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Eye on Private Equity: Embarrassing

David “Ruby” Rubenstein gave a keynote speech at the 15th annual venture capital and private equity conference at Harvard Business School earlier this week. His comments were at best embarrassing.

According to news reports, Ruby blamed both the private equity industry for doing deals that didn’t make sense and the investment banking industry for offering cheap debt with loose terms to finance the deals.

Specifically Rubenstein stated:

“I analogize it to sex. You realize there were certain things you shouldn’t do, but the urge is there and you can’t resists”

While the analogy may be funny to some and interesting on some level to others, this is an American leader of one of the largest private equity firms in the world speaking to one of our top business schools. As such, it would be a great place for Ruby to show some accountability for an industry that has gone wildly awry and lost untold billions for shareholders.

Comparing the private equity industry to the sexual urges of a teenage boy, for we assume most adults can control their urges, is not the type of accountability we would hope for from said leadership. Hope, of course, much like levering up to buy assets into cyclical tops, is not an investment process.

Into the weakness associated with the Barron’s cover article this past weekend, we covered our short position in Blackstone (BX) in our Hedgeye Portfolio, but suffice it to say we remain negative on the fundamental and ethical trends in the private industry and will likely be looking to re-short any strength.

With Obama’s forced expansion of US consumer lending, a steepening of the US Yield Curve, and the global TED Spread having narrowed to less than 100 basis points, the “Liquidity Crisis” of October/November 2008 is behind us. What we have now is an “Illiquidity Crisis” combined with a “Crisis in Credibility” – those two crises will be the crosses to bear for some, and create forced sale prices for the next generation of American capitalists who own liquidity.

Daryl G. Jones
Managing Director

LIZ: Bill Throws Us A Bone

Finally! LIZ announced an 8% headcount cut, which I think is huge. With margins going up and capex coming down, I think this is the near-term bottom for EPS revisions. More strategic call-options remain.
To put this into perspective, assuming $125k/yr per employee on average (including benefits, and the suspension of bonuses for remaining employees), this equates to $90mm in EBIT, 2.2 operating margin points (off a base of 4.0%), and about $0.60 per share in earnings. In addition, this can fund LIZ’s entire maintenance capex budget for each of the next 3 years.

My view on this name has been, and continues to be, that it is not going bankrupt – which a $2 stock suggests is quite possible. The company has secured new lines of financing to mitigate default risk, is cutting capex net year in half, and is now FINALLY cutting into what has consistently been one of the fattest SG&A structures in apparel (43% SG&A ratio???).

We’ve seen the near-term bottom of estimate revisions for LIZ, and with what I believe is minimal balance sheet risk, and a call option on monetizing Juicy, Lucky, and Kate Spade while selling the legacy Liz Claiborne brand to a major retailer (like Wal*Mart?), it is not tough for me to build to a net value 2-3x where the stock is trading today.

Natural Forces of Accountability

“When you strip away a country’s or an individual’s right to fail, you take away their ability to succeed. Let the natural forces of accountability work for all.”
-Stuart Witt (Mohave Air & Space Port, 2009)
I thought this was one of the more American statements I have read in a very long time. This is what this country is built on – American capitalists taking on tremendous personal risks in search of earning the ultimate reward - their economic freedom.
While we still have to trudge through the vortex of the manic media’s negative groupthink (a Herculean task), my sense is that we may be in the midst of crossing the chasm of peak fear associated with the obvious.
What is the obvious? The #1 and #2 stories on Bloomberg this morning are about Wall Street bonuses (UBS and CSFB); Obama finally pulled the rip cord and confirmed last night that he is of the view that we should let more banks “fail”; and Vikram, “The Pandit Bandit”, is on the tape confirming that Citigroup has “obligations” to the US government…
When the obvious morphs into consensus, you need to be considering the other side. As the “improbable” becomes more probable, I start to get invested closer to those improving probabilities… there’s no hope in that – it’s all process.
Yes, everything has both a time and a price. If you do not respect those two critical factors, you are going to underperform the market in 2009. Right here and now, “investing for the long run” has revealed itself as a narrative fallacy that supports asset management fees and your headaches. Every day this behavioral game of expectations changes, and so does the math alongside it. This game is both global and local. You need a repeatable process to understand it.
Locally this morning, alongside Obama’s now predictable and populist rhetoric, we have the “Bandit’s” sinking ship acknowledging that Citigroup will issue $36.5B of that US government issued TARP. Over 70% of those moneys, allegedly, will be issued in the form of American mortgages. After everyone and their brother freaked out on yesterday’s Senior Loan Officer Survey that quantified the shockingly obvious revelation that banks weren’t lending their TARP – guess what? They’re going to be forced to start lending their TARP!
This expansion of lending is positive for the immediate term “Trade” in this country, as over 70% of America’s economy is driven by consumer spending. Sadly, without credit flowing, this economy doesn’t work. Trust me, Obama has new rooms full of groupthink economists who can figure this out – this is the math.
Alongside forcing Citigroup to behave like the Government Sponsored Enterprise that they have become (no more $50 million dollar planes Mr. Parsons), Congress has effectively summoned all of the bankers who received TARP moneys to testify in front of the American people next week. As my long time hero of investigative reporting, Tim Russert, would have said, “This is BIG.”
Finally, the rhetoric associated with Obama’s fanfare will be tested and tried. Transparency, Accountability, and Trust – that’s been my mantra since I left Carlyle at the end of October of 2007 – now we’re going to at least see the whites of the eyes of those who haven’t fled these horse and buggy whip investment banks. Make no mistake, they will be lending soon, at a bank near you.
Everything that matters in our macro models happens on the margin. While levering up the American consumer will end badly, in the immediate term what I think it should do is provide the impetus for our almighty US Dollar to stop going up. As we transfer the bankers’ toxic waste onto the lap of America’s balance sheet, the other side of that immediate term “Trade” should be a weaker currency. Whether we like the sound of this or not, the only way the US stock market stops going down is if we break the buck’s upward momentum.
The US$ is up again early this morning, and the US futures are down as a result. The US$ is already up almost 6% for the year to date, and the US stock market is down -8.6%. Take that US Dollar down by 300-600 basis points and let me know how what feels in your portfolio. Yes, that would be inflationary… and the only way out of a deflationary spiral, in the immediate term, is to “re-flate”.
Globally, asset classes from Chinese and Brazilian stocks to Gold are “re-flating.” It works. China’s stock market tacked on another +2.4% overnight, taking the Shanghai stock exchange up to +13.2% for the year-to-date. No matter what your views on capitalism vs. communism, at this stage of the global socialization of losses this Chinese leadership march is impressive. Cutting taxes and interest rates, while you plug in the stimulus afforded to you by the virtues associated with cash on your balance sheet works. No, this is not “Chindia” – this is China.
Australia moved to cut interest rates by a full 100 basis points last night to 3.25%. I think Glenn Stevens and the Reserve Bank of Australia has done an admirable job – unlike the politicized and polarized Greenspan Federal Reserve, this man actually saved some of his bullets. While I have not yet bought back a position in Australian equities, they are getting more interesting. They, after all, are geographically located very close to the guys with the cash – China – and they should participate in any global “re-flation” trades that occur.
While hope is not an investment process, it is what we kiss our children good night with – it’s a global virtue. At this stage of consensus’ peak pessimism, it’s actually all we have left. We have to hope for “re-flation”, because without it … our assets continue to deflate. In the meantime, we need to keep allocating capital to the winners as we re-regulate and take it away from the losers. At the end of the day, we need to let these “natural forces of accountability work for all.”
My downside target for the SP500 is 810, and I will be getting invested again on market weakness. Patience will pay in The Year of The Ox.
Best of luck out there today.

Natural Forces of Accountability - etfs020309

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TBL: Numbers Look too High For ‘09

Fundamentally, I’m not comfortable with TBL here. I think ’09 es are high by 50%. Keith’s models suggest an 8-handle if I am close to right. If I’m off fundamentally, watch the 11.24 shark line.

Brian: I’m not thrilled w TBL right now. TBL’s share appears stable, and price points are relatively healthy. But TBL has had 3 quarters in a row where it meaningfully improved both its sales/inventory ratio as well as margins due to its efforts to close unprofitable stores and license out its apparel business. FX has been a 2-3% tailwind in the past 4 quarters, and that goes to -4% in 4Q and stays negative at current rates for the bulk on 2009. Also, with 45% of sales in Europe in 10% in Asia, TBL is disproportionately affected by declining consumer trends outside of the US. I like the long-term call that TBL has proactively invested in its own business over the past 3 years to make up for sins of the past and gain share in the new consumer landscape. But it simply cannot move as quickly as the current environment requires.

For the quarter, I’m at $0.25 vs. the Street at $0.29. The Street is looking for a down '09 -- $0.70 vs. $0.80 in '08. That’s not conservative enough. I’m at $0.45. Do I like the balance sheet? Yes. Do I think that either Nike or VFC ill own this name over 1-2 years? Yes. But I don’t know how much of that will matter right no if earnings come down by a third. On my numbers, this name is pushing 7x EBITDA. I need to be really wrong on the fundamentals in order to make this name reasonably cheap relative to peers.

Keith: TBL is broken and needs to take a good hard look at breaking $10 again… if it breaks 10.21, the 8 handle is in play… this one could see a massive squeeze however if it can find a reason to close above 11.24 and hold its gains.

[I know, the 'margin walk' below is tough to read -- even when enlarged. Check out the larger image in the pdf, or simply shoot me an email.]


The latest Export data from Korea and India seem to tell different stories…

Indian Export data for December was released today, registering at -1.05 % year-over-year. This is the third consecutive negative Y/Y figure for Indian exports, but a significant improvement from November’s number –both on a Y/Y and an absolute basis. The agony for Korean exports shows no in end sight with a January figure of -32.79% decline –the lowest Y/Y level recorded, worse even than the massive decline following the US withdrawal from South Vietnam and the later collapse of the Saigon government (South Korea was a primary hub for US equipment shipments then).

The divergence between India’s relative December resilience and Korea’s descent into the abyss is interesting but is ultimately somewhat misleading. The critical service industry component of the Indian growth story is ultimately more important than a rebound in exports of cheap motorbikes. This high tech service sector is sinking in lock step with the decline of financial services in the western economies and other major outsourcers with no hope of internal demand to offset the slump.

For the mature industrial block of the Korean economy, the picture is grim. Despite some pockets of strength in the heavy industrials that are still working through a healthy backlog (evidenced by shipbuilder Daewoo’s record numbers reported today), the export market for Korean goods, particularly automobiles and light trucks, continues to contract.

We have been negative on prospects for both India and Korea over the past year and are currently short the Indian equity market via IFN.

Andrew Barber

RT – Looking at the “Gap to Knapp”

An important way of measuring RT’s success in fixing its same-store sales problem will be the narrowing of the company’s “gap to Knapp.” Over the past year, RT same-store sales have been disastrous, but the “Gap to Knapp” has been narrowing recently. Sales trends in the current quarter support that this thesis will continue. At the core of RT’s sales issues is that the concept has been hardest hit in the rural areas of the Southeastern part of the US. This is due in part to high gas prices, but also the availability of gas in gas stations last summer. Both of which have self corrected.

Ironically, I attended a comedy show last night and have never laughed so hard at jokes about how bad the food, service and décor is at Applebee’s. I thought it may just have me laughing because I’m a restaurant analyst, but nope, the crowd really “got the joke.”

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