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CONCLUSION: We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here.


HEDGEYE ASSET ALLOCATION: 0% exposures to commodities; average daily exposure to commodities since the start of APR ’11 < 3%. Not being invested in an asset class is, in fact, a risk-managed decision.


THEMES AT PLAY: Deflating the Inflation; Bernanke’s Bubbles


If, in 2008, after a -28% drawdown in commodity prices from their YTD peak (as measured by the 19-commodity CRB Index), you increased your gross exposure to this asset class on the heels of China’s first interest rate cut (SEP 16 of that year), you were dead right – for five days. The CRB Index rallied +9.5% to another lower-high in the week post the Chinese interest rate cut and then proceeded to plummet -46.4% from there to its ultimate bottom on MAR 2, 2009.




As we penned in the conclusion of our FEB 21 note titled: “CHINA LOWERS RRRs – NOW WHAT?”: “… we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.”


Alas, GROWTH remains the most important factor in our core three-factor fundamental screening process. While each reflexive factor (GROWTH/INFLATION/POLICY) is indeed vital to the process, we continue to stress that buying on rate cuts alone is akin to buying stocks on valuation – neither are truly catalysts in and of themselves. A positive inflection in GROWTH needs to become a probable outcome in order for market participants to broadly see opportunity.


For China, whose benchmark Shanghai Composite Index closed down -0.7% ahead of the rate cut, that is simply not the case at the present moment given the current Chinese GROWTH model:




Moving along, at the current juncture we would add that given the recent acceleration to the downside in Chinese economic growth statistics/expectations, China may need to implement a fiscal stimulus package as well to cause the slope of its economic growth to inflect in a positive direction. On this front, has been our official view since early OCT ’11 that China is unlikely to pursue such a strategy ahead of the late fall changing of the guard atop the Politburo and perhaps even as far out as the MAR ’13 change in the presidency and premiership.


That’s a long time from now as it relates to the heighted financial market volatility borne out of gaming policy expectations emanating from the ECB to the PBOC to the Fed and back again.


Per Wikipedia: “ If previously implemented retirement policies are followed, no other current members of the [Politburo Standing Committee] will continue to serve in that capacity. About 70% of the members of the Central Military Commission and the executive committee of the State Council will also turnover in 2012, resulting in the most significant leadership transition in decades.”


Given the potentially massive changing of the guard atop China’s economic and political leadership, it is our view that it will take a material economic slowdown for China to announce an economic stimulus package and/or materially peel back the existing curbs on its real estate market over the intermediate term. The latest commentary out of various Chinese policymakers afford us conviction in this view: 

  • “The country will steadfastly continue curbs on the residential real-estate market and won’t flip-flop on its policies,” per an unnamed Housing Ministry Official via the Shanghai Securities News. This statement echoes a similar pledge out of the State Council (via the official state-run Xinhua News Agency) earlier in MAY.
  • “China has no plan to introduce stimulus measures to support growth on the scale unleashed during the depths of the global credit crisis in 2008… The Chinese government’s intention is very clear: It will not roll out another massive stimulus plan to seek high economic growth… Current efforts for stabilizing growth will not repeat the old way of three years ago… Pumping in government money to achieve growth targets is not sustainable and China will instead focus on encouraging private investments in railways, infrastructure, energy, telecommunications, health care and education,” per an article on economic policy via Xinhua. 

Briefly looking back, the 2008 stimulus package was CNY4 trillion or 12.7% of GDP at the time – that’s a fairly large hurdle to climb for an economy that is roughly ~50% larger in size (on a nominal basis) from its year-end 2008 level. Moreover, some CNY2.8 trillion of that package ultimately wound up in the form of incremental LGFV debt – an asset class that poses material risks to Chinese banks’ balance sheets  over the long-term TAIL.


All told, we don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here. If China is signaling anything to those willing to pay attention – it’s that both Chinese domestic and global growth are slowing at a faster rate in the immediate term. Be on the lookout for confirmation of this conclusion in China’s MAY economic growth data dump this weekend.


Darius Dale

Senior Analyst


Keith shorted MGM in the Hedgeye Virtual Portfolio at $11.37.  According to his model, the TRADE resistance is at $11.71 and the TREND resistance is at $13.15.



We're negative on the long-term outlook for US casinos given the structural changes in the economy - read: housing - and more importantly, the bleak demographic outlook.  The average age of the high margin slot player continues to increase, younger generations are not playing slots, and that great gambling baby boomer generation will eventually die off.  In real terms, a return to peak EBITDA for MGM looks like a pipe dream to us.


Over the near-term, we don't see anything more than sluggish Strip growth.  Worse, 2012 EBITDA estimates look too high for MGM.  Q2 is looking more and more like a miss.  Historically, 1Q REVPAR is very strong and current Street estimates call for even better REVPAR in 2Q and 3Q.  We think this is unlikely as a difficult macro environment and difficult comps will weigh on future quarters. 




Not Good: SP500 Levels, Refreshed

POSITIONS: Short Industrials (XLI)


Bernanke did not deliver on what some conflicted and compromised people were begging for, so the USD rallied from this morning’s lows and Gold sold off. Stocks are well off their highs, making lower-highs, again – and that’s not good.


Across my risk management durations, here are the lines that matter to me most: 

  1. Intermediate-term TREND resistance = 1369
  2. Immediate-term TRADE resistance = 1332
  3. Long-term TAIL support = 1283 

In other words, we’re a long way from 1283 – and the bigger question now is does that line hold?


I do not know, but we did sell into this hopeful move.


Hope is not a risk management process.



Keith R. McCullough
Chief Executive Officer


Not Good: SP500 Levels, Refreshed - SPX

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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 - better weather, a favorable calendar, and higher operating margins, particularly in Black Hawk, drove an EBITDA beat


    • BETTER:  leverage ratio 5.7x came down a little bit from 5.8x last quarter
    • MIXED: Cape Girardeau expected opening moved up two months ahead of schedule but the capex cost increased $10MM to $135MM
    • BETTER:  FQ4 2012 capex was a little below $30MM, below company guidance of $45MM
    • SAME:  Pompano still doing well use to an aggressive marketing program and loyalty program. Pari-mutuel revs have also stabilized.
    • SAME:  Mississippi properties continue to face the realities of a sluggish economy and heightened competitive pressures
    • WORSE:  Saw an uptick in promotional spending in the Kansas City market due to the recent openings of the new casinos. Biloxi promotional spending environment continues to be fierce.





"Overall, we had a solid quarter marked by incremental revenue growth resulting from our refined business model, more favorable weather conditions than last year and an increasingly renewed asset base.  Even after adjusting for the fact that fiscal 2012 had an additional week when compared to fiscal 2011, we grew revenues and adjusted EBITDA."


- President and Chief Executive Officer Virginia McDowell



  • They have now collected all of their insurance recoveries
  • No R/C borrowings outstanding
  • $0.5MM of capitalized interest for the Q and $1.1MM for the year



  • Blackhawk, for the first time since ASCA opened, had market share growth. 
  • Have turned a corner in Vicksburg
  • Disruption impact of the consolidation of LA operations was in the range of $300k 
  • Pompano:  Coconut Creek opened recently but they have had improved promotions and the roll-out of their guest loyalty program.  Racing revenues have stopped declining.
  • Cash build is temporary as Cape Girardeau construction ramps and have notes that they will likely take out next year
  • Impact of the extra week? Just pro-rata the quarter.
  • Update on closing of Biloxi? 
    • Sometime in the summer
  • Cape Girardeau budget increase was infrastructure-related
  • New competition coming into Blackhawk over the next 6 months? 
    • They are in discussions with the new property owner next door and are going to work together to strengthen their pod of properties. They are also renovating the rooms there and using the Pompano as an example. Have done a lot to the slot floor, poker room, and putting in a new buffet.
  • No change in customer behavior/ spending patterns over the last few weeks
  • Any overly promotional markets out there?  Biloxi is really the only one there... very competitive for mid-week business.  Margaritaville opened without a big impact but is a very promotional environment there. Also saw an uptick in Kansas City.
  • Feels like there may be more M&A as companies' balance sheets are more in order and there has been compression in the bid-ask spreads.  They are always looking.



  • "We expect to open Cape Girardeau by November 1 of this year, two full months ahead of our initial schedule, and will complete the rebranding of Vicksburg within the next several months (F2Q13).  Further, as we continue to renew our asset base and provide guests with more options and more experiences, we have an aggressive schedule of targeted capital improvements planned for our properties during the coming months, including renovated hotel rooms, new buffets and a full rollout of our enhanced customer loyalty program."
  • "Black Hawk benefited from favorable weather conditions, completed facility enhancements, including renovations to the poker room and casino floor, and a reduced gaming tax rate compared to the fourth quarter of fiscal 2011."
  • "Pompano continued to exhibit revenue growth resulting from changes to our game mix, enhanced food and beverage amenities and the rollout of our enhanced customer loyalty program during the prior quarter, while competing with a major new expansion at our nearest competitor."
  • "Waterloo showed strong growth in adjusted EBITDA margins during the quarter...as a result of operating improvements and reduced costs."
  • "Adjusted EBITDA margins decreased... primarily a result of severance and marketing costs resulting from the consolidation of our riverboat operations into a single facility.  We are benefitting from a lower cost structure in Lake Charles as a result of consolidation following the sale of our smaller riverboat in February 2012."
  • "Our properties in Mississippi continue to face difficulties stemming from a lagging economy in the area.  In particular, our property in Lula is facing increased competitive pressure from competing facilities in Arkansas.  However, in Vicksburg we benefited from operating improvements... partially offset by construction disruption associated with the ongoing rebranding of the facility."
  • "Kansas City property, however adjusted EBITDA decreased... primarily as a result of competitive market pressures following the opening of a new facility in the area during the quarter.  Our property in Boonville increased adjusted EBITDA margins... as a result of operating efficiencies and the introduction of the Farmers' Pick Buffet in the beginning of this fiscal quarter."
  • "We are currently renovating the 253 hotel rooms in the main hotel tower in Lake Charles and 237 rooms in the Isle Black Hawk Hotel.  We expect the $15 million complete refurbishment of the Lake Charles rooms to be completed by November 1, 2012.  In Black Hawk we are replacing carpet, wall coverings, and furniture at an expected cost of approximately $2.0 million, and expect to be completed by December 1, 2012."
  • "Intend to open additional Farmer's Pick Buffets in fiscal 2013 including at Cape Girardeau, Pompano, Black Hawk and Waterloo.  Additionally, we plan to add a Lone Wolf bar in our Waterloo facility."
  • "Expect to introduce [Fan Club loyalty] program to five additional properties during the first and second quarters of fiscal 2013, and intend to have it fully implemented across the portfolio by the end of fiscal 2013."
  • The expected cost of Cape Girardeau has been revised up $10MM to $135MM
  • "The appeal hearing for the gaming license awarded to Nemacolin Woodlands Resort for the final resort license in Pennsylvania was held on March 7, 2012. No date has been determined for an expected ruling on the appeal or the ultimate resolution of the matter.  We expect to begin construction on the property following a successful conclusion to the appeal process and receiving any other necessary approvals, and to open the property approximately nine months after the commencement of construction."
  • FY2012 capital expenditures were $75.2MM, of which $34.9MM related to Cape Girardeau, $0.7MM related to Nemacolin and $39.6MM related to maintenance capital and projects at our existing properties.
  • Net leverage, as calculated under our senior credit facility was approximately 5.7x 
  • Unusual items in the Q:
    • $112.6MM write-down to the value of Biloxi after the sale annoucement
    • Recorded a charge of $16.1MM related to the sale of our smaller riverboat and associated gaming license in Lake Charles, Louisiana, completed on February 9, 2012
    • Impairment charge of $14.4MM against the goodwill at our Lula property
    • Net revenues and operating income for the fourth quarter include $8.6MM of insurance recoveries 
    • Accrued approximately $2.0MM, including interest, in connection with a judgment issued in a legal case in connection with the Company's previously owned property in Vicksburg, Mississippi, which was sold in July 2006.  We are appealing the judgment and plan to vigorously defend our position.
  • FY2013 Guidance 
    • D&A: $76-78MM
    • Cash income taxes: < $5MM (primarily related to state taxes)
    • Interest expense (net of capitalized interest): $83-85MM
    • Corporate & development expenses: $40MM (including stock comp)
    • Capex: $140-150MM (including approx $85MM spent on Cape Girardeau)
    • Pre-opening of $5.5MM related to Cape Girardeau
    • FY13 will have 52 vs. 53 weeks in FY12

FNP/LIZ: Kate Japan Math

FNP’s is expected to take over ownership of its Japanese Kate Spade business later this year (Q4), which would add $1-$2 in value to one of our favorite longs near-term. While we expect the EPS impact to be a wash next year (+/- $0.02), it is likely to add $12-$17mm in EBITDA in F13 and up to $0.10 and $15mm-$30mm in EPS and EBITDA in F14. The bottom line is that we’ve never seen a higher-end brand take back control of its content and distribution and it not be a positive event – we expect this deal to be no different.

Consider the following:

  • With 52 points of distribution, Japan’s store/door productivity is ~$1.4mm/store ahead of where we expect China is running and at nearly half Kate’s current store productivity.
  • Given that sales are up ~20% despite the tsunami impact, we’d expect productivity and sales to continue growing at a double-digit rate and likely exceed that growth over the last 12-months as FNP continues to grow its store base.
  • With $71mm in sales as of August ’11 and 20% growth, we assume Kate Spade Japan will generate revenues of ~$90mm by year end when the company expects to take sole ownership of the business.
  • The profits from this business will shift from being recorded in the Other Income line to being incorporated into the P&L as it becomes wholly owned. With operating profit margins in the HSDs, we expect Kate Japan to add $12-$17mm of incremental EBITDA in F13 reflecting modest margin expansion and $15mm-$30mm in F14 as the company realizes further margin expansion by leveraging existing headcount and operations in Asia.
  • COH has over 170 locations in Japan compared to Kate’s 52 suggesting a substantial runway for long-term growth. When COH took over control of its Japan business in 2001, it had 76 locations and $40mm in revenues. Today COH generates more than $700mm in revenues in the region. We think 20-25 locations over the next two years and $150mm in revenues by F14 is reasonable if not conservative for Kate.
  • The incremental addition of Kate Japan will add ~6pts to revenue growth in F13 suggesting 23% total top-line growth in F13 on top of high-teens growth in F12 (pro forma).

All in, this notes offering pushes out the duration of FNP’s debt maturity six years while reducing P&L volatility with the elimination of existing Euro Notes and most importantly the company assumes control over the Kate Spade Japan business. While these deals often result in minimal financial impact in early years, we think the earnings impact will be neutral in Yr1, but the EBITDA contribution from Kate Spade which already accounts for over 50% of the total is worth $1-$2 in value immediately. FNP remains one of our top longs.


Casey Flavin


FNP/LIZ: Kate Japan Math - FNP Japan EBIT


FNP/LIZ: Kate Japan Math - FNP SOTP w Japan



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