EYE ON GERMANY: More Negative Data Points with a Pinch of Optimism

Today the Federal Statistics Office in Germany reported the following Q4 ‘08 data on a quarterly basis:

-Exports declined 7.3%
-GDP fell a seasonally adjusted -2.1%
-Consumer Spending dropped -0.1%

Additionally, IFO sentiment data released yesterday was marginally worse, yet in line with estimates.

IFO Sentiment data for February registered a tick downward with the Business Climate index (based on a survey of 7,000 executives) at 82.6, down from 83 in January, in line with expectations that the index wouldn’t move dramatically. The Ifo’s gauge of current conditions also fell, declining to 84.3 from 86.8, while the measure of expectations rose to 80.9 from 79.5. A separate survey, the ZEW, reported that German investor confidence rose to -5.8 in February from -31 in the previous month, the biggest jump in 15 years.

German data remains a primary focus for us, as it is the country with the largest European economy and the strongest credit (based on yield). Germany provides an important pillar for which to compare the relative health of Europe against.

The DAX has had numerous nasty closes in the last two weeks and is down -19.01% YTD. That’s worse than the YTD performance of the SP500. Despite the anticipation of Chancellor Merkel’s stimulus program, which at 1.6% of GDP is the biggest spending package in Europe, the economy cannot recover from domestic tax cuts and infrastructure investments alone. In Keynesian economic policy does anyone trust?

Germany, as an exceptionally export dependent economy, is equally levered to the health of the global economy. As the global recession continues so too wane, so does the world’s appetite for German goods. GDP slumped 2.1% in Q4 ’08 on a quarterly basis (the biggest drop in 22 years) and the economy is estimated to contract 2.5% this year according to the IMF.

We expect the ECB to reduce its benchmark at least 50bps to 1.5% at its next policy meeting on March 5, which will in part benefit countries like Germany by weakening the Euro to make exports more attractive. Despite the bearish data points from Q4, the jump in investor confidence is bullish on the margin, and one of the many factors we’ll have our Eye on.

Matthew Hedrick

Dealing With Hope

“A leader is a dealer in hope”
~ Napoleon Bonaparte
From The Wrestlers to the Raccoons out there in this marketplace, President Obama has his hands full. There is no doubt that this man inspires hope – and he did his best in changing his tone to a more hopeful one in last night’s address – but hope, as we say here at Research Edge, is not an investment process.
Napoleon proved that inspiring men to fight for you is the best way to win. He also proved that when hope morphs into doubt, your fate falls by that very same sword. Make no mistake folks, the breaking down through the November 20th support levels that we saw on Monday matters. The Crisis of Credibility that this country faces will not be resolved by a bear market rally, or a good speech.
Yesterday, I had twice as good a day as I had a bad one on Monday. That’s how it goes when you sign up to dance with a bear that you’ve beaten before. Once you are locked into that cage match, and the entire market calls you dead – the only thing you can do is trust your process, bury your head into that bear’s chest, and know in your gut that that’s the one moment that you’ve proactively prepared for.
The SP500 closed up a strong +4% yesterday at 773, pairing its YTD losses for 2009 back to -14.4%. Volatility (measured by the VIX index) took an elbow smash to the forehead at down -14% on the day, while volume on the NYSE ripped the hair off the short seller’s head, moving +10% versus Monday. The squeezing of temples in the Financials (XLF) was pronounced – the XLF ETF closed up +12% on the day. Citigroup (C), which we said (on our Monday morning client call) could put on a +35% move from Friday’s close, tagged the bears in the butt for a +22% gain, taking its cumulative move from last week’s “nationalization” low to +33%. I don’t want to touch Citigroup here.
The market’s breadth expanded alongside accelerating volume into the close. The Advance/Decline line on the NYSE was 81% for advancers versus 17% decliners by the time the bell rang. One, Two, Three… the daily dance with the bear was won.
Now what Mr. Wrestler? Well, as one of the finest of Wall Street memes goes – “that’s a great question.” And I’ve already locked my answer on the tape – selling into the close was the prudent move to make. When you look at the last 150 years of trading in this country, not selling anything on +3-6% up days during bear markets would render me part of the thundering herd. I don’t do herds.
Make no mistake, fully loaded with whatever hope our new President wants to issue, the intermediate “Trend” in this market remains bearish. Unless we can close above 824 in the SP500, that will not change. Can you position yourself in the cage match to make bullish immediate term “Trade” moves? You tell me … some people say they “don’t do trading”… others said they didn’t “do macro” either. I do both.
Until the next bull market returns, this is a market that needs to either be traded or avoided. If you “have to be invested”, I suggest you trade your exposures even more aggressively. Otherwise, you may as well dress up like a WWF Wrestler and keep pretending that “investing for the long run” works right here and now.
In our Asset Allocation Portfolio, by the time yesterday’s bell rang, I’d sold down the exposure that I grossed up in US Equities from 29% to 18%. I held onto that long position I bought in the QQQQ (Nasdaq) at 3:27PM EST on Monday, and while I don’t know if that print looks lucky or brave, it really worries me.
Whether you are pretending to be a wrestler or risk manager, I think you should always be worried. You can and will be wrong – so the best process is to perpetually question the validity of why you think you can be right. I never used to worry. Between the years 2000 and 2004, I’d built up such a consistently solid performance run that I got cocksure of myself, like a lot of men and women of the hedge fund gridiron do… then I got body slammed for a quarter and, trust me, it had an impact.
I’ve trained myself to worry about being wrong, because that’s what you should do when serving as a fiduciary for other people’s money. They worry about their hard earned money every day, and given the level of socialization rhetoric brewing in this country right now, so should you.
President Obama,
Thank you for your message last night. But today is another day in the ring for we who are wrestling the bear. No matter where you think this market is going this morning, there it is. My advice for you, Mr. President, is the same as it has been – break the buck. Until you figure this out, you will not stop deflation. Irving Fisher was of this view, and John Maynard Keynes was not. Last night you said, “I, get it…”… but do you really? Fisher vs. Keynes – it’s going to be a cage match, and all I can do right now is hope that you “get” that message.
I remain short gold and short Asia. In the USA, my new downside support level in the SP500 is 732, and immediate term upside target is 793. At down -5% vs. +3%, the risk in this market once again stands taller than the reward. Trade and tread carefully…
Best of luck out there today,


Dealing With Hope - etfs022509


Steve Wynn is a capitalist. He also built his business from nothing, the epitome of the small business owner, and treats his employees well, in good times and bad (no layoffs). He’s also an honest capitalist. He’s also an honest capitalist with some valuable, real world, and thoughtful insight more relevant now than ever before. This man understands economics and the dangerous political tide we are all facing. All were clearly evident in yesterday’s conference call.

Here is Mr. Wynn referring to the convention business his company lost after President Obama’s negative comments on companies’ outings to Las Vegas:

“If that’s that class warfare or as I mentioned earlier that capitalism needs to be punished, if that is part of the mentality of this administration we’re in for a worse time than we expected….I created 4,000 or 5,000 new jobs here, does that make us a bad guy? How many new jobs did Uncle Sam create? Zero.”

Nor was he one-sided in his criticisms:

“…the political leadership from Washington was completely lacking in the first $350 or $400 billion they spent last year. So, that money went down the drain and didn’t produce the kind of result it was suppose to. Theoretically there was suppose to be some smart people on the job paying attention to this like the Secretary of Treasury and people like that, the former chairman of Goldman Sachs….this last stimulus program that has come out of Washington is more of a welfare program than a real jobs creation program in spite of what the President says.”

On the honesty and transparency front, Mr. Wynn spoke openly about the difficult environment and didn’t try to sugar coat it in any way. He talked down an overly excited sell side analyst who was trying to justify his buy rating. Wynn provided an education on why the low hold % was not just bad luck. Rather, it was also due to the lower velocity of actual gambling when chips are taken out (see our post “WYNN WON’T BE WINNING AS MUCH” for a more detailed discussion). The low hold percentage will continue, Mr. Wynn said. He didn’t have to volunteer this analysis but he did.

This corporate transparency should be applauded.

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Some on the sell side will be trying to normalize the low Q4 table hold percentage generated by WYNN in Las Vegas. This isn’t appropriate as Steve Wynn transparently discussed last night.

As we wrote about in our 9/18/08 post, “HOLD % AS A HEDGE TO DROP IS BREAKING DOWN”, when players spend less time gambling, the hold % becomes distorted. Unlike slot machines, table games are not computerized. The actual amount wagered cannot be measured. Only the amount of chips exchanged for cash can be determined. If gambler walks around for an hour with $100 worth of chips in his pocket, the drop will be the same as the one that gambles. Obviously, the casino win will differ.

WYNN/Encore Las Vegas produced a 15% hold versus a normal 21-24%, resulting in a $25-30 million hit to EBITDA on properties that generated only $33 million in EBITDA. That’s the superficial analysis. Now the real analysis: hold percentage is likely to remain depressed in this economic state. Assuming that half of the hold delta was actual “bad luck”, the LV properties significantly missed estimates.

It’s not all bad for WYNN. Wynn Macau actually put up a decent quarter that was pretty much in-line with consensus. Wynn’s commentary about Macau was surprisingly positive, unlike the very somber tone of the Las Vegas discussion.

The stock deserves to go down today but it has already been hammered so much that it may find a bottom pretty quickly. We’ve consistently predicted a disastrous WYNN Q4 since our 12/10/08 post on Macau so it should not have been a huge surprise.


It is almost a mathematical certainty that LVS will breach a covenant on its US facility in Q2/Q3 unless some drastic measures are taken. Asset sales, credit facility amendments, or even a US bankruptcy filing are potential remedies. These scenarios are discussed below.

First some background on LVS’ $5BN US facility, here’s some background. The US facility’s maximum consolidated leverage ratio is currently 7.5x, stepping down to 7.0x for the period ended March 31, 2009 and then continuing to step down 0.5x every six months to 5.0x for the period ended March 31, 2011. At the end of the 4Q08, consolidated leverage stood at 6.2x. The calculation of consolidated leverage allows for $100MM of “equity contributions,” and an addback of roughly $16MM of interest on the $250MM Senior Notes to the TTM EBITDA calculation. The TTM EBITDA calculation also allows for pro-forma treatment to new openings (like Bethlehem). The consolidated debt is calculated net of unrestricted cash over $75MM at LVSC and its Guarantors.

According to our calculation, LVS will breach its maximum leverage covenant on the US facility in either the 2Q or 3Q09. LVS has the ability to move cash around or procure a cash infusion to cure a small breach at the US level, so they may be able to make it past 3Q09. However, the size of the breach amount widens considerably in 2010 as the leverage covenant continues to step down.

Conceivably if LVS could sell some non-core assets this would also go a long way to alleviating a technical default scenario. Unfortunately, they have already sold the Palazzo retail, but will likely only get an unsecured claim in GGP’s likely bankruptcy when payment comes due in 2010. Another asset LVS would probably love to sell is the St Regis residence tower, which is a much tougher proposition, but currently that asset produces no cash flow, so any price LVS can get would be de-leveraging. We believe that LVS would happily sell it at cost if it could (roughly $600MM). However, the sale of the St Regis Tower alone would probably not be enough to avoid breaching the covenant.

Given the licensing hurdles and mark to market that banks would need to take, many gaming operators that stumble into technical default are able to get amendments at a price. We believe that the banks would want at least an additional 200-400bps ($100-$200MM) in interest spread in return for leverage covenant relief. The actual increase in spread would depend on what else they offered the banks. The US facility is secured by the two Las Vegas assets’ “Guarantor”. If LVS offers up Sands Bethlehem as collateral, and perhaps a stock pledge of the public entity, this would help in lowering the additional spread that they would need to pay to secure an amendment.

However, coupling the licensing issues with the fact that LVS is levered approximately 12.5x through the bank debt, which is trading in the 50 cent range, and that there is no residual equity value at the Guarantor level, we don’t think that the banks have a lot of leverage to extract any material amendment fee. In fact, we believe that the most likely scenario is that the banks just charge LVS a modest amendment fee and allow LVS to continue making interest payments.

The banks’ only other alternatives are to either take over the collateral, or throw LVS into bankruptcy. Unlike distressed buyers of debt, the banks probably own the bank debt at par, and hence they would own the assets at 12.5x EBITDA. They would also have to hire a licensed operator and spend a large chunk on restructuring advisors and attorneys. If the banks attempt to seize the assets, then LVS would likely file for bankruptcy protection. The end result would likely be some sort of pre-pack where some of the bank debt would get equatized. There’s no real reason for banks to force LVS down this path when they can just sit and collect their interest payments and avoid the mark down of their loans.

Even in the unlikely scenario that LVS does end up filing the US Subsidiary for bankruptcy protection, this doesn’t render the stock of LVS worthless. In the event this scenario plays out, as we already mentioned, some of the debt will likely get “equatized” and the current shareholders of LVS will get diluted. In a perverse way though, this may actually boost the value of the stock.

At the current stock price, investors are clearly pricing in a high probability that the company is worth zero and herein lies the issue. We agree that the US entity is worth zero, but that doesn’t render the Macau and Singapore subsidiaries worthless. A filing at the US entity doesn’t trigger a default at the Macau or Singapore facilities. Macau may be worth around $6.00 (if the covenant situation there is overcome) and Singapore around $4. Even if the US entity files, and equatizes $1-2BN of debt, there is still value in the remaining two entities, and now the probability of zero is largely eliminated.


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