Space Dogs

Oh how quickly the facts can change in this increasingly interconnected global market place of trading. Nine different analysts have cut “estimates” for Goldman Sachs (GS) in the last week, and every other reporter is being tipped off that Lehman is going to take another multi-billion dollar write-down here in Q3. So much for policing insider trading.

Q3 is only halfway done, you see - it’s been whippy out there, to say the least. Asian growth has slowed, commodities have tanked, the US Dollar has soared, Musharraf has been ousted, and the Russians started a war. What does any of this have to do with tricky Dick Fuld at Lehman? A lot actually. On the ‘About Us’ tab of the Lehman Brothers website, the entrée into their business description is that they are “an innovator in global finance”. With all of the aforementioned cross currents associated with a global slowdown, Fuld is undoubtedly waking up to new risks that he didn’t prepare for, daily.

Not all “innovation” creates positive long term P&L. Ask the Russians, who on this day in 1960 launched Belka and Strelka into orbit. At least Sputnik carried 40 mice and 2 rats along for the dogs joy ride. Maybe Fuld should have tested some of his financial “innovations” with animals first!

Now that the “BRIC” (Brazil, Russia, India, and China) stock markets are all in free fall, our friends up here on science hill at Yale are calling us on the super secret whisper line suggesting that Wall Street investment banking structures are being struck by a breaking new discovery – gravity.

Russian space dogs succumbed to the same phenomena as Sputnik came back to Earth’s reality. It was as fascinating then as it is today. Like a space ship bracing for its landing, the Russian stock market is trading down -3.4% so far this morning, taking the RTS Index down to 1717, which marks a -31% decline since it’s May 19th, 2008 peak. On the bold red-army-colored cover of ‘The Economist’ this week, the page is titled “Russia Resurgent”. This looks more like “Russia Revealed” to me.

In Asia, gravitational forces continue to pull down everything that had expectations for moon shot flight patterns. We’ve been focusing on the horrendous economic data points out of Japan, Singapore, and Hong Kong over the course of the last few weeks, and their stock markets were down another -2.3%, -1.8%, and -2.1%, respectively overnight, testing new year to date lows. There is a Chinese company that’s listed on the Nasdaq, China TechFaith Wireless (CNTF), that is looking down -19% pre-open. “TechFaith”? – how innovative!

The Bank of Japan decided to keep its socialist regime intact, leaving interest rates at 0.50%, and issued newfound concerns that gravity may very well indeed continue to affect them more severely. They have no idea on the duration of this economic downturn, but they are certain that they will keep the easy money bailout monetary policy that has not worked for almost two decades.

European trading is quite weak, on the heels of the highest reported inflation number that the Germans have had to read since 1981. At +8.9% year over year growth, the German PPI confirmed what the leaders of the Bundesbank tried to warn Wall Street of yesterday – a deflating Euro imports inflation! Alongside Putin’s stock market getting crushed, European indices are trading down -1.5% to -2% across the board. From a quantitative perspective, the momentum factor implied in the FTSE in London actually looks a lot like that in the S&P 500. A break down and close through the 5387 line turns immediate term momentum to negative. For the S&P, my critical support line is 1267.

The US Dollar has been working now that everything that went up is coming down. Gravitational force, like cash, is king. At 77.23 this morning, the US$ has had one of its sharpest short term rallies on record (+7.6% in a month!). What is good for the US$ may not be so good for everything else, particularly if all assets classes start to auto correlate to the downside.

If your broker has any “innovative” space puppy products in your portfolio, sellem’ while you can.



A weak dollar and strong worldwide economies have masked what would otherwise be a pretty bleak RevPAR picture in the US. All year, US “international” cities have outperformed the rest of the country in terms of RevPAR growth. The following chart highlights the positive correlation between growth in international visitation and RevPAR by city. A weak dollar combined with solid economic growth overseas was a big contributor to RevPAR growth. Despite strong international visitation during the first half of 2008, the rate of change in RevPAR growth slowed from 2007. The weak link: domestic business and leisure travel. While domestic travel remains sluggish in the back half of 2008, the other 2 trends have reversed. The dollar has strengthened and overseas economic growth is slowing. Looks like one weak link has turned into three.

Weak $ contributed to international & RevPAR growth. What happens now that $ is strenghening?

China Needs To Avert A Gold Medal Hangover

It’s easy to get excited about a 23% boost in China’s retail sales for the month of July, the highest rate since February 1996. But let’s not forget that despite China’s growth profile it still only accounts for 17% of Asian GDP (and 5% of world GDP). While we’re seeing Olympic-fueled growth rates out of China, the rest of Asia is hitting the skids.

South Korea’s three largest department stores just posted the slowest growth rate in 5 months -- with July’s 5.9% at less than half the prior month’s rate. Hong Kong’s GDP rose 4.2% (down from 7.3%) -- the slowest rate in 5 years due to slower consumption and exports. Perhaps the biggest nugget is Japan, which posted a 12.9% yy decline in department store sales of clothing. This is the second weakest reading on record in recent history (-16.5% in March 1998), and the weakest 3 month trend in at least 30 years.

What happens if China cools? Let’s hope the Olympic hangover is a short one.

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LDG - California Dreaming

During my career as an analyst and an investment banker, I spent a lot of time looking at real estate transactions for a number of different companies. In most cases, the business model was better off owning the real estate, as it provided a level of stability to earnings. I will go as far to say that selling a company’s real estate portfolio is about as effective in creating shareholder value as an activist shareholder telling a company to use leverage to buy back stock!

Even during the bull market for real estate, monetizing a company’s real estate portfolio did not maximize value for shareholders. Today, given the secular bear market in real estate (and financials); I can’t imagine that an activist would still peruse a real estate strategy as a means of creating shareholder value. It is as if someone is still holding on to a dream. I guess if Bill Ackman can prove to the world that LDG’s real estate can add incremental value, it will validate his other consumer holdings. There could be a lot riding on this strategy for Ackman!

In short, selling a company’s undervalued real estate creates an enormous tax burden, which limits the cash available to maximize value for shareholders. I truly believe that Bill Ackman knows this, and I have yet to see a structure from him that would get around the tax issue completely.

Here is a list of companies with significant real estate holdings that I have followed that have had activists and others try to create value:

1. MCD – The McREIT has been a dream for years!
2. WEN – selling the real estate was part of the “grand” plan, but it never materialized.
3. CBRL – Nelson Peltz tried, but the bankers decided a leverage recap was better. The stock is significantly below where they did the recap.
4. RYAN - went private, did a sale-leaseback and now the company is bankrupt. The lender is going to end up owning the company.
5. OSI – owned 1/3 of its R.E before it went private. OSI did a massive sale-leaseback and now the company is teetering on the verge of bankruptcy.
6. BOBE - lots of speculation but nothing ever materialized. The margins in the business cannot support incremental leases. (i.e. RYAN)
7. DRI – The single largest casual dining restaurant company with over 1,100 pieces of property (and it sits in a REIT today). The real estate portfolio is a safety net for the company in difficult times. Management is on the record saying that the R.E is worth more as a part of DRI.

Two other high profile companies where real estate was the focus are SHLD and TGT. Both are key holdings for Pershing Square. The Eddie/Sears story was real estate based, and nothing ever materialized - thankfully for SHLD. SHLD is in trouble operationally! Can you imagine how bad things would be if they had sold off the real estate and had all that incremental leverage? I would bet money that SHLD would have already filed chapter 11 if they did a sale-leaseback two years ago. The same is true for LDG! LDG’s EBIT margins are 3.3% (6.4% for CVS and 5.8% for WAG). With 3.3% EBIT margins, the business can’t support doing a sale-leaseback on 142 stores.

The speculation is that the real estate is worth $1.0 billion, or $7mm per store. Seems a tad aggressive! A close look at the 10K will show that they own the land and building on 28% of the store base or 142 stores (I have seen numbers as high as 40 %). According to a highly regarded supermarket analyst, Publix recently paid $10 million/store for some Albertsons stores in Florida, or about $200 per sq ft. At $200/sq ft that would value LDG stores at $595 million. I know that LDGs real estate is in California, but who is going to pay a premium for California real estate today?


On Friday American Express Credit Corp. floated $2 Billion in 5 year paper with a yield of 7.34% -almost 20 basis points higher than the current yield for corporates on the lowest investment grade rung.

There are still buyers out there, but only for issuers who are willing to pay up.

Andrew Barber -Director

YUM – Struggling!

From my Partner Keith McCullough - Very bad under 37.56 now; stock sells off on big volume, has up days on low volume - negative Trend developing

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