Gnarly: SP500 Levels, Refreshed

POSITIONS: Long Healthcare (XLV), Short Industrials (XLI)


Growth Slowing and Deflating The Inflation, at the same time – gnarly.


I don’t think people want to hear me opining about this anymore. We made the research call in March, when it should have been made. Now it’s all about the risk management levels: 

  1. Intermediate-term TREND resistance = 1366
  2. Immediate-term TRADE support = 1344
  3. Long-term TAIL support = 1281 

In other words, we’ll probably keep bouncing to lower-highs on no-volume and mean reverting towards 1281 on the downside until the fundamental Growth Slowing slows at a slower rate and/or we see a close > 1366.



Keith R. McCullough
Chief Executive Officer


Gnarly: SP500 Levels, Refreshed - SPX

BBBY: Congratulations on Diworsification

This one is ominous. After three years of benefitting from a competitor’s demise, BBBY’s organic growth rate is slowing due to secular and cyclical forces. So what does it do? Buys something 3x larger than any other deal it’s done. Good luck.


Congratulations BBBY, you just made it a notch higher on our short list. Seriously…Cost Plus? What’s next, Big Lots? Shopping rule number 1… Just because you could get something cheap it does not mean you should buy it. With your $515mm purchase of CPWM, you get an extra $1bn in revenue, including $400mm in consumables (something you do almost none of today). This is a different animal altogether. Translation = you have a healthy, 16% EBIT margin business today, and you just bought something that struggles to keep up even the hope of getting to a 5% margin.


Asset turns higher at CPWM (therefore offsetting low margins to keep returns high – a la Costco and Sam’s). Yes. But we’re talking 2.65x asset turns vs 1.67 for BBBY. COST runs at 3.50, and BJ runs at 4.85.


As for timing, BBBY is running against some obvious secular challenges with internet competition, and is also facing tough compares as it relates to where it is in its cycle. Driven by mid-to-high single digit comps upon lsd square footage growth over the past 3-years, operating profit grew 46%, 31%, and 22% in 2009, 2010, and 2011, respectively. Many people forget that this is the precise period after which Linens and Things went bankrupt. Since then, EBIT growth has eroded sequentially, Amazon has come on hard, and the company has taken evasive maneuvers to streamline its operations – including relocating its headquarters by 50 miles (causing a potential talent retention problem).


The bottom line here is that this business needs to be fixed. And fixed in a pretty meaningful way. BBBY has done acquisitions in the past, and has ‘fixed’ them to an extent. But lets keep the numbers in context. Each of its prior three acquisitions accounted for less than 30 stores – or 7% of BBBY’s existing size – at the time of acquisition. Cost Plus equals 22%. This is a major statement by the company that it has to move further outside its (extremely profitable) core to continue to deliver the growth that it’s multiple deserves.


We don’t like it one bit.


BBBY: Congratulations on Diworsification - bbby stores


Fast Facts About Cost Plus:

Cost plus is a specialty retailer of casual home furnishings and entertaining products in US. They currently operate 258 stores in 30 states under the names “World Market”, “Cost Plus World Market” and “World Market Stores”. The company’s strategy is to differentiate itself by boasting a largely unique, ever-changing selection (many of which are imported) at value prices in an exciting shopping environment. A large portion of products are proprietary or private label. The “World Market” brand is typically not available in department stores or other specialty retailers. One of the primary differences between BBBY & CPWM is that 40% of CPWM sales are in consumables with the remaining 60% in home furnishings. Additionally, within home furnishings, CPWM offers ready to assemble living room/dining room pieces as well as sofas, chairs, as well as outdoor furniture.


Home Furnishings: Furniture, rugs, pillows, bath linens, lighting, window coverings, frames, and baskets. Furniture products include ready-to-assemble living and dining room pieces; sofas, chairs; unique handcrafted case goods and occasional pieces; as well as outdoor furniture made from a variety of materials.


Consumables: Gourmet foods and beverages, including wine, microbrewed and imported beer, coffee, tea, and mineral water. The wine assortment offers a number of moderately priced premium wines. Foods generally have a shelf life of 6 months or longer.


Stores (generally 15,700 square feet) are designed to evoke a “marketplace” feeling. The company feels its stores are a destination store with a specific purchase in mind (largely similar to BBBY).


Online sales currently represent ~3% of sales (



The Company purchases its merchandise from approximately 2,000 suppliers; the largest of which represented approximately 3% of total purchases in the fiscal year ended January 28, 2012. A significant portion of Cost Plus World Market’s products are manufactured abroad in over 50 countries in Europe, North and South America, Asia, Africa and Australia.



Net sales were $964mm in 2011 at an 32% GM and 3.3% operating margin. 


BBBY: Congratulations on Diworsification - cost plus outside


BBBY: Congratulations on Diworsification - cost plus main floor 


BBBY: Congratulations on Diworsification - cost plus 3


Yes hold was high but Mass continued it's upward trend



"These results highlight our continued success in developing our mass market business, particularly at the premium end, where we have further strengthened our diversified range of products, services and amenities to address Macau's fastest growing gaming segment."


- Mr. Lawrence Ho, Co-Chairman and Chief Executive Officer of Melco Crown Entertainment




  • Opened 3 new junket rooms at CoD recently, which should benefit their RC volumes in 2Q
  • Opened their new premium mass/gaming segment CoD earlier this month
  • Ted Chan has assumed the role of COO
  • MSC: continue to work with the government to bring this project to reality. Think that they can restart construction at the end of Q2
  • Believe that their Mass hold rate will be in the 25-30% range going forward due to some changes that they have put in place at CoD
  • Hold adjusted EBITDA would have been $210MM
    • Hold adjusted EBITDA margin of 22% 
  • 2Q guidance:
    • D&A: $90-95MM
    • Corporate expense: $18-20MM
    • Net interest: $23-25MM



  • MSC budget of $1.9BN is still their target budget.  They are still bidding out the project with several construction companies and have not gotten any push back so far.
  • They are looking at improving the VIP segment of their slot offering and that has benefited their slot win.  There are a lot of synergies between the premium mass business and high limit slot area.  Their recently opened premium gaming area includes a new high limit slots room.
  • They are still looking at building a sky walk between CoD and Venetian.  They are in discussions with Sands China.
  • With the table cap they have been on a table optimization program for the last 4 quarters. They have moved some of the junket VIP tables from Altira to CoD. They moved about 15-20 tables from Altira. 
  • SCC impact/ effect: Currently, they just have a limited offering but even so they have seen a lift in traffic and visitation to the Cotai Strip and CoD.  Think that once the property is fully open it will be even better for the Strip in driving visitation.
  • New premium mass space at Grand Hyatt
    • See great depth in the market which allows them to continue to focus on the high end Mass segment. They have allocated more rooms in the Grand Hyatt to the premium Mass segment and that is helping them on the Mass hold rate as well. There is also more potential to allocate more rooms to this segment
  • MSC: they remain very respectful of the government approval process. Their approval process is a little different. They will only make an announcement when they get permission to restart construction.  They still expect a 36 month construction timeline once they commence construction. 
  • MSC financing: still have no plans to raise equity
  • MSC theme: taking the movie concept to the next level. In due course when they restart construction they will announce their plans.
  • They do have the capacity to consider additional projects in or outside of Macau. However, outside of Macau, timing on any new projects is not imminent. They are focused on MSC.  
  • Regarding the Philippines - they are more interested in the larger and more stable jurisdictions.  Phillipines is definitely up and coming.  Their main focus is getting MSC off the ground. They are a "very focused group."
  • It looks like there will be at least 3 projects that are targeting openings in Cotai in mid-2015-2016.  How will they compete for tables and labor?
    • The government will likely want to stagger the openings of these projects to avoid all these projects opening at the same time 
    • They have a head start on the competition since they have already completed the piling work
    • When there is a need for additional labor, the government will allow more foreign workers to come in
    • There is a clear communication that from now until 2022, an additional 2,000 tables will open.  The table additions don't necessarily have to be equally spread across each year.
  • On the VIP segment, they are no longer competing along credit and commission lines but rather on quality. On the mass side, there are some changes in the market, but they do not see a significant impact since they are focused on the higher end mass segment. 
  • Bad debt / receiveables: the provision is flat to where it's been trending and they had a decrease in receivables sequentially. Not seeing any collections or credit issues in their business.
  • Why did VIP volumes decrease YoY at Altira and a slow down in CoD volume?
    • There has been additional supply in Cotai 
    • Also in April they have been renovating their space as well which impacted them at CoD
  • Why not add another tower at CoD?
    • They are looking at doing that and have made certain submissions to the government
    • They do want to make sure that MSC gets off the ground first, but don't need to wait for MSC to be complete to start on the tower
  • What permits do they need for MSC to proceed?
    • CoD had been re-gazetted 4 times; each time there were changes to the design. So, yes MSC will need to get re-gazetted since the land was originally granted 11 years ago. 
  • How will the 3 new junkets impact the mix of Mass/ VIP at CoD?
    • Added 23 new tables for these 3 operators - so 10% more VIP tables were allocated to VIP at CoD
    • Still have 229 tables on the Mass side
  • What exactly is driving the higher hold ratio in Mass at CoD?
    • Higher average bet
    • Better service level and room comp alignment 
    • Increased customers in that segment
    • More aggressive pricing in that segment at those tables
  • 30% margins are not out of reach for them in CoD, however, they aren't sure about the timeline of that happening. However, as they continue to shift more towards Mass, they should be able to achieve better margins.
  • How is the strata title conversation with the government? 
    • They have given up that conversation with the government given the controversy surrounding the issue of condos on Cotai.  3 years ago, they decided that the second tower at CoD would just be hotel rooms.
  • 23 VIP tables across 3 rooms - how much rolling volume should that bring in?
    • Can't disclose performance but the junkets that they brought in were some of the biggest operators in Macau.  The junkets are doing roughly 30% higher productivity than what they were doing at Altira
  • How much table and slot capacity and hotel rooms are MSC looking to add on?
    • The government will approve the additional tables when the cap is unfrozen in March 2013
    • 1,600 hotel rooms in MSC in PH1
  • New hotel tower at CoD?
    • They are finalizing the number of rooms/budget now so they aren't ready to guide on that yet



  • Net revenue of $1,027MM and Adjusted EBITDA of $243MM, which was slightly ahead of our estimate and 13% of consensus
  • Hold at CoD was high across VIP (3%) and Mass (28.8%) and VIP hold at Altira was also high at 3.1%. If we just adjust for high VIP hold, we estimate that EBITDA would have been $26MM lower. If we factor in high Mass hold we estimate that the total benefit was closer to $41MM. 
    • Altira's historical hold rate is 2.8% excluding 1Q. Using the historical hold rate, net revenue and EBITDA would have been $33MM and $15MM lower
    • CoD's historical hold rate is 2.86% excluding 1Q. Using the historical hold rate, net revenue and EBITDA would have been $27MM and $11MM lower
    • CoD's Mass hold in 2011 was 24.4% and the last 2 quarters has trending in the 25-26% range.  If we use 26% hold rate as normal, then net revenue and EBITDA would have been another $25MM and $15MM lower, respectively
  • "The 100% year-over-year increase in Adjusted EBITDA in the first quarter of 2012 was attributable to an improved group-wide rolling chip win rate, as well as substantial growth in the mass market table games segment, particularly at City of Dreams which, combined with a strict company-wide cost control culture, drove operating leverage and profitability."
  • "We continue to optimize our current portfolio of assets, with a strong focus on improving table yields across City of Dreams and Altira Macau and leveraging our hotel and other non-gaming amenities to drive company-wide operating performance, while at the same time maintaining our strict control over our cost structure."
  • "Our strong performance in the mass market table games segment... resulted in us capturing meaningful market share in this increasingly important and profitable gaming segment. The importance of this gaming segment is clearly evident in the improvements in profitability and operating cash flow during the quarter, where we achieved year-over-year EBITDA growth of 100%, on revenue growth of 27%, highlighting significant operating leverage and improved margins."
  • "We believe Studio City will further enhance the experiences available for visitors to Macau with its expected range of unique entertainment offerings and interactive attractions. We continue to work with the Macau Government to bring this project to realization, moving forward with the remaining approvals required to restart construction on this exciting project."

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In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.



OVERALL:  BETTER - Another big beat by MPEL driven by hold percentage and Mass volumes.  They beat our Street high EBITDA estimate.

    • SAME:  still expects to add 3 junkets by end of Q2 at City of Dreams.  CoD junket table productivity is doing 30% better than those at Altira. 
    • SAME:  Do not see much change in junket commissions and credit policies.  Provision for doubtful accounts has been stable.
    • SAME:  remains optimistic that construction can restart by the end of Q2. Construction/design budget of $1.9BN is unchanged. 
    • BETTER:  management has no plans to raise equity in either Hong Kong or US
    • BETTER:  75% of 1Q EBITDA came from the mass segment.  Market share and EBITDA better than expected
    • SLIGHTLY WORSE:  1Q D&A was $95.1MM, slightly worse than company guidance of $90-95MM
    • SAME:  1Q corp expense came in at $20MM, at the high end of its $18-20MM guidance
    • BETTER:  1Q net interest expense came in at $23MM, below company guidance of $25-30MM

Wide Acceptance

This note was originally published at 8am on April 25, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Wide acceptance of an idea is not proof of its validity.”

-Dan Brown (The Lost Symbol)


I continue to be fascinated by the groupthink that permeates our profession. You’d think that after all that we have been through in the last 5 years, that would have changed as the facts have. Nope.


I’m not talking about Apple. I don’t have the “edge” on that stock that the 58 sell-siders who follow it purport to have. Legitimate “edge” on a stock like that would probably raise one’s risk to wind up wearing an orange jump suit anyway.


I’m talking about the Wide Acceptances we’ve seen in 2012. From Europe is “fine now” (right before Spain started to crash, again) to “Dow 15,000” (cover of Barrons in February right as Global Growth started slowing, again). Fascinating. As a Risk Manager, you shouldn’t be tasked with chasing returns. You should be tasked with disproving every widely accepted thesis impacting your P&L.


Back to the Global Macro Grind


One of the most widely accepted one-liners from the media and sell-side this week has been some version of a Most Read (Bloomberg) headline this morning: “US Stocks Rise Amid Better Than Forecasted Earnings.”


That, of course, is nonsense. Generally speaking, stocks have been falling during this earnings season. Sure, some stocks have risen on better than expected results, but some have been getting tattooed on inline to worse results versus buy-side expectations.


The key to what I just wrote is “buy-side expectations.”


For as long as I’ve been on the buy-side of this game (since 2000), I can’t remember a time when the game wasn’t gaming the game of buy-side expectations.


The sell-side consensus that pundits refer to on “beating expectations” is just a backboard that buy-side pros play against. Consider AAPL expectations: you get multiple sell-side firms slap $1000 price targets on AAPL into March quarter end; the buy-side proceeds to sell stock into that for a -12% AAPL drawdown from April 9th-24th; and presto, the stock is up +9% on an “earnings beat.”


Obviously if AAPL wasn’t going to “beat” the sell-side’s actuall earnings expectations, the US stock market would be crashing this morning. So, we averted one of those. Nice.


Another way to think about a Wide Acceptance of an event or Storytelling line of consensus from the sell-side (the media has no choice but to use them as their research “source”) is to use that event as an opportunity to Fade Beta.


What does Fade Beta mean?


It means that if the market is up or down (beta), allegedly, on a widely accepted idea that has no proof of validity you either:

  1. Buy on red
  2. Sell on green 

I know. That’s some really complex stuff…


Here’s an example of how a Global Macro investor considers Fading Beta today. Start with simple questions: 

  1. Does Apple’s beat mean Growth is no longer Slowing, globally?
  2. Will Apple’s quarter inspire Ben Bernanke to move to iQe4 at his 215PM FOMC speech?
  3. What are Global Macro market prices telling us about questions 1 and 2 in real-time? 

The beauty of our process is that A) we built it ourselves B) it’s repeatable and C) there are specific answers to question #3: 

  1. Hong Kong, South Korea, and India’s stock markets all closed DOWN by the end of the session = #GrowthSlowing
  2. Hong Kong’s Export report for March came in at a startling -6.8% y/y = leading indicator for Global Growth
  3. Singapore’s Export report for March came in at a almost-as-startling -4.3% y/y = nasty
  4. Chinese stocks closed up +0.75% and we think they really work during a Deflating The Inflation (ie no iQe4 from Bernanke)
  5. UK GDP missed and moves back into the official “recession” zone of -0.2% for Q1 = #GrowthSlowing
  6. UK stocks (FTSE) have reversed their early morning Apple gains, barely up on the day
  7. Spanish stocks (IBEX) lead the short-term squeeze rally in Europe (after crashing, again) = low quality signal for bulls
  8. German Stocks (DAX) are up, but need to recover and sustain intermediate-term TREND support of 6688 to be bullish
  9. European bond yields don’t seem to care, at all, about iStuff
  10. Latin American debt, currency, and interest rate risk continues to accelerate in Mexico, Argentina, and Venezuela
  11. Oil prices are pushing higher = the #1 factor in our model for continued #GrowthSlowing, globally
  12. Copper is up small (+0.6%) and remains in a Bearish Formation (bearish across all 3 risk management durations)
  13. Gold is down, again, implying to me that the answer to Question #2 is a no today (Gold goes up when Bernanke devalues)
  14. Treasuries couldn’t care less about the US Equity Futures move; 10yr yields remain in a Bearish Formation at 1.98%
  15. US Treasury Yield Spread (10yr minus 2yr) remains 17bps below where it was when Growth Slowing wasn’t consensus 

Sure, I picked all of the factors that are bearish signals, on the margin, relative to widely accepted storytelling that suggests otherwise. That’s the point. That’s what I do. I don’t change what I do based on what other people are forced to do.


In other news, Donald Trump is going after Scottish Parliament in Edinburgh today for proposing to fire up a wind farm near the ole Don’s latest golf course project. Wide Acceptance from The Scottish People to Mr. Trump’s self-interested whining is not expected.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index and the SP500 are now $1627-1655, $118.51-121.60, $79.01-79.46, and 1361-1392, respectively.


Best of luck out there today,



Keith R. McCullough

Chief Executive Officer




Wide Acceptance - 1



Wide Acceptance - 2

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