Unproductive Works

This note was originally published at 8am on April 13, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.”

-John Stuart Mill


John Stuart Mill was arguably the most influential philosopher of the nineteenth century and his writings are still widely studied.  Mill is probably best known for “On Liberty”, which discusses the limits of power that can be justly exercised by society over the individual.  Underscoring his views on liberty are the harm principle and the idea that the individual should have the right to act as she wants as long as those actions do not harm others.  To Mill, protecting and defending individual rights in the face of a potentially tyrannical majority are critical.


One way a majority can negatively influence the rights of the minority is through capital allocation by the government.  We often cite the long run historical work of Reinhart and Rogoff that highlights when government debt-as-a-percentage of GDP reaches 90%, or more, economic growth slows.  Certainly governments play a critical role in providing certain services that are critical and broadly benefit society, but, at a point, government works become unproductive.


With all that is happening in the world, I’m sure many of you missed the U.S. budget numbers for March.  As I said on twitter ( @HedgeyeDJ ), they were, in one word, ugly.  The federal government received $171 billion in revenue and spent $369 billion for a total budget deficit of -$198 billion, or 5.5% year-over-year monthly growth in the deficit. This is the largest March budget deficit of any nation, ever. 


Almost exactly a year ago, in a note titled “The Case of the Missing Stimulus”, I wrote:


“Interestingly, if we look at government spending in the 2008 – 2010 period we can actually see the impact of the stimulus act on government ledgers. In fact, according to the U.S. federal government spent $2.98 trillion in 2008 and $3.59 trillion in 2010. So, the net increase over this period was just over $600 billion, which roughly equates to the spending portion of The Stimulus.”


My point in that note was that while there was a one-time step up in government spending, there has not been a step down as the stimulus plan has been anniversaried.  A year later the same story holds. 


The Chart of the Day today highlights government outlays by month going back ten years.  The conclusion is that the “one-time” increasing in government spending for the stimulus plan has led to a seemingly permanent increase in government spending.  Given the anemic growth we’ve seen in the U.S. over the last 18 months, it is pretty clear this spending fits the category of Unproductive Works.


At 11 am eastern today we will be holding our quarterly theme call. (Please email if you are qualified subscriber and do not currently have the dial in information.)  The quarterly theme call is our summary of what we think will matter in the coming quarter from a global macro perspective and the best way to play the themes via asset allocation.  The themes for this quarter are as follows:

  • The Last War: Fed Fighting - We take a historical look at U.S. Federal Reserve policy to contextualize the impact of Ben Bernanke's Policy to Inflate, Extend & Pretend rock-bottom interest rates, and Burn the Buck on the broader economy and financial markets from Main Street to Wall Street.
  • Bernanke Bubbles - A highlight of the top ten leverage price bubble charts perpetuated and encouraged by The Bernank's policy stance.
  • Obvious Asymmetric Risks - In a macro environment of slow global growth and historically low interest rates we present asymmetric risks to capitalize on over the intermediate term. Low equity market volatility is but one signal of what's ahead for investors.

Underlying much of the discussion today, will be our view that global growth is slowing.  On that note, and despite rumors to the contrary, Chinese GDP growth came in at 8.1%.  This was well short of the estimate of 8.4% growth and dramatically below the “whisper” number of 9.0% that was floated yesterday.  This is the 5thconsecutive decline and the slowest growth rate in three years.  As our Asian Analyst Darius Dale would likely tell you, the actual number shouldn’t surprise anyone as the Chinese have already told us they are going to slow growth.


In other global macro news, European sovereign debt issues are once again front and center.  Yesterday, I wrote a note on Spain and the impact of further decline in real estate prices on Spanish growth (if you didn’t read the note and want a copy, ping  Spanish 5-year CDS are wider again this morning at 492 basis points.  Meanwhile, Spanish equities are down another -2% taking their return in the year-to-date to -14%.  As if that wasn’t bad enough, Spanish CPI was also up +0.7% for the month.  (Not so great for the 23% of Spaniards that are unemployed.)


If you are looking for a positive catalyst today, Chairman Bernanke speaks at 1 pm today in New York.  Even if he doesn’t hint at it, no doubts rumors of QE 3, 4, 5, and 6 will be spreading faster than Chinese growth ahead of his speech.


As you head into the weekend and start contemplating the upcoming Presidential election, I’ll leave you with a quote from a guy that knows a thing or two about U.S government, former President George Washington, who said:


“Government is not reason; it is not eloquent; it is force. Like fire, it is a dangerous servant and a fearful master.”




The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), Euro/USD, and the SP500 are now $1617-1675, $118.89-122.64, $78.74-79.66, $79.83-83.02, $1.31-1.33, and 1354-1392, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Unproductive Works - Chart of the Day


Unproductive Works - Virtual Portfolio


TODAY’S S&P 500 SET-UP – April 27, 2012

As we look at today’s set up for the S&P 500, the range is 11 points or -0.64% downside to 1391 and 0.14% upside to 1402. 












    • Down from the prior day’s trading of 1631
  • VOLUME: on 4/26 NYSE 780.19
    • Decrease versus prior day’s trading of -5.11%
  • VIX:  as of 4/26 was at 16.24
    • Decrease versus most recent day’s trading of -3.45%
    • Year-to-date decrease of -30.60%
  • SPX PUT/CALL RATIO: as of 04/26 closed at 1.31
    • Down from the day prior at 1.45 


  • TED SPREAD: as of this morning 38
  • 3-MONTH T-BILL YIELD: as of this morning 0.09%
  • 10-Year: as of this morning 1.93
    • Down from prior day’s trading of 1.94
  • YIELD CURVE: as of this morning 1.68
    • Unchanged from prior day’s trading 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Employment Cost Index (1Q), est. 0.5% (prior 0.4%)
  • 8:30am: GDP (Q/q) (Annualized) 1Q A, est. 2.5% (prior 3.0%)
  • 8:30am: Personal Consumption, 1Q A, est. 2.3% (prior 2.1%)
  • 9:55am: U.Mich Confidence, Apr. F, est. 75.7 (prior 75.7) 


  • Obama speaks to troops at Ft. Stewart in Hinesville, Ga.
  • FCC meets on practice of billing for unauthorized charges known as “cramming,” national broadband plan,  11am
  • House, Senate in session:
    • House Ways and Means panel holds hearing on premium support model for Medicare, 9am 


  • U.S. GDP probably gained at 2.5% annual rate after biggest increase in consumer spending in yr, economists est.
  • Ford Motor’s European outlook may be focus for investors as automaker releases earnings today
  • Merck may comment on new drugs, M&A as part of earnings discussion
  • Real estate investors competing to buy Manhattan apartment buildings have sent prices to record highs: Real Capital Analytics
  • Yuan declined more than 0.5% from central bank’s reference rate
  • for first time ahead of China-U.S. talks next week
  • Spanish Economy Minister Luis de Guindos ruled out seeking a bailout hours before S&P cut rating
  • Samsung overtook Nokia as world’s biggest vendor of mobile phones: Strategy Analytics
  • Global earnings: Nomura profit beats est.
  • Goldman Sachs banker Matthew Korenberg has been subject of U.S. insider-trading probe for 2 1/2 years related to Galleon: lawyer  Client
  • Companies must resubmit clean-energy loan applications in Washington by today for U.S guarantees denied last year
  • Huse approved a Republican-backed cybersecurity bill yesterday; Obama has called measure flawed and threated veto 


    • Calpine (CPN) 6:00am, $(0.13)
    • Covidien (COV) 6:00am, $1.03
    • Magellan Health Services (MGLN) 6:30am, $0.90
    • Newell Rubbermaid (NWL) 6:30am, $0.31
    • Barnes Group (B) 6:30am, $0.44
    • Goodyear Tire & Rubber/The (GT) 6:30am, $0.07
    • Coventry Health Care (CVH) 6:30am, $0.67
    • Ford Motor (F) 7:00am, $0.35
    • DTE Energy (DTE) 7:00am, $1.09
    • International Paper (IP) 7:00am, $0.50
    • Merck (MRK) 7:00am, $0.98
    • Simon Property Group (SPG) 7:00am, $1.68
    • Procter & Gamble (PG) 7:00am, $0.92
    • Lazard Ltd (LAZ) 7:00am, $0.24
    • VF (VFC) 7:00am, $1.88
    • Imax (IMX CN) 7:00am, $0.07
    • Flir Systems (FLIR) 7:30am, $0.33
    • Ventas (VTR) 7:30am, $0.86
    • American Axle (AXL) 7:30am, $0.64
    • KKR & LP (KKR) 8:00am, $0.72
    • Pilgrim’s Pride (PPC) 8:00am, $0.09
    • Canadian Utilities Ltd (CU CN) 8:07am, C$1.36
    • TransCanada (TRP CN) 8:11am, C$0.54
    • Chevron (CVX) 8:30am, $3.28 


  • Gold Traders Get More Bullish as Central Banks Buy: Commodities
  • Oil Falls From Four-Week High as Spain Cut Renews Demand Concern
  • Copper Swings Between Gains, Drops on Lower Stocks, Debt Crisis
  • Soybeans Set for Third Monthly Advance on South American Crops
  • Sugar Smuggling Into China Soars to Highest in 17 Years on Price
  • Gold May Fall in London as Stronger Dollar Curbs Investor Demand
  • Copper Stockpiles in China Climb to Record, StanChart Says
  • Gold May Advance Above $1,700, Infinity Says: Technical Analysis
  • Mercuria Seeks Investor for 20% Stake as It Expands in China
  • Cnooc Cuts Costs With Bonds After Bohai Oil Find: China Credit
  • California’s Mad Cow Had Been Euthanized After Falling Ill
  • Newmont First-Quarter Profit Beats Estimates on Gold Production
  • YPF Grab Spurs Biggest Jump in Default Risk: Argentina Credit
  • Cocoa Heads for Third Weekly Gain as Investors Buy; Sugar Drops
  • Global 2012 Steel Use to Rise 3.6% on U.S. Recovery, Group Says
  • Mittal Aids India-Pakistan Detente With Border Refinery: Energy























The Hedgeye Macro Team



The Macau Metro Monitor, April 27, 2012




The unemployment rate for January-March 2012 was 2.0%, down by 0.1% point over the previous period (December 2011-February 2012).  Total labour force was 347,000 and the labour force participation rate stood at 72.9%. 

Daily Trading Ranges

20 Proprietary Risk Ranges

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AMZN: Key 1Q Deltas

No secret that AMZN smoked the quarter. They give sparse guidance and disclosure -- combined with meteoric growth on a massive $48bn revenue base and sub-2% margins, this company has never been afraid to print a number three standard deviations from the mean. 


Importantly, after 3 quarters of deterioration in the underlying 2 yr top line trends, 1Q marked a reacceleration in growth with the midpoint of 2Q guidance suggesting additional improvement in underlying trends moving through 1H. Although EBIT guidance of (-$260mm) to $40mm was shy of expectations ($152mm E), its worth noting that AMZN has remained profitable after guiding to a potential operating loss in both of the last 2 quarters. 


What Drove the Beat?


Revenue: +34% vs. +31E (North America contributed 20 points of growth, Int’l 14 points)

  • North America: +36% vs. +34E
  • International: +31% vs. +28E


Gross Margin: +114bps vs. -47E


SG&A: +54% vs. +46E (+295bps as % of sales vs. +230)


EBIT Margin: -181bps vs. -277E


Equity Method Investment (net of tax): $89mm benefit vs. $17mm unfavorable impact LY ($0.19 benefit)




Below is the AMZN SIGMA and the Key Takeaways from this evening’s conference call:


Quarterly Review:


TTM FCF: -39% to $1.15bn

ROIC: 12% (Down from 24%)

Stock repurchase in Q: 5.3mm shares at $960mm



North America: +36% Sequential Deceleration

  • Media: +17% Acceleration
  • EGM: +45% Deceleration
  • Other: +65.3% Acceleration
  • EBIT margin: -61 bps


International: +31% (+32% constant currency) Sequential Acceleration

  • Media: +21% (+18% cc) Acceleration
  • EGM: +40% (+42% cc) Acceleration
  • Other: +24% (+26% cc) Deceleration
  • EBIT margin: -313 bps


Worldwide: +34% (+34% constant currency) Sequential Deceleration

  • Media: +19% (+19% cc) Acceleration
  • EGM: +40% (+43% cc) Deceleration
  • Other: +61% (+61% cc) Acceleration
  • EBIT margin: -181 bps


Additional Metrics:

Worldwide paid unit growth: +49%

Active Customer Accounts exceeded 173mm

Worldwide active seller accounts exceeded 2mm

Seller units: 39% of paid units vs. 35% paid LY


SG&A: +54% (+295bps as % of sales)

Fulfillment: +52% (+115 bps as % of sales)

Marketing: +47% (+32 bps as % of sales)

Technology/Content: +63% (+129 bps as % of sales)

G&A: +50% (+17 bps as % of sales)

Other: +39% (+1 bps as % of sales)



Balance Sheet:

Inventories: +47% (turns 10.4, down from 11.6 LY)

Accounts payable days down 62 from 66

Capex: $386mm (reflects business growth, investments in tech infrastructure incl AWS and additional capacity to support fulfillment operations)


2Q Guidance:

Revenues: $11.9 billion to $13.3 billion (+20%-34% vs. +30E)

  • Anticipates 240bps unfavorable impact from FX

Operating Income: $(260) million and $40 million vs. $152.4

Capex: $0.8 to $0.9bn



Q&A Rundown:


2012 Fulfillment Center Plans:

  • Have announced 13 fulfillment centers thus far for 2012
  • Any changes will be announced but experiencing strong growth at retail as well as third party growth increasing over 60%, FTA also strong


North American Operating Margins:

  • Investing heavily in both NA & International
  • Have launched new Int'l' geographies over the last few years where AMZN continues to invest which is some of the dynamic impacting international margins vs. North America


Third Party Growth

  • Strong growth across Int'l as well as North America
  • Investing on behalf of customers and sellers as well as retail for the required capacity
  • Fulfilled by Amazon having a positive impact on all of the geographies AMZN operates in


Employee base growth:

  • Adding a great deal of resources across a number of areas
  • Vast majority of Q1 employee growth in operations and customer service
  • A lot of Q4 hires are temporary with a lot of those going permanent coming out of 2011 in 1Q12



  • Currently have inventory on hand to support the Amazon Supply business
  • Inventory increases have been broad across a number of different business, categories and geographies


Amazon Supply

  • Have been serving businesses for sometime- Amazon supply is a separate URL with an interesting selection to continue to serve businesses


Kindle Fire:

  • Pleased with the growth seen in Kindle Fire
  • Customers buying a lot of content particularly in North America
  • Part of acceleration in Media growth in NA due to Kindle content


Media growth:

  • Video games are a seasonal business and brought down growth in Q4 which did not continue into 1Q12
  • Adding more video content which is reflected in top line guidance


Category headwinds/tailwinds:

  • Supply issues related to Thailand floods created a headwind in 4Q11 & 1Q12 in categories including cameras, audio equipment & office equipment- It helped in cases where third party sellers still had inventory
  • Had strong broad based growth in Q1 across many categories
  • Strong growth in kindle globally
  • AWS is growing fast


Europe impact on international sales

  • Having some impact on performance


Mobile purchasing behavior:

  • Mobile business is growing fast and is an exciting opportunity
  • Will continue to work on the category to enhance the customer experience over time



  • Approx 50% of sales collect a sales tax or value added tax (several states in the US today and a large number of geographies outside of the US)
  • Have good businesses in those geographies

 AMZN: Key 1Q Deltas - AMZN SIGMA


BYI delivers another beat with a bright outlook


“Our third quarter financial and operating results are showing the payoffs from multiple investments as we execute on our growth initiatives. Bally continues to have a bright future as we partner with our customers to innovate the gaming experience.”


 - Richard M. Haddrill, the Company’s Chief Executive Officer



  • In June, they will begin placing Michael Jackson
  • 22% share of new openings this quarter
  • 21% ship share in Ohio, which they will recognize in the June Q
  • Have 7,500 iVIEW DMs deployed with 9 applications
  • Game sales: 2936 units were sold in NA, 635 of which were opening and expansion units and 2,301 replacement units
  • Had higher conversion kit revenues in the quarter which also helped margins
  • Anticipate game sales gross margin will decline slightly in the 4Q given the number of new openings.  However, they still maintain that margins will reach 48-49% in the next few quarters.
  • Strong recent success with cash connection products (WAP) helped game operations revenues. 
  • Systems revenue: Maintenance was $19.6MM. Anticipate that 4Q systems margin will return to the higher end of their historical margin of 70-75%.
  • March 31: $35.7MM of cash
  • Expect to increase their buyback authorization in the next few months if needed
  • Made good progress in Italy - they had finished their trials before going live.  However, the delays in approvals have lead some customers to seek other suppliers for their VLTs.
  • Progress in Australia has been slower than expected but they did ship more units sequentially
  • Continue to make good progress in Illinois.  Had good discussions with customers there, have signed several contracts and feel their products are well positioned for the market.  They expect to begin initial VLT shipments in Illinois 2H CY2012.
  • Developing iVIEW DM account wagering applications
  • Sees great systems growth ahead for the next few years
  • General industry trends seem to be improving
  • Still pursuing acquisitions in the area of technology where they can leverage their expertise


  • Canadian systems update: moving along exactly as planned.  They are already generating service revenues and will begin recognizing go-lives at the end of calender 2012.
  • Expects systems margins, depending on mix, to trend in the 70-75% range
  • Expect to reduce cost of game cabinets over the next 6-9 months which is why they think that they can get to that 48-49% margin without taking ASP increases into account.  Conversion kits also helped.
  • Cannibalization is really hard to measure, but they assume it will be relatively low given that they don't have a lot of WAP games out there
  • Game performance on Grease is very strong and exceeding their expectations. Expectation of success, based on prior experience, is getting 750 of each title out. They still think that those expectations are reasonable.
  • ASP delta on international vs. domestic games is about $1k - depending on how many Mexican units they ship
  • September is usually the weakest replacement quarter; the others are harder to predict.  They do not think that March was a pull-forward quarter.
  • The vast majority of their WAP units this Q were Grease
  • There is no change to the Michael Jackson schedule based on Grease.  It's expected to be out about 30 days ahead of schedule.  They just want to get it out in the field as soon as possible.
  • This quarter was their largest DM installation quarter.  They expect that trend to continue. 
  • Their core games are doing well.  They have shifted a little more of their R&D to WAP than their core premium game segment.  Overall premium segment yield hasn't really changed QoQ.  They are always releasing conversions for their premium cabinets.
  • Hope to have one or more poker partners announced within 60-90 days or sooner.  Partners are important to enhance liquidity.
  • As they get more video content, and as most international markets are video based, it will help them grow internationally
  • See their operating margin getting into the 25% range over the next 3-4 quarters.  
  • The impairment was 2-2.5 cents  - so adjusted EPS would have been 69 cents
  • Conversion revenue was up slightly YoY but more so QoQ.  Conversion revenue is still relatively small for them, so this is an opportunity for slow and steady growth for them.
  • The Eldorado computation ran for 3 weeks from the beginning of April 
  • The write-off of $1.75MM was included in their SG&A line
  • I-gaming strategy:
    • They are converting BYI content to be internet ready
    • Growing their mobile content
    • Platform to link the information from their I-gaming customer to their land-based systems
  • Games like Michael Jackson and Grease should produce ample revenue to offset the cost of the IP.  Look for them to do a few IP titles per year.


  • Raised the low end of the range for FY12 EPS guidance by 12 cents to a range of $2.37 to $2.45 compared to the Street at $2.42
  • “This quarter’s operating results are a testament to our continuing progress in all major business areas. Our ALPHA 2 Pro Series titles are performing well..., our gaming operations installed base is expanding driven by products like GREASE, and our Systems business continues to move forward at a healthy pace both in terms of product improvement and the number of new customers joining the Bally Systems family every month."
  • “We continue to thoughtfully allocate capital to invest in our growth, as well as to enhance shareholder value.  This quarter represents the 18th quarter in a row that we have repurchased stock. Since December 31, 2011, we purchased approximately 1.2 million shares of common stock for $54 million at $45.69 per share, of which $41 million was in our third quarter, all while remaining under two turns of leverage.”
  • "As of today, the Company has approximately $57 million available under its Board-authorized share repurchase plan."
  • Product sales:
    • New devices: 4,147 (international: 29%)
    • ASP: $17,073
    • "ASP... increased... primarily as a result of product mix and an increase in ASP from international sales"
    • "Gross margin increased... primarily due to mix and cost reductions on certain models of the Pro Series line of cabinets. Additionally, the prior year included certain write-downs related to older technology platforms."
  • Gaming operations:
    • "GREASE, our latest wide-area progressive, reached an install base of 127 units, with better-than-expected initial performance. Overall wide-area progressive revenues set a quarterly record, and overall wide-area progressive revenue-per-day exceeded $100 per unit during the quarter.”
    • "Revenues a quarterly record... driven by growth in the installed base of premium and wide-area progressive games, as well as placement of games at the recently opened Resorts World Casino New York"
  • Systems:
    • Maintenance revenues increased to a record $20MM
    • Gross margin decreased...YoY "primarily as a result of the change in mix of products. Specifically, hardware sales were 36% of systems revenues, and software and service sales were 30%, as compared to 34% for hardware and 31% for software and services in the same period last year."
  • "SG&A increased $6 million primarily due to an increase in payroll to support key new markets and includes a
    $1.8 million impairment on notes receivable related to development financing"

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