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MGM: OPTIONS YES, AN OPTION? NOT YET

MGM will report its Q4 earnings in a couple of weeks and the shorts are having a field day. The short thesis is that the fundamentals are horrible, numbers are coming down, and the company will either bust a covenant or be forced to raise highly dilutive equity. Citibank recently slapped a sell rating and a $2.50 price target on the stock (why not just call it a zero?) and, like a pot calling a kettle black, Bank of America/Merrill reiterated an underperform rating. Clearly, we have a consensus call here folks.

Now for an “out of the box” call. MGM has more credit remedies than people think. Some of these may come out of the Q4 conference call. With a short interest probably higher than the 33% reported on 1/12/09, this stock has squeeze written all over it. I’m not sure the catalyst will be fundamental, unless they’ve cut costs more than expected. Rather, it is likely to be related to liquidity/covenants/balance sheet. Here are some possible remedies:

1. Bond buy backs – MGM should be buying its heavily discounted bonds back with borrowings off their credit facility or from proceeds of asset sales. The only reason they wouldn’t be is because they want to maintain their very strong relationship with their banks which brings me to #2.

2. Renegotiation with banks – MGM actually has some leverage in the negotiations because of the threat of bond buy backs which devalue the bank debt, and the fact that banks do not want to own casino assets. MGM has a very good relationship with its banks. These factors could lead to a lifting of the leverage covenant to get MGM through 2009.

3. Asset sales – MGM should be taking whatever they can for their significant but non-cash producing land portfolio. Any land sale would be a positive.

4. Hotel/casino sale – Rumors of the death of The Mirage sale are greatly exaggerated.

5. Government help – Don’t laugh. CityCenter is a huge job creator and the Senate Majority leader Harry Reid just happens to represent Nevada. As we wrote about last week, there is already a provision in the stimulus plan to defer taxes on the gains from bond buy backs. The provision was crafted by Harry Reid and the other senator from Nevada, John Ensign. Stay tuned, this may not be all.

6. CityCenter financing – Obviously, this would be huge.

7. Shareholder help – Whether it’s Kerkorian, Dubai World, or others, credit relief could come from unlikely sources.

We are not making a call on improving fundamentals. We were negative on MGM’s prospects for all of 2008. It’s not a call on the long-term value of MGM either. It is a call that there are credit remedies MGM can pursue to get through 2009 and buy some time for a more favorable credit environment. Interestingly, on their Q4 conference call PENN management indicated that the banks were becoming more flexible recently and relations with the industry were quite good.

Bearishness is unprecedented in this sector and in this stock. The negatives are generally known but the positives may not be.

Pride and Politics

“I like to see a man proud of the place in which he lives. I like to see a man live so that his place will be proud of him.”
-Abraham Lincoln

The scariest part about this week’s US market rally, which is the 1st up week since the first week of January, is that for it to continue, we need this circus of the US government’s help.

Whether you are a Republican or a Democrat (or neither), you have to admit that Washington has turned into a certified gong show. If you thought Wall Street’s “economists” were bad, man oh man are we being given an entertaining expression of economic “strategy” by these Senators and Congressmen – this, as the Captain of the Charlestown Chiefs in Paul Newman’s “Slap Shot” would say about the Hansons before game time, “is em-bah-rah-ssing.”

While I am proud of the New Reality’s liquid long American capitalist finally seeing a steepening of the yield curve, and very much happy to see those who invested in Chinese and Brazilian equities this year make tremendous year to date returns, I am truly embarrassed to have these economic crackerjacks YouTubed by the world. The American financial system loses credibility by the day by simply having these US politicians open their mouths.

Effectively the only economic data point that matters this morning is the US employment report. Guess what – it’s going to be really bad… yes, Nouriel Roubini told us, remember – dig bunkers in your basements and hoard Kraft dinners, the Depression cometh…

After yesterday’s +1.6% move, the SP500 is now +12.4% above the low print that is still freaking out poor ole Harry Reid. Even “no drama” Obama raised his voice about that apocalypse past yesterday, multiple times actually, reverting to Bushy’s go-to move of fear mongering these idiot economic savant politicians into getting another trillion dollars of stimulus passed.

Thank God that stock markets are leading indicators that can reveal political rhetoric as useless. A bi-partisan global macro investment process has concluded that all of the major stock markets around the world, with the exception of Russia, continue to make higher lows on selloffs, and higher highs in some cases, like China, on rallies.

China? When was the last time Roubini went to China? Right after Davos, the man went to Russia! Nouriel, I’ll bet that was outright depressing… the Russian stock market has lost almost 80% of its value since the Goldman prop desk top ticked oil last year. The Russian currency has lost over a third of its value, and Putin has turned out to be the raccoon Georgia found in her garbage can.

China, as in that really big country with a lot of people and a lot of cash, was up another +4% last night, taking the 2009 year-to-date performance of the Shanghai Stock Exchange Index to +19.8%. Bull market what? Yes, much like the Bovespa in Brazil, Darwin’s 2009 scorecard of global economic power shifting continues to reveal The New Reality. While American traders were trying to figure out if Pelosi was going to speak again intraday, the Bovespa was belly dancing on the heads of the short selling community (sorry Cramer, but I bet you liked it anyway), locking in another impressive +2.4% day, taking the Brazilian stock market to up almost +10% for the year-to-date.

If you want to see the men and women of this country proud of the place in which they live, let her hard working blood sweat and tears lock arms with the American capitalists who don’t need leverage to run their businesses. Stop lending moneys to the socialist bankers and give it back to the capitalists. Let them borrow short, lend long, and earn an unlevered return. Let them crush every single competitor who needs debt to compete with them. Let Darwin’s rules reign.

When was the last time you saw Chinese or Brazilian politicians on CNBC? When was the last time one of these cruise line organizer Wall Street conferences asked the central bank governor of China to the key note speaker? No, no… instead, our manic media gives the mike to Washington’s Hanson Brothers… and we embarrass the American flag with their economic idiocy.

As the US Treasury Yield Curve continues to steepen (the spread between 10 and 2-year yields is a healthy 195 basis points wide again this morning), and long term American cost of capital continues to increase, the long-awaited process of creative destruction in the US financial system is picking up momentum. The faster we can expedite my team crushing Ken Lewis’ research team, the less we will have to depend on these politicians pontificating on socializing Bank of America. Stocks that go to zero can’t go down anymore.

This Bank of America is not America’s Bank – not the America that I want to raise my son in at least… and certainly not the one that Lincoln envisioned. As Obama and Geithner herd their politicized cats into the West Wing this weekend, I will be praying that the man who claims to have “no drama” eliminates it from the process. If yesterday wasn’t drama, I could have just as easily have turned the channel to the Young and the Restless.

This country is where she is today because we didn’t have a proactive process – going right back to the reactive and politically charged solutions of Paulson’s short history past is only going to make things worse. Please, Mr. President, please… those of us who haven’t asked for bailouts are begging you – please, let the uncompromised Americans of this country be “proud of the place in which they live.”

Have a great weekend.

Pride and Politics - etfs020609


UA: Don’t Get Sucked In To The Wrong Debate

The question with Under Armour’s running shoe launch is how much of the $5bn market it can capture, not how many shoes sold on Day 1 vs. the Cross Trainer launch. The variables, circumstances, and most importantly, the strategy are all completely different.

Over the past week I’ve had at least a dozen people ping me with a question sounding something like… “So I hear UA’s running shoe launch is luke warm. Does this change your view?” This kinda drives me nuts. There is no change in my view because 1) the launches are simply not comparable, and 2) the big call on UA is one that cannot be derailed by a day’s, week’s, or even a quarter’s sales.

Cross training is a $300mm category. Running is $5bn. Nike owns this category with 65% share, and the next largest brand (Asics) at 15%. Past that, there are several more brands that bring up the rear in the 2-6% range. UA is not even on the map. The consumer genuinely wants this brand to succeed. Don’t underestimate that. Every point of share is 3-4% top line growth to UA (not including running apparel). I still don’t see why this company cannot have 3-5% of the US footwear industry over 3 years, which alone grows UA by 2/3.

As for comparisons to last year’s launch, check out the exhibits below. Cross training was backed up by a $5mm superbowl campaign and was geared toward crushing the category in year 1. Running is a slower build. UA will not overship or overpromote this initiative and risk long-term success. Of that I am certain.

People also ask me how I can get comfortable with this name at 20x earnings. I’m not even going to point to historical multiples – bc that argument never ends well and would be ridiculous on my part. But I will say that it has traded more on revenue and cash flow than anything else, and both of those will reaccelerate in 2009. 7x EBITDA for a 20% EBITDA grower? I’ll take that…

Zach Brown
Research Edge

Hedgeye Statistics

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

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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.

THE LV LOCALS MACRO MODEL

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.

ASSUMPTIONS
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.

RESULTS
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.

CONCLUSION
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

EYE ON EUROPE: THE PAIN IN SPAIN

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
Analyst

Andrew Barber
Director

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