Who Is Worse?

Tim Geithner is 10 minutes into his speech, and he is scaring me.

I didn't think this was possible, but this reminds me that anything in life is... but Geithner may be worse (or at least as bad) than Hank "The Market Tank" Paulson.

Paulson would stutter, but at least the man didn't look frightened by the camera. What this country needs is confidence. That all starts with leadership. We can't have Geithner be You Tubed by the world like this. Our country is better than this. Give this guy the hook!

The US Dollar won’t budge, and the US stock market is reminding us that, for now at least, cash remains king.

America has voted.

Keith R. McCullough
CEO & Chief Investment Officer

Geithner's Greenback...

The market has now absorbed Tim Geithner’s prepared remarks. These US Treasury Secretary’s pre-speech comments weren’t enough to break the buck and, as a result, we have ourselves a problem in the US stock market. The market’s immediate term inverse correlation between the US$ and the SP500 continues to hold.

I still don’t think that the groupthink crowd agrees with me on this, but the reality is that if the USA wants to compete for China’s business, she is going to have to do it from a lower adjusted currency rate. Without it, the USA is hostage to her domestic growth in horse and buggy whip industries like financial services – this country has a very hard time growing in these sectors on an UNLEVERED basis.
Unlevered growth is best found from earning Brazilian and Chinese orders. In this organic growth environment, liquidity is king. Leverage is our disease. The only way to improve the American patient’s health is to de-value and “re-flate”.

My line in the sand on the US Dollar index is now $84.51. After Geithner is done with his speech, he should go back to his office and focus on breaking that line in the buck. I’d appreciate it if someone would send him and his new boss, President Obama, this note.

Keith R. McCullough
CEO & Chief Investment Officer

PFCB – Getting Closer and Closer

PFCB is one of the better concepts in the restaurant industry. It has a good management team; though it did hang around the growth camp just a little too long. Management also committed the same mistake that nearly every successful restaurant company makes - diversification. We all make mistakes and should be forgiven when we correct the sins of the past.

Over the past four years, I have always looked at CAKE and PFCB the same way. Great concepts, but both management teams were growing the core concepts too fast. Both companies unsuccessfully diversified away from their core businesses to an inferior concept and as a result, margins and returns declined. Now, both CAKE and PFCB have slowed growth and are generating significant free cash flow. Additionally, PFCB announced on its 3Q earnings call that it would immediately close 10 underperforming Pei Wei units, which it expects will improve the concept’s restaurant margins by 70-80 bps in 2009. Management is extremely focused on cost saving initiatives at Pei Wei and expects its project evolution initiatives to benefit margins by 200 bps by 2008 year end on top of the 100 bps of labor savings it expects to realize from its new labor scheduling tool, which will be fully implemented by the end of 1Q09. So the company is working to improve margins while slowing growth, which should help to reverse declining returns at its inferior concept.

Neither company has a balance sheet issue, but PFCB’s average ticket is in a precarious spot (Management has said that it has no plans to increase prices at either of its concepts in 2009). Like CAKE, PFCB’s core store base is located in the most economically challenged housing markets in the US, so we know same-store sales are going to be challenged. Co-CEO Bert Vivian confirmed this view when he presented at an investor conference back in early January and provided colorful commentary on business trends, saying, “Yesterday, RUTH reported that comparable sales declined over 18% for the fourth quarter. Don’t be surprised by these types of numbers. Whatever numbers you are expecting for the industry should most likely be ratcheted down” (please refer to my January 13, 2008 post titled “PFCB – New Co-CEO Provides a Dire Outlook for Casual Dining”).

Both concepts will benefit from lower YOY commodity price increases as we progress through 2009. Importantly, there is a real possibility that in the next 3-6 months same-store sales trends will look less bad, which is a positive. So why is the short interest on PFCB 33% and CAKE 6.5%? I guess the easy answer is that over the past six months EPS estimates have only declined 2% for PFCB versus 20% for CAKE and 8% for all full-service restaurants. Given that PFCB management has not yet provided 2009 EPS guidance and Co-CEO Bert Vivian's rather dismal view of the industry, either he is a big “sand bagger” or guidance will be below the consensus view. Even in the aftermath of lowered guidance, we would be far more constructive on PFCB.

The Research Quantitative Edge

Looking at the Research Edge quant models, PFCB is bearish from both a Trend and Trade perspective, but just barely. It looks like a very high-risk situation for the short sellers at this stage of the game. The model says that basically both Trend and the Trade momentum lines are starting to converge at $19.18 and that is a bullish sign. Essentially, this means that the range is narrowing as volatility is dampening. Importantly, if the market gets a sniff of better than expected or “less than toxic” news, the shorts are going to get eaten by the $19.18 SHARK LINE. From the SHARK LINE, there is no resistance until $23-$24. On the downside, if the stock fails to overcome that line, $17.15 is support unless there’s a disaster in the making here. PFCB looks like a lot of broken growth names, as it’s setting up to continue to make higher lows vs. November when the stock went to $15 and short interest was at 28.6% of the float.

It does not appear that there is a big payday being short PFCB. There is no insider activity of consequence. It is, however, important to note that the holder list has a high concentration factor, which could be a liability for the bulls if one or two of these big holders flinch. Under that scenario, the stock goes to the $17 level, expeditiously.

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Low gas prices and especially the removal of the $500 loss limit more than offset the awful consumer environment and some very bad weather. ASCA, PNK, and PENN are the primary beneficiaries of the Missouri strength. These stocks have been strong as of late so some of the good news was anticipated. However, I am very encouraged by the relative recent strength of the regional markets, not just Missouri but Iowa, Indiana, and the racino markets such as Pennsylvania.

Pure gaming revenues are less discretionary than most consumer industries and are more sensitive to changes in gas prices. These traits are advantageous in this environment. Given the data, estimates are starting to look reasonable for some of the regional operators including BYD, PNK, and PENN. PENN recently provided 2009 EBITDA guidance in-line with the usually stale sell side estimates. That was a positive. Considering the incredibly depressed valuations, growing visibility on revenues and EBITDA could continue to drive some of these stocks towards more reasonable valuation levels.

A Whale Called Warren

“What counts for most people in investing is not how much they know, but how realistically they define what they don’t know.”
-Warren Buffett
These days this is easier for Buffett to say than it is for most investors. As Berkshire and the cash on its balance sheet expand, Buffett gets better information. That’s the way that Wall Street works. As a result, defining what Warren doesn’t know gets de-risked. After all, no one (including the US government), gets the preferred terms that Buffett has been getting in recent months. Preferential treatment has its perks.
Swimming alongside America’s value investing sage is another big whale these days – her name is China. Like that whale called Warren, she also has the enviable position of a cash full belly and preferential terms on investments. While chewing on Steve Schwarzman’s Blackstone stock wasn’t as tasty as some American bankers forecasted it to be, the Chinese whale has said goodbye to that $3B loss on her investment and, ostensibly, gone back to feed on her domestic shores.
The Chinese feeding at home is creating a rumbling sound in the stomach of Buffett, and American bond holders alike. US Treasuries have had one heck of a time in 2009, and the objective mind can’t help but wonder what it is that we don’t know. Has the largest customer of the Greenspan debt feedbag stopped buying Treasuries? Is she selling them?
Whale watching is what Wall Street loves to do. Whales like Schwarzman and Ackman come and they go. Across economic cycles, the visibility that our manic media provides us to these whales is always the same – these self purported genius navigators of the depths of the investment oceans never miss an opportunity to smile for the camera. Life in the world’s largest fishbowl has its perks, until these whales don’t “realistically define what it is that they don’t know.”
Buffett knows this all too well. He has spent the better part of his investment career feeding on the plankton and depressed prices that these bloated whales create. I wouldn’t be surprised if that whale called Warren isn’t running the math on buying himself some preferred shares in Target today. Everything has a price, and Warren loves to eat what forced sellers have on the offer. I just hope our national mammal of the investing oceans saves some of that cash in his belly for rainier days.
Those leverage sharks who get starved by not having access to cheap capital are in trouble. This is why Blackstone’s stock was down another -8% yesterday in an up tape for the US Financials. This is why poor Billy Ackman is blowing up another hedge fund, and “apologizing profusely” for it.
Whether we know or don’t know what the Chinese are doing with their American bonds is not the point – the fact of the matter is that a lot of people are selling them back to us, and even more people have stopped buying them. As a result, you see the cost of long term capital on the long end of US Treasuries increasing, as access to long term capital tightens.
Despite putting in its second consecutive up day yesterday, at $9.90/share, the US Financials Sector etf is down -22% for the year-to-date. The whales of leverage cycles past are still for sale, and I see another -13% of downside left in that exchange traded fund before we can wipe our hands clean of that fishy smell that we have to wake up to every morning. This is Darwinian, and it should be – Americans don’t invest in losers. That’s what these government state enterprises are going to be, regardless of what Tim Geithner says at 11AM EST this morning.
The SP500 closed at 869 yesterday. It is down -3.8% for the year-to-date (outperforming those nasty financials by a considerable margin) and now looking for direction from the US government. This Obama government is not the kind of whale that American capitalists want to be invested in – at least not yet. Last night, President Obama lacked clarity on the financial front – and that doesn’t work. Investors like it to be, as Jack Nicholson said in ‘A Few Good Men’, “crystal.” Confusion breeds contempt.
If we want to be long a government, just buy China’s. As unpatriotic as that may sound, that’s what is working. Last night, the Chinese printed fantastic inflation readings on both the producer and consumer price front of -3.3% and +1% year over year, respectively. Chinese stocks raced higher on the news, closing up another +1.8%, taking the Shanghai Stock Exchange Index to +24.5% for 2009 to-date. This massive mammal is cutting taxes, cutting interest rates, and chowing down on the world’s stock market league tables – this folks, is a WHALE!
Realizing that most of the masters of the hedge fund universe told you 18-24 months ago that they “don’t do macro”, be rest assured that they all will be today. Geithner is going to have to pull off a miracle of sorts to get the US futures to turn around from the weakness born out of Obama’s first press conference last night. If the SP500 closes below the 862 line, this market will be in trouble again. My support levels are 847, then all the way back down to 811, which would be a -6.7% drop from last night’s close.
With the political rhetoric dominating the market’s dialogue right now, the only thing I have left is hope. Hope, as you know, is not an investment process… but sometimes that’s all we have left. We better hope that whatever comes out of Timmy Geithner’s mouth this morning creates US Dollar weakness. Unless we break the buck below the line of support that it held yesterday (84.51), that big Chinese whale has no incentive to buy whatever it is that our bankers are going to try to sell them next. Like Buffett, this Chinese whale likes to eat lower prices.
While I wish we were all in the preferred investor position of that American Whale called Warren, that isn’t The New Reality. The reality is that many American investors are still locked in marked-to-model and illiquid investments that they “realistically don’t know.”
Best of luck out there today.


A Whale Called Warren - etfs021009


Everyone knows that room rates in Vegas have taken a big hit. However, we thought it would be interesting to attempt quantifying the effect of lower ADR rates on EBITDA for the WYNN, MGM, and LVS.

Unlike occupancy, change in ADR is a direct hit to EBITDA. In the table below we illustrate the flow-through to gross profit of a theoretical ADR decline. In addition to direct room expenses, there is also overhead (reservations team, back office, front desk management, utilities, etc) which we believe comprises of about 90% fixed costs. Realistically, casino operators will try to cut costs to offset some of this pain, but a 50% rate cut may render many properties unprofitable.

As a point of reference the average ADR for the Las Vegas properties of WYNN, LVS, and MGM for the last twelve months was $295, $235, and $151 respectively. On Wynn’s pre-announcement conference call (or whatever it was) management spoke about room pricing of $169/$199 post Encore opening. If Wynn is charging under $200 a night at their properties, a 35% YoY decline, this bodes very poorly for LVS and MGM, as WYNN’s property’s typically set the ceiling on pricing.

We estimate that at a blended ADR of just over $210, WYNN’s consolidated EBITDA in Las Vegas will fall to below $200MM from a peak of over $400MM in 2007. For LVS, we believe that a 35% drop in rate will translate into an aggregate Las Vegas EBITDAR of approximately $240MM, down from our $409MM estimate for 2008. For MGM, our best guess is that rates will be off 30% to an ADR of just over $100 night causing Las Vegas EBITDA to plummet to approximately $825MM (pre-condo rentals) for 2009, down from over $2BN in 2007.

Is there a scenario where profitability drops to zero for these companies? Without factoring in changes in casino and other spending, we’ve carried the analysis to the break-even point for each company. WYNN, LVS, and MGM would have to see a further 25%, 45%, and 50% decline, respectively, in YoY ADR beyond our estimate to drive EBITDA to zero. A highly unlikely outcome but the fact that we are even having this discussion is telling. The good news is that free and independent room rates on the Strip appear to have stabilized recently, down in the 20-25% range over the past several weeks. Not good, but a little better sequentially and offering an ever so small ray of hope.

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