We believe all of the residual equity value of LVS resides in Asia, mostly in Macau although Singapore is a contributor. The trick for LVS is to get beyond the leverage covenant in its Macau facility. Asset sales, IPOing a minority stake in the Macau operations, or amending the credit facility are all viable options.

So on that note, let us give you some background on the $3.3BN Macau Facility. The maximum consolidated leverage for the Macau facility is currently 4.5x, stepping down to 4.0x for the period ending March 31, 2009, and 0.5x thereafter every six months to a final level of 3.0x for the period ending March 31, 2010. At 12/31/2008, leverage at the Macau entity was 4.0x. Like the US facility, the Macau facility allows for $40MM of “equity contributions” towards the TTM EBITDA calculation and pro-forma treatment of new developments (like Four Seasons). Unlike the US facility though, the debt calculation is a gross one.

At 12/31/2008 there was $490MM of cash at the Macau entity, most of which will be used towards Capex on sites 5 & 6 and the completion of the FS condos. However, once LVS complete shuttering Sites 5&6 and the FS condos, the Macau subsidiary could generate approximately $400-$500MM of FCF annually. If LVS manages to negotiate an amendment or raise enough capital, through either asset sales or an IPO of a minority stake in the Macau sub, it can use this cash flow to complete Sites 5 & 6, which will then allow it to de-lever further.

According to our math, barring an asset sale, LVS will trip its maximum leverage covenant by 3Q09. We believe that LVS would be able to get an amendment (requires a 51% vote) to keep the maximum leverage level at 4.5x. In order to get the amendment, we believe that LVS would have to pay an additional 300 bps or so (~100MM in incremental interest expense), plus provide additional protection to the lenders. This would probably eliminate LVS’s ability to get any cash out of Macau. Nonetheless, if the covenant was raised to 4.5x (current level), that would give them ample breathing room to recommence and complete Sites 5 & 6. This would allow them to further de-lever and create additional equity value at the sub.

The current credit agreement has a restricted payments basket of $800MM, of which $300MM is unused. LVS made $1.3BN of loans to the Macau subsidiary, which it can get back after some tax penalty. Finally, in the event of an asset sale, LVS can repatriate 25% of the proceeds. I mention this, because given the situation at the US subsidiary, being able to bring back cash, albeit after some tax penalty is very important to the company. We suspect, should LVS need an amendment, the bank group will seek to close these loop holes. For this reason, we believe that company is fervently pursing all of the options to sell assets.

Some assets will probably not be sold. LVS cannot sell Sites 5 & 6 because they do not have a concession on that land. Even if they did, there are no motivated buyers for that land, given LVS’s “distressed” situation. LVS cannot sell the retail in Singapore without approval from the government because there is a 10 year moratorium on selling the property, and we doubt that the government of Singapore will change that rule given the political issues surroundings such a move. Even if LVS can do some sort of forward sale on the Singapore retail, they cannot do so before that property opens which is after 3Q09.

So what assets can they sell? Obviously the best option is to sell the FS condos since those are non-cash generating assets. LVS may want $1BN from the sale of the residences, but we believe a number closer to the cost of approx $400MM is more likely if a sale occurs.

Then there’s the retail, which has a current NOI run rate of $130MM. However, many of the retailers will not be able to sustain current rent payments given the slower than expected ramp in sales. Therefore, LVS will likely offer these tenants percentage base rents instead of base rents in return for longer term commitments. A more sustainable NOI number is closer to $100MM. Assuming a 10% cap, we believe that LVS can clear about $800MM of net proceeds. LVS can try to sell the Sands, which had a run-rate EBITDA of roughly $200MM. This asset would likely be attractive to a wealthy national or Chinese sovereign fund that doesn’t need to depend on junkets. We believe that the Sands could fetch net proceeds btw $1.3-1.7BN. The only issue is that a sale of the Sands would require 100% lender approval.

Lastly, LVS can try to spin-off a minority stake in Macau and Singapore to raise cash. This is clearly complicated given that the HK market hasn’t been so open to IPOs of late. This could be the most attractive option if the market could provide a multiple of 8x or more. Our guess is that given the gun to its head, LVS will do some combination of the above to avoid a breach.

As can be seen in the grid below, there is significant equity value if LVS clears the covenant hurdle. We calculate the Macau subs could be worth $6-7 per share if they do.

LVS likely to breach Macau covenant this year unless action is taken
Significant equity value in Macau subs assuming covenant hurdle is overcome


The Asian leaders meeting in Thailand this weekend to discuss economic strategy announced a $120 billion foreign currency reserve pool to help stabilize economies in South East Asia –more than 50% larger than the fund initially proposed last year. The Chiang Mai Initiative, as it is known, will allow the Association of Southeast Asian Nations (ASEAN) to work in consort with China, Japan and South Korea in a multinational bucket brigade that can provide liquidity rapidly when needed. The meeting, held on the heels of Secretary of State Clinton’s visit to Asia, sent a clear message that China has ascended to the economic leadership role in the region.

During her visit Secretary Clinton downplayed human rights issues as she sought assurance from Asian leaders that they will continue to finance the US deficit, a sharp reversal from the negotiating position of strength her husband’s lieutenants held during the 1997 crisis. Then, the only option for the floundering Tigers were IMF bailouts which left deep political resentments that still linger in Asia today.

The massive foreign currency reserves that China, Japan and South Korea built after 1997 are now allowing them to help their smaller neighbors as well as themselves. Regionalism has been a theme we have hit on consistently over the past year and, with this accord, Chinese and Japanese leaders appear to be moving towards building a strong cooperative block with the major South East Asian nations. Indeed, the ASEAN economies are in dire need of help from outside –Thailand announced Q4 GDP of -4.3% overnight.

Clearly, the odd man out in all of these changing policy currents is India; the ASEAN constituents (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam) are hitching their Wagons to the Chinese Ox.

We sold our long China exposure (CAF) this morning but will buy it back on a down day, meanwhile we remain short India (IFN), Hong Kong (EWH) and, as of today, the weakest hand of the North Asian big three: South Korea (EWY).

Our Asian thesis remains unchanged, we will seek to be long liquidity and internal demand and short debt and export dependence in the region.

Andrew Barber

Casual Dining - January Trends

Malcolm Knapp’s reported January same-store sales numbers showed once again that the lights went out in December but came back on in January. Same-store sales growth came in down 4.1% with traffic down 6.0%. Although these are not strong results, on the margin, they show a definite improvement from December’s 9.5% comparable sales decline and 10.5% traffic decline.

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Interesting Bankruptcy Trend

Retailer filing rate continues to climb, which is no surprise, but Textile/Apparel companies have gone the other way. But that’s beginning to reverse, and is likely to accelerate…

Here’s an interesting trend… The number of retail bankruptcies has been accelerating steadily since 2005, and is on track to shoot past last year’s 23 major bankruptcies. As of Feb 22, we’re already at a rate in 2009 that is ahead of any year between ’02-’07.

At the same time, Textile and Apparel bankruptcies have slowed to just one year-to-date, and a total of 2 over the past three years. On one hand, you can argue that there are simply not that many left. The domestic textile mills have largely gone under or have gone offshore. But on the flip side, there’s no shortage of Apparel brands that have steadily drawn down cash and built up debt. This number is likely to climb meaningfully throughout the year.

We’ll update you with candidates as we gain conviction on the ‘who’ and the ‘when’.


Last week one of my competitors downgraded CAKE to a sell after the company reported earnings. The analyst cited a numbers of factors for the downgrade, but the focus was clearly on the balance sheet and fear that the company could not handle its debt. The report basically regurgitated the company’s press release regarding its newly amended credit agreement. If fact, the research report, while citing significant balance sheet concerns, only included an income statement and not a balance sheet or cash flow statement. This seems slightly irresponsible in the current environment, where accountability is king.

Concerns over CAKE’s ability to stay below its maximum Debt/TTM EBITDA debt covenant are overblown. To be clear, fiscal 2009 will be another challenging year for CAKE. Based on the company’s EPS guidance of $0.57-$0.67, the company could face a nearly 20% decline in EBITDA after falling 8% in 2008. Partially offsetting that decline, however, is the fact that the company ended 2008 with over $80 million in cash.

After a more detailed analysis of CAKE financials, you can’t come to the same conclusion as my competitor that CAKE is at risk of defaulting on its covenant. In fact, using the analyst’s estimates the company is not anywhere close to tripping a debt covenant. Even assuming the low end of the company’s guidance, CAKE does not come close to tripping a debt covenant. In fact, it would take a decline in current trends for the company to come in at the low end of its guidance and a significant deceleration for the company to default. I have waited some time since the initial report to see if there would be any follow up with the supporting documentation. Needless to say, the downgrade on CAKE includes only one paragraph, no balance sheet and no supporting documents two weeks later. The conclusion – buy the controversy. But there is no controversy.

CAKE amended its revolving credit facility earlier this year, resetting its leverage ratio (defined as funded debt to trailing 12-month earnings before interest, taxes, depreciation, amortization and non-cash stock option compensation expense, or “EBITDA”) from a maximum of 2.25 to a maximum of 1.75 through 1Q09 and a maximum of 1.50 thereafter. It is this covenant step down in 2Q09 that has some investors worried. Based on our calculations, if CAKE’s 2009 numbers were to come in at the low end of the company’s guidance, which I think assumes that things get worse from here, the company still has the potential to generate over $65 million in net cash flow from operations or cash from operations after the planned $45-$50 million in capital expenditures. This free cash flow combined with the $80 million of cash on hand gives CAKE the flexibility to pay down enough cash in the first half of the year to stay in accordance with its covenant. Specifically, if the company pays down only $50 million in debt in 1H09, which is conservative, CAKE’s EBITDA would still have to decline by another $3.5 million in 2Q09 off of what are already extremely conservative estimates for the quarter with EBITDA down 18% year-over-year. Assuming the company only needs to maintain a cash balance of about $25 million rather than the current $80 million on hand, this $3.5 million EBITDA cushion in 2Q09 on a gross debt basis grows to nearly $33 million on a net debt basis because CAKE currently has such a substantial cash balance.

Company Question of The Day: How Does HPQ Pop 50%?

Below I have included our head of Technology’s (Rebecca Runkle) note on Hewlett Packard (HPQ). We went through this on our 830AM morning client call. If you’d like access to this call, please email Jen White Kane at

Rebecca continues to be bearish on HPQ – their blowup last week reinforced most of what she has been saying for the past 6 weeks.

If you are looking for levels to trade HPQ, it will finally be oversold at the $29.37 line – I would cover shorts there, and re-short all strength associated with these Barron’s type calls up to what has turned into to a formidable intermediate term Trend line up at $34.94/share. This stock remains over-owned based on expectations that we see as unreasonably optimistic.

Keith R. McCullough
CEO & Chief Investment Officer
Question of the Day: “How Does HPQ Pop 50%?”

In December, Mark Veverka of Barron’s wrote a cover article on Hewlett Packard entitled “Picture of Health”. In it, he opines on Mark Hurd’s leadership skills, HPQ’s defensive positioning and ability to gain share as well as HPQ’s track record for not lowering earnings (in stark contrast to other tech titans). The stock was at $35.

This weekend, we were treated to “How HP Could Pop 50%”. Now that’s an attention getter if I ever saw one. Despite a miss and downward revisions, Veverka continues to like HPQ “over time” and he remains enamored with “Hurd’s operations acumen and proven ability to deliver strong profit margins in the face of adversity”. He claims his HP thesis remains intact and that it was never about revenues in the first place.

Going into the quarter, my HPQ thesis was largely driven by a belief that while HPQ is an impressive cost-cutting story, revenues do matter and revenue expectations (along with earnings and cash flow forecasts) remained too high. There was a level of investor complacency related to HPQ that I just didn’t and still don’t get. Indeed, HPQ missed revenue targets and built inventory on its books and in the channel. This quarter – revenue headwinds remain and now margins will likely suffer as working capital is “fixed”. While there is no doubt that Mark Hurd is one of the most talented executives in technology and that HPPMA (Hewlett-Packard Post Mark’s Arrival) is a much stronger franchise than before – it is not immune to secular and cyclical challenges.

Longer term, I worry about the printing franchise. During HPQ’s investor call, CFO Cathie Lesjak detailed HPQ’s printing results and both Hurd and Lesjak pointed to a correlation between GDP, unemployment and printing demand. When people aren’t working; they print less. Fair, but that’s not the entire picture.
There are secular forces at work too and anyone who thinks printing will return lockstep with the economy is looking at past correlation models and not the New Printing Reality. What is this New Reality? Just take a step back and think about what’s changed and what’s changing. Younger people, who grew up on computers and never really learned to print, are entering the workforce. Our computer screens are higher resolution and larger than they were – even 2 years ago. Behaviorally, we are adapting and don’t feel the need to print as much as before. Wireless technology has penetrated the print environment and while it feels great to get rid of cables – I have yet to rid myself of that laziness factor. If my printer is in the other room and I am comfy on my couch – I think twice about hitting Alt-F, P. This is especially true as I increasingly worry about the environment and “being green”. Technologies are changing beyond the consumer as well – be it Amazon’s Kindle or electronic bus-stop posters – books and advertising are quickly moving to digital form.

Ironically, HPQ is increasing supplies prices in this environment. Perhaps the end-user really is stupid and/or inelastic. But in this economy, with viable third-party alternatives, HPQ runs the risk of pushing those who are still printing into the arms of others (be it competitors or third-party supplies manufacturers). Regardless, I am less inclined to give HPQ the benefit of the doubt then others. When the economy recovers, I doubt print will recover in similar fashion. If I am right, 50% from here (and a return to early 08 multiples) isn’t a slam dunk anytime soon.

PS - FWIW, Hurd sits on News Corp’s board and Barron’s is owned by News Corp.

Rebecca Runkle
Managing Director
Research Edge LLC

Daily Trading Ranges

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