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THE GREAT WEALTH TRANSFER

Isle of Capri announced today a tender offer to buy back up to $140 million of its bonds at 58 cents on the dollar. This transaction allows ISLE to deleverage by the amount of the discount, adjusted for taxes. In this case, ISLE spends only $140 million to retire $241 million worth of bonds. The current tax regulations force ISLE to pay tax on the differential at the company’s ordinary tax rate so the net effect is 35-40% less but still material.

Other companies that have the ability to follow this strategy include MGM and BYD. Both companies maintain ample availability on their credit facilities but face covenant issues. Clearly, buying discounted bonds should be a major deleveraging maneuver that both should pursue. Their bonds are more liquid so hopefully bond buybacks are already underway for each company. MGM appears to be willing to compound the positive impact by selling off assets and potentially using the proceeds to buy more bonds. Importantly, MGM’s credit facility does not restrict it in this area.

The following example details the math behind the strategy. Assuming a company with $200mm in EBITDA and an enterprise value of $1.4bn tenders for $200mm face value of bonds and pays 10 cents on the dollar above the market price of 50 cents, $51mm of equity value is potentially created.

Of course, a stock is a discounting mechanism so some of the potential may already be factored in. However, we don’t think many equity investors understand the power of these transactions, particularly for a company like MGM where sentiment is wildly negative surrounding covenants, liquidity, and its balance sheet. MGM equity holders probably have the most to gain with a corporate bond buyback strategy.


PFCB – NEW CO-CEO PROVIDES A DIRE OUTLOOK FOR CASUAL DINING

Bert Vivian, PFCB’s new co-CEO as of earlier this month, presented at an investor conference this morning and spoke rather generally about current trends in casual dining. While his commentary is entertaining, he did not paint a very optimistic picture. Below are some of his comments (I am paraphrasing):
Casual dining has been ugly and it is going to continue to get uglier.

The lights went out on December retail same-store sales…This is not just a retail problem.

Yesterday, RUTH reported that comparable sales declined over 18% for the fourth quarter. Don’t be surprised by these types of numbers. Whatever numbers you are expecting for the industry should most likely be ratcheted down.

During the fourth quarter, particularly in December, people had a reason to go out shopping. When people are out, they occasionally also go out to eat. We see no reason for people to go out in 1Q. It is going to be a cold 1Q in retail and restaurants. There is nothing to change people’s behaviors in the next few months.

This is a tough sales environment. 2009 for our group is going to be a throw away.

There is no need to be in a hurry with this group. There is nothing we see that makes us think business is going to take off any time soon.

The casual dining group’s decline in development in 2009 is likely going to stretch out into 2010 because once the hammers stop, it is tough to get them going again. (This might have been the most positive thing Bert said as it relates to really fixing one of the biggest fundamental problems facing the group as a whole).

Below are some of Bert’s more positive comments:

In the past, PFCB has used its free cash flow to build new restaurants. With the slowdown in development, this is not going to be true for this year and most likely for the next few years. What do we do with our free cash flow? (Bert answered his own question, saying that PFCB will most like use its cash to pay down debt and buy back shares.)

The sun will shine again on this group…We just don’t know when.

The current market cap of all of the higher-end steak players combined suggests that people are not going to eat steak anymore…I am going to continue to eat steak.

People are going to continue to eat out. The casual dining business is not going away. There are going to be casualties, but there are also going to be survivors. 2009 is going to be a tough year, but PFCB will be one of the survivors and should come out a stronger company.

Politics, Process and People

Politics, Process and People - asset allocation011309


“There’s been a breakdown between the conduct of politics and the people”
-Yoshimi Watanabe, last night…

Japanese Cabinet Minister, Watanabe, walked out on his political position last night and called for the resignation of Japan’s latest token Prime Minister, Taro Aso. Since Koizumi stepped down, Japan basically changes their said “leader” every 9 months, so it wouldn’t surprise me whatsoever if Aso eventually resigns – what does surprise me, however, is this loud and public ‘You Tubing’ of Japan’s long held (and accepted) bureaucratic order. It’s about time – well done Mr. Watanabe, well done!

Japan’s stock market is one that I have asked you to avoid like the bubonic plague for the better part of, well… since I started writing these notes – so I trust that you have. As Marty Whitman would say, “a bargain that remains a bargain… is no bargain.”

Japanese stocks got hammered last night closing the session down -4.8% on decent volume. That was the worst performing market in Asia, and it should be. Japan’s yield curve has been flat for a decade – they have inspired ZERO foreign investment as a result. When you pay out ZERO returns, that’s what you get – the American political machine better not forget that as it locks arms with the beggars of the politico and trudges along the lows of a global socialist bailout program. When there is a “breakdown between the conduct of politics and the people,” the people in America always win. Americans are taking their country back from the bankers right now. Thankfully, this long overdue process is in motion.

All three of the American indices that I called out yesterday broke down and closed below my support levels. Make no mistake, this is bearish. Now those support levels become my resistance levels – unless we can close above them, you are best served to be making sales on up days.

Do I like getting smacked around out there in the marketplace? No. The risk/reward in my macro model’s math played to the bullish side yesterday, and it still does this morning… just from a lower price. As prices change, expectations do. The Obama inauguration catalyst that I have been highlighting, bullishly, for the last month, is what it is – a month into my ranting about it. Could the US market’s +16% rally from its November lows have already discounted the positivity associated with Obama’s new leadership in The New Reality? Maybe – as the math changes, I will.

From yesterday’s close of SP500 870, I see a risk/reward in buying the SPY’s (SP500 etf) at -1% risk for +3% reward. That’s why I bought SPY into the close yesterday in our virtual Portfolio (see www.researchedgellc.com ). Every decision in markets has a time and price. If I allow my mind to be infiltrated with the negative thoughts of giving away a goal, I will never have the clarity needed to get back in the faceoff circle expecting to win the next puck back. That’s just how this game goes – if you let your mistakes eat you up inside, they will.

The following levels of resistance in the SP500, Nasdaq, and Russell 2000 need to be overcome for our “Obamerica” and “MEGA US Consumer Squeeze” rally to continue to make higher 3-month cycle highs and higher lows: SP500 889, Nasdaq 1554, and Russell 477.

If those levels are overcome, and the US emotional index (VIX) can keep a lid on itself under the 54.35 line, the US stock market is going to go up as fast in the next week as it has dropped in the last one. Since I asked you to make sales at 941 SP500 last week, don’t forget the math – the SP500 has effectively dropped -7.5% in a straight line, inspiring the “Great Depression” friends of my bear clawing past to re-populate their mugs all over your local manic media TV channel. Everything has a time and a price. All of the other noise that occurs in between timing and pricing is what it is – revisionist history.

Other than the Pandit Bandit compromising whatever credibility he had left yesterday, what was it that had people run for the global equity exits? I can give you a laundry list of things – surely, this too is revisionist history by virtue of it being yesterday’s news – but here’s what gets the red marker in my notebook this morning:

1.      Asian stock markets have broken short term momentum support

2.      Asian currencies (ex-Japan) are going down in concert

3.      European stock markets broke short term support

4.      Russia came back from their holidays, and devalued both the ruble and the RTSI exchange

5.      Middle Eastern conflict has passed through its apex of Israeli attacks (they need oil to go up, not down)

6.      Brazil had a -5.2% correction yesterday, after seeing a +40% move to the upside

7.      Commodities (CRB) were down -3.9% yesterday, underperforming equities

8.      Oil prices have lost -25% in 6 days

9.      The US Dollar has strengthened from its lows, weakening everything “re-flation”


I’m stopping with 9 contributing factors that I have interpreted as negative. There are plenty more that I will touch on during our daily “Macro” client call at 830AM. I don’t wake up every morning looking for data points to support my “call”. I strap on the accountability pants and call the river cards on the table as they lay. The facts don’t lie, people do… and I for one, am not going to stand up this morning and be proud of losing yesterday.

Today is a new day, and not losing your money remains the objective. Start clean and don’t start selling the lows into the market’s opening weakness. We are one day closer to the Obama catalyst. We have $36/oil, zero percent interest rates, the narrowest TED spread we have had in months, and an arguably a deserved “Bush Bottom” (see yesterday’s intraday Macro post at www.researchedge.com  for that note) as a result of “a breakdown between the conduct of” American politics…  “and the people.”

Best of luck out there today.

Politics, Process and People - etfs011309


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Charting The Street's Emotions

Inclusive of today’s -1.5% intraday SP500 selloff, we are a long way from anything in the area code of the quantified anxieties associated with the October/November freak-out. Below is one measure of that reality – the Volatility Index (VIX).

Today the VIX is up another +3.8% at $44.43. While this is up +20% from where I was calling this out last week as oversold, I wrote that we could see a “full +27%” run-up in the VIX and nothing will have changed this fundamentally bullish “Trend” of Volatility breaking down. On the margin, this continues to back my case that the US stock market has seen its 3-month cycle low. The SP500 should continue to make higher lows and the VIX lower 3-month cycle highs.

The chart shows two lines:
1. An immediate term overbought line for the VIX at 48.59 (dotted red)
2. An intermediate overhead resistance “Trend” line for the VIX up at 54.33.

If these lines hold, alongside a narrowing TED spread (3mth LIBOR minus 3 mth US Treasuries), we will continue to see a more palatable environment to not have our hard earned dollars locked up in our ZERO interest bearing savings accounts.
KM

Keith R. McCullough
CEO & Chief Investment Officer

Eye On India: This Isn't China!

MACRO: ASIA -Indian Industrial Production

Although the November numbers look bullish on the margin, we think it is a head fake…

India’s industrial production numbers came in at 2.4% for November, unexpectedly stronger, sequentially, after October’s -0.34% decline. This positive data point was not enough to stem the tide of post -Satyam selling as Sensex sold off by another -3.2% on the heels of a -1.88% decline in Friday’s session. The cumulative decline in India’s stock market has been approximately -12% in less than a week.

This production data looks positive on the margin. From an industrial manufacturing standpoint, India should have a few things going for it now… in Theory:

• Cheap Labor and good engineering schools
• Lower basic material prices globally
• Strategic geographic location
• Sharply decreased maritime shipping costs
Whereas the Services sector is being held hostage by declining demand in the US and Europe, and the problems facing the agricultural sector are too involved to touch on here, the Industrial portion of the subcontinent’s economy should be able to retain a relatively competitive stance in pursuit of what demand remains. It probably won’t.

India’s union biased employment laws and socialist governmental policies will make it difficult for producers to capitalize on the vast sea of cheap skilled and unskilled labor around them effectively. Additionally, the obese overlapping state, local and national governmental bureaucracies have made it virtually impossible to create new industrial facilities –with years’ worth of legal wrangling required to build new factories and badly needed new ports.

We have been negatively biased regarding India since I started at Research edge, which was the day we opened our door. We continue to believe that the deep structural flaws in the Indian economy outweigh the massive potential that lies there.

Andrew Barber
Director

Golden Eye: Buying More Gold Today

The last time/price we sold out of our long position in GLD (Gold’s etf) was 12/29 at $86.66. The only fundamental facts that have changed since that date play in gold’s bullish favor.

As the entire free world devalues their respective currencies (at $31.12 per USD, the Russian ruble dropped to a 6yr low this morning, putting it down -25% since the price of oil peaked in July/August of last year) in order to stoke export growth and re-flation, gold continues to look attractive. Today I am taking Gold to 6% of my Asset Allocation model, up from 3% prior.

See the chart below for my buying range in the GLD etf (in green): in terms of physical gold, this green range is the equivalent of $812-$838/oz. I’d sell some up at $891/oz (dotted red line).

Keith R. McCullough
CEO & Chief Investment Officer

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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