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DKS: Pays the Piper

DKS’ $145mm intangible write down (36% of total) is proof that overpaying at the peak will ultimately catch up with you. I never liked DKS, but there are potentially positive ramifications.

I always scratched my head on the kind of multiples DKS paid for its acquisitions. Many others did as well. Management always had a great story to tell about synergies, and reasons why paying up for superior real estate would yield superior returns. I never got it, and still don’t.

The good news for DKS is that the quarter appears to be coming in at least at the mid-point of guidance. But let’s remember that we’re still talking a -8.6% comp and 15% earnings decline (on 7% square footage growth).

Two possibly positive considerations.
1) DKS will finally change its tune and focus on growing organically and investing to drive traffic in its own stores instead of relying on new assets to take the top line higher. After all, despite my views on financial management at the company, DKS remains the best concept in this space.

2) Let’s not forget Sports Authority, which was bought by Leonard Greene in 2006 for $1.425bn, or 7.6x EBITDA. But that was with TSA at a peak 7.6% EBITDA margin. Since then, it has closed stores, and margins initially improved. But if DKS is comping down 8.6% -- I’d be shocked if TSA was not down double digits. In hindsight, this transaction was done for something closer to 12x EBITDA. What happens to a highly-levered TSA in this climate? If this domino falls (like so many SG retailers before it have), it would be a huge long-term positive for DKS as TSA represents 14% of industry capacity.


I’ve dusted off my University of Chicago statistical and modeling tools to analyze the Las Vegas locals gaming market. I looked at a number of different macro factors and statistically analyzed the relationships with gaming revenues. The multitude of regressions yielded a model with four factors that together explain 99% of the variance in revenues. This is a huge R Square.

The following local factors were considered but rejected:

• GDP – statistically significant by itself but unimportant when other variables were included. Eliminated.
• Gas prices – Unlike other regional markets, gas prices were not significant in driving gaming revenues in the Las Vegas locals market
• Population growth – Insignificant when combined with the other variables. Population growth is correlated with housing, interest rates, and labor force size.

The final model included the following variables:

• Unemployment – Hugely significant and negatively correlated with gaming revenues for obvious reasons
• Size of the labor force – Hugely significant and positively correlated
• Interest rates – surprisingly significant and positively correlated. Station management was right all along. The significant retiree population in the LV metro area benefit when interest rates rise. This variable produced a t Stat of almost 8 when 2 or greater is considered significant.
• Housing prices – The Wealth Effect, of course housing is significant and positively correlated.

As can be seen in the first chart all of these variables are highly correlated with locals Las Vegas gaming revenues. Additionally, all of the variables generated t Stats well above the 2 threshold.

The tables below the chart are grids for 2009 and 2010 using varying assumptions. We assume a consistent 4% 20-yr treasury rate for both years and a housing price index level of 120, also for both years. The housing index finished November at 138 and averaged 159 for all of 2008. Moody’s projects a further 25% decline in 2009 which is consistent with our assumption. Remember that housing in Las Vegas began falling earlier than the rest of the country so our assumption here could be conservative.

The remaining variables are outlined in the grid: Labor force growth of 1-4% and Unemployment of 9-11%. The labor force has grown 4-5% YoY every month since early 2005. Unemployment finished 2008 at 9.1% and The US Conference of Mayors projects an average unemployment rate of 10% for 2009.

Our best guess is the midpoint of the grids. That is, a 9% drop in 2009 gaming revenues and a strong 2010 rebound of almost 7%. That assumes no recovery in housing or unemployment and assumes that today’s rock bottom interest rates don’t change. Given the low cost of living (no state income tax) and the favorable climate, we project population growth to continue to push the labor force higher, albeit at a more conservative rate than experienced over the last 10 years.

A 9% drop in 2009 locals Las Vegas gaming revenues probably wouldn’t surprise most investors and market followers. However, the 7% projected growth in 2010, even on conservative assumptions, will likely surprise most people. A resumption of growth would be a huge boost to BYD shareholders and bondholders and Station Casinos bondholders.

All variables are statistically significant in explaining gaming revenues
Projected gaming revenue growth based on varying assumptions for Unemployment and Labor growth


According to data released today by the NSI, Spain’s Industrial Production fell by a record 19.6% year-over-year in December (seasonally adjusted), following a 15.3% contraction in production at Spanish factories, refineries and mines in November.

The production breakout for December was: Durable consumer goods -31.40%, Non-durable consumer goods -7.30%, Consumer Goods (aggregate) -10.80%, Capital goods -33.60%, Intermediate Goods -33.60%, Energy -3.40%

On 1/23 we wrote an article entitled “Spanish Nightmare” in which we reported on Spain’s Q4 unemployment number of 13.9% and rehearsed the implications of the government’s expected 16% unemployment for 2009, which some view as conservative, including a think tank at Spain’s ESADE business school which has projected 20%. As we noted in that post as well, the rising unemployment falls disproportionately upon the youngest components of the working population.

One of the prime drivers of employment over the boom period (and, by extension, one of the prime drivers of immigration) was the residential construction sector. Now many of the people employed in construction during the boom are literally out on the streets. The real estate collapse is costing more than jobs, however: according to data from the Bank of Spain, real-estate and building companies, which make up almost half of domestic corporate borrowing, now owe Spain’s banks some €315 billion and €156 Billion respectively. A separate report shows that the number of Spanish companies starting bankruptcy proceedings in Q4 rose to 960 from 260 a year earlier. Unlike their European neighbors who engaged in trading exotic derivatives linked to US sub-prime mortgages, the Spanish bankers were able to create toxic credit waste without any outside help.

The Eurozone “imbalances” among countries are now clearly showing face. We’ve written on the divergence of bond yields in the Euro area in the past to highlight this issue, now with the European Commission officially projecting Spain’s economy to continue to contract this year and next the cat is largely out of the bag.

Eurozone Q4 GDP will be announced on Feb 13, with consensus expectations currently hovering at -5%. We will continue to follow the diverging rates of economic contraction between EU components as countries like Spain face more profound obstacles to recovery and present a challenge to EU unity.

Matthew Hedrick

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Eye on Obamerica: Volcker Kept on the Bench

The media this morning reported that Paul Volcker, former Governor of the Federal Reserve, is being kept at a distance from important economic decisions and meetings by Larry Summers, the Director of the National Economic Council. While we can’t verify these reports, the fact is, Volcker has only attended one White House meeting in his role as leader of the Economic Recovery Advisory Board. To the extent that these reports are accurate, we view this as a real negative in terms of the open mindedness and effectiveness of the Obama economic team.

On September 27th we sent a note to our clients entitled, “Eye on Leadership: Volcker as Bailout Czar.” In that note we made the case that the 6’7 foot Volcker should be appointed as the Bailout Czar. Our summary view on Volcker was as follows:

“As we have said repeatedly, facts don’t lie, people do. And the facts in regard to Volcker’s ability to manage through a prior fiscal crisis with integrity and against popular opinion speak for themselves. Volcker is rightfully credited with ending the United States’ stagflation crisis of the 1970s. Chairman Volcker abandoned interest rate targeting and adopted policy to limit the growth of the money supply. His policies led to a sharp recession and were widely unpopular, but inflation which peaked at 13.5% in 1981 was 3.2% by 1983. Volcker was decisive, unpopular, but ultimately more right than any economic leader has ever been.”

Bush and Company did not tap Volcker for the position of Bailout Czar as we recommended, but President Obama did wisely bring in Volcker to head the Economic Recovery Advisory Board, noted above, whose goal is to provide outside and unbiased advice to the White House on this economic recovery plan.

Having one of the most successful and knowledgeable successful central bankers providing input and advice can only help President Obama and his economic team; not accepting his input will likely detract from any policy recommendations. Additionally, to the extent that these reports are accurate, they, on the margin, call into question the President’s ability to keep egos in check within his White House, specifically in the way of Larry Summers. We hope Summers et al will fully engage Volcker in the coming months and that President Obama will realize the value of Volcker’s experience.

EYE ON THE UK: BOE’s Road To Zero

The Bank of England cut its benchmark interest rate 50bps today to 1%, as Governor King attempts to transition the UK out of recession. The cut, taking the rate to the lowest since the central bank was founded in 1694, was not reciprocated by Trichet and the ECB, who opted to maintain their benchmark at 2% when it met today.

The UK economy is mired in a multifaceted mess with no relief in sight: credit conditions have continued to tighten despite the bank restructures and nationalization recaps; housing prices continue to collapse —we last reported that January data released by Hometrack registered a decline of -9.4% year-over-year for the average cost of a home in England and Wales; and unemployment is at its highest level in January at 6.1%.

On the balance this cut might help combined with Prime Minister Brown’s £20 Billion package of tax cuts. If the Pound can decline against the Euro (see chart) and Dollar, this could be a short term catalyst for exports (see Korea’s recent uptick in some industries) –provided that corporate Britain can make good on the opportunity. That said, this cut does seem like too little, too late.

We’re currently short the UK via the EWU etf.

Matthew Hedrick

Is The Nasty, Good?

I will not mince words - this week’s 626,000 new jobless claims was a nasty number. This report is up significantly from a revised 591,000 for last week and 44,000 above the 4 week moving average.

In a perverse way, this is going to ultimately end up as a positive for the US stock market. At this stage, I think the US market needs nasty and socialistic data in order to break the buck. If we break the buck, short sellers get squeezed, and the US market continues to make higher lows versus November’s.

Breaking the buck will also, in a Darwinian way, force terrible management teams in corporate America to face the You Tubes of being the guys that fired their people right before export demand accelerates. That type of reactive management stands in stark contrast to our views of proactively managing risk. Those execs who built capacity at the economic cycles top, and bought back stock to pander to their momentum investor wants, behaved, as our President put it, “shamefully.”

The only way to right size this sinking ship of public equity market cap is to let the liquid long American Capitalist of the New Reality start eating into these reactive corporate management team’s cakes.

That’s change I can believe in.

Keith R. McCullough
CEO / Chief Investment Officer

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