EYE ON THE UK: A New Banking Rescue Act

Over the weekend the UK issued the Banking Act of 2009, which allows the Bank of England, Financial Services Authority (FSA) and the Treasury to step up more quickly to rescue troubled institutions, including provisions to temporarily nationalize or sell-off stricken banks. For investors with monies tied up in injured banks, the Act calls for funds to be rapidly transferred to other banks and depositors may now access their money in a matter of days rather than weeks under previous conditions.

The Act is largely a response to the lethargic response of regulators to the collapse of Northern Rock in 2007, in which depositors made a run on the bank after it emerged that Northern Rock sought government help.

Over the weekend PM Brown met with European leaders from the Group of 20 states in Berlin to discuss the global crisis. He said that "banks must act in the long-term interests of their shareholders and therefore of the economy as a whole, not in the short-term interests of bankers." Brown rejected the Banking industry's bonus culture and signaled that Britain must return to traditional savings and mortgage banks. He voiced that loans must be made on "prudent and careful terms," while equally stressing that domestic growth would come from granting loans to first-time buyers, entrepreneurs, and individuals of middle and modest incomes.

RBS and Lloyds, both part-owned by the taxpayers, have asked the government to insure almost 500 Billion Pounds ($720 Billion) of assets as part of the Treasury's plan to spur lending, noted the Sunday Telegraph. Today RBS said it plans to cut cost by more than 1 Billion Pounds by splitting the bank into two units, including a "core" business and second division holding toxic assets. Additionally, Chancellor of the Exchequer Alistair Darling ordered Northern Rock to expand lending by 14 Billion Pounds.

These measures are the first in a series to be announced this week to revive the U.K. banking industry. RBS reports on Thursday and, alongside JPM’s Investor Day, will be our primary focus in terms of timing a catalyst on marked to market, banking regulation, transparency, etc…

Matthew Hedrick


I have communicated three main concerns about RRGB’s business model in the last year or so. First, I thought the company was continuing to grow too fast. Second, I was concerned about the company’s increased contribution to its national advertising fund as management would never quantify the return being generated from the company’s investment. RRGB’s campaign focused only on brand-building advertising, which is never as effective as promoting products at specific price points. Additionally, the expense associated with a national T.V. advertising campaign does not seem warranted for a 400-unit restaurant company. Third, I was bothered by the company’s capital allocation decision to borrow money to buy back stock. RRGB spent $50 million in FY08 to buy back about 1.5 million shares at an average purchase prices of $33.76 while increasing its debt by nearly $70 million.

RRGB addressed all of my concerns on its earnings call last week. The company lowered its FY09 new unit growth to 13-14 new units, down from its initial guidance of 20 and cut its FY09 capital spending expectations by more than 45% from its FY08 level. Management also stated that it has not yet made any decisions about its development plans for FY10, which highlights that the company recognizes the need to be cautious in this environment (20% company-operated unit growth will no longer yield the necessary returns).

The company also announced its intention to lower its contribution to its National Advertising Fund to 0.25% of restaurant revenue in FY09, down from 1.5% in FY08, which depending on sales could result in a $11 million reduction to FY09 marketing expenses. Specifically, RRGB does not plan to run any national cable advertising. Management justified this decision, saying “In the second half of 2008 while we continued our brand building campaign on national cable TV we began to see a slowdown in incremental traffic so to help form our 2009 plan we tested both pricing and product news on TV in two markets in Q4. Based on this test and the overall results of our advertising in the second half of 2008 we concluded that in this current economic environment it would be more prudent to capitalize on the awareness gains and focus our marketing dollars on more targeted traffic driving and retention initiatives in 2009.” Although I am not sure whether the company’s advertising was ever yielding the necessary returns, I am encouraged to see that the company was evaluating the effectiveness of its marketing spend and decided to lessen its investment at this time. Going forward, the company is going to allocate more of its marketing dollars to its national online advertising and loyalty initiatives.

Regarding share repurchases, RRGB still has a $50 million authorization in place and said that it may make opportunistic purchases of common stock in FY09. The company does not, however, plan to increase its debt to execute these share repurchases. Instead, management stated that it expects to use its free cash flow to pay down outstanding debt during the year.

RRGB, like its competitors, will continue to face margin pressure in 2009 as it expects both same-store sales and traffic to remain negative. Due to the uncertainty around sales, the company decided not to provide either FY09 sales or earnings guidance. That being said, in this environment, it is encouraging to see companies that are working to manage the things they can control and RRGB seems to finally be heading in the right direction on that front.

Barney’s In Credit Penalty Box?

Credit is drying up for Barney’s. It’s on the block, but price expectations need to come down to Earth. Indirect impact on vendors is a greater consideration than a near-term hit.

Rumors are swirling in the industry that the Factors (intermediaries facilitating frictional credit between retailers and suppliers) have put Barney’s in the penalty box and stopped approving Spring orders. Unfortunately for Barney’s, this is usually a self-fulfilling prophecy in that once ‘payment issues’ are the topic du jour, it usually ends up impacting product flow and business to a greater degree.

I’m not sure if the issue here is solvency. In fact, since Istithmar (Dubai’s government-funded investment arm) bought Barney’s from JNY in 2007, it has underperformed, but remains profitable. The issue is that there is no CEO, and Istithmar is trying to sell Barney’s for a price in the vicinity of the $942mm it paid JNY in July 2007.

Guess what Istithmar… the 14x EBITDA you paid in mid-2007 before the credit crisis is a lot different from where such an asset would be priced today. You should know this -- $75 oil helped fund your mid-’07 purchase when you outbid Japan’s Fast Retailing. Not as much to bank on after a 45% slide in oil, a 2-3 point slide in margins, and weaker sales on the margin. I’d need to assume a high teens multiple no for anything close to $1bn. Sorry… no can do.

Fortunately, no vendors are overly exposed to Barney’s. Most of the companies dependent on Barney's listed in public documents (per Cap IQ) are systems and software-related. But Barney’s is an important ‘showcase’ account. For example, Timberland had a big win when it got a pair of its lux boots sold in Barney’s last year. This creates a halo effect for the brand. Saks is not exactly knocking the cover off the ball either. I don’t like seeing fewer showcase locations. If Barney’s situation gets worse, this will definitely nudge some companies into evaluating how they approach brand positioning.

An important consideration is if that Barney’s credit issues are solely because of uncertainty around its future ownership – but as a stand-alone retailer it remains a viable entity (quite possible), then this could be an opportunity for those retailers with solid balance sheets (i.e. RL) to pick up a few points of share by working with Barney’s during this period.

Slum Dog Short Seller

“Courage is being scared to death, but saddling up anyway”
-John Wayne
Short sellers can be scary, particularly if they are the kind with real capital that don’t know what they are doing. Some short sellers know exactly what they are doing – trying to scare people to death with their narrative fallacies. Don’t be scared of them – they are Slum Dogs, and you can make a career for yourself in this business picking them off.
As sad as this is to say, making stuff up is actually an investment process that some market participants use, daily. If you have no moral compass, and the SEC isn’t going to regulate your slumming tactics of fear mongering, heck … why not keep doing it? Well, as one of our clients said to me on Friday, “these raccoons all have a plan, until someone punches them in the face.”
I am a proactive risk manager and short seller, and I have had to endure these Slum Dog Short Sellers for the better part of my career. The difference between my last 10 years in this business and now, is that now I have a platform by which I can shine a flashlight on them, publicly, when they are slumming in the garbage cans of information transfer. As I wrote in Friday’s missive, “it’s time to drop the gloves.” I’m saddling up for this fight, and while I am scared of socialization, I am not scared of raccoons.
On Friday I dropped the mitts with the Slum Dogs at 1:21PM EST, and posted a real time note to our clients to “Buy SPY, with the SP500 at the 754 line.” Now call me a knucklehead hockey player or call me right – that turned out to be both the low of the day and of the year to-date. I sincerely hope that those Slum Dogs who were floating their shameless rumors and pressing their shorts in Citigroup on that line doubted the power of The New Reality.
This market needs leadership. This market needs a voice. That voice can be Chinese, Arab, or American – global markets are as interconnected as they have ever been, and collaboration amongst the uncompromised is going to get this done right.
Despite the Slum Dogs shopping their short thesis’ into the US market close, Asian markets charged higher last night, reminding us that there are new Chinese leaders in town. China was up another +2%, taking the Shanghai Stock Exchange to +26.6% for 2009 to-date. How is that short China “because they lie and make up the numbers” thesis treating you this year Mr. Slummer? Isn’t it annoying when someone who is lying like you are is crushing the short side of your P&L? Or are they lying? Inquiring and accountable minds want to know…
Asian governments also took slum lord matters into their own hands over the weekend and, with China’s leadership, established a massive $120 billion dollar Asian Currency Pool. After seeing Asian currencies hit 3-month lows last week, this proactive risk management move makes sense. Remember, China owns both her own cash and liquidity at this stage of the game of global economic power re-balancing. China is doing what she needs to do, when she needs to do it – she is controlling her own destiny, and with our being long China via the CAF closed end fund, I support her message.
In the Middle East, they rang the short squeeze sirens in the United Arab Emirates last night, taking the Slum Dog Short Sellers for a little visit up on top of one of their monstrous buildings, giving the perpetrators of storytelling a peek over the ledge. Like the Chinese, the UAE decided to take matters into their own hands and lend Dubai a cool $10 billion at a 4% rate – I bet the Pandit Bandit wouldn’t mind some of them petrodollars – no regulation strings attached! The UAE’s stock market is trading up +7.9% so far this morning – leadership matters…
Saudi Arabia’s stock market is also trading higher in the face of what looks like a bottoming process in the price of those petrodollars. I had been buying oil for the last few weeks and stating my case against the Slum Dogs that buying oil under $38/barrel gets we un-compromised American capitalists paid. Despite all of the manic media’s noise about gold last week, oil actually outperformed gold on a week over week basis. Gold was +5.6% for the week, while oil was +6.7%. This has not happened for a long time. This doesn’t fit the narrative fallacy of the Slum Dog momentum trader either – oh what is a raccoon to do when that light is shining in his face?
For the immediate term “Trade”, I am long oil and short gold. On an intermediate term basis, gold is bullish and oil is bearish – so why trade? Trading is the only means of survival in this market, and it’s also the best way to pick off the Slum lords and Slum Dogs of the land without moral compass. Is it a battle in these trading trenches? You bet your Madoff it is  - and I am signed up for it. Gold is trading down -1.5% so far this morning, and oil is up again, testing $41/barrel – game on!
My downside target for the SP500 remains a higher low versus the November 20th low of 752. I have put my money where my mouth is and taken my cash position down to 58% versus the 64% position I was carrying into Friday’s open. I have a 21% position in US Equities, and I am Long America, for a Trade. I am short gold and short the Slum Dog Short Sellers, at a price.
Best of luck out there today,


Slum Dog Short Seller - etfs022309

LIZ: Tremendous Call Option

Only 3 weeks after an 8% workforce cut, LIZ is selling a cost center for cash. I’m also gaining confidence that the debt covenants will not be breached, and top line pressure (though not integral to the story here) is easing on the margin. By late 2009, I think that investors will be eyeing EPS closer to $0.75. I maintain my view that this company will remain solvent, and that the stock under $3 is a tremendous call option.

1. LIZ announced this morning that it is selling its sourcing operations to Li&Fung for up to $83mm in cash. This makes perfect sense to me, as LIZ has invested way too much capital in its internal sourcing arm over the past 10 years with negative cumulative return. Not only will this take a cost center off of LIZ’s P&L, but they’ll get paid cash for it. Will LIZ see higher FOB costs on its apparel? Yes. They’ll need to pay Li&Fung for execution on orders. But I’ll take that any day for LIZ. With the transaction, net debt comes down by 8%, and EBITDA goes up by 10% using even the most conservative estimates.

2. Watch the top line. LIZ is not a top line growth story. I repeat…It is not a top line story. But with sales of its Partner brands (40% of total) falling by over 30% over the past 3 quarters, let’s keep an eye on changes on the margin. Specifically, Kohl’s recently launched Dana Buchman as an exclusive from LIZ, and the company finally launched the long-awaited Mizrahi redesigned Liz Claiborne line. My digging suggests that this is actually performing well relative to expectations. I still think that LIZ should take the Claiborne brand and sell/license the whole thing to Wal*Mart while it monetizes its other brands like Juicy, Lucky and Kate Spade. That’s probably not in the cards soon – but it does not need to for a $2.33 stock to work.

3. Debt covenants look good. Even before this morning’s announced sale to Li&Fung we’d been getting warmer on LIZ’s ability to hold the line on its debt covenants. The bottom line is that we need to justify that margins are down 450bp in ’09 in order to breach. I find it tough to logically, or mathematically, get there. A few considerations on the EBITDA coverage calculations that give a bit more cushion that I think many are currently looking for…

a. There is $150mm of cash restructuring added back in ’08 and up to $60mm in ’09 in the numerator.
b. The lenders are not counting ~$100mm in CapEx in F08 that was spent on store growth, which is being deducted out of the numerator.
c. In the Interest calculation, cash taxes and dividends are added as well so with the dividend suspended and no cash taxes paid, there is no impact from these lines.

Little Light at End of European Tunnel

Here’s an overview of Eastern Europe exposure by apparel/footwear brand. Adi and Nike are most exposed. Not good that the athletic retail base in Western Europe is weakening on the margin.

More than a few people have asked me to rank exposure to Eastern Europe for apparel and footwear companies given the turmoil in its financial markets over the past week. The good news is that most US companies have no more than about 5% exposure in revenue and profits. The bad news is that this is not about direct exposure, but rather indirect exposure throughout the rest of Europe and the World if the situation there worsens.

As it relates to direct exposure, the two top companies on the list are Adidas and Nike at 9% and 6%, respectively. Also worth noting that the two key Western European sporting goods retailers are on the skids – with JJB Sports (22% of the UK market) on the verge of going away. Sports Direct (37% share) has been doing better, and is likely to benefit from JJB’s problems. That’s a challenge in itself given the often irrational pricing behavior of Sports Direct’s management team. This is not good…

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