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SLOT HOLD AS A PRICING LEVER

The Isle of Capri conference call was the first time a casino company discussed lowering “pricing” on slot play. As we noted in our 07/18/08 note, “I’LL HAVE A SLOT MACHINE, HOLD THE WINNINGS”, hold percentage has been steadily increasing for years. Slot “tightening” and game mix shift toward video and penny slots were the main culprits. Effectively, consumers have received fewer and fewer payouts for their dollars wagered. Maybe that’s the price for higher entertainment value.

The charts below show the slot hold percentage trends over time for the Las Vegas Strip, Atlantic City, and Missouri. Missouri is used as a proxy for the regional markets due to readily available data in that state. Slot hold percentage in Las Vegas and AC experienced similar increases. Pricing power in Missouri was much greater, no doubt due to the limited license nature of that market which limits competition. With the exception of Mississippi (unlimited licenses), the other regional markets generated similar increases in hold percentage to Missouri.

I’m not sure whether ISLE’s decision to lower the slot hold percentage in certain markets represents an industry wide cut. However, it is a signal that “pricing” has gone up for too long and has probably peaked and the economy may keep the payout ratio in check.

This is a trend that investors should follow closely. Depending on the tax rate in the jurisdiction, flow through rates on a change in hold percentage can run from 50-90%. To show you the materiality of this issue, take a look at the Strip over the past 15 years. The hold percentage increased from 5.4% to 7.0% over that time. The 160 basis point improvement on 2008 slot volume represents about $650-700 million in profits to the Strip.


EYE ON BUSINESS CONDITIONS: ISM NON-MANUFACTURING

The ISM report for February arrived above consensus estimates, but at levels that were far from positive. The business conditions index, derived from surveys of purchasing and supply executives, declined for the fifth consecutive month, registering at 41.6 versus January’s 42.9. The price index declined for the fourth month in a row after the previous 65 consecutive months of increases while the new orders and employment indices also registered at negative levels.

The data, although grim, is not without some positives. It is interesting to note that the only industry in which surveyed respondents reported an increase in all three categories of prices paid, employment and new orders was Real Estate, where managers also reported decreased inventories for the month. This data appears at first blush to support the thesis spelled out in Howard Penney’s Feb. 24 post on the decelerating rate of declines in home sales; that the real estate market could be close to a bottom.

We will keep our eye on manager survey data as it arrives, constantly testing each investment thesis.

Andrew Barber
Director

EYE ON CHINA: THE OX IS STARTING TO WAKE

Shipping data seems to confirm this heavy industry bias is purchasing patterns. Baltic shipping indices have shown significant improvement YTD overall, but on a % basis the western Australian route has outperformed the broader freight indices (For the purpose of comparison note that the W. Australian route is a single component of the broader indices and, as such, inherently more volatile), which also supports our fundamental thesis on base metal reflation and Australian equities as a component in the Chinese recovery theme.

Premier Wen Jiabao will announce new stimulus in his annual address tomorrow, with expectation running high that the new measures announced will fulfill the politburo pledge of a “massive” increase. All the cards on the table are in the hands of Beijing at this point, so the speech will be the sole focus of global markets as investors continue to grope for a bottom.

We remain long Chinese equities via CAF and retain a bullish bias on both Australian equities (we sold our EWA this morning to book a gain) and base metals like copper. We are keeping our plow firmly hitched to the OX as long as all available data continues to support our thesis.

Andrew Barber
Director

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Obama's Bottom?

"What you're now seeing is profit and earnings ratios are starting to get to the point where buying stocks is a potentially good deal"
-Barack Obama, March 3rd, 2009


The best part about Obama making his first real "call" on financial markets yesterday was the predictable reaction of most people in our industry to it...

No, this is not a political statement. Yes, this is another point that needs to be made on the behavioral side of economics. Wall Street teaches itself memes... then the manic media follows its embedded mimetic desire, copying those memes ... then we find ourselves with proactively predictable behavior...

Whether it was shorting gold at $999/oz or calling out the predictable reaction that a President shouldn't be able to call markets, it's all one and the same -picking off the thundering herd isn't magic folks - anyone who isn't part of the daisy train can see this quite clearly - it's called common sense.

From the Washington Post to Fast Money, the stock market's entertainers immediately lined up Obama's market comments as something that the community organizer is just not equipped to do. It's actually quite hilarious to see these very people who were buying into the SP500, say +55% higher, question the man's entry point ... with a straight face.

Let me be clear, I don't think the President of the USA should make a habit making stock market calls. But neither do I think 95% of those market pundits and money managers alike who have swallowed their own "invest for the long run" tongues in the last 18 months should either. At the end of the day, he or she who actually makes the "bottom is in" call, on the day that the US market bottoms, will be looked back on by historians not as a politician or pundit, but as that person who was right.

Obama didn't actually call for a bottom. But, for the sake of transparency and accountability, let's assume that his aforementioned quote inspires one to believe that he thinks the SP500 down -23% for 2009 to-date is a "good deal." Let's time stamp that and see how the man does. Isn't he allowed to be in this game? Or is this a game that's only allowed to be played by our financial system's wizards?

Don't forget that he Obama has both a YTD low and the low print since 1992 in hand right now - there are a lot of you who are reading this, including me, who have a higher price than that...

I bought the SP500 +2.5% higher than Obama (on the 715 line) and I bought the Nasdaq a little closer to his time stamp. I would love to see all of those brave souls out there who call themselves "strategists" and Investment Chief of Herd Island give us their time stamps, real time, daily... That would make for some really exciting journalism!

The SP500 was down another -0.64% yesterday so I added to my exposure to US Equities, taking my Asset Allocation Model up to 22% in the USA versus the 9% I had allocated in the US as of Monday morning. Immediate term bottoms are processes, not points... so when prices are lower than my entry point, I buy more. Buy low, you know... like the community organizer said!

When I started buying exposure to Chinese stocks in November of last year, China's stock market had taken a -70% swan dive from its prior peak. When I started buying crude oil (in the $35-38/barrel range) the peak-to-trough decline was even steeper. Now China is up almost +30% from those lows, and the price of West Texas crude oil is +20% from the lows where the Thundering Herd dude at Merrill slapped his oil is "going away" price target on it...

This morning, are US stock market futures indicated up because Obama looks to be calling for a bottom, or because those who sold China's bottom are reminding us that they need to cover their shorts? Is the USA up because China is buying oil? Or is she up because a guy in Omaha called a guy in China and told him to stop buying the bubble in Treasuries, and buy into the community organizer's call?

All of this conjecture is as ridiculous as the notion that only certain people in this world are equipped to be "financial advisors" who can "make the call." The New Reality is that anyone with an internet connection and a line to the daisy train at CNBC can - including one, Barack Obama.

I have a 6% Allocation to International Equities, and half of that is in China via the CAF closed end fund. China, unlike the USA, continues to own her own liquidity and destiny. Two TRILLION dollars in cash reserves on a balance sheet has it's perks, and China's Premier, Wen Jiabao, is going to be "making a call" of his own on the Chinese stock market at tomorrow's Chinese equivalent of the State of the Union address...

I know, I know... Presidents and Premiers aren't supposed to be able to "call markets." But guess what? They both just did!

Oh, and by the way, Chinese PMI (manufacturing) came in much stronger than the herd expected last night (49 in Feb vs. 45 in Jan). We have been calling for a sequential acceleration in China in Q1 versus her November lows - and much to the chagrin of the China bears, we're getting one...

Chinese stocks had a huge session overnight, closing up another +6.1%, taking the Shanghai Stock Exchange Index to +20.8% for 2009 to-date. I am on the tape, long both USA and China right here and now, alongside Obama, Jiabao, and my investment process. I see another +12% of immediate term upside in the CAF from yesterday's close, and I have an upside target in the SP500 that's +7% higher from Obama's Bottom at 696. Game on.

Best of luck out there today.


CURRENT ETF ALLOCATION

LONG ETFS

QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day on Monday.

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

SPY - SPDR S&P500- We bought the etf perhaps a smidgen early with the S&P500 at 715, yet will take it at a discount.  The market is also close to three standard deviations oversold.

CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +13.75% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

GLD - SPDR Gold- We bought gold last Thursday with the S&P500 in the red and gold down. We believe gold will re-find its bullish trend.

TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.

SHORT ETFS

LQD -iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

SHY -iShares 1-3 Year Treasury Bonds- On Thursday of last week we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is down versus the USD at $1.2517. The USD is up versus the Yen at 99.3350 and down versus the Pound at $1.4090 as of 6am today.


LIZ: Initial Take… I Like It

Overall…good stuff. Had a write down, and they guided low. But they will beat – as in this Q for the first time in 2 years. People are underestimating the ‘balance sheet repair’ factor.
The crux of my call on LIZ is that 1) the aggregate value of the pieces are worth at least 3x the current EV, 2) contrary to market conjecture, LIZ will not go under, and will not even breach a covenant, 3) the Street is underestimating the levers at LIZ’ disposal, and effective immediately the 2-year downward spiral in estimate revisions is finally over. Ultimately, investors will re-focus on the equity value of LIZ in ’09 as the balance sheet is fixed, and estimates for ‘09/’10 will approach $0.75/$1.00. This can’t sustain a sub-$3 stock for too long…

The quarter reported this morning largely synched with my thesis. Here are some key points.
1. Adjusted EPS of ($0.04). Horrible numbers, but better than my estimate ($0.07), the Street ($0.09) and guidance. Again, the downward spiral of revisions is over.

2. LIZ paid down $175mm in debt in the quarter due to lower capex and aggressive working capital management. This does not include the extra $90mm in tax refund LIZ received in Feb, or the $83mm net proceeds from the Li&Fung deal.

3. The company is likely to use these proceeds to take down debt further – to under the $600mm mark (from near $900mm previously).

4. LIZ is on track to realize $70mm from recent 8% corporate headcount cuts.

5. Guidance is very tepid. Actually, it is nonexistent for ’09. The company noted that it will have an operating loss in 1H, and is planning its business accordingly. I’m not suggesting that its business is good, but guess what folks… with that statement LIZ is speaking to its creditors – not you or me! It is planning its business around expectations for an operating loss – but will come out better.

6. The company recorded a $382mm impairment charge associated with its US business. This was news to me. LIZ noted that it was required to do so bc the current market cap declined to a level below book value, and LIZ had to mark to market. I’m all for marking to market. But my sense is that when the actual cash flow from these assets is realized in hindsight the book value will prove too low.

PNK BLOWS THE DOORS OUT

PNK delayed the filing of its 10k but the reasons appear harmless. The company needs more time to determine the amounts of various impairment charges it plans to record in Q4. Impairment charges are all the rage in gaming these days and PNK has its share of impaired assets. No doubt, the land in AC ranks near the top.

More importantly in my opinion, PNK looks like it will beat revenue and EBITDA estimates for the 2nd straight quarter. Not only did the $45.6 million in adjusted EBITDA beat the Street, but they blew it out. We estimate the street was projecting about $37 million in comparative EBITDA. Revenues were certainly impressive at $259 million versus the Street at $254, but margins were the real driver. Margins were 300 bps higher than expectations, due in part to the ramp-up at Lumiere Place and better flow through of the strong revenues in Louisiana.

PNK continues to buck the gaming and consumer trend. Is it sustainable? Probably not at the same rate but gas prices remain low and the regional markets seem to have stabilized. Indeed, pure gaming is proving less discretionary then many other forms of consumer spending. At some point the energy industry may be a drag on the Louisiana economy but we haven’t seen it yet.
I personally own shares of PNK

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