Eye on Re-Regulation: Where There's Smoke...

Late For A Fray, But Not For A Feast

The amount of money in both these pots may not be enough to solve the problem.
Alan Greenspan

Allan Bloom, the Twentieth-Century American philosopher, bemoaned the state of modern culture. In the past, educated people would turn for guidance to the Bible, to The Philosophers, and to the works of Shakespeare. Bloom saw the decline of culture as a grand tragedy. For the abandonment of culture is not merely the loss of a moral compass - as though that were not devastation enough - it is the wholesale rejection of wisdom.

In the Gorgias, Plato draws from the mouth of Socrates one of his most famous and trenchant images. Against the notion that happiness comes from ridding oneself of all restraint, from the unfettered and endless exercise of power and appetite, Socrates presents the parable of a man filling jars with wine, honey and milk. Leaky jars, says Socrates, can never be full.

How far can we fill our leaky urns, before we realize that we are in the grip of a hunger that will not be sated? As our best wine and honey and milk flow through the cracks, how much longer before all our resources run dry?

To mix philosophers, governments too should bear in mind Keynes' dictum that markets can remain irrational longer than the money can hold out. Chairman Bernanke testified this week, with a smile, that we can continue to lend money in this environment, because it is not costing us anything. This was in reference to our current effective zero rate of interest on Treasurys. And when that rate turns up? Surely Chairman Bernanke is enough of an economist to realize that refinancing cheap money with dear is not a sound plan.

We were fascinated, too, to see Chairman Greenspan's speech in which he endorsed nationalizing the banks. Trotting out this old warrior - even though somewhat hobbled by his own inability to see the oncoming freight train - seems an obvious way for the Administration to prepare the markets for what comes next, as they approach the crisis caused by excessive consumption by urging the world to spend money.

The Government's pressing the banks to lend is really a plea for consumers to consume. There is no apparent shortage of money in the system, but banks may be right in their timidity to lend. Should they lend to the institutions? What happens when the Feds pull another Lehman? As to the shell-shocked consumer market, anyone running out to borrow money for a nonessential purchase, please step forward. Don't everyone come rushing up all at once, now.

Our Government is testing the waters on nationalizing the banks as the only way to force that money into circulation. If the consumer won't spend it, who will?

The compulsive shopper of last resort, that's who.

Quoth former Fed Chairman Greenspan, "what we are currently going through is a once-in-a-century type of event. It will pass." Which means, not that we shall return to wisdom, nor see the folly of permitting our resources to flow out of cracked jars, but that one day people will again start buying things they don't need. People's memories are short. The Government's program calls for a return to moral hazard as a way of life.

And we are working hard to share the hazard. Now, for example, instead of lending more money to the US, in return for "In God We Trust", the Chinese are lending money to the Russians in return for a long-term lock on the price of oil. No, no, says Hillary. You have to double down on Treasurys!

Welcome to our new Secretary of State - Stockbroker of Last Resort.

The Other White Meat

Oh, I love to eat it every day, and if you ask me why, I'll say,
"'Cause Oscar Mayer has a way with B-O-L-O-G-N-A."

President Obama's first bill has succeeded beyond his wildest dreams. It was the Bill Of Goods - his loudly trumpeted and ceaselessly repeated Bipartisan mantra.

Knowing full well that all politics are viciously partisan, President Obama got to ring the bell every time a Republican took issue with an item in the Pelosi stimulus package - and it is a porcine package, even by Bridge To Nowhere standards. To be fair, President Obama is not the only high-visibility politician to have made substantial hay of the Bipartisanship canard, but Rush Limbaugh notwithstanding, the Republicans do not need a failure to say "I told you so." The underlying argument is not that Obamulus won't work, but that it will have too little effect, for too much expense.

Whether it is Wall Street's appetite for cash, Detroit's refusal to acknowledge reality, or Washington's inability to say No to anyone, the jars are broken. Increasing the flow will not mend the leaks.

What might this mean for the securities industry?

Politicians are in a porcine snit about the compensation of the Top Dogs in banking. Meanwhile, Washington has blown close to a trillion dollars on restructuring Wall Street to make it impossible for the customer to say No. Wildly bullish stock analysts are feeding highly paid stockbrokers, who will soon be calling you. Remember that the thirty thousand-odd brokers newly acquired by B of A and JP Morgan will probably get most of this year's compensation from accelerated payout on commissions. Congress does not understand this, so you had better.

And you can forget the compensation cap. Top bankers will loophole their way around that boondoggle - for instance, by taking equity stakes in LLCs that act as trading or banking units of their own institutions, and drawing management fees, as well as a percentage of the top-line revenues.

You didn't think these guys were going to base their compensation on performance, did you? And neither do the guys we voted for. Sample from last year's Wall Street Journal (September 16, 2008, "Wall Street Political Donations Set To Slow"): "From the time Sen. Obama launched his presidential campaign last year until May 30 this year, the securities and investment industry had donated $9.2 million to his campaign." This was all while complaining that Obama was going to be a return to traditional Democrat high taxes. Those contributions will only continue to roll in to the extent the Greed Is Good crowd continue to pay themselves off the top.

Thus, vociferous calls to strengthen the hand of regulation and punish Wall Street run at cross purposes to the very business of politics. The electorate, being Customers of both the Street and the Hill, should bear this in mind. We would all do well to heed the words of John Maynard Keynes to President Roosevelt: "It is a mistake to think businessmen are more immoral than politicians."
Pork goes best with gravy.

She's Baaaaack!

In what should be "Friday the 13th, Part II" for Friends Of Chris ("FOC"), Mary Schapiro has appointed Kayla Gillan as Special Adviser to the Chairman of the SEC.

Ms. Gillan, most recently Chief Administrative Officer of RiskMetrics Group, launched the corporate governance program at CalPERS, taking on companies and their boards of directors over acts of fiscal irresponsibility. Gillan understands how companies destroy shareholder value, and how boards of directors resolutely don't do their jobs. She has proven to have the diligence and tenacity to bring real concerns to company boards, and the legal acumen to force them to listen. No wonder Chairman Cox didn't want her around.

Ms. Gillan and Chairman Cox butted heads over his refusal to implement tough accountability standards. After she launched the Public Company Accounting Oversight Board, Cox finessed her out of any real control and cut short her term. Chairman Cox took his mission to seek greater harmony seriously, to the extent that he refused to alienate the very entities the Commission is charged with regulating.

Suffering a similar fate was Charles Niemeier, former Chief Accountant at SEC Enforcement, and likewise a proponent of strong controls. Rumor has it that Chairman Schapiro will be bringing him back as well, and with greatly increased visibility and clout.

We won't say that we are tired of hearing our own voice, but we applaud Chairman Schapiro and hope this is the tip of a very nasty iceberg.

But let's not forget that none of this would be happening without Bernard Madoff.

Bernie Madoff did a host of small investors a huge favor. Not to downplay the losses that may ultimately be identified in the unlikely event that this mess is sorted out, but look at the profile of many who lost money. Henry Kaufman - the granddaddy of all Wall Street economists and the original "Dr. Doom". Ezra Merkin, a leading money manager; Daniel Tully and David Komansky - former CEOs of Merrill Lynch - not to mention the likes of Steven Spielberg or Mort Zuckerman, who have access to good enough financial advice that they have only themselves to blame.

The sting of missing the warning signs at Bernie's shop has led the SEC to mobilize on a rash of other files that have been gathering dust for years. The highest visibility is the Stanford case - in which thousands of small investors, CD buyers and just plain bank depositors have been wiped out. We hear rumors that not only the SEC, but also the FBI have had allegations about Stanford going back more than a decade. Thanks to Bernie, they have now been brought to light.

Then there is Billion Coupons Inc, which the SEC accuses of bilking deaf investors out of over four million dollars. Linda "Smokey" Thomsen was quick to herald this new success. "This emergency action shows that the Commission will act quickly and decisively to help victims of affinity fraud." We are waiting to hear how long that docket sat around gathering dust in the SEC's offices.

Affinity Fraud cuts deeper than the press stories reveal. It's not just about Foundations. In the wake of the Madoff scandal, there are a number of wealthy individuals in the Jewish community who give both generously, and anonymously. We are aware of one New York investor who supports one hundred families, anonymously doling out tens of millions of dollars a year. If that money is the interest on a half-billion-dollar Stanford CD - or the returns on a $200 million Madoff portfolio - it may not change his family's lifestyle, but he is keenly aware of the effect on hundreds of people who rely on him for their sustenance.

This is the less visible side of affinity fraud. People taking care of their own. Across America and around the world, there are Catholic families, Jewish families, Moslem and Hindu families - and now deaf families - reeling from the losses that have hit their anonymous benefactors.

Bush Senior's famous Thousand Points of Light were real. We wonder how many of them are winking out.

Get With The Program

I don't have to show you any stinkin' badges!

How did the FINRA and SEC examiners not detect that Bernie Madoff managed tens of billions of dollars without a single customer trade in over a decade? Because regulators look at what the firms present to them. No auditor will take a handful of recorded trades and track them through the broker, to the clearing firm, to the customer report, and tie this all in with specific trade information from the market and with trade counterparty reports. Even though all this information is readily available. Indeed, the regulators themselves create a significant part of it, and oversee the creation of all the rest. If this had been done on the Madoff audits, it would have become immediately apparent if there were falsified trade records. As someone once said: C'mon, guys!

Kayla Gillan recently told Compliance Weekly "Some people at the S.E.C. wanted the auditors to really only look at the process that companies go through... and not actually look at the controls themselves."

SEC examiners work from a standard audit checklist. Among the items they request are the firm's internal compliance checklists. If all boxes on both forms are checked, the auditors get to go home. But sometimes firms are slow to meet document requests. This upsets the examiners greatly, because it puts off their schedule, meaning they will take a hit to their efficiency ratings.

Now Lori Richards, Head of the SEC Office of Compliance Inspections and Examinations (OCIE), announced a get-tough policy on foot draggers. Ms. Richards has been concerned "for the past six months" (it's Madoff season, remember) that firms were not forthcoming in submitting documents. Note that Ms. Richards is not announcing a get-tough policy with auditors who do not dig for actual problems.

This appears to be an automatic Enforcement referral program for firms that delay submitting documents. Sort of a Rockefeller Law for registered investment advisers. But the SEC's only real clout comes from its ability to stop people from doing business, and to tie people up in criminal proceedings, both of which take excruciatingly long to implement.

In order to put teeth into Ms. Richards' threat, the SEC will have to wield its subpoena power liberally. But even this does not mean that Enforcement will actually investigate, much less find anything. This is primarily a mechanism for adding new fines, thus driving SEC revenues. Firms will be paying more in lawyer fees, and the focus of audit delays will shift from the inefficiency of both the firms' oversight and the SEC bureaucracy, to the logjam in the court system, as hedge fund and SEC Enforcement lawyers jockey for space before judges whose dockets are clogged with mortgage foreclosures.

The SEC should be kicking itself over not putting more weight behind the examination request letter that came out of the New York OCIE last year. The letter required firms to disclose real and actionable information, and was met with a firestorm of protest from the Managed Funds Association and other RIA and hedge fund groups. Chairman Cox dithered, apparently concerned that it would alienate the FOC's in the hedge fund community. Ultimately the letter was dropped, and the head of the New York office took more blame than he was entitled to.

Saying it again: Chairman Schapiro needs to use the momentum of the Madoff case to bring industry professionals on board. In the recent report from the Chamber of Commerce, former SEC Chairman Harvey Pitt offered the notion of a panel of industry insiders who would review the business and the regulators every two years. This fits with what we have been saying: Chairman Schapiro must make it attractive - and feasible - for real Wall Street professionals to join up. When you know not only where the bodies are buried, but how they were buried, and by whom, and with which tools, then you don't need no stinkin' badges.

Watch for elements of the notorious New York OCIE audit letter to resurface. Unlike last time around, SEC staffers will be fighting to claim credit for it.

Widows And Orphans

There are two times in a man's life when he should not speculate: when he can't afford it and when he can.
- Mark Twain

The North American Securities Administrators Association, the organization of state regulators, is urging Congress to revise the Accredited Investor standard.

If you are a stockbroker, an Accredited Investor is someone presumed to be sophisticated enough to open an account. This is the basic suitability standard, and often no further test will be applied.

An Accredited Investor is a person having a net worth of one million dollars. Not cash. Not a stock portfolio. Not a history of investing. This means that your grandmother, who has the family homestead and the farm in western Pennsylvania in her name, can open a brokerage account with one of the tens of thousands of taxpayer-funded salesmen at B of A. And when she loses her money - well, she was suitable.

The State Regulators, many of whom actually understand the industry, do not have the power to change industry suitability standards. That power resides with Congress - you know, the guys who get campaign donations from Wall Street - and the Accredited Investor definition has not changed appreciably in 25 years. We remember when a million dollars was enough to retire on. Today it is no longer enough to be financially secure. But it's still enough to open a brokerage account.

Now The Good News

At the latest Practising Law Institute's "SEC Speaks" conference, Chairman Schapiro said "Because of the unique role the SEC plays in our markets, I am confident the SEC will emerge from this process stronger and more relevant than ever before." This was taken as an affirmation that the SEC will remain independent, and will not be crammed together with the CFTC into a "super-regulator".

"The SEC is a proud institution with a remarkable history and a tradition of activism," said Chairman Schapiro. "In the days ahead, we will rise to the new challenges of today's financial and regulatory realities, both by embracing new approaches and by maintaining the great traditions that have defined this institution throughout its history."

Ms. Schapiro neglected to mention one of the greatest traditions of the heads of regulatory agencies: making the rounds on the Rubber Chicken circuit - such as the PLI luncheons - where We Who Are About To Be Regulated find out about these initiatives. These non-events take up tremendous amounts of regulatory resources, and give the regulators a much-needed break from the hard work of ignoring tips, not auditing the paper trail on firm trades, and refusing to share information across agency lines in an effort to get a full picture of what is going on in the markets.

In all the confusion and turmoil, the idea that the SEC will remain independent may be the best news of all. It's called containing the damage.


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.

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.

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