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Emulation is not going to get it done in the domestic QSR burger category for the same reason it did not work for Linens ‘n’ Things in retail.  A thesis has been put forward over the last few days that the QSR burger industry is not a zero sum game.  In this industry it is difficult to neatly delineate boundaries of competition or addressable markets but we are of the view that, if not a zero sum game, the niche of the burger industry that Burger King inhabits could possibly be shrinking.  Recent commentary from Wendy’s CEO Emil Brolick supports this view.




Given the rapid growth of “better burger” category, or fast casual in general, it is easy to make blanket statements about the QSR industry because such proclamations are difficult to refute in the absence of definitive market share data.  Justice Holdings took advantage of this in framing its narrative describing Burger King’s growth prospect, touting the strong expansion of the QSR industry over recent years.  QSR is becoming more varied, however, both in terms of price point and product offerings.  McDonald’s, Wendy’s, Burger King, and Taco Bell occupy a certain sector of the QSR industry; we think that the growth in that sector is stagnant and only differentiated concepts can achieve the level of growth that would justify the $16 per share price tag that is being attached to Burger King’s IPO.  Just looking at the products Burger King is currently offering versus the McDonald’s menu highlights how little in the way of differentiation Burger King is bringing to the table.  An article published last month by Advertising Age titled “Nothing Exciting About Burger King’s Menu Expansion” outlines this issue comprehensively.  Discussing the “folly of emulation”, the author writes, “What was Linens ‘n’ Things’ strategy? Emulate the leader with similar stores and similar marketing strategies”.  Burger King – a follower – emulating McDonald’s – a leader – is equally unwise.





There is a reason why McDonald’s has recently bought up billboards and radio air time in markets where Wendy’s tested breakfast; the competition in the segment of the market where those companies operate is fierce because of the difficult macro environment, growing ranks of competitors, and a consumer that demands not only a great product but a great overall experience too.  We see it as highly unlikely that all four of the aforementioned QSR concepts are going to see positive same-store sales over the next few years absent a dramatic turnaround in the macro environment.  We believe that in this small group, someone is winning and someone is losing.  For that reason, making life difficult for your competitors – as McDonald’s does – is a winning strategy.  Along the same lines, trying to emulate a better-positioned industry leader – as Burger King is doing – is unlikely to be effective. 


This cut-throat environment is going to hamper the efforts of Wendy’s and Burger King to convince investors that their respective turnaround stories are in place.  That’s bad news for two chains that need to attract billions of dollars in capital to restore severely depleted asset bases.   Taco Bell’s slogan, “Think Outside the Bun”, underscores how much they compete with the burger companies.  Both Yum Brands and McDonald’s have tremendous ammunition to spend.  Both Taco Bell and McDonald’s have shown a willingness to lead with price and value to attract customers from other chains.  McDonald’s has benefitted from the mismanagement of Wendy’s and Burger King and has recently squared up to Dunkin’ Donuts in its core geography of New England in a bid to steal some breakfast market share.  Companies are hyper-competitive in their pursuit of consumers at the moment.  Our view is that Burger King and, to a lesser extent Wendy’s, are facing a difficult battle to regain their prior statuses in the industry.





Clearly our contention here is that a rising tide is not going to lift all boats in the domestic QSR burger industry.  Burger King and Wendy’s are the two names that we would be most concerned about from an operational perspective over the next two-to-three years.  Specifically, we think same-store sales growth could be weak at those concepts.  This is suboptimal given that top line growth is needed to inspire confidence among investors, lenders and franchisees if the turnaround is not to turn into a protracted siege that can do long term damage to the brands.


Of course, given that “activist” investors are deeply involved with both Wendy’s and Burger King, adds another element to their stories.  Weak operational performance may not lead to stock price weakness.  Taking Burger King first, we believe that the $16 is a price tag that should give investors pause when considering an investment in the company.  The implied valuation multiple, on an EV/EBIT basis, is 17x which makes Burger King the most expensive of the four companies (MCD, YUM, WEN, BKC).  Our “Too Big To Fix” thesis contends that the issues at Burger King may be much more substantial than people realize. 


Moving on to Wendy’s, the company is trading at a 26% discount to Burger King but at a 12% premium to McDonald’s.  We think that represents a mispricing of the company’s fundamental outlook but investors’ expectations of Nelson Peltz’s possible next move.  Given the sideways move in the stock over the past 3.5 years and the vast amount of capital needed to fix the asset base ($3.5 billion), it would not surprise us if Mr. Peltz was becoming a little anxious about Wendy’s future.  Perhaps the changes that need to be brought around would be better implemented in the context of a public company, away from investor and analyst scrutiny?  It would not be shocking if, in the not-too-distant future, we woke up to a rumor that Trian is shopping the company.  The possibility of that happens, we believe, is helping to maintain that premium to McDonald’s which otherwise doesn’t seem to have any grounding in a fundamental comparison of the two companies.


Wendy’s CEO Emil Brolick’s recent comment on his company’s category was insightful: “we were hopeful that our February promotion of Dave's Hot 'N Juicy would help us regain our momentum, but unusually intense competitive couponing and discounting negatively impacted our sales growth.”  This corroborates our view that the burger industry is, effectively, a zero sum game. 



Howard Penney

Managing Director


Rory Green







Selling Opportunity: SP500 Levels, Refreshed

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


Same fundamental research thesis – Growth Slowing and Deflating The Inflation.


From a price, that will be good for US and Global Consumption Growth, but that (like all good sustainable things in life) will take some time.


Across our core risk management durations, here are the lines that matter most: 

  1. Intermediate-term TREND resistance = 1368
  2. Immediate-term TRADE support = 1338
  3. Long-term TAIL support = 1281 

In other words, your new immediate-term risk range = 1. Sell on green on the way up to 1368, and buy on the way down to 1338 – but be mindful that the gravity associated with 1281’s mean reversion risk is very much new and in play over the intermediate-term; particularly with the Financials (XLF) being the lead relative performance gainer in the market YTD – plenty to give back there.


Enjoy your weekend,




Keith R. McCullough
Chief Executive Officer


Selling Opportunity: SP500 Levels, Refreshed - SPX

Deep Dive into JP Morgan



TRADE (3 Weeks or Less)

JP Morgan is being punished by the market following the announcement of $2B in trading losses out of the CIO’s office.  The real loss, however, is the impairment to industry credibility just as the Volcker rule is being finalized by Congress and the regulators.  The apparent weakness of controls at the firm is a problematic indicator, particularly in the current regulatory environment. Additionally, the imminent downgrade of many large financials, likely including JPM, by Moody’s will add  further short-term pressure.


TREND (3 Months or More)

JP Morgan is likely to suffer as we approach implementation of the Volcker rule on July 21st.  While  CEO Dimon was clear in his view that the trade in question was not proprietary (and thus permissible under Volcker), optics of the trade are working against him.  A loss of $2B over the course of six weeks certainly gets regulators’ attention.  With the trade now public, the loss is likely to grow in the coming weeks. 


TAIL (3 Years or Less)

Over the long term, we expect the impact from Volcker will be less severe than the market fears.  Former Citi Chairman & CEO John Reed recently noted that banking lobbyists in favor of a weaker Volcker rule outnumber and outspend consumer lobbyists by 25 to 1. We expect significant downside in the stock on both regulatory fears and macro data over the course of the next several months – but this downside could ultimately present an attractive entry point. 






Deep Dive into JP Morgan  - JPM Levels 051112






Risk will ramp back up throughout the summer months, as seasonal factors drive optical weakness in economic data.  We expect this will provoke greater concern in the U.S. about Europe and other external negative factors, as the defense of “de-coupling” vanishes. Spain is the likely vector for contagion fears in 2012, just as Greece was in 2011.  The global moneycenter banks and large broker-dealers (JPM, BAC, C, GS, MS) are most exposed.  Until yesterday, the market was indicating that MS and C were perceived as the greatest risks among this group. This week, JPM has lost some of its “fortress” credibility, increasing the risk that they will be viewed more punitively.  






Deep Dive into JP Morgan  - Screen Shot 2012 05 11 at 10.39.48 AM

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Financial Fallout: Analysis of JP Morgan's $2B Trading Loss

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The Macau Metro Monitor, May 10, 2012




President and COO of LVS, Mike Leven said, “We made a few mistakes in the conference call. Namely we did not disclose specifically the results of Sands Cotai Central…We should have said we were pleased with the early GOI [Gross Operating Income]. SCC is doing great, always crowded, with excellent restaurants, shops and services."


Mr Leven said that the relationship with the Macau government is on excellent terms and that “the presence of Chief Executive Dr Chui Sai On at the opening of Cotai Central is proof enough of that…I and Ed Tracy here, are in constant contact with the officials.”  Leven said that the Macau government assured the granting of the remaining 200 tables for phase 2 of SCC and if “there would be eventually any delay, we are talking of a maximum of a couple of months which doesn’t worry me at all.” 


'NOT WORRIED' Macau Business

MGM China chairperson Pansy Ho says its Cotai land application is being finalised and she's not worried.  She also says that the government “must give special attention” to future projects in Macau as the non-gaming aspect should also be taken into consideration.



Chinese banks wound down their lending in April from 14-month highs to extend 681.8 billion yuan (US$107.98 billion) worth of loans, missing analysts' expectations of 800 billion yuan.




Gross revenue blowout comes at a high cost



Sky high rebates, low non-gaming revenues, and higher fixed costs took away from what was a great top line quarter.  It's clear that the flow through on GGR to net revenues at RWS is simply inferior to MBS.  This quarter, net gaming revenue was only 66% of GGR at RWS (a record low flow through for the property) vs 81% at MBS.


The Good

  • At S$999MM, GGR was S$90MM better than we estimated and likely higher than any sell side estimates.  There was volume growth across all segments of the business QoQ.
  • VIP:  RC volume of S$15.5BN was 4% higher than we estimated.  Gross win was S$527MM (S$78MM above our estimate).
  • Gaming machines: we estimate that win was S$178MM on handle of S$3,717MM, a 10% sequential increase


The Bad

  • Non-Gaming Revenues Should Have Been higher: 
    • Non-gaming revenues were down QoQ when they really should have been at least flat given the addition of 200 rooms
    • Room revenue should have been up S$3.5MM QoQ with the increase in RevPAR and room count.  
    • USS revenue was down S$7MM QoQ, which implies an S$8MM decline in F&B and other which is odd since those revenues are usually correlated with room revenues.
  • Holy rebates Batman!
    • While Genting management stated that was no change in their rebate policy aside from giving some breaks from early payments of receivables, the numbers tell a different story
    • We saw a huge spike in rebates (including GST and gaming points) in the quarter, which are simply the difference between gross gaming revenue of S$999MM and reported net casino revenues of S$655MM
    • Rebates were S$344MM in 1Q or 34% of GGR. As a point of reference, the rebates as a % of GGR have averaged 29% at RWS so this is a big spike.  In comparison, MBS's rebates were only 19% of GGR.  Put another way, the property's GGR increased S$96MM QoQ but net gaming revenues only increased S$11MM.
      • Here is our estimate of the rebate breakout in the quarter:
        • VIP:  S$239MM or 1.75%
        • GST:  S$47.5MM
        • Mass gaming points:  S$25MM or 1.9% of drop
  • Higher fixed costs
    • It looks like fixed costs increased to S$202.5MM, about S$17MM sequentially.  Some of this is for the hotel rooms coming online.  Unfortunately, non-gaming revenues were down QoQ while costs were up.


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