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DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL?

Takeaway: We are likely to hit the Debt ceiling right around Christmas day; that may be used politically to hamper or delay Fiscal Cliff negations.

SUMMARY BULLETS:

 

  • Our analysis suggests we are likely to hit the Debt ceiling right around Christmas day. More specifically, the US Treasury is on pace to breach the Debt Ceiling on 12/24 in Scenario A (the average pace of daily net debt issuance for business days during FY13) and on 12/26 in Scenario B (the average pace of daily net debt issuance for business days during FY11-FY13).
  • It may be that the Treasury dramatically slows or stops issuing new debt altogether around Christmas time, but the point remains: the US government is likely to breach its Congressionally-imposed $16.394 TRILLION Debt Ceiling right around then. Notably, this late-DEC estimate is a bit shy of our previous projection of JAN ’13.
  • The paramount implication of a late-DEC Debt Ceiling breach is that it would likely give the GOP – particularly House Republicans – bargaining leverage in any fiscal cliff negotiations. To some extent, one could’ve argued that the public handed the leadership conch to the Democrats based on the recent election results, but a renewed Debt Ceiling impasse could actually strengthen the Party’s resolve in any Fiscal Cliff negotiations.
  • On the margin, that would be negative for US GROWTH over the intermediate term to the extent any cliff resolution is delayed and/or thwarted outright.

 

While much Manic Media attention has been given to Fiscal Cliff negotiations in recent weeks (and rightfully so), we on the Hedgeye Macro Team continue to warn clients that the timing of the Debt Ceiling breach dramatically lowers the probability of a “grand compromise” that we think the throng of investors that remain bullish on the equity market is likely hoping for.

 

As an aside, per the latest BofA/ML fund manager survey, hedge fund net exposure to equities at 40% is the highest since JUN ’07 – coincidentally right around the last time we saw the corporate earnings cycle roll over like we are seeing today (refer to our Q4 Macro Theme of #EarningsSlowing for more details).

 

Per everyone’s favorite Treasury Secretary Tim “The ‘Tools’ Man” Geithner, “the government could bump into its borrowing limit before the end of the year”, though he was quick to remind the audience that “the Treasury has enough tools to keep the government afloat into early 2013”.

 

We’ll take his word on the latter part of his statement, as we learned from MAY 16, 2011 to AUG 2, 2011 (~2.5 months) that the Treasury Secretary does indeed have a robust bag of tricks to help the government stave off a technical default. As a reminder, those tools include (but are not limited to):

 

  • Declaring a “debt issuance suspension period”;
  • Suspending (until further notice) the issuance of State and Local Government Securities;
  • Prematurely redeeming existing Treasury securities held by the Civil Service Retirement and Disability Fund;
  • Suspending new issuance of Treasury securities to that fund as investments;
  • Suspending the daily reinvestment of Treasury securities held by the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan; and
  • Suspending the daily reinvestment of Treasury securities held as investments by the Exchange Stabilization Fund.

 

It’s worth noting that each of these steps is overwhelmingly benign as it relates to any implications for the economy and/or financial markets. To the extent you’re interested, however, or would like to brush up on historical Debt Ceiling impasses for any clues as to how this one may play out (1985, 1995-96, and 2002-03), please review our MAY 11, 2011 note titled: “FEAR MONGERING MEETS BRINKSMANSHIP: A COMPREHENSIVE GUIDE TO NAVIGATING THE DEBT CEILING DEBATE”. The conclusion of that note was as follows:

 

“We expect the current debt ceiling debate to heat up substantially in the coming weeks, resulting in a measured pickup in volatility across global financial markets, primarily as a result of increased  volatility in the US Dollar being driven by the whims of D.C. politicking. Further, we expect the debt limit to be increased prior to any sort of default on any of the federal government’s obligations. And within that legislation, we would expect to see the groundwork laid for potentially meaningful fiscal reform ahead of the FY12 budget debate – an event that is likely to prove dollar bullish when it’s all said and done.”

 

With the looming Fiscal Cliff (inked back in late JUL ’11; ~$8 TRILLION in tax hikes and spending cuts over the long term) posing as “the groundwork laid for potentially meaningful fiscal reform” and the US Dollar Index up about +8% since publication (in spite of now-perpetual QE and Bernanke perpetually kicking the can down the road on interest rate hikes), that call has proved to be rather prescient.

 

Jumping ahead to the current Debt Ceiling showdown, we do not take Geithner’s words on the timing of the upcoming breach at face value. Rather, we conducted our own analysis that suggests we are likely to hit the Debt ceiling right around Christmas day. More specifically, the US Treasury is on pace to breach the Debt Ceiling on 12/24 in Scenario A (the average pace of daily net debt issuance for business days during FY13) and on 12/26 in Scenario B (the average pace of daily net debt issuance for business days during FY11-FY13).

 

DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL? - 1

 

DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL? - 3

 

It may be that the Treasury dramatically slows or stops issuing new debt altogether around Christmas time, but the point remains: the US government is likely to breach its Congressionally-imposed $16.394 TRILLION Debt Ceiling right around then. Notably, this late-DEC estimate is a bit shy of our previous projection of JAN ’13.

 

The paramount implication of a late-DEC Debt Ceiling breach is that it would likely give the GOP – particularly House Republicans – bargaining leverage in any fiscal cliff negotiations. To some extent, one could’ve argued that the public handed the leadership conch to the Democrats based on the recent election results, but a renewed Debt Ceiling impasse could actually strengthen the Party’s resolve in any Fiscal Cliff negotiations. On the margin, that would be negative for US GROWTH over the intermediate term to the extent any cliff resolution is delayed and/or thwarted outright.

 

Per House Minority Leader Eric Cantor this week:

 

“Resolving the issues surrounding the fiscal cliff, especially the replacement of the sequester, and the next debt limit increase will require that the president get serious about real entitlement reform.”

 

Moreover, House Speaker John Boehner was out earlier in the week saying he would not allow Congress to duck tough decisions with another round of short-term measures. To the extent he holds the GOP true to his words, we could be looking at one messy political showdown in the coming weeks – especially if the Republican Party continues balk at any revenue increases outside of “dynamic scoring” (i.e. closing loopholes and reducing deductions).   

 

As if Washington D.C. wasn’t messy enough…

 

Darius Dale

Senior Analyst


RE-VALUING ASCA

PENN’s transaction has implications for most gamers – all positive – but none potentially more significant than for ASCA.

 

 

Obviously from our comments today, we think ASCA is the most likely pursuer of PENN’s real estate strategy.  In fact, we think it is actually likely – only the timing is uncertain.  Even if it’s not for two years – following the opening of Mojito Point in Lake Charles – the market is right for ascribing value now.  While the stock is already up 16% today, we don’t think the market has gone far enough today.  We project total company value at $49 to $70 with a $59 midpoint in two years.  Discounted, the midpoint value is still $47.  And that’s with EBITDA/EPS projections below Street consensus.

 

Why does it make sense for ASCA?  While leverage is not necessarily low, ASCA generates a huge amount of free cash flow.  The balance sheet is in good shape.  ASCA owns a lot of real estate.  The only development is Mojito Point in Lake Charles which will open in 2014.  That is probably the only real hold up and the reason why we are projecting a 2 year timeline of consummation.  ASCA’s management team is up there with PENN as the two most focused on creating shareholder value and they are great operators.  Leverage, while somewhat high at 5.5x will drop considerably following the opening of Mojito Point.

 

Even if ASCA decides against this strategy, investors should and will likely focus on free cash flow rather than EV/EBITDA following the PENN announcement.  This bodes well for ASCA’s valuation.  Even after the big move today, the FCF yield for 2013 is still 18%.  The stock could support a yield that is half that in our opinion.  So without a transaction (and our $47 valuation), ASCA could still be worth $35-40 with the re-value.  We're not ready to go quite that high but the theoretical case can be made.  Stay tuned.

 

 

RE-VALUATION DETAILS

 

Assuming a structure similar to PENN’s OPCO/PROPCO design, we came up with a value of $49-70/share off of our 2015 projections.

  • Big picture assumptions
    • ASCA has assets that will meet REIT requirements for a tax-free spin
    • Ability to obtain an IRS ruling and get approval from all the jurisdictions in which they operate in
  • ASCA 2015 forecast
    • $1.5BN of net revenue
    • $504MM of property-level EBITDA
    • $446MM of Adjusted property-level EBITDA
    • Net debt of $1.9BN
    • 34MM shares outstanding
  • ASCA PROPCO REIT
    • Adjusted EBITDA of $225MM
    • 5.5x leverage or total debt of $1.24BN at a cost of 6.5%
    • $15MM of overhead and other expenses
    • AFFO:  $130MM
    • 90% payout ratio gets you a dividend of $3.46
    • Similar to PENN, we think ASCA should be valued at a 7-9% yield or a 12x implied 2015 EV/EBITDA multiple ($38-$49/share). 
  • ASCA OPCO
    • Adjusted EBITDA of $221MM
    • Remaining debt at OPCO of $760MM or 3.4x leverage at a cost of 6.5%
    • Maintenance of $77MM or 5% of net revenue
    • Based on today’s $19 share price, ASCA trades at roughly 7x 2013E EBITDA
    • We believe that ASCA OPCO should trade at a material discount of 5.0-6.5x ($10-$20/share).
      • A $10-$20 valuation would represent a 20-10% FCF yield 

FL: Footwear Sales Growth

With Foot Locker (FL) putting up a solid quarter this week, Wall Street's concerns over slowing sales have been put to rest. Hurricane Sandy has affected inventories as well as future comp prospects, but we think Foot Locker still has potential for further upside in performance through year-end. We’re targeting $3 earnings per share for next year and think it’s entirely possible for Foot Locker to do that while still growing margins. We remain bullish on FL.

 

FL: Footwear Sales Growth - FL FW sales chart normal

 


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PENN OPCO-PROPCO CALL

Takeaway: ASCA, PNK, and BYD are the only other candidates in our universe. unlikely for MGM, CZR, LVS, and WYNN

$53 per share is the midpoint of our value range

 

 

CONF CALL NOTES

  • This transaction has been in the works for 18 months and will unlock the value of their real estate. It will allow them to enter markets that they can't currently participate in
  • In order to finalize this deal:
    • They need to get approval from all the states where they do business
    • They need to reach an agreement with Fortress to convert their preferred shares
    • Carlino family needs to come to an agreement on selling down their ownership of PNG
  • There will be no dividend in 2013 since the transaction will not be affected in time, but they wanted to give people an idea of what the REIT would pay based on 2013 projections
  • Following the exchange, Fortess can either sell (up to the time of the spin) or hold onto it. As soon as Fortress sells their non-voting stock, it becomes voting.  The company has agreed to repurchase those shares at $67/share. If Fortress sells the shares in the open market (not to PENN), then the company will have more cash and that could mean a larger distribution.
  • Spinoff of Propco shares is expected to occur sometime in 2H13 and they expect to elect REIT status as of January 2014
  • Hope to break ground on the Ohio VLTs in early 2013. They are relocating their licenses. Expected to open in 1H2014.
  • They do expect to refinance all of their debt securities, including tendering for the bonds
  • This transaction gives them a huge first mover advantage.  Individuals at the REIT will be licensed. Expect that their gaming regulators will be ok with this structure.
  • It is not their intent to pursue non-gaming assets, but they do have that option
  • This also solves some of the gaming regulatory ownership issues
  • Lowers their cost of capital
  • Spread between the multiples triple net lease REITS is usually between 13-14x vs. the 7-8x range that regionals trade at
  • Want to make sure that OPCO has no issues paying rent and remains healthy. Underlying health of the OPCO impacts valuation of the PROPCO cash stream.
  • REIT will share in OPCO growth opportunities.  There can also be downward adjustments in the lease payments to the PROPCO under certain scenarios.
  • Employees will get the same treatment as shareholders in regards to the spin-off
  • REIT will be able to become a source of financing for the gaming industry and can enter into sale-leaseback arrangements with PROPCO
  • Because they would bring down the market cap of the OPCO, it would make it more interesting to acquire smaller casinos and enter into management agreements with tribes.
  • REIT will have a lower cost of capital and cost of debt than OPCO
  • There are a number of jurisdictions where PENN faces the limitation of just being able to own one property
  • There are no adjustments regarding individual properties in the Master Lease 
  • Ohio Casinos pay 20% of monthly net revenues
  • Fixed rent component gets reset every 5 years equal to 4% of the excess (if any) of the average net revenue for such facilities for the trailing 5 years over a baseline
  • REIT will not be able to finance any other building/ greenfield projects that would compete with OPCO
  • Based on their stress tests, under their worst case scenario (lowest historical EBITDA), OPCO still remains viable and able to make rent payments

 

Q&A

  • They are done with the IRS. They do not need to go back for any more approvals from the IRS
  • Suppose TX comes along, it may be the case that PROPCO is the best source of financing but it's unclear now
  • Growth prospects for OPCO given the new competition - especially when and if National Harbor comes online. They have incorporated that into their expectations though when structuring the lease payments. There are also opportunities in MA and PA for OPCO. International opportunities are open to OPCO. They will also have the 2 Ohio tracks coming online in 2014.
  • Bill Clifford will definitely spearhead the financing for both companies but will not be CFO of both companies
  • Total debt range: $3.75-4.25BN. The higher end number anticipates buying the shares from Fortress ($417.5MM)
  • Additional overhead between both entities? Yes - since there will be 2 separate management teams and support staff. There are also some landlease deals on existing properties where they do not own 100% of the land.  They don't expect corporate overhead to be anywhere near $25MM.
  • Financing of greenfield projects like MA?
    • REITS typically keep their debt fairly stable and then issue more equity for acquisition needs
    • OPCO will pursue financing starting around 3x or more if they have an existing asset to leverage. OPCO generally wants to stay under 5.0x
    • If the MA opportunity gets financed outside of PROPCO, and it may since there are JV properties, they wouldn't take leverage over 5x
  • Triple net structure?
    • 80% is a traditional payout ratio
    • Why NNN structure? Wanted to make sure that OPCO had control of its own destiny to run the assets the right way and from a PROPCO structure, a non-NNN structure requires a lot more overhead.
  • Expected lower cost of capital on the new debt but don't want to disclose
  • Two assets in the taxable REIT subsidiary? Why? 
    • In order to qualify for a tax free spin and these two fit the bill
    • For example, the assets in the TRS can't own a hotel
  • What other opportunities can they pursue now that they can't currently pursue?
    • Non-gaming deals - although those are low on the todem pole now
    • They just announced the PA opportunity
    • They also see themselves as a source of capital for others.  You can bet if TX happens that they will talk to PNG and their partners and other companies.
  • Why is Net revenue for PROPCO higher than rent? Because it reflects Perryville and Baton Rouge revenues
  • Non-Columbus/Toledo assets-rent will be fixed for 5 years, so any upside goes to OPCO.  After 5 years then there is a reset. The tracks at Ohio will also be subject to that calculation after 5 years. For Columbus and Toledo it;s an 20/80 split.
  • Dividend for them will grow faster than at most lodging companies.  2014 REIT dividend will go up a lot. 
  • Regulatory approval process is a highly information intensive review. 
  • The germination of the idea to do this spin began 18 months ago
  • It's also a lot easier to grow a $430MM EBITDA company than a $900MM company
  • It would be a big challenge for them to acquire entire gaming company and split it into a REIT and OPCO
  • PENN has no NOLs 
  • Think that they will close the transaction in 4Q next year. There is a provision in the bonds that allows them to tender at T+50.
  • They are giving Fortress the ability to sell their shares in the open market at $67 or sell back to PENN.  It's really a function of where the stock is.
  • There will be two overlapping Directors but the Boards will be independent. 
  • They apply a simple multiple on the rent stream to come up with a 5.5x adjusted leverage ratio
  • The REIT can technically own international assets but the rules may not be favorable. Depends on the situation.
  • Have some assets in mind that they think can be liberated
  • The two Ohio casinos are also under a triple net lease structure, just at a much higher rate. Let PROPCO participate in the upside going forward. The $450MM of rent does include the two Ohio Casinos.
  • In 2014, when the 2 Ohio tracks come online, there will be an adjustment to the rent calculation at 4% of net revenues for those 2 tracks. 
  • The different between the $450MM of rental payments from OPCO and the $459MM projection is that the PROPCO projection includes EBITDA from Perryville and Baton Rouge, less overhead and land lease payments.

KNAPP TRACK & RESTAURANT VALUE SPREAD

Takeaway: We remain bearish on BWLD, DRI, TXRH, and cautious on the casual dining sector.

Industry data continues to suggest that casual dining restaurant companies are at risk of missing consensus expectations in the fourth quarter.

 

 

Knapp Track

 

According to Malcolm Knapp, estimated Casual Dining comparable restaurant sales growth for October 2012 was -0.9%.  The sequential change, in terms of the two-year average trend from September to October, was -80 bps. 

 

Guest counts declined -2.8% versus October 2011.  The sequential change, in terms of the two-year average trend, was -55 bps.  While these results are disappointing, they are not as bad as had been feared intra-quarter.  We remain negative on the casual dining category.

 

 

Restaurant Value Spread

 

The Restaurant Value Spread, or the spread between CPI for Food Away from Home versus CPI for Food at Home, updated for October CPI data released this morning, is implying that inflation at restaurants continues to outstrip inflation in the grocery aisle.  We believe this is a negative for casual dining pricing trends.

 

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KNAPP TRACK & RESTAURANT VALUE SPREAD - rvs casual dining sss

 

 

Takeaway


We continue to believe that consensus is far too bullish on casual dining top-line trends.  Anemic real wage growth is just one of many macroeconomic headwinds that we believe merit caution going forward.  Consensus is assuming a strong recovery in industry same-restaurant sales in 4Q12 and 2013.  Accelerating negative declines in traffic growth suggest that trends could deteriorate further from here.

 

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


HOLX: Lots To Like

In the past, we’ve been bullish on Hologic (HOLX) and we think the time has come to go long the stock again. We added HOLX to our Real Time Alerts yesterday based on the stock’s potential for long-term growth and the company’s new business model following the GPRO acquisition that relies less on lumpy capital equipment sales and offers more exposure to physician utilization uptick and birth recovery themes. 

 

HOLX: Lots To Like - HOLX   levels 11 16 12 normal


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