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The “Delta” charts below display some of the “less bad” and stabilizing results we’re seeing in the gaming markets. Year over year monthly same store revenue growth is presented against a six month moving average to analyze the sequential deltas.

Not all gaming markets are moving in the right direction, however. We’ve separated the markets into the categories of The Good, The Less Bad, and The Ugly and have included the tickers of the companies with exposure to each.

The Good:

• Louisiana – I’ll have what they're having. Lower energy prices not making a dent on this energy economy. Hurricane relief and construction workers appear to be gambling. (PNK, BYD)
• Missouri – They lost the loss limit and presto more revenues. (ASCA, PNK, PENN)

Positive Growth
Positive Growth

In Mervyn King the UK Trusts?

Bank of England Governor King argued today that its newest measure to buy 2 Billion Pounds ($2.7 Billion) of government bonds with newly created money will “work in the long run” to prevent further deflation.

Today’s monetary action is the first installment in a 3-month plan of the central bank to spend as much as 75 Billion Pounds on bonds, whose maturities range from 2014-2018, and comes after officials cut the interest rate to a record low of 0.5% last Thursday.

King hopes that the “new money” being pumped into the financial system will work to help return inflation to the 2% target and promote what PM Brown stressed in late February, namely, that “domestic growth would come from granting loans to first-time buyers, entrepreneurs, and individuals of middle and modest incomes.”

For the UK to turn around the deflationary current, King is relying on UK Banks to pass the line of credit onto lenders. With data out today that the UK trade deficit widened in January to 7.7 Billion Pounds (from 7.2 Billion Pounds a month earlier) and the UK economy contracted 1.8% in the quarter through February, King will have to track more than just loans reaching Main Street to get a handle on controlling the inflation/deflation balance.

Matthew Hedrick

Hedge Fund Industry: The Darwinian Implication of Capacity Declines

“In the long history of humankind (and animal kind, too) those who learned to collaborate and improvise most effectively have prevailed.” –Charles Darwin

We wanted to write a quick note to highlight a number of recent media stories about capacity declines in the hedge fund industry. No surprise, negative absolute performance has led to the closing of funds due to an inability to pay employees and an increase in investor withdrawals that have led to a cost structure that is no longer manageable for many general partners.

Specifically, the Options Group estimates that “hedge funds may cut 20,000 workers worldwide this year.” This is on top of the estimated 10,000 job losses in 2008. The primary driver of this is hedge fund closures, which hit roughly 920 funds last year, or almost 12% of the industry.

An article on Bloomberg by Kathy Burton yesterday discusses the implications of the industry decline when it comes to hiring. She quoted our good friend, Hank Higdon from Higdon Partners, the preeminent investment management search firm in the world, who said: “Hiring activity is much reduced and it’s going to get worse.” For anyone in the industry, this isn’t totally surprising. We are hearing stories of people working for free for periods of a quarter or more as a trial employment period. This idea of actually having to prove yourself was unheard of less than a year ago.

The upshot of these capacity declines is that hedge funds will once again become the bastions of entrepreneurism they once were. Some of the best and largest money managers in the world, started as very small shops with limited assets under managements, sometimes in the single digit millions, firms like SAC, Third Point, Atticus, Bridger, Harbinger, Citadel and others come to mind. These firms are now some of the most prominent and durable in the industry, and manage assets in the billions, but have shown the wherewithal to grow and thrive at a much lower asset base.

The benefit of building your business from such a small base, and by the sweat of your own labor, is that you fully understand all parts of the business and investment process, and you can very easily adjust to changes in the market. While 2008 was an incredibly challenging year for hedge funds, undoubtedly 2009 will be a year in which Darwinian rules take hold. Those funds that have been able to prosper through the cycles will continue their dominance. The upstarts will no longer be blessed with multi hundred million, or in some cases billion, dollar launches, but will have to make due with $25 - $50MM at launch. Ultimately, overtime, this will make them stronger managers and the hedge fund class of 2009 will likely be a strong one indeed.

Daryl G. Jones
Managing Director

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Ox Blood: Chinese Trade Data Is Nasty, But Help Is On The Way

Overnight we received more insight on the extent to which global contraction is compressing Chinese economic activity and the degree in which the 4 trillion yuan stimulus package is compensating for the implosion of export-driven growth so far. Although the trade data is ugly, Investment and credit figures show that, without a doubt, that stimulus is now coursing through the Ox’s veins


The General Administration of Customs’ statistics revealed that the February trade gap narrowed to $4.8 billion, following January’s $39.1 billion surplus, as exports contracted 25.7%, a record, and imports fell 24.1%, reaffirming the severity and the synchronized nature of the global economic contraction.

As the collapse in exports has intensified, forcing businesses to close and increase unemployment, the government has continued to announce measures to support the export sector. This week Commerce Minister Chen Deming announced plans to gradually eliminate export taxes and to subsidize exporters in an attempt to sustain growth. Further, faced with the weakening currencies of competitors and the resultant disadvantage, the central bank governor, Zhou Xianchuan, did not rule out a devaluation of RMB, more confirmation that the Chinese government will use any and all measures to increase exports.


According to the National Bureau of Statistics, urban fixed asset investment totaled 1.027 trillion yuan ($150.35 billion), during January and February, a 25.5% increase over 2008. Investment in the primary sector increased 100.3%, while the secondary sector and the tertiary sector experienced increases in investment of 24.8% and 26.9%, respectively. Central government project investment increased 40.3% while local government projects increased 25.1%. During the first two months of 2009 real estate investment was 239.8 billion yuan, a 1% increase, down from 32.9% over the same period in 2008.

Clearly that he 4 trillion yuan stimulus announced in November is driving the increase in fixed investment, which now accounts for 40% of GDP. Infrastructure projects increased 28% y-o-y, as the government invested in railroads, agriculture and mining, including $35 billion in energy projects. The National Development and Reform Commission announced that the central government will invest 908 billion yuan in infrastructure projects in 2009, a 20% increase in fixed asset investment over 2008.

According to Su Ning, a deputy central bank governor, total lending by China’s financial institutions will exceed 5 trillion yuan ($731 billion) in 2009. The most recent People’s Bank of China release stated that domestic banks issued a record 1.6 trillion yuan in new loans in January, with February estimates in the vicinity of 1.1 trillion yuan. The Bank of China reported extending 100.45 billion yuan in new loans to small- and medium-sized enterprises (SMEs) YTD, with total outstanding loans for SMEs reaching 860 billion yuan by the end of February.


With the stimulus impact starting to trickle through the financial system, the waiting game begins as we digest any data that may provide clues to the trajectory of economic activity. We have been bullish on China consistently since December of 2009 and remain so – we are long China via the CAF closed end fund.

Andrew Barber

EAT – Bullish about margins

EAT’s CFO Chuck Sonsteby presented this morning at an investor meeting and said that relative to when the company reported its 2Q09 earnings in January that he is feeling bullish about margins. During the second quarter, EAT reported better than expected earnings as a result of better cost control and better than expected margins. At that time, however, Mr. Sonsteby said he was pessimistic about the company’s ability to maintain that level of margins with sales slowing. Today, he commented that he is optimistic about margins because EAT is benefiting from slower unit growth, which takes costs out of the business. In the past, EAT’s business model, particularly as it relates to margin growth, was built around growing the top-line through new unit growth. This growth led, inevitably, to increased costs and inefficiencies within the system. With slowed growth, management is more focused on eliminating these inefficiencies and better managing costs. As a result, Mr. Sonsteby said that EAT is experiencing improved labor productivity, lower employee turnover and better food cost control. Management is also working to take fixed costs down by renegotiating with its landlords. At the same time, commodity costs are coming down.

Although Mr. Sonsteby did not say that sales trends are improving, the fact that he is more comfortable with margins shows that the company is managing the things it can currently control. And, when sales do finally pick up, EAT will be well positioned to outperform! That being said, EAT, particularly Chili’s, has consistently outperformed the casual dining industry’s same-store sales growth as measured by Malcolm Knapp, and the monthly Knapp Track numbers improved sequentially in January. If Chili’s has been successful in maintaining its gap to Knapp, that might be one reason for Mr. Sonsteby’s optimism.

Controlling what it can, management is focused on using its free cash flow to pay down debt and increase the company’s financial flexibility in this difficult environment. In fiscal 2009, the company is expecting to spend $115 million in capital expenditures, which is down $155 million from fiscal 2008. Based on this lower capital spending, EAT said it should generate over $180 million in free cash flow in 2009, up from $48 million in 2008, and this is with an expected year-over-year slowdown in same-store sales growth.

PSS: Keeping the Faith vs. Throwing in The Flag

OK. So do you go all-in, or throw in the towel? That’s the question that most holders of PSS will be thinking today. Though it’s not in our portfolio, this is definitely a name I’ve liked, and have been warming towards recently, so I am definitely in the same camp. Here’s a few notables…
Reasons to consider throwing in the towel
1) PSS missed both the Street’s and my estimate (-$0.44, and -$0.36, respectively) by a mile. Losing $0.54 with such negative momentum is not exactly indicative of being one of the ‘winners’ in this climate.

2) It’s been over a year since the Stride Rite acquisition, and over 2-years since this management team hit stride in its strategy to regain control of the consumer and grow the business. At some point sooner than later, we need to draw a line in the sand and expect results.

3) ‘Consumer connection’ has never been higher per Payless’ internal scoring system, but what good is that if we’re not seeing it in numbers?

4) Costs out of China are higher than the company guided, though this is not a big surprise to us.

5) Due to promotional environment & inventory levels at competitors, higher cost shoes were discounted so heavily that they impacted sales at PSS’s “primary” brands.

Reasons to keep the faith
1) Price point is up, transactions are up, product mix is improving, customer scores are reportedly getting better. Weak traffic is the problem. If there was ever an environment to give a zero-square-footage-growth retailer the free pass on traffic, then this is probably it.

2) Very interesting to hear Rubell say that he’s never seen inventory more healthy. Inventory in dollars ended the quarter up mid single digits, but in units it was down single digits. Setting the stage for better gross margins in 2Q onward?

3) SG&A cost reductions better than expected ~$30mm of identified reductions in 2009 with more possible. We’re modeling SG&A down 3-4% in absolute dollars in 2009.

4) Sperry and Saucony continued double digit growth rates with category growth for Sperry and channel expansion for Saucony (Europe) promising.

5) Significant CapEx reduction (from $130 to $85) will boost FCF. Even with operating cash flow down by a third, FCF growth should still be positive for the year.


7) How I’m doing the math, the cash flow here should get total net debt down by 80% over the next three years. What does that mean? It means that today the EV/EBITDA multiple of 3.8x is nothing to write home about on the long side. But with debt coming down, we’re at 1.5-2.0x EBITDA 2-3 years out. At that point, we’re also looking at about 4x EPS. I’ll take that.

8) Timing considerations… In 2H, we see costs from China come down, duplicative DC costs come off, SG&A cuts, lower interest expense and tax rate, all at the same time we cycle very easy top line compares. When I put this in context of my view that cash flow for the group overall will begin to turn in 2Q/3Q (see my 3/5 note I’m Getting Fundamentally Bullish), and it starts to paint a nice multiple-expanding picture for PSS.

I’m definitely not throwing in the towel here. In fact, expect me to synch more with Keith on this one as it relates to his timing and sizing models for a potentially powerful long-term call.

Casey Flavin
Brian McGough

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