There are three major tenants to the Macau short thesis: excessive visa restrictions, dissipating junket credit availability, and too much supply. Unfortunately for the bears, the recent deltas for all three are positive.

As we wrote about last week, mass market visitation appears to have ticked up in recent weeks, possibly indicative of a loosening of the visa restrictions. Even if that ends up not being the case, we believe Beijing will indeed loosen later this year ahead of the new Macau Chief Executive taking over. On the credit side, we don’t see any evidence that more credit is being offered to the VIP players. However, we are only 5 months away from a potentially positive year-over-year comparison in the Rolling Chip business. We can see the light at the end of the tunnel.

This weekend we got a favorable supply catalyst. SJM, controlled by Stanley Ho, announced the company would no longer pursue a mega casino hotel complex in Macau. This should ease the supply concerns considerably, leaving only MPEL’s City of Dreams (spring 2009) and WYNN Encore (earyl 2010) as the only definitive supply increases in the market.

Macau should be looking more and more attractive to investors.


The following list details the recent gaming debt restructurings and defaults. Given the significant financial leverage in the sector heading into the downturn and the material drop in cash flows, it shouldn’t be surprising that the list is long.

The list of actions taken by each debtor to avoid bankruptcy is also long, which brings us to our main point. Even though there are some other seemingly dire situations out there such as MGM, and potential covenant breachers (LVS, PNK, WYNN, BYD), there are many remedies. However dire some of these situations may be, the fact is, the banks do not want to own the assets, and will not likely foreclose on the assets, at least not anytime soon. The MGM saga is likely to drag out for some time and, meanwhile, the equity will trade like an option. The other potential covenant breachers are likely to find their banks fairly aggreeable to amendments and waivers.


    December 2008 private exchange offer: selected old notes of Harrah’s Operating Co. (“HOC”) for new 10% senior secured notes due 2015 and 2018; offer closed as of December 24, 2008; reports indicate debt load reduced by $1.14 billion.

    March 2009 private exchange offer: selected old notes of HOC for up to $2.8 billion of new 10% second priority senior secured notes due 2018;

    March 2009 private cash tender offers—
    – by Harrah’s BC Inc. (sibling of HOC) for Priority 2 notes issued under March 2009 exchange offer;
    – by affiliates of Apollo and TPG for 10% senior secured notes due 2015 and 2018 issued under December 2009 exchange offer (and potentially under March 2018 exchange offer);
    – by HOC for Retail Notes held by certain holders.

    Banks and bondholders organizing, retaining restructuring professionals; high probability of chapter 11 filing in 2009.

    Private exchange offer for selected Old Notes, to refinance debt and cure looming loan defaults, terminated in December 2008 due to lack of sufficient participation.

    Retained restructuring professionals to engage in negotiations with banks and secured lender groups, resulting in modification of loan terms, contribution from sponsors and an agreement by secured lenders to support a Prepackaged Plan of Reorganization.

    Currently soliciting votes on the Prepackaged Plan, in conjunction with a second exchange offer for notes; both still pending.

    Recently, Boyd Gaming has expressed interest in purchasing Stations, reportedly for $950 million in cash, either as part of or after a Chapter 11 reorganization. To date, Stations has rejected Boyd's offer, but Boyd continues to pursue a potential acquisition.
  • TRUMP:

    Delays in asset sale and continued financing expenses for expansion:
    – Agreement on sale of Trump Marina Hotel Casino reached for $315m in May 2008 but renegotiated (lower price and waiver of financial commitment letter);
    – Scheduled May 2009 closing, but w/o financial commitment in place;
    – Planned opening of Chairman Tower to generate more cash flow, BUT additional construction required cash outlays.

    Missed $53.1m interest payment on December 1, 2008 on Senior Secured Notes due to liquidity issues. Failed to cure within 30-day grace period.

    Commenced chapter 11 bankruptcy on February 17, 2009.

    Missed coupon payment to senior secured bond holder in Jan 2009 which triggered cross-default provisions on its Senior Secured Credit Facility and Sub Notes

    Also tripped several financial covenants on its Senior Secured Credit Facility in Jan 2009, and are now in technical default

    Obtained limited forbearance with banks and bondholders, which have since expired

    Most probably outcome will involve takeout of Senior Bank Debt (only $15MM facility), equitization of significant portion of Senior Secured Bonds, and essentially “flushing” Sub Notes

    Breached leverage covenants in late 2007 after decline in earnings.

    Subsequent downgrades due to deteriorating financial conditions.

    Revocation of New Jersey gaming license due to inadequate operation levels, leading to EOD under loan agreements and takeover by state.

    Various attempts to resolve liquidity issues before bankruptcy:
    – Appeal of decision revoking gaming license;
    – Attempted sale of Tropicana AC to various investor groups;
    – Further downgrades and inability to cure EOD impeded out-of-court resolution.

    Retained restructuring counsel and financial advisor.

    Commenced chapter 11 bankruptcy on May 5, 2008.
    – Proposed plan of reorganization calls for senior secured debt to be converted to common stock and unsecured debt to receive warrants. Common stock and other equity interests are to be eliminated without distribution. Disclosure statement was approved in early March 2009; solicitation of votes next.
    – Case appears to be in flux/stalemate
    – Decline in earnings starting in 2007, leading to difficulty meeting financial covenants.
    – Downgrade of corporate rating and issued debt after missed loan payment in early 2008.
    – Several attempts to secure liquidity and avert bankruptcy:
    – equity infusion from sponsor group;
    – forbearance agreement with lenders until August 2008;
    – concessions sought from state on tax rate, attempted muni-bond raise;
    – high probability of chapter 11 filing in 2009, de-levering by converting secured debt to equity.
    – Retained restructuring counsel and financial advisor.

    Decline in earnings starting in 2007, leading to difficulty meeting financial covenants.
    - Downgrade of corporate rating and issued debt after missed loan payment in early 2008.
    - Several attempts to secure liquidity and avert bankruptcy:
    o equity infusion from sponsor group;
    o forbearance agreement with lenders until August 2008;
    o concessions sought from state on tax rate;
    o high probability of chapter 11 filing in 2009, de-levering by converting secured debt to equity.

    Retained restructuring counsel and financial advisor.

US Market Performance: Week Ended 3/20/09...

Index Performance:

Week Ended 3/20/09:
DJ +0.8%, SP500 +1.6%, Nasdaq +1.8%, Russell2000 +1.8%

March to-date:
DJ +3.1%, SP500 +4.6%, Nasdaq +5.8%, Russell2000 +2.9%

2009 Year-to-date:
DJ (17.1%), SP500 (14.9%), Nasdaq (7.6%), Russell2000 (19.9%)

Keith R. McCullough
CEO / Chief Investment Officer

Early Look

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There is a bit of tailwind building relative to typically stale Street estimates. As can be seen in the chart, the US dollar index is down 6% in less than 2 weeks. Against the Euro, the dollar has also fallen 6% over the same period. Sure, the dollar is still up 15% on the Euro over last year but that should already be reflected in Analysts’ estimates. Most of the lodging companies have reported earnings over the last month and have given guidance based on a higher dollar.

Bernanke’s recent efforts could continue to pressure the dollar. Our Macro team has been arguing for a weaker dollar to re-inflate assets and stocks. The two lodging companies in our sights with significant FX exposure are HOT and OEH. The dollar move thus far is not yet significant enough to warrant an estimate change for HOT, but it may be for OEH. We calculate about a 1% and 5% positive impact to company EBIT, respectively. If we’re right on the dollar, the impact will be more pronounced. Stay tuned.

SP500 Levels Into The Close...

Volatility (VIX) and the US Dollar Index are both finally seeing an overdue bounce here today. Dollar Up = Stocks Down. There’s nothing new here in terms of the playbook inverse correlation that matters.

What is new is that volume is decelerating on the down moves and accelerating on the up moves. Yesterday’s volume on the NYSE for example was down 34% from Wednesday’s (when the US market was up). On balance, this is bullish for the market – but only at a price. I think the lows for 2009 are locked in, at least for the intermediate term (next 3 months). I think we continue to make higher lows on selloffs, and higher immediate term highs on up days.

Bullish support resides in the range that I have outlined in green below (754-758 in the SP500). There’s TRADE line resistance up at 809 (dotted red line) and TREND line resistance (solid red line) up at 829.

The big meltup and meltdown moves for 2009 are behind us, for now. Trade this very trade-able range. Buy low, sell high.

Keith R. McCullough
CEO & Chief Investment Officer

SBUX – Advertising: Offense or Defense?

First we had the “cola wars” as Coca-Cola and Pepsi sparred for market share in the 1980s, with many casualties on both sides of the corporate battle-front. By the 1990’s we moved from colas to the “burger wars.” Although I would note that the “burger war” is still being waged, as McDonald’s success and a sluggish economy has caused erosion in traffic trends. As a result, the dollar menu has legs. For the second half of this decade, get ready for the “coffee wars!”
Last October, I said, “Starbucks will be forming a new advertising strategy – they have no choice.” Starbucks is a great brand and is too big of a company not to be using the media to communicate with customers and to defend the brand against bold attack by its competitors.

Both McDonald’s and Dunkin Donuts are strong brands competing for their share of the breakfast day-part. Not long ago, Dunkin’ Donuts fired a shot at Starbucks by saying that it beat SBUX in a recent national blind taste test, and SBUX had no way of responding. Not good brand management!

Also, in May/June 2009, MCD will be on TV talking about its coffee initiative. Taken together, McDonald’s and Dunkin’ Donuts will be spending a significant amount of money promoting their respective brands.

At the recent Starbucks annual meeting, CEO Howard Schultz spent some time talking about advertising and how in the past the company did not feel the need to advertise outside its 4-walls. Mr. Schultz addressed head on the false claims competitors are making about SBUX and the myth of $4 coffee. Although Mr. Schultz did not comment specifically on McDonald’s billboard advertisement that stated “Four bucks is dumb”, he definitely was including McDonald’s among the competitors that he says have made false claims about SBUX when he talked about the myth of $4 coffee. As of today, SBUX has had no real way to respond to these types of claims so the company has been silent on the subject, but according to Mr. Schultz, that will not be the case going forward.

The CEO said that SBUX is ready to take its gloves off… There is something exciting about a good corporate battle! The Starbucks strategy has been primarily focused on the quality of coffee, while the competition has focused on price alone. Starbucks does not plan to compete on price alone as selling quality coffee will always be at the forefront of its strategy, but the company hopes to change consumer perception around the value of the brand. As Starbucks noted, half of its beverages cost under $3, 1/3 cost less than $2 and its brewed coffee represents strong relative value. Mr. Schultz stated, “We have allowed others to define us…stay tuned.” He also said the majority of the people not going to SBUX as often are not going to fast food restaurants for their coffee – but instead making it at home.

If Starbucks goes full throttle with a U.S. advertising strategy, and spends 4% of U.S. system-wide sales on advertising and promotion, based on FY08 numbers that would equal nearly $450 million. This compares to U.S. advertising spend of $1.1 billion for MCD, $364 million for Burger King, $404 million for Wendy’s and $1 billion for YUM (includes spending on KFC, Pizza Hut and Taco Bell), according to Advertising Age.

That being said, to be competitive, Starbucks needs to spend $300-$400 million. Although Starbucks will not get to this level of spending right away, the company will have to eventually allocate this amount of money to advertising in order to be offensive rather than defensive in its attempt to increase its share of voice. What I mean is that Starbucks will have to spend more in order for its advertising dollars to generate real returns for the company rather than just helping to stop further erosion of the brand. For reference, $300-$400 million would represent 60%-80% of the total cost savings the company has articulated it can achieve in FY09. This level of spending would eliminate the bulk of the company’s newfound earnings potential but is, nonetheless, necessary to the long-term strength of the brand and the company. It is encouraging to see that SBUX has finally admitted the need for advertising!

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