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Too Big To Bail

“It occurs at first very slowly, then all at once.”

-Ernest Hemingway


That’s what Hemingway said about going broke. That’s also what I said in response to my research team’s questions in the morning meeting yesterday about levered sovereign nations and their banks. From a time and price, this entire thing becomes Too Big To Bail. If it wasn’t, why are the Spaniards banning short selling?


But do people really believe they won’t be bailed out? Listening to the sad whisper of Qe Begging each and every market day, I’m not so sure. While the likes of Timmy Geithner may believe “deeply” that it would be “irresponsible” to not raise taxes, this economy is digging into a deepening hole that some of these banks may not be able to exit without the government’s hand.


But how many hands does the US government have? How many Spanish and Italian banks is Geithner going to have to attempt to bailout via the US tax payer backstopped IMF? How much time does the government have in a stagflating economy to bailout a domestic bank like Morgan Stanley? If it’s happening All At Once, neither you nor I know.


Back to the Global Macro Grind


As Keynesian central planners around the world continue to spin their wheels looking for the next “growth policy”, they continue to perpetuate #GrowthSlowing by piling more debt-upon-debt.


As Growth Slowing’s Slope accelerates on the downside, some of the few remaining leading indicators that were relatively stable for the last 6 weeks are now showing signs of the same economic gravity that has gripped them since March:

  1. Hong Kong’s Hang Seng Index – down -3.8% in the last 2-days has once again snapped intermediate-term TREND support
  2. Italy’s MIB Index – down -13% from its July high has snapped its YTD closing lows established at the end of May
  3. USA’s Russell 2000 – down -5% from its early July high has snapped both its TRADE and TREND lines of support

Oh snap.


All the while, some investors are obviously getting whipped around, buying high and shorting low. But that institutional performance chasing problem isn’t nearly as problematic as the causality driving the whip.


The worse the global economic data gets, the more Qe begging for bailouts the market hears. The more they beg, the more the government creates an expectation that they’ll be there to bail them out. These expectations are now in and of themselves becoming the market’s biggest risk.


Now, you could say that “growth expectations are low and stocks are cheap.” If I hear that a dozen times a day, I see it tweeted 100x over. So that’s consensus. It’s also what consensus has been saying since March. Growth continues to surprise on the downside and “cheap” stocks keep getting cheaper.


Looking at the Big Macro Data this morning, you can say whatever you want to say – but the data is the data:

  1. German PMI (manufacturing index) tanked in July at 43.3 versus 45.0 in June
  2. Chinese “flash” PMI rose in July from 48.2 to 49.5
  3. Brazilian inflation rose “surprisingly” on the mid-July reading back up to 5.2%

Hedgeye Playbook: get the slopes of Growth and Inflation right (sequentially) and you’ll get a lot of other things right:


1.   GROWTH: given that any PMI reading below 50 is just plain bad, you can call the growth data better than awful in China – but, at the same time, agree with Moody’s that Germany’s economic growth picture is, well, awful.


2.   INFLATION: that’s the most important Global Macro inflation data point we’ve had so far in July (primarily because it’s one of the few July numbers that have been reported!). This is the first sequential uptick in Brazilian inflation since September.


Does anyone remember September 2011? Ooh-lah-lah. Lots of bad stuff started happening to markets All At Once. In a #GrowthSlowing global economy, marginal food/energy price inflations also slow growth further.


Whether you go back to the July 2011 highs in stocks or commodities (and trace a draw-down line to the October lows), you’ll see the same thing. The world’s growth slowed, All At Once, after the Qe2 sponsored commodity price inflation shocks of July-August.


Now, I’ll be the first to agree, this is not 2011. This isn’t 2008 either. This Time Is Different! This is 2012. And, oh my, does the entire world have more sovereign and bank liquidity issues today than Lehman or Greece did in either of those periods. In 2012-2013, this globally interconnected web of debt, banks, and broken political promises might just be Too Big To Bail.


My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Hang Seng, and the SP500 are now $1, $98.39-108.37, $83.22-83.98, $1.20-1.22, 184, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Too Big To Bail - Chart of the Day


Too Big To Bail - Virtual Portfolio

Where's The Growth?


Hedgeye Risk Management CEO Keith McCullough went on CNBC’s The Kudlow Report to discuss how getting the dollar right affects many other aspects of the market. A stronger dollar equates to lower prices at the pump and that’s something almost every American can get behind.


There are three major issues going on that have evaporated confidence from our capital markets. Growth continues to slow, abysmal job creation and the debate over the fiscal cliff continue to drag on. Luckily, there’s hope in the US Dollar (affectionately known as #KingDollar on Twitter).



Early Look

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HedgeyeRetail Visual: UA's Got a Spine

Regardless of the print, expect to hear a lot about the launch of the 'Spine' lightweight runner. Early trends are positive. Here's some context on the product.


While apparel is still (unfortunately) the overwhelming driver for UA, you should expect Plank to allocate a good amount of the conference call's real estate to UA’s new “Spine” lightweight running shoe. Here's some context so you know what he's talking about. 


Consider the Following:

  • The “Spine” represents UA’s initial entrance into the lightweight running market. The new design is more of an entry level lightweight shoe weighing 9.7oz vs. Nike’s Free at 8.6oz and Saucony’s Kinvara at 7.7oz but remains UA’s lightest shoe to date.
  • Importantly, the launch of the “Spine” lays the foundation for the Spine technology (minimal material sole) which will be implemented into other UA FW designs including Football and Basketball.
  • HIBB noted on its 1Q12 call ahead of the launch that UA “hit the market well this time” referencing the Spine and indicated they would carry the shoe in more doors than past releases.
  • The “Spine” sells at an ~$100 ASP compared to the Charge RC at $120, the Micro G Split at $90, Micro G Stealth at $80 and Assert at $70.
  • UA currently has ~1% market share in the running category, down from ~1.2% in 2010- UA need’s to execute on its launches in order to reaccelerate share gains.
  • Taking into account the scope of the sample, UA’s “Spine” unit volume in its first 3-weeks in the market has been well above that of Micro G split/Stealth and Charge RC launches on both an absolute basis and as a percent of total units sold.
  • While week 3 volume is on par with the UA Assert which launched at the beginning of 2011, the “Spine” is sold at a $30 premium to the $70 Assert.


HedgeyeRetail Visual: UA's Got a Spine - UA COTD


HedgeyeRetail Visual: UA's Got a Spine - UA running share


UA "Spine"

HedgeyeRetail Visual: UA's Got a Spine - Spine


Legacy Launch

HedgeyeRetail Visual: UA's Got a Spine - legacy launch


We’re nervous about this quarter and the remainder of FY12.  The Street’s FY12 expectations imply a strong second half of the year.  We believe that reality is likely to be at odds with those expectations as same-store sales are slowing and the company is ramping up expenditure through investment in several new initiatives. 


Here are the key topics we will be focusing on heading into earnings on 7/26:

  • Guidance: Management is expected to provide its initial outlook for FY13 financial targets
  • Evolution Fresh: The Company previously stated that it intended to have Evolution Fresh beverages available across the Starbucks U.S. retail store system this summer.  We have seen several stores in the NY/NY/CT region without the beverage line and it is almost August!
  • Refreshers:  The new “refreshers” beverage offering has been on offer now for a couple of weeks. 
  • G&A: The Global Leadership Conference that the company is hosting in October is expected to cost $35-40mm.
  • La Boulange: Additional details on the acquisition are expected and we the company to quantify the dilutive impact of the acquisition to FY13 EPS.
  • Accelerating unit growth: The Company’s business is becoming more complex with five concepts in four different segments of the food and beverage industry. 
  • China: Given the recent macroeconomic commentary from list of consumer companies, Starbucks will likely address its performance in China during the second quarter.
  • Europe: MCD had nothing good to say about Europe.



While 80% of the 31 analysts covering Starbucks rate the stock “Buy”, we are of the opinion that management is too optimistic. 

 SBUX: NERVOUS NELLY - sbux sell side sentiment


 Below, we discuss some of the forward-looking commentary recently offered by management:




“Now importantly with these headwinds I've spoken about with the fact that in this back half of the year commodity costs are still higher than they were relatively speaking a year ago, with the EMEA headwinds that I've have just spoken about, with the investments that we're making in things like La Boulange, food program overall, the continued integration of the Evolution Fresh business, which we acquired earlier this year, with all those headwinds we're accelerating earnings growth in Q3 and further in Q4.”


HEDGEYE – The Company has said that it expects company-operated comparable restaurant sales to grow at “mid-single digit pace”.  We believe that a 4-5% number would likely fall short of providing the leverage the company needs.  According to Consensus Metrix, the street is looking for 8%, -1%, and 18% growth for the Americas, EMEA, and CAP, respectively. We believe that, on all three counts, the Street is too aggressive.




“Now specifically to fiscal 2012, we are expecting earnings per share in the current year of $1.80 to $1.82, that represents about 18% to 20% earnings growth over the $1.52 that we earned a year ago and you can see the big hit that commodity cost take out of this first year right out of the gate, north of $200 million of commodity cost pressure in this fiscal year. Now, specific further to the second half of 2012, growth in earnings is expected to accelerate as we move into this third quarter. Accelerating from the first half of the year to 22% to 25% we expect in Q3 and 24% to 27% earnings growth expected in the fourth quarter. That reflects EPS of $0.44 likely we believe now in the third quarter with upside of that at $0.45. I'll come back to that in just a moment and in the fourth quarter our expected range is $0.46 to $0.47 EPS.”


HEDGEYE – We believe that there is a strong possibility of another guide down when the company reports on Thursday.




“Our total business unit G&A as a percentage of total net revenue increased slightly over last Q2 due largely to growth in our Channel Development segment as we ramp up support of the high growth business.” 


HEDGEYE – We know they are building five different concepts and investing in the core food offering.  If the economic malaise persists or worsens, we would expect the company’s margins to deteriorate as a result.




“It's clear that we'll have increased pressure from EMEA in this third quarter… we are living in a tough EMEA environment here for a while.”


"In March, our EMEA team launched what we're calling the Renaissance plan, our blueprint for turning around performance in that important region, which is modeled after the success of our transformation agenda in the U.S."


HEDGEYE – We remain skeptical on a turnaround in Europe absent a stabilization of the economic environment there.   The 2Q12 McDonald’s earnings call does not inspire much confidence that a rebound is forthcoming. 


CAP - China/Asia-Pacific


“Operating income in CAP was also strong, increasing 59% to $70 million in the second quarter. Operating margin grew 660 basis points to 39.8% despite higher commodity costs of approximately 140 basis points. This quarter's results were also impacted by the favorable timing of income for certain of our joint venture operations which we do not expect to occur in future. Our team is continuing to do an excellent job of following our growing revenue through to the bottom line, despite continued inflationary pressure in key Asian markets like China.”


HEDGEYE – The one-time items that benefitted results in 2QFY12 are less likely to repeat going forward.  Continuing economic sluggishness, as highlighted by McDonald’s, is likely to impede Starbucks’ progress in the region.




We believe that, over the near-term TRADE and intermediate-term TREND, the Street is too bullish on Starbucks.  There are pockets of hype that continue to buoy sentiment; K-Cups for example, will continue to generate attention but as a relatively insignificant portion of the company’s earnings, that business is unlikely to offset the other major headwinds the company faces heading into FY13.  One tailwind that the company expects in FY13 is coffee costs.  The operating income tailwind should be in the order of more than $100mm and an additional year of favorable coffee costs is expected in 2014.



Howard Penney

Managing Director


Rory Green



In preparation for IGT's 2Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.




IGT Granted License from Gaming Commission for Online Poker (6/21/2012)


IGT Announces New $1BN Share Repurchase Authorization and $400MM Accelerated Stock Buyback (6/14/2012)

  • IGT entered into an accelerated stock buyback agreement with Goldman Sachs under which it will repurchase approximately $400MM of its common stock.  The accelerated stock buyback will be conducted as the first part of the Company's new $1BN share repurchase authorization. 
  • Initially, Goldman Sachs has agreed to deliver approximately 21MM shares IGT's stock  on or before July 6, 2012.
  • The remaining $600MM is currently anticipated to be utilized over the next 3 to 4 years.

IGT Partners with Atlantic Lottery to Upgrade VLT Network (5/24/2012)

  • Signed an agreement with Atlantic Lottery, a public corporation owned by the governments of Nova Scotia, Prince Edward Island,New Brunswick and Newfoundland and Labrador, to provide 1,612 video lottery terminals for the replacement of obsolete units.





  • "I would say the mood is improving but still tempered. I think we're all wondering about the economy as we go into this election cycle, and then, post-election, kind of what things look like next year. And I think there's always a great intent to make investments and then just stopping short of actually making it at the same robust level....I would say people are enthusiastic but still a little anxious."
  • "We feel very good about our position there [Canada], that market is going through a huge replacement cycle in 2013 and 2014, fiscal 2013 and 2014 for us, is kind of a once-every-10-year opportunity, so when it comes, you have to really be prepared. We feel like we are prepared. It's a huge opportunity for us."
  • [DoubleDown] "We've owned it now for three or four months, and we're comfortable that it's out ahead of what we expected it to be at this point financially. It will be accretive on an adjusted basis this year, and accretive on a GAAP basis in 2014."
  • [DoubleDown] "On your projections, EBITDA should roughly triple from here, and that would equate to a purchase multiple of roughly 6.5 to 7 times EBITDA on 2014. Are we in the same ballpark?"
    • "So I would say your math makes sense in this kind of a worst-case, and we think there's actually a lift from that in the business, just based on the R&D that has been spent years ago, and putting some legs on that R&D as we repurpose a lot of our content into the social gaming space and monetize it, again, when it's been sitting on the shelf."
  • [Bringing a theme via Double Downs] "It's one-third the cost generally to get something out into that marketplace, which is important for us. If you think about the hits business that you're in in the casino floor, it really reduces the strikeouts and makes sure that you have more hits in that marketplace, so a very important testing vehicle for us as well as just a revenue and customer touch point."
  • "The Dark Knight has moved out from Vegas into some of the regional markets. It's doing well in the regional markets. We've moved our Dark Knight into Monaco. I had an opportunity to be there for the unveiling of The Dark Knight. And it's amazing; you don't think it really would translate to a bunch of French tourists, but the reality is it really does translate, and it all comes down to the video that we talked about earlier. That video component, that immersive component really pulls people in. Sex and the City has moved to the Asia-Pac region, which has been great, and it's playing well down there, and our MegaJackpots into Macau, the first MegaJackpots into Macau, again, really performing well and ready to expand down there. We're excited about the product lineup looking very good"



  • "Our international business pace continues to accelerate, with improvement in both quantity and quality of order flow."
  • "Our first Cloud trials are up and running across Europe, and our partnership with Lottomatica in Italy underscores the value of our leading game content and our intense focus on driving higher returns on our investments in research and development."
  • "We expect our financial results will continue to strengthen throughout the remainder of this fiscal year."
  • "We are responsibly focused first on reducing risks and managing that which is within our control."
  • "Our core objectives for 2012 remain consistent, as we look to grow revenues, build on the momentum of our internal improvements, leverage our income statement and energize our Interactive business."
  • "We're generally pleased with our WAP product performance. It continues to perform as expected.  Really, the quarter was really just a mix to the lower earning units and we expect continued improvement sequentially over the remainder of the year."
  • "We had an isolated non-standard cost situation in our Asia-Pac region in the quarter, so we are anticipating that the gross margins across the board... will pick up between now and the year – and the end of the year back to more normalized levels."
  • "We're very comfortable, if you look at the accretion to cash earnings that Double Down has provided, we feel very comfortable that it's outperforming our expectations in the business case going into the acquisition. I think the thing to keep in mind is that the way we count our daily users is a little bit different than others in the market because we count them when they come in the door of Double Down. So if you go into the Double Down casino and you play more than one machine, it still is only counted as one. So we're very focused on the stickiness of the full-on casino as opposed to an individual game."
  • "Our outlook is positive for North American replacements. It will, we think, continue to strengthen throughout the year, we will expect North American replacements to grow modestly over the remainder of the year, but there wasn't anything extraordinarily unusual in the quarter that doesn't lead us to believe that there's continued strength in that market for us...the replacement market is going to be flat to growing has kind of been IGT's stance now for about six months. This year's going to be flat to growing and our share in that is going to be in the mid 30%s. So I think that tells you year-over-year, our North American replacement markets will be in that kind of 3% to 5% growth range with, you know, about a mid 30% share."
  • "It's just worth noting that when you think about our business on an annual basis, we're targeting in that kind of mid-30% market share range"
  • "I would say that we have drawn out the retention payments because they are of a short duration. They will only be in place for a short number of years. And recognize that currently they are not cash payments. They are accruals against cash payments that will be earned into the future"
  • "In the quarter on an adjusted basis, Double Down contributed about a penny. And we expect that to be the case for the next couple of quarters as well."
  • "Just to add clarity, on the $0.15 that's in our press release, that predominately relates to the amortization of certain intangibles which we detail out separately in the current quarter, and we'll most likely continue to do in future quarters, as well as the retention payments, which we are also independently calling out on our income statement due to their size and the short-term nature over which they will appear in our income statement."
  • "We're certainly hoping to count on a couple more pennies to carry forward this quarter's performance of Double Down forward, but not in the bank yet."
  • "It's a reflection of our focus on the international market, moving ourselves to higher ground there with more sophisticated installations and the investment that we've made, the R&D investment to build localized content."
  • [Replacement level] "We've recognized 8,100 units. I think that's a comfortable kind of six month rate for us that we feel very comfortable with. And as we indicate I think every quarter, you're going to find things moving around quarter-to-quarter but kind of sitting in at that level on an annual basis is something we're comfortable with."
  • "Gross margins for the Interactive business, Double Down in particular, is a little skewed because of the way the Facebook credits come through. So a little bit higher revenue growth, a little bit more stretched gross margins. We expect those gross margins because of the way it's so kind of clinical in the calculation, right? It's ...$0.70 of every dollar for us. We expect them to kind of hold in there in the Double Down business and the general Interactive business outside of that, we expect slight margin pickup there in the back half."
  • "We haven't really pursued the Cloud domestically at this point. We've been very focused with both regulators and customers outside the U.S. and are very comfortable with the trials and we're very focused now on converting the trials to commercials. That will take place over the coming months. And I would say the U.S. is still well into 2013 or 2014, until we really start thinking about. There's a lot of work that has to be done regulatorily but also just in really exercising the Cloud technology with our customer set ahead of bringing it into the U.S."
  • "It's interesting to see the legs on Sex and the City internationally.  That's been a real pleasant surprise for us, to see how applicable that product is outside the U.S. So we've really been able to pick up some strength by adding life to the Sex and the City product, the original product. Dark Knight not just here in the U.S. but outside the U.S. also very strong for us, Ghostbusters as well. So we're feeling very good. Breakfast at Tiffany's is doing very well. It's moved from an exclusive out more generally into the market. So we feel good about how the product is playing. And Big Buck Hunter is kind of the next generation for us. So I feel like we have a nice lineup of product in the bag of the sales folks at this particular point in the game ops side."
  • "Asia is a great opportunity for share pickup for us. In Central, South Latin America, it's really more about new openings and some share pickup. But, you know, I will tell you that our EMEA group has really done a remarkable job at really getting us back in doors that we had not been in in a very, very long time introducing new product that many of our customers had not been introduced to. So I would just say we can't count out our EMEA region. They really are scrambling for every machine order and they've proven that, you know, every machine order matters."
  • [International share target] "Can we set our sights on being north of 20%? I think we can set our sights on that."
  • [Canada VLT] "We still think we might get some in the September quarter. It just kind of comes down to timing and revenue recognition issues. It's really going to be more of a 2013 event. There may be 1,000 contracts or so that sneak into September. But we... obviously got a very good share from the first announcement and we're hopeful that those kind of trends continue."
  • "Our current forecast is that the Ohio properties will be recognized in June. That being said, that largely comes down to the licensure process and the requirements we need to meet in order to ensure appropriate revenue recognition but our current perspective is those will be recognized in our third quarter."

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