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To Hedge, Or Not To Hedge, That Is the Question: SP500 Levels, Refreshed

POSITIONS: Long US Dollar (UUP), Short Industrials (XLI), Energy (XLE), and German Bunds (BUNL)


Keith is out in California meeting with some of our larger west coast based subscribers, but managed to find a few minutes to sneak into Starbucks and short the SP500 in the Virtual Portfolio.   We’ve been waiting and watching on a price, and our risk management models gave us the signal today.  So, regardless of your strategy, we see this as an opportunity to hedge and reduce exposure.


As of 2:15pm today, the SP500 was up 0.63% to 1,372.  Akin to many of the equity market rallies we’ve seen over the past three years, the rally over the last week from the 1,327 level on July 12th was characterized by light volume.   The other important factor in our quantitative models is volatility.


The VIX, a measure of SP500 volatility, is down almost 3% on the day to 16.00. Over the past three years, a VIX level of 15ish has pretty consistently signaled a near term bottom in U.S. equities.  We’ve highlighted this in the chart below.


To Hedge, Or Not To Hedge, That Is the Question: SP500 Levels, Refreshed - VIX


The primary fundamental catalyst over coming weeks is earnings season.  Currently, 73% of the 63 companies that have reported earnings in the SP500 have beat results.  Interestingly, according to analysis from Bloomberg, the entire SP500 is expected to report a -2.1% decline in earnings year-over-year this quarter.  It is difficult to make a case for equities when earnings are not growing.


The other key point related to corporate earnings is that downward revisions are a major headwind, especially into 2013.  Currently, SP500 EPS estimates for Q1 2013 and Q2 2013 are for 14% year-over-year growth in each quarter.  Those numbers are likely going a lot lower.



Daryl G. Jones

Director of Research



Several issues have us concerned despite our expectation for a decent quarter and guidance.



We expect IGT to report an in-line to slightly better quarter than the consensus of 29 cents.  In a sea of misses, a meet is not such a bad thing.  Guidance shouldn’t change much, also probably a positive on the margin.  We appreciate IGT’s cash flow generation and willingness to return cash to shareholders and the favorable long-term fundamental backdrop for the slot industry makes for a favorable long-term story – on the surface. 


On the other hand, IGT has also held in better than most of our names through the turbulence of the past 3 months.  Moreover, there are a few issues that concern us that could weigh on the stock.  Given the following issues – which probably haven’t been appropriately vetted by investors and analysts – we prefer to be on the sideline for now.

  • Industry replacements will likely fall in CYQ2 versus last year.  During the next two years new and expansions units (including Canada) should grow at a healthy clip and drive large YoY increases in total shipments.  However, replacements still make up the lion’s share of total NA shipments and it is disconcerting that after several years of growth, they appear to be stalling out at about 55,000 units/year.
  • We’re once again hearing that there is an ongoing brain drain at IGT.  When CEO Patti Hart joined the company in 2009, there was the expected changing of the guard.  We are now hearing – 3 years later - that there is more discontent and departures among key box and content developers.  The brain drain may have an impact on the next wave of developments down the road.  The wave of new openings and IGT’s share procurement in Canada may hide the impact for a while, but it raises an important red flag for long-term investors.
  • According to AppData, Double Down’s MAU looks like they’ve taken a breather since April and DAU’s also look flat QoQ at 1.4MM.  While DoubleDown is not going to make or break the quarter, it is a sore topic for many investors.  Therefore, disappointment in interactive may elicit an exaggerated response from the investor community, especially given that Patty has marketed this segment as a large source of growth for IGT.


F3Q Detail


We estimate that IGT will report $576MM of total revenue (2% ahead of consensus) and in-line adjusted EPS of $0.29.


Product sales of $264MM at a 53.7% gross margin

  • NA sales of $167MM and gross margin of $94MM
    • $105MM of NA box sales: 7,150 gaming machines at an ASP of $14.7k
      • 4,250 replacements and 2,900 new units, including shipments to:
        • 684 units to Scotia Down
        • 1,425 units to Cleveland and Toledo
        • Over 400 units to PNK’s Baton Rouge
      • ASP’s should be down sequentially due to mix and volume discounts on large orders which shipped this quarter
      • We expect margins to be down slightly on a QoQ basis to 56.4% from 57.1% in the March Q
    • Non box sales of $62MM
      • We expect a sequential uptick due to the Revel opening, for which IGT provided the system.
  • International sales of $97MM and gross margin of $48MM
    • $77MM of box sales: 4,500 units at an ASP of $17.1k
    • Non box sales of $20MM
    • 49% gross margins down from 50% in the March Q
  • Gaming operations revenue and gross margin of $312MM and $187MM, respectively
    • End of Period install base of 56,750
    • Core gaming operations revenue of $272MM, implying an average win per day of $53/day
      • Maryland Live Games came online but only for 23 days of the quarter
    • $40MM of interactive revenue
      • $29.6MM of DoubleDown revenue
      • $10.5MM of other interactive revenue
  • Other stuff:
    • SG&A: $101MM
    • R&D: $55MM
    • D&A: $19MM
    • Net interest expense: $20MM
    • 37% tax rate
    • Weighted average shares outstanding: 294MM

IMPORTS: Are The Holidays At Risk?

Labor strikes are an American past time that have been a constant source of disruption in every industry.  As we get closer to the holiday season, who would have thought that a bunch of longshoremen could prevent us from getting our children the Tickle Me Elmo that they absolutely must have?


The International Longshoremen’s Association and US Maritime’s contract runs up in September. They essentially control 20% of total apparel products coming in from Asia. While this could be basic jockeying for a more lucrative contract, recall that in 2002, a 10 day lockout of the west coast ports including the twin LA ports resulted in a $10bn to $20bn hit to the economy daily. Ouch.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.48%
  • SHORT SIGNALS 78.35%

Egypt . . . Now What?

Takeaway: The recent Egyptian political uncertainty is supportive of our view that the post Arab Spring transition in the Middle East will be complicated and long tail in nature.  As such, political transitions in the Middle East, in particular Egypt, should remain front and center as a global macro risk.


Back in April of 2011, when the Jasmine Revolution and Arab Spring were front and center for global macro risk managers, we wrote the following:


“In many ways, Egypt will be a real litmus test for the Middle East. With 85 million people, it is the largest country in the region and geographically it is very central. Furthermore, Egypt does not have any major tribal or sectarian issues, like many sovereign states in the Middle East, so it should have the best chance at a peaceful and democratic transition. Not dissimilar to Egypt’s role in the late 1970s when it was the first Arab nation to officially recognize Israel via the 1979 Egypt-Israel Peace Treaty, Egypt’s leadership may usher in a new era in the Middle East."


We believe this view continues to hold as it relates to Egypt. In the note below, we provide some background on Egypt and a couple of scenarios as to the political future of Egypt -- a nation that is and will continue to be a litmus test for the entire region.


Background: Egypt’s Political History

Egypt has been a republic since 1952, when members of the military over threw the old monarchy following a defeat in the 1948 Arab-Israeli War. After a brief attempt at civilian rule, the officers terminated the old constitution and declared Egypt a republic on June 19, 1953.


Since then, Egypt has had four presidents. Muhammad Naguib was sworn in as the first president of Egypt in 1953, and remained in office until he was succeeded by Gamal Abdel Nasser Hussein, famous for representing Egypt during the Suez Crisis. Nasser held office until his death in 1970, at which point Anwar El Sadat commenced an eleven-year presidency that culminated with his assassination in 1981.


Sadat fundamentally changed Egypt’s economic and political direction by re-establishing the multi-party system and negotiating the Egypt-Israel Peace Treaty.  After Sadat’s death and a brief interim president, Sadat’s former vice president, Muhammad Hosni El Sayed Mubarak, became Egypt’s fourth president in October of 1981.


Mubarak’s almost thirty-year presidency was characterized by broad corruption and abuse of power.  Not surprisingly, the Egyptian economy floundered under Mubarak and was in a large part supported by annual aid from the U.S.  Mubarak’s regime maintained one-party rule under a continuous state of emergency, refusing to null the emergency law that had been enacted after the Six-Day War in 1967 and thereby preserving the government’s unchallenged power to censor, imprison, police, and suspend constitutional rights. Under the Mubarak regime, political activists were imprisoned without trial, undocumented detention facilities were established and universities, religious buildings and publications were discriminated against based on political affiliation.


In late 2010, Tunisian President Ben Ali was ousted with the advent of popular uprisings across the Middle East and North Africa.  Given Mubarak’s seemingly self-serving and dictatorial rule, few astute political analysts were surprised when in early 2011 Egypt became the epicenter for the “Arab Spring” and popular unrest in the Middle East.


As protests escalated in early 2011, Mubarak made a number of live, televised appearances in which he promised governmental reform, but refused to step down from his office. Finally, in mid-February, Mubarak caved – Vice President Omar Suleiman announced that Mubarak was resigning his presidency and turning power over to the Egyptian military, led by Field Marshall Mohammad Hussein Tantawi.


Post-Mubarak and the Current Situation

In the aftermath of Mubarak’s deposition, Tantawi dissolved Egypt’s Parliament, suspended its Constitution and promised open presidential and parliamentary elections within six months. The prior cabinet, along with Prime Minister Ahmed Shafik (a secularist with ties to the old regime), was appointed to serve as a caretaker government until a new one was formed. In response to protests, Shafik was replaced on March 5th with Essam Sharaf, Egypt’s former transport minister.


In the new political landscape, Islamist parties such as the Muslim Brotherhood demonstrated a renewed strength, taking lead roles in constitutional changes, voter mobilization tactics, and demonstrations.  For many observers, the reemergence of the Muslim Brotherhood signified increased Islamic influence in Egypt and raised questions about the country’s future relationship with Israel, and whether Egypt would be able to assimilate and appease its broad political and religious interest groups.


Despite Mubarak’s resignation, protests continued throughout the remainder of 2011, fueling international concern over how long the military junta would rule the country. Parliamentary elections were held in January 2012, with the Muslim Brotherhood winning roughly half of the seats. In March, the Brotherhood reneged on their previous promise to seek the presidency and nominated Mohamed Morsi for office after their first-choice candidate was rejected by courts.  


After the first round of voting in Egypt’s presidential election from May 24-25th, the winners were Morsi and Shafik. Around this time, the Egyptian military took a number of legislative measures to extend their powers in what critics labeled a “silent coup.” Such measures included the dissolution of Parliament on the grounds that the law under which it had been elected was unconstitutional, and the passing of a charter limiting presidential authority and giving generals legal and economic control of the country.  The second round of voting took place from June 16-17th, and on June 24th, a week after the polls closed, Muslim Brotherhood candidate Mohamed Morsi was confirmed as the official winner of the election with 51.7 percent of the vote to Shafik’s 48.3 percent.


In the month since the second round of voting, a string of events have thrown the country’s switch to democracy into confusion as relations between the military establishment and the Brotherhood have grown increasingly strained. The Brotherhood had been well-established during Mubarak’s reign as the primary opposition to his military dictatorship, and its decision to join young liberal activists in revolutionary protests was integral to the revolution’s overall success. That said, it was the military that ultimately ousted Mubarak and took control of Egypt.


Ultimately, Morsi’s electoral success gave the Brotherhood a boost in its struggle for power with the Egyptian military. On July 8th, Morsi surprisingly ordered Parliament to reconvene, directly challenging the reigning military that had reaffirmed its order to dissolve the body. Despite this “breach,” the military made no move to prevent the legislators from gathering for a brief parliamentary session on July 10th.


At a military ceremony on July 17th, Field Marshal Tantawi asserted: “Egypt will not fall. It is for all Egyptians, not for a certain group – the armed forces will not allow that.” There is ample reason to believe that this defiant statement was addressed to the Brotherhood, and that there may be turbulent times ahead.


Expectations for the Future

Egypt has the 27th largest economy in the world, and remains incredibly relevant due to its place as an important American ally in the region and its role in global commerce as the home of the Suez Canal, which transports roughly 8% of the world’s oil supply. Moreover, Egypt has served as a key arbitrator in the Israel-Palestine peace process for thirty years.  As The Economist aptly stated in a recent article:

“With its strategic situation, its cultural influence and a population double that of any other Arab country, Egypt has for three decades now been the linchpin of a precarious but enduring regional Pax Americana.”


 At present, a number of unknown variables drastically complicate national (and regional) prospects for a stable future.  Moreover, accelerating internal unrest due to skyrocketing unemployment, as outlined in the chart below, is also a key factor.


Egypt . . . Now What? - chart2


Each group involved in the present power struggle seems to have a different ideal outcome in mind. The U.S. wants a thriving democracy to bring stability to the region; the army seems to want to maintain a status quo peace; the Muslim Brotherhood wants to establish a nation governed by traditional Islamic values. As a result of these conflicting interests, it’s nearly impossible to confidently predict where the nation is heading. Taking that into consideration, there are three possible directions in which the Egyptian political situation could head over the next few years.


Scenario one: The Egyptian military refuses to give up power and re-asserts control. The military wasn’t afraid to seize control of the country during Mubarak’s ousting, and there is no reason to believe that they wouldn’t do so again. Though they did concede in allowing Parliament to endure a five-minute session, they have the self-ordained legislative power to step in at any time. However, if the military did reassert control, it is likely they would face significant international pressure. Specifically, this pressure would come from the U.S. who provides more than $1.3 billion a year to Egypt in military assistance. (In the chart below, we highlight the close relationship between the U.S. and Egyptian stock market over the last six months, which is a point that is likely indicative of the massive U.S. support given to Egypt.) Moreover, if Islamists and liberals alike were to become convinced that the military had no intention of relinquishing power, we would see an increased probability of a second revolution with an unpredictable outcome.


Egypt . . . Now What? - Egypt


Scenario two: Morsi and the Muslim Brotherhood assert power. In response, the military would likely challenge the action in court, which will lead to more even more uncertainty and take months, if not years, to resolve. Even if the Egyptian military were to unexpectedly accept Morsi’s presidency, the challenge of leading Egypt remains monumental. The Egyptian population has endured a tumultuous past couple years, and citizens will be impatient in demanding immediate change. Apart from being forced to juggle what will most certainly be an overwhelming influx of social demands, Morsi will need to be cautious of threatening the military’s economic, commercial, and political interests. Morsi lacks political experience, and whether he has the nerve and/or ability to lead Egypt during this difficult transitional period remains to be seen.


Scenario three: Egypt enters a period of conflict and political paralysis, and party disagreements lead to violence. While Morsi may be the “official” president, it is critical to keep in mind that over 50 percent of Egyptians did not initially vote for either Shafik or Morsi, and instead supported more moderate candidates. It is uncertain how this demographic will respond to Morsi as a leader, yet they play a key role in determining the country’s political future. Many who initially supported the revolution are stuck between a rock and a hard place, having to choose between a traditional Islamist and an old-regime secularist who might threaten revolutionary progress. In the face of a prolonged power vacuum, there’s a risk for conflict Egypt’s political parties to take a violent turn and trigger a second revolution.


As Shakespeare wrote:


“Expectations are the root of all heartache.”


Currently, expectations in Egypt for a quick resolution of the current political stalemate are low, but perhaps these low expectations are just what the nation needs as it comes to grip with a new governing reality.



Daryl G. Jones

Director of Research




The New America







Italy is just in full blown destruction mode with the MIB index down -21% from its year-to-date top. Their debt problem is so big that almost no one can bail them out. Come September 12th, Mario Monti and his cronies will have some explaining (read: begging) to do in order for the German Parliament to sign off on whatever package they end up getting.   



Oh goodness. We almost felt sorry for Ben Bernanke yesterday when Senator Chuck Schumer started berating him to “get to work.” Yes, we realize that Congress will never agree on anything ever again and that the US political machine is broken. But demanding Bernanke “get to work” because the last bastion of hope is the Federal Reserve? Please.



Having a 100% cash position isn’t always the right call. Sure, we’re fond of it, but you need to have some wiggle room for when the market gives you an entry point for a specific sector. Keep your exposure to equities and commodities low and you’ll be fine out there. Fade that beta.




Cash: Down                U.S. Equities: Flat


Int'l Equities: Flat Commodities: Flat


Fixed Income: Up        Int'l Currencies: Up





The bulk of the bad news is on the table following disappointing F2012. Rebased F2013 estimates far more reasonable, and revenues should be supported by our expectations for rising physician utilization, and in the near-term, a flu season that is shaping up as a considerable tailwind.







SS volume accelerated in 1Q12 and employment remains a tailwind to both admissions & mix. We expect acuity to stabilize and births and outpatient utilization to accelerate out of 1Q12, while supply cost management continues as a margin driver and acquisition opportunities remain a source for upside.







The company continues to control its own destiny through investments in all the right areas. We think 30%+ top line and EPS growth for 5+ years. One of its failures, however, has been in penetrating markets outside the US. That will happen. But for now, its failure is a competitive advantage in the face of a strengthening dollar. We like it in sympathy with a LULU sell-off.








Tweet of the Day: “$CORN RT @douglas_blake: I'd go see Dark Knight Rises this weekend, but I can't afford the Popcorn.”-@ReformedBroker


Quote of the Day: “Glory is fleeting, but obscurity is forever.” –Napoleon Bonaparte


Stat of the Day: In the last three months, 225,000 net jobs were added in America. During that same time period,  246,000 were added to Social Security’s disability insurance.








Even after normalizing hold, the Q was not good.  Whisper expectations were for a first down punt, however.



Wynn missed Street expectations, even after normalizing hold.  We had low hold already factored into our Wynn Macau and Las Vegas projections (not low enough for Vegas) and Wynn still needed a Hail Mary pass in the form of favorable reserve adjustment to make our number.  So why do we think WYNN could rally?  We’re pretty sure buy side expectations were lower and Wynn may have actually covered the point spread.  Moreover, the stock has been in a tailspin, down 42% and 28% from its 52 week high and recent April high, respectively.  Keep a trade a trade, however.  Wynn is still down by a lot and the opposing side is looking tough:  market share still at risk, Macau VIP may disappoint further, and the modest Las Vegas recovery seems to be moderating further.


Netting the impact of low hold and the benefit of the reversal of provision for bad debt, we believe that Wynn would have reported $1,32BN of revenue and $378MM of EBITDA, still 2% and 3% below the Street.  Wynn recorded a positive adjustment to its receivable reserve which we calculate favorably impacted EBITDA by $25 million.  As a former CPA and Audit Chair of a publicly traded company I find it hard to believe the auditors recommended getting less conservative.  Nevertheless, Wynn has clearly over-reserved historically so the end result on the balance sheet is appropriate.  Only the timing is suspect.




Wynn reported net revenue of $908MM which was just 0.4% below our estimate.  Adjusted EBITDA was 7% higher than we estimated, almost entirely due to a reversal of bad debt provisions.  Lower than historical hold on the VIP business was largely offset by high hold on Mass.  If hold was “normal”, net revenue and EBITDA would have been $15MM and $3MM higher, respectively.  If we adjust for the reserve and normalize for hold then we estimate that Wynn Macau would have reported net revenue of $923MM and Adjusted EBITDA of $289MM, 4% and 3% below consensus going into the print.

  • Net VIP table win was $1MM lower than we estimated. 
    • RC volume declined 7% YoY, despite a 9% increase in the number of VIP tables.  Volumes dropped 10% QoQ despite no change in tables.
    • Direct play was 8.3% vs. our estimate of 11.0% and hold was 5bps better than we estimated, resulting in gross table win that was $1MM above our estimate.  
    • The rebate rate was 30.8% or 84bps, a bit higher than we estimated
    • We estimate that all junket commissions & rebates were 41.9%, a little lower than we estimated and impressive in the current “aggressive” promotional environment that Wynn described.  However, we won’t know for sure until Wynn Macau files.
    • The property’s historical hold rate since opening, inclusive of this quarter, has been 2.92%.  Using the historical hold rate, net revenues would have been $27MM better and EBITDA would have been $8MM higher.
  • Mass table win was $2MM lower than we estimated
    • Drop declined 5% QoQ, despite a small increase in the number of tables and was 9% less than we estimated but the win % was 2.3% better.  
    • Wynn’s mass hold in 2011 was 28.4% and Wynn considers 26-28% normal. Assuming 28%, revenues would have been $15MM lower while EBITDA would have been about $5MM lower.
  • Slot win was $1MM below our estimate
    • Slot handle was down 22% YoY on a 11% reduction of average slots on the floor
    • Hold was 5.3%, 20bps better than we estimated
    • As Wynn mentioned on the call, they are adding some slots, so we’ll be watching to see if more supply drives demand here
  • We estimate that fixed expenses totaled $108MM, in-line with our estimate and flat QoQ


Las Vegas

Las Vegas revenues and EBITDA missed our numbers by 6% and 18%, respectively, and missed the Street’s EBITDA estimate by 24%. The entire miss came from lower than normal hold on Wynn’s high end baccarat play which held at only 9% and took down the hold on table games to 15% which is about 9% below normal.  The impact of low hold which the company estimates impacted EBITDA by $34MM was partly offset by the reversal in bad debt provision, which we estimate benefited Wynn Las Vegas by $9MM.  Net/net, we think that on a “normalized” basis, Wynn Las Vegas would have reported $392MM of net revenue and $107MM of EBITDA, which was still a little below consensus.  

A large part of the miss came from lower room revenue and higher promotional spend.  Despite management’s statements on the call, we believe that trying to inflate ADRs probably cost Wynn a lot of occupancy and hurt their gaming and non-gaming revenues in the quarter.

  • Net casino revenues were $31MM below our estimate
    • Table drop actually grew 8% YoY vs. our estimate of 5% growth but hold was way below normal, resulting in table win being $26MM below our estimate (we suspected low hold but not this low)
      • Hold was 15%, significantly below the company’s normal range of 21-24% and the 9 quarter trailing average of 23.5%.  Assuming 23% is normal, table win would have been $46MM better and according to Matt Maddox, EBITDA would have been $34MM higher.
    • Slot win was $2MM lower than we estimated
      • Slot handle 2% better than we estimated but the win % was 40bps lower at 5.7%
    • Total gaming discounts and promotions totaled 22% of gross casino win, higher than the 17.7% discount rate in 2011 and last quarter’s rate of 18%.
    • We estimate that the reversal in bad debt benefited EBITDA by $9MM 

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