Europe.  In Europe they still have a way to go on exteriors.  We will be close to 100% of all the sites that we've identified that we want to do by the end of 2012.”


HEDGEYE:  In 2012, we are anticipating a slowdown in two-year average trends in Europe.  Clearly the European market has also benefitted from remodels and the company selling premium products.  The conclusion of the remodeling program and the result now-impactful austerity measures could nullify these positives. 


For the majority of 2011, the two-year average trend for MCD’s Europe comps was just above 5%.  McDonald’s has said that in the past that the remodel program has boosted sales by 6-7%.  Heading into 2012, 85% of stores in Europe are remodeled.  This program has allowed McDonald’s to increase capacity via the drive through, in particular, but the new look and feel has also enabled the company to sell more premium products.





MCD: “I think the projection for 2012 is for the grocery store prices, the food at home to moderate a little bit in the maybe 4% to 5%, 3% to 4% range and food away from home to be more like 2% to 3%. So that gap is closing but the projections are still for the grocery stores to be a little higher. If that means for us, our back store cost won't increase as much, that's a good thing.”


HEDGEYE: As our chart below illustrates, the spread between food at home CPI and food away from home CPI has been narrowing over the past four months.  If the trend over the last four months were to continue, assuming the average rate of narrowing since the spread stopped widening, by the end of the second quarter the spread would be closed.  While this is not a foregone conclusion, it is important to note that – on the margin – the gap has been closing and offering less of a competitive advantage to restaurants versus grocery stores.  CPI data released tomorrow will update us on this trend.


MCD: READING BETWEEN THE LINES - food at home vs food away from home cpi white



Howard Penney

Managing Director


Rory Green




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