ASCA announced today that it had negotiated covenant relief. More restrictions were put in place but the main cost was 125bp increase the rate and $9 million dollar amendment fee. In return, the banks raised the senior leverage covenant by 0.50x to 1.25x depending on the quarter. Per our model, this puts ASCA in the clear at a modest price, about $0.20 in annual EPS.

Due to the leverage step down in Q2 and again in Q3, we had ASCA tripping its senior leverage covenant in Q2. Now, ASCA would seem to have ample room as seen in the first chart. Investors must be cognizant, however, of a new covenant that requires ASCA to maintain minimum consolidated trailing twelve month EBITDA of $275 million. We are currently projecting 2009 EBITDA (per the covenant calculation) of $328 million. Other, less important, changes include a smaller basket for dividends and share repurchases.

While Street EPS estimates need to come down to reflect the higher interest cost, Street EBITDA estimates look too low. Yes, I actually stated that a gaming company is likely to exceed EBITDA estimates. Favorable regulatory changes in Missouri and Colorado and stabilizing demand in most of the regional markets. For once, the analysts were conservative enough. ASCA is really starting to capitalize on the $500 loss limit removal. Look for more effecting marketing efforts to drive incremental demand and better margins. The Street may be over $10 million too low on 2009 EBITDA.

With only two more quarters of development Capex, ASCA has got the makings of a cash machine. The second chart details free cash flow and free cash flow yield on a TTM basis. Net free cash flow should turn positive in Q3 2009 and escalate from there to almost $150 million annually. The FCF yield could exceed 20%.

Gaming is a strong cash generative business with high barriers to entry. Demand is less sensitive than most consumer discretionary sectors. Most gamers egregiously exploited the easy money era and many won’t survive the current environment. The survivors will face less competition, higher cash flows as Capex has been scaled back, and consequentially, higher valuations. ASCA looks like it has entered the survivor pool.

ASCA maintains significant cushion under the new leverage covenant
Significant free cash flow potential

Oil: Pricing Geopolitical Risk

In this morning’s Early Look, we walked through a key component of our investment process which incorporates the concept “Prices Rule”. In effect, prices are often leading indicators, or just actual indicators, of fundamental events before they are more broadly known. The underlying assumption is that distribution of information is far from linear and generally someone will know about an event before the investment masses, which leads to prices often being an early predictor of future events.

Today’s price action in oil hammers home this simple point. As the price of oil rises, the cast of Geopolitical Risk characters from Putin to Chavez find a voice (see chart). This is the tradeoff in an global market of re-flating prices. This is not new, but needs to be both respected and understood.

According to the most recent information from EIA, Venezuela, Iran, and Russia produce roughly 2.4MM, 3.9MM, and 9.4MM barrels of oil per day. In total, this is equivalent to almost 18.7% of world oil production. In addition, since all three nations are oil exporting nations, unlike say the U.S. which produces a large amount of oil but not enough to export, they have the potential to disproportionately impact the balance of world oil supply and demand.

Prior to today’s powerful intraday recovery, the price of West Texas Intermediate was +23% in the last 4 weeks, which in hindsight seems to have been a leading indicator for some of the recent actions we’ve seen from Russia, Venezuela, and downing of an Iranian drone in Iraq. We remain long Oil via the USO etf. On this morning’s client Macro Morning Call, we outlined intermediate Trend line support for the price of oil at $44.30/barrel.

Keith R. McCullough
CEO & Chief Investment Officer

Daryl G. Jones
Managing Director

Dollar Up = Exports Down...

Since my prior note, “Dollar Down = Stocks Up”, intraday the US Dollar has declined further, and the stock market has rallied higher. This USD/SP500 inverse correlation continues to fortify itself. Unfortunately, for the past 3 months, American Industrial exporters have been on the other side of this (Dollar Up = Exports Down). President Obama, please write this down and ask Timmy G. if he gets what a strengthening US Dollar does when China is the Client (PS: the Client shops elsewhere).

Looking at February US Industrial Production stats, you can see how US Exports get choked off by a strengthening USD (in February the US Dollar Index remained strong). At down -11.2% year over year, this chart (see below) is quite nasty. If we don’t break the buck’s upward momentum, sustainably, expect more of the same here.

Interestingly, within this IP report was the lowest capacity utilization number the US Industrial base has printed since 1982 (just under 71%). If you don’t deflate the Dollar, you get deflation. That’s bad. Stopping deflation starts with starting to break the buck.

Keith R. McCullough
CEO & Chief Investment Officer

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Jon And Jim’s Excellent Adventure

I never wonder to see men wicked, but I often wonder to see them not ashamed.
- Jonathan Swift

This year we had two Friday the 13ths back to back – first February, now March. If you are Jim Cramer, you might be reading this while hiding under the bed and wishing your astrologer had warned you about making comments like “A comedian’s attacking me! Wow!” in between two Friday the Thirteenths. Thursday’s “Daily Show” turned out to be the Main Event, for which Steele vs. Limbaugh was merely the undercard.

By the way, Jimbo, there will be Friday the Thirteenth Part III in November, so if you’ve already got your head down, keep it down.

Cramer showed up on the Daily Show and sat abashed, embarrassed and tongue-tied as Jon Stewart, setting aside his arch funnier-than-thou persona, gave the most direct, on-point grilling of a public figure’s irresponsible behavior that the major media has seen in a generation. One of the great takeaways of the evening was the clarity with which Stewart laid bare the incestuous relationships in the Media-Financial Complex.

Sensationalism, the sine qua non of journalism, is inimical to proper investment process. How does Cramer appear on TV and not run smack into conflict? Like the stockbroker who must generate a trade to get paid, the media star must keep his viewers frothing at the mouth to maintain ratings. Cramer’s entity,, is registered as an Investment Adviser with the SEC. Its registration Form ADV states that the entire business of the entity is providing an investment newsletter, and the website’s Terms of Use includes all the right disclaimers.

Cramer looked more than a little uncomfortable when Stewart tossed out the notion that both of them are in the business of selling snake-oil – but that The Daily Show labels it as snake-oil, while Cramer appears to be marketing his brand as having magical curative powers.

“I’m not Eric Sevareid,” Cramer said at one point. “I’m not Edward R. Murrow. I’m a guy trying to do an entertainment show about business.” Ah! Now you tell us…

Are we the only ones who find this revelation confusing, on the heels of years of “In Cramer We Trust”? Do Cramer’s lawyers fear we are facing a legal and legislative inflection point where all the disclaimers in the world won’t keep you out of trouble? Which is it? Is Cramer the Solon of investment wisdom, or merely the Ed Sullivan of Wall Street?

Arbitration panels and regulatory enforcement divisions have taken a dim view of aggressive sales organizations that rely too heavily on the small print. We wonder which enterprising lawyer will be first to make the case that Cramer’s shrieking and horn honking constitute high-pressure sales tactics, not in search of commissions, but of ratings.

Yes, Cramer is a knowledgeable Wall Street professional. Yes, Cramer has taken stands on critical issues – and we have agreed with many of them. And yes, Cramer admits when his calls have gone against him. But as Jon Stewart rightly points out, all Cramer’s knowledge, experience and self-correction blend into a cacophony of constant patter. Any deep message there may have been is lost in the maniacal screaming.

This goes to the tenor of the dialogue that has so ill-served the investing public. The owners of the debate so far have been those with enough cash to buy air time, and enough bluster to scream Booyah! at the top of their lungs.

It’s enough, folks. Enough.

The Wall Street Journal, which also must sell newspapers (a dying business, we are told), has this screeching banner headline on Friday: “Madoff Jailed After Admitting Epic Scam”.

“Epic”? Bernard Madoff is not Achilles. He is a common creep who got mega-lucky. The greatest tragedy of the Madoff affair is that he will not be tossed into an open cell. That he will not be sent out to the prison yard to exercise and lift weights and play basketball and get abused and stabbed with the rest of the inmates. This punishment will never fit the crime – which means it will neither punish the perpetrators, nor deter future criminals.

Sorry, Bernie. You are not “Epic”. You are not Lear. You are mere garbage, and to pretend anything else is to debase the suffering you have caused.

The way of Wall Street used to be that one’s word was one’s bond. Lost in the need to sell newspapers, Madoff has taught us that Trust is still the fundamental principle. Don’t look to Ezra Merkin or Henry Kaufman. Don’t look to Dan Tully – or even to Steven Spielberg or Fred Wilpon. Those professionals were themselves, or were advised by people in a position to Know Better. They all knew that Madoff was doing something highly illegal, they just didn’t know what it was. And, as long as they were the beneficiaries, they were willing not to ask deep questions.

But alas, poor Miriam Siegman, now on food stamps. Alack, poor Sharon Lissauer, whose entire life savings were wiped out. These were the Little People – not in a position to Know Better. They trusted the mechanism of the market to keep things legitimate.

Were they wrong?

The proliferation of scammers has taken the markets by storm, and has now laid them low. Jim Cramer made himself Court Jester to Bernie’s Wizard of Oz, and now the curtain has been ripped aside. The scummy underside of the industry has been turned up and the maggots are writhing in the sunlight – the talking heads of the Wall Street-Media Complex not the least.

Miriam Siegman and Sharon Lissauer were fools to not seek more information. Yet, fundamentally they were not wrong. We must be able to have trust in our markets, otherwise there are not only no markets. There is no capitalism, and there is no America. There is nothing. The media do us a disservice by obfuscating the real issue. The flip side of the coin of Trust In The Markets is not More Regulation. Rather, it is socking away a year’s supply of food and buying an AK-47.

This week saw analysts on Bloomberg talking about civil unrest in the wake of the global financial meltdown, and we do not need a roadmap to know that the government has drawn up contingency plans for civil war. When the S&P goes to zero – when people are bartering gold for liquor and hogs for bullets – when the Social Contract represented by the dollar bill has been dissolved and in God we no longer trust – the ultimate doomsday scenario becomes highly credible.

Those of us who believe in the natural integrity of the markets must do everything in our power to restore that integrity. It is people, not markets, that lack integrity. People, not markets, that cloak their actions under a curtain of falsehood.

Jim Cramer knows all about regulatory error, wrong-headed legislation, and outright fraud and market manipulation, having admitted to a range of interesting dealings in his earlier incarnation as a hedge fund manager. By diverting all his immense energy away from exposing these problems, and putting it all into getting folks to call in and ask what to buy, he has done his employers a great service, and the world a great disservice. This is perhaps the definition of dishonesty – diverting one’s talents from producing effects, to producing income.

On Thursday morning – mere hours before Cramer walked the Last Mile to Jon Stewart’s desk – the talk on MSNBC’s “Morning Joe” turned to Obama-bashing. One commentator (our back was turned) attacked the Obama team’s notion that Every Crisis Is An Opportunity. He said “To paraphrase Groucho Marx, ‘Sometimes a crisis is just a crisis.’”

This reveals much about why the media are so feeble at explaining what is really going on. Sigmund Freud, an inveterate smoker of large cigars, was once asked about his own oral-phallic fixation. His response: “Sometimes a cigar is just a cigar.” We realize that both Freud and Groucho were Jewish cigar smokers, but beyond that we do not see how anyone could confuse them. Should a man whose mind is disorganized enough to confuse Sigmund Freud and Groucho Marx be trusted to give an analysis of the policies of a President he has already told us he dislikes?

Cramer is one of the guys who knows where the bodies are buried in this industry, having buried plenty himself. Cramer went for sympathy at one point, and his whining did not do him credit. It is pathetic for this self-styled major television journalist to complain “I’ve had a lot of CEOs lie to me on the show! It’s very painful!”

Dick Fuld “lies to me, lies to me, lies to me…”

“We/re not always told the truth…”

Looking mournfully into Stewart’s eyes, Cramer said “It challenges the boundaries” to say on television that Henry Paulson lied.

Since challenging the boundaries is what journalism is, by definition, all about, we are glad that Cramer has finally enlightened us as to what he actually does. “I’m a guy trying to do an entertainment show.” Thanks for clarifying that.

Jon Stewart, by the way, earns our highest accolade for his simple restatement of what made America great: “When are we going to realize in this country that our wealth is Work.” Wow! Jon Stewart for President?

The morning after this interview aired, it was announced that Thomas J. Clarke was stepping down as CEO of Cramer’s company, We are not believers in the gods of Coincidence.

So now for the Sixty-Four Trillion Dollar Question. Why did Cramer show up for what he knew was going to be the equivalent of a Red Chinese self-criticism session? Guys like Cramer don’t get their butts whipped in public unless their lawyers tell them they had better. Does Cramer get a bye, because no one takes a television personality seriously, or does he now get skewered on the rapier of public opinion and a thundering herd of highly motivated lawyers? Is he Bozo The Stockpicker, or is he personally liable for millions of people’s losses in their personal portfolios?

This one ain’t over yet. We’d get short Cramer, if we could find a borrow.


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

Swiss Cheese
We notice that Swiss banks are suddenly buying US Treasury bonds by the cartful. Could this be a sop to get the US to back off the UBS client list?

Chief Anti Money Laundering Compliance Officers take note: The US authorities pushed for the establishment of offshore relationships for major money center US banks in the 1960’s. The unstated, but very real purpose was to create a captive market for US Treasury debt. Illicit funds that domestic US banks could not take in as deposits, could go to these arms-length relationship banks. Laundered proceeds of arms dealing, drug dealing, and other Dark Arts could safely go to banks in certain Caribbean nations. Those local banks, in turn, through their New York correspondents, would buy up Treasurys for their portfolios.

If you wonder why certain dicey jurisdictions are treated with kid gloves, while the Swiss are suddenly Public enemy Number One, you might look at the Treasury Department’s list of Treasury Bond holdings by country. As of year-end 2008, the Chinese held $727 billion of our debt, the Japanese $626 billion. Third on the list is an entry that reads “Caribbean Banking Centers”, with $197 billion. Switzerland ranks eleventh, after Taiwan, and with half of the Treasury holdings of Russia ($116 billion) or Brazil ($127 billion), clearly, the Swiss can do more.

Switzerland’s holdings of US Treasurys went from under $44 billion in June of 2008, to above $62 billion at year end. This 50% increase is still a rather small percentage of total assets on their books. US authorities appear not to care that the Swiss Franc is itself a reserve currency. With the top ten Swiss banks holding assets on the order of three trillion US dollars, having the entire Swiss banking system hold only $62 billion looks downright… un-American.

The US push to shake loose tens of thousands of confidential account relationships looks like extortion designed to force the Swiss to put more assets at work in our marketplace. After all, we can’t count on the Chinese to do all the heavy lifting. In addition to all the other wonderful financial things our Government is doing, are we now vying to be the Money Launderer of Last Resort?

Swiftian Justice
Laws are like cobwebs, which may catch small flies, but let wasps and hornets break through.
- Jonathan Swift
On March 4, the SEC announced a success in a long-running litigation against 14 specialist firms. The firms in question have collectively agreed to pay $70 million in disgorgement and fines, versus alleged customer harm on the order of $58 million or more.
The SEC’s complaint charges these firms with Trading Ahead – which is filling a customer order from the firm’s proprietary account while holding matchable customer agency orders; Interpositioning – which is filling the outstanding matchable agency order from their own account, after having traded ahead; and Trading Ahead of Unexecuted Orders – which is not filling the customer order and taking the trade for the firms own account.
In addition, the regional specialist firms in the inquiry were alleged to have traded against their customer orders by executing trades on the NYSE that, since they were not recorded in a customer trades blotter, looked like firm proprietary trades. It’s not Bernie Madoff, but it ain’t good.
The activities took place during the period 1, which means that it has taken ten years, since the initial infractions, to build and prosecute this case through to its conclusion. We are not sure whether this qualifies as Swift Justice, but the irony is not lost on us that customers are not being protected by the agency.
But it gets better.
The $70 million that the SEC collects will go into their coffers. Face it, how complicated is it to figure out, customer by customer, trade by trade, who lost what? The firms will pay out, the SEC will add $70 million to its bankroll for the year, and in their year-end report for 2009, they will point to this as a significant achievement.
It is a signal irony of the regulatory process that people never get punished, but only told they must share the wealth. The Consent Decree in the case means that, even though they are paying out millions, the firms in question are neither affirming nor denying their guilt. And their further punishment? An order will be entered saying that, in the future, these firms are not allowed to break the law.
We will bet a very large nickel that, even after paying out on this consent decree, the firms all booked substantial profits on the practices in question.

Regulatory problem – why this happened, and why it will happen again: the exchanges do not share information with each other. We have been given to understand that the SEC will close the matter after taking the Specialists’ money. It should not stop there, because the regulatory mechanism that permitted this to occur has not been remedied.

We do not need to fault the exchanges individually, but we observe that, despite having the same market participants trading across multiple exchanges, the exchanges do not share oversight information. Specialists executing improper trades on the regional exchanges were doing closing, or layoff trades on the NYSE. Since neither exchange saw the entire transaction, these illegitimate transactions looked like proprietary trades. Had the exchanges matched their blotters and the customer orders on the specialist books, many of these illicit practices would have been run down and the firms disciplined.

So far, the SEC has not required the exchanges to share this information. This looks like a typical – and major – lapse on the part of the regulators. Closing this gap would eliminate the loophole that made this abuse possible in the first place.

Are we missing something?

Too Big To Regulate
It is a maxim among these lawyers, that whatever hath been done before, may legally be done again: and therefore they take special care to record all the decisions formerly made against common justice and the general reason of mankind.
- Jonathan Swift

We have been eavesdropping on the global jaw-jaw over introducing a new financial regulatory regime. We would not characterize this as a Dialogue. It is more a cacophony of monologues, with each group, political party, and government telling everyone else why We are Right and You are Wrong.

We do not pretend to have the global solution for the ills that have beset our markets. We are mildly amused at, for example, Senator Schumer – a longtime Wall Street groupie – who is shocked to find rampant greed-fueled speculation driving the financial industry. So far his major overhaul of the system appears to consist of merging the SEC and the CFTC (an awful idea that will leverage the inefficiency of the SEC and extend it to a market they have heretofore not been able to neglect); to adding one hundred junior-level lawyers to the SEC staff (giving the incompetent senior lawyers fresh meat to train in all the tried-and-untrue methods of not following up on leads and tips); and moving the SEC from Washington to New York City (now that DC has a voice in Congress, let’s not let this crisis go to waste).

We will make one fundamental observation, and we hope those who make laws and rules will bear it in mind.

In the 1980’s and 1990’s, large brokerage firms beefed up their compliance departments to keep the regulators at bay. Many of the largest and most successful firms of that era, all household names at the time, no longer exist. Many were absorbed into Citi – itself teetering on the brink of a black hole. Then, there were whole floors in major Manhattan office buildings staffed with lawyers and paralegals. A typical day for a typical mid-level compliance attorney at these firms included multiple Trades Reviews. The reviews would consist of a computer printout being placed on the lawyer’s desk first thing in the morning. These printouts were often a thousand pages or more, each page would have scores of customer trades. The evidence of the review consisted of the attorney signing the cover sheet. The blotter would then be packed up at the end of the day and shoved into a file drawer. After two years, it would be taken from the drawer, packed into a Banker’s Box and sent to a warehouse in Jersey City.

The sheer volume of transactions, by its nature, overwhelmed the human capacity to know what was going on. Permit your correspondent to step out of the Editorial We for a moment and explain a bit about my background.

As a branch manager and compliance officer for retail brokerage firms, my daily routine focused on the blotter. I started my day with the prior day’s trades before me – when I ran compliance for a retail firm with 350 producers, doing over $100 million in commission business a year, I nonetheless made it my business to look at every trade in every account, every day. To be sure, there were things I missed. But it was not for not looking for them.

These hands-on, close to the ground daily reviews are what give supervisors the ability to know when something is wrong. The supervisor gets to know the patterns of trading by broker, by customer, by trading desk, and by security. When the brokerage firms got so large that the reviews were taken off the branch manager’s desk and shifted upstairs to the attorneys, it was the signal that things would never again work properly. You can not tell when something looks wrong if you don’t know what it looks like when it is right.

Today’s failed financial institutions are not Too Big To Supervise. And since the regulatory system runs on a daisy-chain of Reliance, they are Too Big to Regulate. If there were ten times – or fifty times – or a hundred times the supervisory personnel in these institutions, and if they took the trouble to get to know what really went on on their watch, these organizations could be viable. The morphing of the format of business data from individual transactions – be they stock trades, investment banking mergers, or negotiating asset-backed contracts – to computer runs that are checked by upstairs staffers, takes the oversight out of the hands of those who understand how the transaction work. There are very few problems or conflicts that can not be addressed, once you have full information and seasoned managers to process that information. When the ratio of a firm’s information to its managers’ ability to digest that information gets out of whack, the firm is a prime candidate for implosion, regardless of its business mix.

Industries whose major players all grow on this model will collapse sooner or later, as will the societies that stand upon them. There is no substitute for Hands-On oversight.

Of Pots And Kettles
Wall Street indices predicted nine out of the last five recessions.
- Paul A. Samuelson
Latest in the category of Why Are They Reporting On This As Though It Were News? – The Wall Street Journal (11 March, “Obama, Geithner Get Low Grades From Economists”) reports “A majority of the 49 economists polled said they were dissatisfied with the administration's economic policies.”

Showing that even the Wall Street Journal can be fair to Messrs Obama and Geithner, the article also says “The economists, many of whom have been continually surprised by the depth of the downturn, also pushed back yet again their forecasts for when a recovery would begin.” In other words, their predictive acumen has not sharpened measurably since Professor Samuelson made the above observation.

This is a bunch of guys who – like Jim Cramer – get paid not to guess correctly, but just to guess. Forty-nine professional economists criticizing President Obama’s economic policy is like Alice Cooper critiquing Boy George’s wardrobe.

The Wall Street Journal paid someone to write this story, and ran it with a headline that seems to imply a group of experts are telling us we voted for the wrong President. You paid two dollars to buy the paper and spent several minutes of your time reading it. People discussed it all weekend as though it has meaning, and some are now lamenting the day they voted for Barack Obama. The Journal will, no doubt, be able to reference it as it gloats over President Obama’s declining poll figures. None of which has any bearing on whether or not this Administration’s policies will be effective.

With articles like this, the media tread ever closer to the Event Horizon of the Black Hole of meaninglessness. At least they can still sell newspapers. Of such things are public opinion made.

Dollar Down = Stocks Up

In this morning’s Early Look I walked through the quantification of this inverse correlation relative to the week of February 2nd, 2009.

Sometimes, pictures are more powerful than prose. Below we have shown the last 3-weeks of USD vs. SP500. As the USD stopped going up, SP500 stopped going down. As the USD went down, stocks went up.

I don’t want to make this any more complicated than it should be – not very. This macro relationship continues to be a very dominant signal.

Today, we are watching the USD trade down another -50 basis points, and stocks continue their immediate term ascent. My updated math has the USD Index oversold at the 86.71 line (its currently trading 86.86), and the SP500 overbought at the 768 line (currently trading 766).

In the immediate term, if the USD stops going down, stocks should stop going up.

Keith R. McCullough
CEO & Chief Investment Officer

Daily Trading Ranges

20 Proprietary Risk Ranges

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