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Not all European economies are created equal…

It now appears clear to most observers that the European recovery will lag America’s as the difference in economic resilience of the various continental economies become more apparent and the cracks in the European Union become more pronounced. GDP figures released on Friday by Germany, Europe’s largest economy posted Q4 GDP at -1.65 % year-over-year, whereas Italy’s figure, was -2.61% over the same period.

Yesterday, the Eurozone reported a trade deficit of €32.1 Billion in 2008, its biggest since the Euro’s inception ten years ago. The lack of global appetite for European exports is pronounced, in particular European carmakers have been severely hit by the credit crunch. The European Automobile Manufacturers’ Association reported that European car sales plunged 27% percent in January to the lowest level in two decades. Total December Eurozone exports fell 0.9% from a month earlier.

Politically, cross EU dialogue is heating up. Today German Finance Minister Peer Steinbrueck said euro-region countries may be forced to bail out other members of the Union that face problems refinancing their debt, despite the previous understanding that no Union member is obligated to come to the rescue of insolvent members.

While Steinbrueck didn’t mention any countries that may need a bail-out, a quick look at European bond yields helps answer this question. We’ve noted the divergence between Europe’s “most stable” country, Germany, and countries such as Spain, Portugal, and Greece, which have shown widening yields over the recent weeks. Further, Eastern Europe (in particular the Baltic countries, Hungary and Romania) has posted some of the worst GDP declines in 2008 and projected forecasts for 2009/10 as they deal with currency devaluations, the repayment of IMF loans, and major contraction due to weakening European demand for goods and services.

We continue to diagnose the European patient. Respecting that some of these points are rear view, the declining GDP figures and rising deficit numbers still confirm our bearish view of the region. We do not own anything in Europe, and we do not intend on buying anything there for the foreseeable future. At this stage of the global economic meltdown, and at these prices, we prefer being long Chinese, Brazilian, and American Equities.

Most importantly, European investors need to consider that there is tail risk here. Tail risk, after all, is what no one thinks can happen. Steinbrueck’s statement further suggests the fear, however faint, of a potential unwinding of the EU in its present form. Should Europe’s economically stronger countries need to bail out the weaker ones it will only increase Europe’s recovery lag. We continue to trade around the region (on the short side) on a country-per-country basis. We covered our short position on the UK via the etf EWU yesterday in order to capitalize on market weakness.

Matthew Hedrick

Andrew Barber

Monitoring The Patient: The VIX

With the US stock market making fresh 3 month lows this morning, it doesn’t surprise us to see a notable lack of conviction. When it comes to volatility however, the game has changed here, and materially so – bears who are pressing the lows, beware.

Looking back at the capitulation lows of October/November one is reminded of the math. The fact of the matter is that the VIX was spiking at an unprecedented 80 during those dark days in American history (see chart) – today, despite pervasive bearish commentary coming out of the manic media, the VIX is struggling to hold its head above 50. The market patient is no longer under cardiac arrest.

The reality is that we have ourselves a New Reality. Some investors have been rightly burned by not proactively managing risk BEFORE that November 20th, 2008 low… but now… AFTER the fact… those reactive managers are just as wrong in straight lining that risk management environment of 2008 into today’s.

Today the TED spread (measures counterparty risk) and liquidity overall have improved significantly versus November (central banks dropping trillions of free moneys from the sky does that) and, as importantly, the VIX remains broken on an intermediate “Trend” line basis.

I have “Trade” (immediate term) resistance in the VIX is the dotted red line below (overbought today), while “Trend” (intermediate term) resistance is plenty higher up at the 53.46 line. Unless that 53.46 line can be penetrated, I think the SP500 lows are in.

I have been getting invested over the course of the last 36 hours as a result. As always, this market patient needs to be monitored, but please do so objectively. Emotions create heartache.

Keith R. McCullough
CEO & Chief Investment Officer

Conduct Unbecoming

“The amount of money in both these pots may not be enough to solve the problem”
-Alan Greenspan (February 2009)

What has become of American Capitalism when the only thing market pundits and former maestros alike can find as a solution is government handouts?

While I can write depressing books about being as bearish as I was at this time last year, or point fingers and whine about yesterday’s reaction to the US government’s stimulus plan, don’t expect either from me. I am a capitalist, and I will not stoop to this shameless level of manhood. It is unbecoming, irresponsible, and un-American.

Fortunately, I proactively prepared for this final selloff, and had our clients in a recommended 76% cash position going into yesterday’s open. So what? What does that do for me today McCullough? Well… For one, it allows us to stay in the game here – it also provides us the unique opportunity to buy low – and that’s what real American capitalists who have a repeatable investment process have always done. So let’s roll up our sleeves here and be accountable. Blaming Obama for all of this is a loser’s excuse.

Loser? Yes folks, if you haven’t noticed, there are a lot of world class losers out there who are pretending to be fiduciaries of the American economic system. I am tired of hearing their excuses. The time has come to stop putting our country in the hands of their horrendous judgment.

There are plenty of American Capitalists out there who still understand the value of their principles, and trust their counterparty’s handshakes. They don’t need leverage to earn a return, and they certainly would rather roll over into a hole 6 feet under than attempt to socialize the losses associated with their personal mistakes.

Capitalizing individual profits and socializing losses is not the America I want to raise my son in. It’s a pathetic Code of Conduct, and it’s time to stop being charitable to these people who have proven to have behaved willfully blind. Between Rick Wagoner at General Motors asking for another $17B, the government of California looking for $14B, and some billionaire loser by the name of Allen Stanford in Texas committing another $43B Madoff yesterday, we have no reason to trust what was … what was is behind us now… and we have to find the right people who can step up, be accountable, and move this country forward.

If you don’t want to read the rest of my riff, you should probably stop here. On this topic of Code of Conduct, one of our consultants in the field, Dirk Blum, made an important observation this past weekend. Without paraphrasing his words, I’ll give them to you in full. After interviewing a retired US Army Officer, this was what Dirk had to say about his discussion with one of America’s finest:

“It seems like any decision get’s consideration so long as it is legal… at which point the US Army Officer jumped in and said “well that’s why we had conduct unbecoming”.

He was referring to Article 133 of the Uniform Code of Military Justice, which states that: “Any commissioned officer, cadet, or midshipman who is convicted of conduct unbecoming an officer and a gentleman shall be punished as a court-martial may direct.”

The essence of this article is that, only because an officer doesn’t violate any of the other Articles of the UCMJ, that doesn’t mean that he is displaying the conduct expected of a uniform officer of the United States.  You get cute or passive aggressive with another officer, guess what, that’s conduct unbecoming.  You shame the uniform in any way, guess what, that’s conduct unbecoming.

According to a reference to the Navy-Marine Corps Court of Appeals (check the Wikipedia entry), Article 133 refers to an officer and gentleman, because a gentleman is understood to have a duty to avoid dishonest acts, displays of indecency, lawlessness, dealing unfairly, indecorum, injustice, or acts of cruelty.

How many of the executives that we have all gotten to know so well over the past year can truly say that about themselves?”
-Dirk Blum

Now Dirk graduated from Dartmouth, worked in Washington and Baghdad, and now lives in China. He has one of those simple attributes that a lot of Americans appreciate – global perspective. What America has been doing over the course of the last 12 months has been You Tubed by the world, and guess what, we are now ALL accountable for it.

So let’s stop pointing fingers this morning and step up and conduct our respective businesses in a way that is becoming of this great American flag.

Yesterday, I invested 9% of that 76% position I was carrying in US Cash, taking my Asset Allocation Model’s Cash position down to 67%. I bought American and I bought Chinese. On the International Equity side, we now have a 3% position in the Morgan Stanley China Fund (CAF) and a 3% position in Brazil via the EWZ etf. Being a successful American Capitalist in 2009 and beyond will require us to fortify partnerships with foreign buyers. We need to make our handshakes mean something again. That is The New Reality. Protectionism has always been a loser’s game.

With the SP500 closing at its lowest level since the November 2008 capitulation, the US market has yet to make lower lows. My call has been, and continues to be, that we will not close below that 752 low.

I don’t want bailout money. I don’t need a politicized Washington “economist” to tell me what to do with my family’s hard earned capital. All I want is the economic freedom to succeed or fail. My name is Keith R. McCullough, and I am accountable for every call I make.

Best of luck out there today,

Conduct Unbecoming - etfs011809

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Regional gaming revenues (excluding new racino markets) only fell 3% in January. A favorable calendar and low gas prices no doubt contributed, but the trend is positive on the margin. As seen in the chart below, comparisons get tougher, but only slightly, until the summer when they ease considerably. Assuming continued depressed gas prices and no further deterioration in the economy, we could actually see some growth in the back of 2009.

Dare I say 2009 consensus estimates are beginning to look reasonable for the first time in over a year? If so, valuations are very attractive for all the regional operators, particularly BYD, PENN, and PNK. Free cash flow yields of 20-40% and EV/EBITDA multiples of 5-6x with numbers one can believe in? Very compelling, indeed.


Louisiana posted a 10% increase in gaming revenues in January, mostly of the same store kind. While an extra Friday and Saturday probably contributed almost half of that gain, the results are very impressive. Low gas prices certainly helped and more than offset any economic weakness associated with plummeting oil prices.

Aside from the weather and calendar impacted September, Louisiana gaming revenues have consistently grown in a range of -5% to +10%, decent enough but outstanding relative to other consumer sectors.

PNK and BYD were the big winners with gaming revenue up 16% each. PNK and BYD generate 72% and 16% of their EBITDA in Louisiana, respectively. PENN’s Baton Rouge property was up 7% but is only a small contributor to PENN’s arsenal.

I like this trend


At the end of the day ugly fundamentals overruled the “hidden assets” and takeover parts of the long thesis. We called this initially way back in June 2008 (“OEH: IT LOOKS LIKE KOPIN TAN MISSED THE BOAT”) in response to a Barron’s article pumping the stock.

OEH’s dual super voting class stock structure surely disenfranchises shareholders and without a remedy here the focus will be on the fundamentals. As we approach the company’s Q4 earnings release, the following “Youtube” shines the spotlight on some of management’s prognostications from last quarter’s call, provides our thoughts on some of those comments, and also poses some questions for the call.

Management comment 1:
“As I have said, in many areas bookings for 2009 as of the 30th of September are showing signs of stabilizing, with overall bookings for the portfolio already sitting at the same levels as this time last year, despite everything we have seen in the world.”

Our thoughts:
We expect management to drastically revise this assertion. It’s tough to proactively manage one’s business with expectations so far removed from reality.

Management comment 2:
“The impact of the September revenues, coupled with revising our expectation for the fourth quarter, sees us keeping RevPAR guidance in the 6-8% range.”

Our thoughts:
RevPAR likely fell 15-20% in the 4Q08. This is partly due to a 9% decline in the Euro which has been a tailwind for OEH’s RevPAR during the last 2 years.

Management comment 3:
“A simple fact is that some of our properties in the high season achieve a 40% to 50% RevPAR premium on the nearest competitor, therefore pricing, you know, drops in pricing do not come, do not sort of produce immediate returns.”

Our thoughts:
Exactly, that’s why they are in such rough shape. This is a big, big issue for OEH. We're not sure what they can do since reducing the rate from $1200 to $800/ per night is still too rich for most of us that didn’t get a bonus in 2008.

Management comment 4:
“And our focus has been very much and will be very much on preserving cash to enable this company to capitalize on what we believe are investment opportunities that will come its way.”

Our thoughts:
Preserving cash to pay down debt and remaining a going concern should be their priority since RevPAR is taking a nose dive.

Management comment 5:
“In Venice, the Cipriani has seen revenues drop back to 2006 levels as a combination of the weak dollar, the U.S. recession, and the decline in U.K. short break business have hit the city. Some reports show Venice over 30% down in 2008 versus 2007. Similar numbers are coming out of Florence... Our properties are phenomenal properties, well-run, and this winter we continue the works planned at the Cipriani, which will see the property with 16 new suites, adding to the 10 which came online in 2008.

In Italy, we have reduced operating days at all properties next year, thereby compressing demand and reducing variable costs and bookings that are actually stronger by 17%”

Our thoughts:
If demand is down 30% and the company is reducing operating days, why does it make sense to add 26 rooms to the Cipriani? Ok the 10 rooms have already been added but why continue with the 16 other additions?

Management comment 6:
“So what of our current action plans that we have? We have outlined the key items in our press release issued last night. I have implemented significant SG&A reductions, which we currently have quantified in constant dollars at between $20 million and $22 million.”

Our thoughts:
$20-22MM amounts to a whopping 14% reduction in overhead. SG&A has grown 140% from $70MM in 2000 to 169MM in 2007, a CAGR of 13.5%. For the 9 months ended 2008, SG&A grew 14.5%. Not exactly leveraging overhead? With the further erosion of fundamentals, OEH needs to make much more progress here.

Anna Massion