Total Macau Baccarat revenues fell 17% in February, driven primarily by a 20% decline in Rolling Chip (RC) turnover. The 17% drop actually improved sequentially from January’s 19% decline. I actually thought the volume decline would be worse considering the comparison. In the first half of last year, the junkets flooded the market with credit driving 30-60% monthly increases in Rolling Chip volume. Mass market revenue declined 6% in February.

In terms of total market share, LVS was the biggest winner, gaining over 300 bps of share sequentially, although still 400 bps below its December 2008 peak of 28.6%. Galaxy and SJM both gained over 100 bps of share. Galaxy has been on a little bit of a roll with its 2nd straight sequential gain and its 14.2% February market share was the highest since November 2007. The February losers were MGM (low hold % on the RC business) and Crown. Wynn Macau held fairly steady at around 16.2%.

On the super profitable Mass Market business, market shares were fairly consistent with prior months. The only real trends that appear to be emerging are the opposite paths of MGM and LVS. LVS lost a little bit of Mass Market share for the 3rd straight month while MGM gained share over the same time period.

Trends appear to be emerging in the RC segment. MGM and SJM are on the upswing, due in part to higher commissions paid to the junkets. MGM generated 250 bps of market share gains over the last two months. Revenue share would’ve also grown sequentially if not for an abnormally low hold %. LVS and Crown each lost share for the second straight month in RC.

All things considered, Macau seems to be doing fine despite the crazy RC comparisons and the stringent visa restrictions. We’ve been concerned with the RC comparisons, as we pointed out in our 01/08/09 note “MACAU: CREDIT A BIGGER NEAR TERM ISSUE”, but investors have finally discounted that and we can see the light at the end of the tunnel. Macau will lap the credit flood in September where last year’s comparisons actually turn negative. There is also a reasonable probability that the visa restrictions will be eased by then as Beijing may provide a tail wind for the new Macau Chief Executive. Macau remains the only worldwide gaming market with excess demand and we are sensing a turn to the optimistic side of the pendulum.


So Bank of America/Merrill Lynch/US Government raises their 2009 EBITDA estimate by 14% or $24 million and jacks up 2010 by 12%. The 2009 EBITDA hike translates into $0.40 in incremental EPS for a company that is projected to generate no EPS in 2009, yet somehow that is “tweaking”, as the analyst described it.

This is disingenuous. Not only is the analysis disingenuous but it is faulty. Rather than raise his price target by the $3 required by the higher estimate, the analyst lowered his target multiple by a full turn or a $4 reduction. The net result? A target price reduction of $1 and presto: a negative spin on an outstanding quarter. I find it hard to process a lower target multiple when regional market trends are stabilizing in general, and actually improving for PNK.

Of course, this is probably not the sole cause of the strange reaction in PNK’s stock to numbers that surely bested even the whisper numbers. Ahead of the quarter, we were leaning towards sell before the news but the operating performance exceeded our most bullish projections. So why was the stock down? Here are some educated guesses.

• Fear of Texas – A bill was introduced in February to legalize slots in Texas. Most of PNK’s markets service the Texas population. However, there were absolutely no developments late last week. More importantly, we don’t think Texas will legalize slots any time soon.
• The large seller argument – This common explanation for unexplained down moves in stocks actually has some merit in this situation, so we hear.
• Increased Sugarcane Bay budget – PNK increased the scope and cost of its Lake Charles project by $50 million. Nobody likes to see more capex but this project has not even begun. I’m not particularly worried about this.
• Covenants - I actually feel a lot better about the covenant situation. After the strong Q4 results, a 2009 covenant breach is highly unlikely. The 2010 story is hardly dire and while a breach could occur, time is on PNK’s side and so will be the banks. I’m not worried.
• PNK is a gaming stock – What can I say about this? Despite stabilizing trends in the regional markets in general and strong trends for PNK, nobody wants to own gaming, until they do.
• Faulty analysis – See the discussion above.

US Market Performance: Week Ended 3/6/09...

Index Performance:

Week Ended 3/6/09:
DJ (6.2%), SP500 (7.0%), Nasdaq (6.1%), Russell2000 (9.8%)

2009 Year To-Date:
DJ (24.5%), SP500 (24.3%), Nasdaq (18.0%), Russell2000 (29.7%)

Keith R. McCullough
CEO & Chief Investment Officer

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On the surface, RCL is a short seller’s dream: 1) lousy fundamentals,2) high leverage, and 3) liquidity/covenant issues comprise the bulk of the negative thesis. With 31% of the share sold short and a forward p/e ratio of 5.5x, shorting RCL is indeed the consensus call.

We have no response to the high leverage argument. We calculate leverage at 8x in 2010, although it will decline materially once the new ships come on line. Our only counter to the fundamental argument is that near term bookings appear better than investors may be expecting and Europe has been resilient. Where we may differ with consensus is on point number 3.

RCL really doesn’t have any covenant issues:

• Fixed Charge coverage test is actually negative (cash flow from operations/ (sum of dividends + scheduled principal payments – new financings)
• Net Debt to Capitalization Ratio was below 50% at 12/31/2008, and we project it peaking at 57% at the end of 2010, still below the 62.5% max
• Minimum Shareholder’s Equity was $4.7BN vs an actual of $6.6BN at 12/31/2008.

RCL may have some liquidity issues, but not until 2010. We are well below 2009 consensus earnings and cash flow estimates yet RCL maintains more than enough liquidity to fund its significant capex. See the chart below. 2010 will be awfully tight, however. Here are our assumptions:

• They will get the financing for Oasis and Allure in 2009
• By the end of 2009 all ship commitments should be fully financed removing that overhang
• $600MM funding need from: cash flow from operations of $800MM – capex of $2.2BN + new ship financings of $1.7BN – maturities on 2008 debt of $800MM – maturities on 2009 debt of $100MM
• Sources at 12/31/2009 of $650MM: R/C capacity of $400MM + cash on hand of $250MM

A 2010 funding shortfall is a real possibility, a 50% probability in our estimation. However, even in this scenario, RCL would likely procure an extension on one its 2010 maturities, albeit at a higher interest cost:

• Alternative would trigger a cross default and most of the lenders have exposure on multiple pieces of debt
• Last thing unsecured lenders want is for RCL to have to raise secured debt under its carve out
• RCL could always monetize it’s in the money hedges

The good news is that 2010 is truly a bridge year. Capex steps down materially in 2011 and presumably RCL will be in the clear in terms of liquidity. Now if only RCL can sustain the recent “less bad” operating momentum there could be a nice near term story here.

Plenty of 2009 liquidity but 2010 is tight

MCD - Changing the rules in the middle of the game

I have long been a critic of MCD’s coffee strategy because it never made sense to me. The original strategy called for MCD to spend $100,000 per store, to incorporate separate “McCafes” in each restaurant that would serve a new line of espresso-based products and assorted baked goods. At the time, the project was the largest corporate initiative ever undertaken by MCD. Late in 2008, I documented that the company was clearly behind plan in converting restaurants to McCafes in order to nationally promote the product by mid-2009.

Guess what, the original strategy has changed! Even though the original plan never worked, MCD continues to maintain that it is not slowing down the roll out – they can’t! The 2009-2010 business plan calls for the “beverage strategy” roll out! It is how management plans to drive incremental transaction counts, and without beverage sales, trends are going to slow for MCD. As an aside, it’s interesting to see that MCD is starting to test the “high-end” Angus burger in more markets. I guess if McCafe is not working, they need to go to plan B…

More than 7,000 of the 14,000 U.S. McDonald's restaurants have been retrofitted to include the separate “McCafes” that offer espresso based coffees, with the balance expected to be complete by mid-2009. Going forward, however, the espresso machines are being integrated into the front counter rather than moving ahead with the “McCafe” strategy! Are you kidding me! This is the strategy that was going to hurt Starbucks. Not even!

Lastly, I know management needs to tow the corporate line, but they almost sound delusional when it comes to the coffee strategy. A McDonald’s executive is quoted as saying; "That's the great part about McDonald's is that we are actually offering affordable luxuries, so for us we know our customers are looking for those affordable luxuries." Over the past year, McDonald’s US average check growth has been fueled solely by price increases as mix was negative in each of the last four quarters with the Dollar menu growing in popularity. This just magnifies the point that the same McDonald’s customers that are coming to eat off the Dollar menu are not going to pay $3.50-$3.75 for a cup of coffee.

On Monday, MCD will release February same-store sales. Consensus estimates for MCD are; Global +0.4%, United States (0.6%), Europe (0.4%) and APMEA +3.8%. The reported February numbers will be negatively impacted by about 4% as last year’s numbers included one extra day due to the leap year. The January results, on the other hand, were helped by about 2% from a calendar shift. That being said, neither month alone provides a good indication of the underlying trends. The February numbers need to be taken in context with January to get a better feel for what trends look like in 1Q09. Taking the two months together (and adjusting both for calendar shifts), the underlying 1Q same-store sales trends look like; Global +4.8%, United States +3.4%, Europe +4.4% and APMEA +8.0%. If the consensus numbers are close to being right, this would represent a slowdown across each region from 4Q08 when Global +7.2%, United States +5%, Europe +7.6% and APMEA +10%.

The headline on Monday will not look good, the overall trends are slowing and coffee is not working. This is not the MICKEY DEES the street is in love with.

The Great Recession: Why I'm Not Depressed...

This morning’s horrendous 8.1% US unemployment rate is going to wind up being a big positive for the stock market. The only way for this stock market to stop going down is to over-deliver on the misguided apocalyptic expectations that the Great Depression cometh…

Finally, the economic data is terrible enough for the revisionist economic historians (or “economists”) from Washington to Wall Street to absolutely freak-out. As they freak-out, they’ll freak out everyone else… and hopefully break the confidence that global investors have in the US Dollar while doing so…

If the US$ stops going up, you’re going to observe some very itchy trigger fingers in both the short books of wanna be short sellers, and levered long only managers who are sitting on piles of cash. You saw that on today’s market open, and you saw it again when we rallied from down to up again on the day…

Cash? Yes, that stuff that we allocated 96% of our Asset Allocation Model to 6 months ago (September 2008 - before unemployment ripped from 6.2% to 8.1%). Back then, some of Wall Street’s finest savants accused me of “hiding in cash”. Now (after the crash of course) I walk around meeting both existing and prospective clients in NYC and Portfolio Managers are boasting to me how large of a position in cash they have…

You know what this all means - I better start taking down my Cash position from the 70% I was holding prior to this morning’s market opening. I’m doing that more aggressively than I have in a long time, today…

Why? Well, primarily because I am now understanding that what we have here is The Great Recession. While some people on Wall Street are rightly expressing their personal depression, they are wrongly straight-lining that statistically insignificant personal position across a globally interconnected economy. Fortunately, as Dr. Copper, Wal-Mart, and China reminded me this week, Wall Street is no longer going to own the debate as to where this economy is headed next – the clients will. Some of them have blue collars… some of them are Chinese… I know, I know – very weird stuff I am talking about here…

Why I’m Not Depressed: It’s all about the delta. The revisionists are straight-lining the record setting acceleration in unemployment into becoming a repeatable rate of growth – mathematically speaking at least, that’s silly. Whether you want to look at this relative to the mid 1970’s when year-over-year trough to peak unemployment last ramped this quickly (up 300-400 basis points year over year), or in terms of percentage accelerations across different durations, my conclusions are the same – the rate of growth in the US unemployment rate is setting up to SLOW… right as the manic media worries people about it most.

This Is How a Depressionista Can Get To His/Her Numbers: the February 2008 to February 2009 acceleration in the unemployment rate was 330 basis points (from 4.8% to 8.1%, see charts below) – that’s a 69% acceleration of the nominal level of unemployment in this country. If we were to straight line that steep curve (chart) and project the same rate of growth in unemployment to February 2010, you’re looking at a 13.7% US unemployment rate. That would err on the side of a Great Depression type number. Using a shorter duration model, maintaining the current pace of growth in monthly unemployment gets you a 8.6% unemployment rate by the end of March – that too would be depressing, but I don’t think we see that number – if we don’t, the growth rate of unemployment will have SLOWED sequentially.

How Do You Slow The Pace of Growth? Socialize The Country, and Break The Buck: Since The Great Recession began, the USA has lost 4.4M jobs. Obama’s plan is to add back 4M jobs – how convenient is that linear conclusion? In the face of finally adding jobs to the baseline number, can the US unemployment rate continue on this accelerating Trend line? That would be tough math for me to see adding up – and if we get that kind of a Great Depression, I too will join the lines of those who are depressed.

Keith R. McCullough
CEO & Chief Investment Officer

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