Eye on Re-Regulation: Where There’s Smoke… Notes for the Week Ending Friday, March 20, 2009


Whenever blue teardrops are falling
And my emotional stability is leaving me,
There is something I can do,
I can get on the telephone and call you up, Baby.
And, Honey, I know you’ll be there to relieve me.
- Marvin Gaye, “Sexual Healing”

One quadrillion dollars.

You heard it here first.

Chinese Premier Wen Jiabao said he was “a little bit worried” about the safety of US Treasurys. Although the world is now referring to the China-US nexus as the “G2”, Premier Wen was not expressing altruistic concern over his partner’s well-being. This was part of a bout of Mandarin muscle-flexing that has emerged in various forms in recent days.

Also in the news this week, China has a law stipulating that an entity deemed to be a “lifeline of the national economy” is to be protected as a matter of national security. This law was trotted out to put a highly public Kibosh on Coke’s proposed over-priced acquisition of Huiyuan, China’s leading juice maker. We do not disagree with China’s decision – our colleagues Howard Penney and Andrew Barber make a strong case for the Coke acquisition being anti-competitive and a Bad Idea for the Chinese. We see it as another step on China’s Long March to capitalism.

The US has gotten the message. On the heels of White House spokesman Robert Gibbs assuring China that “there’s no safer investment in the world” than Treasury Bonds, Chairman Bernanke stunned the world by offering the Chinese a trillion dollars’ worth of Sexual Healing.

America’s latent racism and xenophobia aside, the Chinese really are giving us something to worry about. They have accurately assessed their dilemma and found no way out. Meanwhile, they are pressing forward deliberately with what appears to be both the determination to become – and the recognition that they are – what America was to the world in the twentieth century.

We hear from one major US bank that the Chinese are setting up customer service call centers chock full of telephones, all manned by Indian immigrant workers – they speak English, the Chinese don’t. The Chinese may be poised to take over this market and dominate it entirely.

The Wall Street Journal’s “Overheard” (16 March) reports China’s Alibaba Group is looking to hire an additional 5,000 employees this year. Specifically sought are Westerners with software and information technology backgrounds. Will the Chinese retaliate by draining Silicon Valley’s brains, or will they slap us by restricting visas for American geeks? The good news: a number of America’s most talented information technology experts already speak Chinese because they were born there.

In the aftermath of the Bird Flu cover-up, and the recent baby formula disaster, are we the only ones struck by the irony of this item from the Wall Street Journal (18 March, “China Investigates J&J Products”)? “Chinese health authorities are investigating products made by Johnson & Johnson in response to a U.S. consumer group’s charges, disputed by the company, that some chemicals contained in the products could cause cancer.”

J&J, according to the WSJ story, has a 69% market share of baby-care products in China. We wonder whether the domestic baby-care products industry also represents a “lifeline of the national economy.”
Chairman Bernanke is offering “Quantitative Easing”, a surreal mechanism whereby interest rates will be functionally brought well below zero. We hope this dicey bet pays off. It appears that it can only work under one of two assumptions. Either we continue to have the financial credibility to borrow money in large enough quantities, and at low enough interest rates, to service these trillions in debt forever. Or our goods and services will sell at such a clip and price level that we have the revenues to buy out our obligations. Economist Hyman Minsky calls this Ponzi Financing. The US now risks becoming the Bernard Madoff of Last Resort.

A Quadrillion Dollars. You saw it here. Send us your guess on when that figure first gets mentioned in the mainstream media. The winner will have the satisfaction of knowing that they pegged it right. By the time we get to that number, there will be little else in this world to be satisfied about.

Squeeze This
Prominently featured on the front page of the Wall Street Journal Weekend Edition is a picture of the Ben Bernanke squeeze doll, handed out at a recent bankers’ convention.

Inside the same paper is what, in these dreary times, must pass for a Human Interest story, “Lehman Can Now Have Its 2,055 Stress Balls Back”. A New York bankruptcy judge has ordered Barclays to return thousands of Lehman corporate premiums – T-shirts, logo pens and pads, messenger bags, and 2,055 Lehman logo stress balls.

There is something else Barclays may have got its hands on that doesn’t belong to it. In fact, it never belonged to Lehman either.

As major brokerages went out of business, hedge funds were forced to find new homes for their prime broker relationships. While very little that is happening in today’s markets can be described as “orderly”, a number of firms were able to transfer their assets. What they are having trouble with is an asset which, while it is in their name, doesn’t belong to them.

Hedge funds and other money managers pay a significant percentage of their commissions out in soft dollars. These are commission dollars generated by trades done at the prime broker, then directed to firms that provide research to the funds. In the last few years the SEC has sanctioned the Commission Sharing Account – or CSA. This enables hedge funds to set aside money for future payment to research providers. This is in keeping with the buy-side practices of the larger funds, which pay their providers semi-annually, on the basis of an internal vote of the portfolio managers. This has replaced the practice of giving individual trades to brokers each time they come up with an idea.

The transfer of assets between prime brokers has been complicated by the status of the CSA balances. These are commission dollars, and no longer belong to the funds. They are for third parties to be designated later, and are therefore not assets of the prime broker.

We hear that prime brokers are not transferring these balances when their clients leave for new relationships. There appears to be confusion on all sides. Neither the old nor the new broker appears to be able to state clearly whether they can transfer these monies between them – it belongs to neither. The hedge funds do not want to take a check, which has been offered in some cases, for fear of it being deemed a commission rebate to an unregistered customer.

Soft Dollar Commissions, the financial equivalent of rollover minutes. We hear that, when the hedge funds fled Lehman, they were glad to get out with their assets intact. We do not know how many millions in CSA or other soft-dollar balances were left behind, and to our knowledge, no former Lehman prime brokerage client has gone after this cash.

We have no way of estimating how much money is involved, but Lehman declared bankruptcy in mid-September, halfway through the second half of the year, which is to say, smack in the middle of a soft dollar allocation period. We don’t know how much money three months’ worth of soft dollars represents, but given that damned near everyone had a Lehman prime brokerage account, we have to assume it’s worth more than the squeeze-balls.

Eye On iShares
Speaking of Barclay’s we note the talk about Barclays selling its iShares business. The media are reporting this as Barclays being forced into selling something of a crown jewel, but we think it may be one of the most fiendishly clever asset disposals in recent years. We are always willing to be proven wrong, but we have written before about what we believe may be significant legislative changes to the ETF market.
The Wall Street Journal (Weekend Edition, 21-22 March, “Barclays To Aid iShares Sale”) mentions private equity firms TPG and Apax Partners as possible buyers for the ETF business. We have commented on the ETF business before. See especially our item “The Gold-Bug” (27 February) which discusses moves by the government which we believe may curtail ETF issuance. It would be the ultimate irony if the TALF gave money to TPG and Apax to buy Barclays’ ETF business, which then ran afoul of Senator Levin’s newly-introduced bill to restrain speculation.
We have seen numerous instances in recent months of side-by-side departments of the US Government not knowing what each other are doing. We suggest that, if TALF does not know what the Senate intends for the ETF market, at least the potential buyers of Barclay’s business should.

Death Spiral
When the facts change, I change my mind. What do you do, Sir?
- You Know Who…
The above much-abused quote from John Maynard Keynes has become the watchword for every wannabe entrepreneur, capitalist, Ayn Rand-ian and business leader. We have also had occasion to note that it is often the media who are changing the facts.
One recent example of rewriting reality comes from Friday’s Wall Street Journal (20 February, “Citi Defends Redesign, Plans A Reverse Split”).
The reverse stock split was long a staple of the over-the-counter world. Stocks that had sunk to levels that could trigger a delisting often sought to survive by doing a reverse split, thereby repackaging their securities into an artificially higher price. One for five. One for ten. We have seen one for one hundred stock splits. Anyone who has worked in the low-priced end of the equities markets knows that these reverses are almost always merely temporary measures that often unleash a death spiral, as the stock quickly sinks back towards its delisting price. If a stock was bad enough to go from over ten dollars, down to below a dollar, it will get there again. We are not aware of academic studies on the topic, but our observation is that stocks decline by a measurable percentage in the days – or even hours – immediately following a reverse, and most companies eventually sink back to the price that stimulated the first reverse split.
This is generally helped by the short sellers. Nothing equates to blood in shark-infested waters like a public admission that you are finished, and the shorts have been only too happy to oblige by chomping on these stocks the moment reverses are done. By the way, if Citi is foolish enough to believe that this will not happen to them, we refer Pandit & Co to recent reports that, of over 5,000 complaints of illegal shorting filed with the SEC in recent years, not a single one has resulted in an Enforcement referral. If you were wondering whose side the regulators are on, wonder no more.

The WSJ has different take on reality. They write that Citi’s planned reverse split “would shrink the number of shares outstanding while keeping the company’s income and shareholder equity unchanged. As a result, each remaining share would have a call on more earnings and shareholder’s equity and the price should rise in relation.”
This information is just plain wrong. The level of earnings and equity in a company do not change, and while the raw numbers go up – by the ratio of the reverse split – the ratio of share price to earnings, equity, cash flow and every other measure, remains in the same ratio to the resulting share price.
A company with a one-dollar share price, and five cents in earnings is trading at a 20 P/E. Reverse the stock 1 for 5 and the result is a 5 dollar share price, with 25 cents in earnings, for a 20 P/E ratio.
The Journal article appears to be confusing a Reverse Split with a company retiring its stock. By shrinking the shares outstanding, the earnings, cash flow, and assets per share do actually increase. We wonder how many of today’s holders of Citi shares have this figured out.
If you are confused by all this, we suggest you ask the Chinese who, one year ago, abandoned a multibillion-dollar investment in Citi. Maybe they were drawing on their own Goldman Sachs brain trust – John Thornton, retired President and Chief Operating Officer of Goldman, retired to become Director of the Global Leadership program at Beijing’s Tsinghua University. We haven’t heard anything about him since, but it is difficult to imagine he is not playing an advisory role.
Or maybe the Chinese, watching the inability of the US financial marketplace to keep its balance, remembered Confucius’ warning: never give a sword to a man who can not dance.

Congress Shrugged
Congress may be on the verge of rescuing capitalism and setting America back on a path of dynamic creativity and explosive growth.

Ably abetted by President Obama, who resolutely refuses to take a stand on anything, Congress has mobilized to punish 73 AIG employees who accepted bonuses of one million dollars or more.
Our associate, Andrew Barber, has written before of his personal relationships with AIG executives, and we will admit that our version of the facts may be slanted, given their source. Yet, this whole story has the ring of truth to it. We have been on Wall Street long enough to know a debacle when we see it.
In a classic scenario of “Sell – to who?” AIG apparently opened its books to Secretary Geithner. Things, they told him, were not going well. The holders of their CDS contracts were unwilling to unwind them at a loss. First, AIG’s counterparty would have to take a substantial loss on their investment. And second, it would create a Last Trade, and force repricing of other CDS contracts, which would mean a tremendous hit to the value of their portfolios.

We are told that no more than ten people within AIG structured and sold $1.6 trillion worth of CDS contracts, representing a substantial piece of the problem. AIG is making a legitimate case for “stay” bonuses for the only people who, in AIG’s estimation, might be able to work out of at least some portion of this paper.

For what it’s worth, we believe it is all Fool’s Gold, and the hundreds of billions thrown at AIG will, in the end, go up in smoke.

Here are some other facts. In 2003, Congressman Charles Rangel pushed through a bill offering exemption from Federal taxes to financial firms that set up in the US Virgin Islands. Congressman Rangel’s friends included financier Jeff Epstein – the billionaire whose conviction for having improper relations with underage girls gave new meaning to the phrase “the US Virgins”.

Epstein and others like him – US Virgin Island-based financiers, not sex offenders – funneled large donations to Rangel’s political machine. In 2006, Congressman Rangel again rushed to protect his favorite islanders from the prying eyes of the IRS.

The NY Times reported (20 march, “For Rangel, A Complicated Relationship With AIG”) “As recently as last year, he was trying to woo the company to donate $10 million to a school to be named in his honor. And while A.I.G. officials mulled the request, Mr. Rangel supported a provision in a tax bill that saved the company millions of dollars.”

As someone once said, Follow The Money.

So why has Congressman Rangel now introduced the bill, now passed by a pitchfork-wielding Congress, to eviscerate the annual compensation of The AIG 73?

If this were “Mr. Smith Goes To Washington”, we would guess it had something to do with the investigation of Rangel’s personal tax issues coming to a head. In the current environment, even Charlie Rangel would not take money from AIG. Asked recently on CNBC why he was going after AIG, Rangel said “When you violate the public trust, different rules apply.”

Remember that statement, Congressman.

Congress has become a raging crowd lusting for blood. It is media distraction, lest We The People step back and contemplate the disaster wrought upon our lives by the incompetent and venal dealings of our elected officials. The mismanagement of our financial markets would be comedy on a Shakespearian scale, were it not a tragedy of Biblical proportion.

The creeps of Wall Street are no innocents, but the wickedness of our legislators at every turn has aided, abetted, and sucked voraciously at the teat of the very industry they were supposed to regulate. The incestuous relationship between The Street and The Hill is not going away any time soon. In a panic that they are on the verge of being found out, Congress has reacted with the Capitalist version of a Stalinist purge, urging the roaring crowd on in their lust for vengeance.

Where is President Obama in all this? The same President Obama who refused to rein in the outright nastiness of Speaker Pelosi over the Bailout Bill is now leaving Secretary Geithner twisting in the hurricane. Secretary Geithner has both Senators and the media clamoring for his blood, while President Obama makes his debut on Jay Leno and gets to say a prime time Shout Out to Timmy.

By revealing their own incompetence and wickedness for what it is – for possibly abrogating the Constitution, and for thrusting a stake through the heart of the relationship which, for all its flaws, was supposed to keep the US the bastion of global capitalism – Congress may have finally hit on The Solution.
The AIG 73 are now looking out the windows of their offices and realizing that there is a world out there. Those who worked in good faith are contemplating leaving, not because they will have to give back their bonuses, but because they do not want their families to have to hear a constant rant of “Blood! Blood! Blood!” They feel like Dr. Frankenstein holed up in his castle as the mob approaches.

Now, all over Wall Street, teams of highly skilled, experienced professionals are realizing that it is Game Over for the major firms. The stories trumpeting the Death Of Wall Street may have gotten it the wrong way round. If you run a trading desk at AIG – a thirty-year veteran, surrounded by ten- and twenty-year veterans, all skilled at making decisions on billion-dollar transactions, and with global connections at all levels of the financial markets – the temptation to walk away is peaking just about now.

When the head of a mortgage-backed desk calls his team of thirty professionals into a room and announces “We are all leaving to start our own firm,” is there anyone who will not say “I’m in”? At this point, it does not matter that there may never again be a mortgage-backed market. Teams of smart, creative people, used to working together to devise financial strategies, will always find ways to make money. The difficult thing is not finding the market, it is crafting the team. This is something that takes years – decades. The heavy lifting has been done, and Congress has now opened the door, freeing all these employees of the TARP firms of the burden of having to work out of distressed portfolios.
We see a brave new day of Capitalism dawning. Instead of holding AIG’s hand while its employees struggle to keep the titanic CDS portfolio afloat, Congress may have forced AIG to go bust. The professionals who know that portfolio intimately will be standing around, reconstituted into independent boutique firms. They will take the TARP financing and pick up the pieces – those worth saving. They will make a fortune in the process. Members of Congress, from Rangel, to Dodd, to… oh, forget it – will continue to get away with fiscal murder. The Chinese will continue rolling forward, while the US taxpayer is left holding a very smelly bag.

At one point in his testimony last Wednesday, AIG CEO Liddy stated “I think the AIG name is so thoroughly wounded and disgraced that we're probably going to have to change it.” We strongly suggest that Congress follow his example.

Congress has taken a significant step towards undermining American society. Passage of the AIG 73 Bill is a body blow to our nation’s credibility, and very possibly to the Constitution. President Obama, by refusing to stride into the middle of the fray and shout the participants back to neutral corners, has created a leadership vacuum when we can least afford it.

Politics abhors a vacuum – because politicians are terrified of uncertainty. But Capitalism loves a vacuum – it gives the smart, the quick and the deft an opportunity to take advantage of whatever comes next.
Congress can not destroy the creativity of Wall Street. By pushing the industry’s top professionals out of the plane without a parachute, Charlie Rangel may have rescued Capitalism.

The final truth remains that, what Atlas has shrugged off, only Atlas can pick up again.


The US Dollar is in the same position as a home owner in default: in the absence of liquidity the debtor has the power not the creditors...

Bank Governor Zhou Xiaochuan’s proclamation that the US Dollar should be replaced as the primary reserve currency in favor of an international currency issued by the IMF echoes similar calls made by Russian leaders in recent weeks.

In advance of the upcoming G20 meetings, the esoteric daydream of a global benchmark currency has gained more political traction with the larger emerging nations –Nations that both resent the US Dollar hegemony and hold the bulk of their nation’s wealth in government controlled pools while their citizens live in relative deprivation. For these leaders the political attraction of knocking the US down a peg is intense.

This rhetoric is powerful and incendiary and, ultimately, meaningless. Even the most reactionary of these governments, if given the actual chance to replace the USD with an international basket, have only to look at the historical failure of international organizations to achieve long-term goals –whether the UN or IMF, or the squabbling between the strong and weak economies that comprise the EU to see the downside in holding reserves in a currency run by international committee.

When the rhetoric passes the US Dollar will remain the benchmark for the time being, and Chinese leaders will recognize that the best way to attack the Dollar’s dominance is to allow the Yuan to float freely and challenge the its leadership status – something that will be a political impossibility in the present environment.

Forward contracts for Yuan rose almost 1% overnight to the highest level in three months as a weaker US Dollar is increasingly priced in while spot rates increased 0.05% to 6.8296 USD. As the Chinese stimulus program picks up steam and the effects of reduced export taxes are felt by producers, the weakening Dollar will be paramount politically.

Andrew Barber

PVH: Pulls a 180 on Acquisition Posture

Last quarter, holding cash was #1 priority. Now deals are working their way back into the fray…
4Q08 (our notes)
Don’t think it’s time to get aggressive on buying back stock in this environment
– we continue to look at acquisitions that would be accretive
- have a history of success putting business on their platform
- that is the likely use of our cash over the next 12-18 months
- not active market right now, be seeing troubled brands
- haven’t found something that meets co. requirements from brand strength point of view and financial metric point of view

3Q08 (CallStreet transcript)
In answer to a question about acquisitions…
“Look Jeff, it is no change. I will -- on that front. Our focus will continue first and foremost beyond acquisitions. I think in an environment like this, you even have to be more prudent about acquisitions and not only do they have to be accretive and deliver value, but they have to be strategic as well. Also, I think in an environment like this, cash is king can. I think we are going to -- next 2009, we are going hear a significant amount of horror stories about our customers potentially, about other industries, about competitors, that are running into liquidity issues, be that tripping covenants, be that maturities debt coming due, so I think in this type of environment, our balance sheet is one of our biggest strength. I think before I use that to go out and buy $150 million in stock, I would have to be comfortable that the credit markets are operating efficiently, that we are back to some level of normalcy in that environment before I go out and buy back stock, even though I know what a good buy our stock is…”

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Cash For Trash

"Success depends upon previous preparation, and without such preparation there is sure to be failure."

Regardless of whether we're bullish or bearish, a proactively prepared investment process allows us to manage the risk implied in deflating or reflating asset prices.
Many a wanna be short seller of everything "Depression" has just been reminded that there is massive risk implied on the upside in a Bear market. Risk in markets is omnipresent. The most relevant risks are always embedded in expectations - this, of course, includes the probability for a raging short squeeze.
After one of the most expedited 2-week bear market rallies in the last 113 years, a lot of the early cycle global macro signals that we've been writing about will now become crystal clear. The entire Street is now getting bullish on the call our head of Tech, Rebecca Runkle, had in semiconductors 6 weeks ago; and all of a sudden some of the most fantastic shark biting of the shorts that I have ever seen in my career is happening in the American casual dining names that our head of Restaurants, Howard Penney, has been bullish on since December. Yes, both main Street Americans, and their pet sharks can still strap on the ole feed bag.
Volatility, as measured by the VIX, has been cut by almost 50% in the last 5 months, and assets from West Texas Crude Oil to Russian Equities have re-flated by over +41% in a straight line over the course of the last 5 weeks. Copper and China are racing one another for the lead in 2009 YTD gold medal race - as of this morning, copper is +25% YTD and the Shanghai Stock Exchange Index closed up for the 7th day in a row, taking YTD gains for the Chinese to +28.5%.
The CRB Commodities Index closed at 229 last night - now it's FLAT for the YTD. The Nasdaq, which doesn't have GE or any of the Financials, closed at 1577 yesterday, and is now only down -1.4% for 2009. Market prices are leading indicators - do all of these aforementioned prices give any objective mind reason to believe that we are on the precipice of entering the Great Depression Part Deux? Of course not - that's what the bears of 2008 are still rushing to their publishers to write books about. It's yesterday's news.
We get paid to have our feet on the floor early every morning in order to help you proactively prepare for today and tomorrow. Understanding history, or yesterday, is a critical component of this process. Some people don't like it when I take victory laps - but that's ok, ask my good friend Benoit Morin how passive I was about celebrating Yale Hockey goals in them ole school Yale/Princeton tilts we used to have up here in New Haven - not very!
We approach this game like professional athletes. There is a discipline, passion, and pace at which you need to play the game. Striking the balance between emotion and control is always the greatest challenge. I call it playing on the Research Edge. But in no sport, that I know of at least, does the replay not matter. In what was the horse and buggy whip Wall Street of yesteryear, I guess portfolio managers could get away without issuing the transparency associated with mirrors - but guess what, You Tube is here - those days are over.
Today is a new day, and I'm only as good as my last game - so what's my "call"? Well, like any proactively prepared risk manager, I make most of my moves into the close on the day prior. I've had my head handed to me enough times in this business to finally understand that there is never a mistake in booking large percentage gains. Do I think that everything we are long should continue to re-flate? I sure hope so... why else would I be long something? Does that mean that things can't get overbought? Of course not...
For accountability/transparency purposes, I issued an intraday note to our Macro clients into the close yesterday titled "Shark Bite, Part Deux: SP500 Levels, Refreshed" outlining the following levels of resistance: SP500 TRADE resistance at 817; TREND resistance at 829.
The SP500 closed 60 basis points above that immediate term TRADE 817 line, but 84 basis points below the intermediate term TREND line. More importantly, my support level for the SP500 was all the way down at 770, which is -6.3% lower. Anytime the risk outruns the potential reward like this, I sell.
I raised the Cash position in my Asset Allocation Model from 59% back up to 71% yesterday. I sold my long positions in Russia and Brazil for +15% and +10% gains, respectively, taking my Allocation to International Equities down from 19% to 10%; and I sold down my Allocation to US Equities from 13% back down to 10%.
Call me conservative, or call me names - this is what I do. I manage risk by managing my exposures around price levels using a scenario analysis that is much closer to a market operator's "stress test" than what the US Government is currently trying to sell you on.
The US Government did the proactively predictable yesterday and traded what economist Paul Krugman accurately labeled "Cash for Trash". No, I'm not a Krugman lover, but you know I love a good one liner that's paired up with an objective conclusion - especially when it stirs a bee in the bonnet of the Goldman brain-trust that continues to dominate the West Wing. Larry Summers was really agitated by Krugman's refusal to STAND DOWN - he doesn't like to hear opinions that differ from his own.
Short term "trading" is what it is. I call it risk management. The US Government is as reactive a short term trader of political capital that you'll find in this global marketplace right now - as long as you understand that, and can remove all emotion while managing around your cash position, you can proactively pick off the market's behavioral patterns associated with the new reactive American crackberry culture.
Be careful out there today. After a 21.6% 2-week re-flation, the real-time risk managers understand that this Bear is far from dead.



EWC - iShares Canada-We bought Canada on Friday 3/20 into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's socialist past, and believe next year's Olympics in gold-rich Vancouver should provide a positive catalyst for investors to get long the country.   

DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.  

XLK - SPDR Technology-Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last several weeks.  Semiconductor stocks, which are early cycle, have provided numerous positive data points on the back of destocking in the channel and overall end demand appears to be stabilizing.  Software earnings from ADBE and ORCL were less than toxic this week and point to a "less bad" environment.  As the world stabilizes, M&A should pick up given cash rich balance sheets in this sector and an IBM/JAVA transaction may well prove the catalyst to get things going.

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +28.4% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-find its bullish TREND.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

LQD  - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".

EWU - iShares UK -The UK economy is in its deepest recession since WWII. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go in the face of severe deflation. Unemployment  is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month, which will hurt the export-dependent economy.

DIA -Diamonds Trust-We re-shorted the DJIA on Friday (3/13) on an up move as we believe on a TRADE basis, the risk / reward for the market favors the downside.

EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD.  Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.

IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.

XLP - SPDR Consumer Staples-Consumer Staples was the third worst sector yesterday. XLP has a positive TRADE and negative TREND duration.

SHY - iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.


As a follow-up to our posts on gaming debt restructurings and defaults, we are providing a list of recent credit facility amendments in the sector below. With the exception of MGM’s 2nd amendment, the cost of obtaining these amendments appears reasonably low. In other words, banks seem willing to be flexible. MGM’s 2nd amendment only bought the company 2 months yet cost them 100 bps and was pretty restrictive.

On the other hand, ASCA’s amendment was particularly attractive for the company. This is probably the best comp when considering PNK in its eventual negotiations for a higher leverage ratio in its covenant. While PNK doesn’t appear to have an issue currently, the company may brush up against its maximum ratio in 2010.

Summary of recent gaming credit facility amendments:
  • MGM MIRAGE, Amendment 1

    • On September 30, 2008, MGM entered into an amendment to its Credit Agreement.

    • Amendment increased the maximum total leverage ratio to 7.5x beginning in 4Q08 which will remain in effect through 4Q09, with step-downs thereafter.

    • The amendment also revised limitations on secured indebtedness

    • Drawn pricing on leverage above 5.0x was increased moderately
  • MGM MIRAGE, Amendment 2

    • On March 16, 2009, MGM entered into a second amendment to its Credit Agreement.

    • Amendment provided a waiver of non-compliance with the total leverage ratio covenant or interest charge coverage ratio covenant for quarter ended March 31, 2009 quarter waived through May 15, 2009.

    • 300MM repayment of R/C funded balance, which may not be re-drawn

    • 100 bps increase in drawn pricing and establishes a base rate floor of 4.0% and a LIBOR floor of 2.0%

    • Additionally the Amendment restricts MGM and its subsidiaries from:
    - Paying dividends or distributions on, or repurchase equity,
    - prepay outstanding indebtedness
    - make certain investments, including investments in CityCenter above the stated thresholds or if Infinity World Development Corp. fails to make its corresponding investments, or if any obligations under CityCenter’s senior credit facility have been accelerated
    - incur additional debt,
    - incur liens on assets,
    - merge or consolidate with another company, dissolve or liquidate
    - dispose of material assets,
    - create unrestricted subsidiaries and
    - prepay trade payables.

    • On November 13, 2008, Wynn Resorts entered into an amendment to its Credit Agreement.

    • Amendment allows Wynn to make a debt buyback of up to $650 million of loans outstanding.

    • Amendment contained the following relevant provisions:
    – Loans acquired under debt buyback are cancelled and retired immediately upon closing;
    – Loans cancelled and retired are no longer deemed outstanding under Credit Agreement;
    – Wynn has the option to conduct Dutch Auction for loans outstanding.

    • Wynn successfully purchased $625 million of loans at a discounted price of 93.375%, resulting in retirement of $625 million of principal for payment of $596 million on November 26, 2008.

    • On March 13, 2009, Ameristar entered into a third amendment to its Credit Agreement.

    • Amendment increased the maximum permitted leverage ratio and senior leverage ratio beginning the quarter ended September 30, 2008 by 25 to 50bps through maturity

    • Increased the applicable margin by 1.25%

    • Added a new covenant where TTM EBITDA needed to exceed $275MM

    • Existing $500MM subordinated debt limitation was eliminated

    • Amount of Cumulative Capital Expenditures permitted increased to $1.1BN from $1.0BN

    • Permitted Annual Dividends payments decreased from $40MM to $30MM

    • Cumulative amount of stock repurchases permitted decreased from $125MM to $50MM (plus any amount available under the dividend basket)

    • Reclassified the maturing R/C due Nov 2010 as non-extending loan commitments and permitted to request in the future to convert their Non-Extending Revolving loan Commitment to a new Tranche of Extending Revolving Loan Commitments that mature on August 10, 2012 (subject to quarterly $12MM of principal amortization commencing on Dec 2010)
    – pricing would be negotiated at the time of the extension request, but amount is non-negotiable

    • The existing Incremental Commitment Facility was expanded to permit ASCA in the future to obtain Incremental Term Loans that mature on or after 11/10/2012 in order to reduce the Non-Extending Revolving Loan Commitments (Terming out debt permission)

    • $9MM on-time fee paid to lenders

Sporting Goods: Return of the Wild West?

March has been a difficult month for marginal sporting goods players. On the heels of G.I. Joe’s Ch. 11 filing on March 4th, Sportsman Warehouse filed this past weekend. Both companies are based in the Pacific Northwest, a region typically dominated by Big 5 and The Sports Authority. While both companies plan to reorganize under bankruptcy protection, Sportsman’s Warehouse is either selling or closing more than half its original locations.

Presuming Big 5 and TSA have the liquidity to pursue these locations, this could offer up an opportunity to fill out their respective stores bases west of the Mississippi.

If these players bow out, don’t completely count out Dick’s. For those who might have missed Dick’s remarks on the Q4 earnings call, they specifically identified G.I. Joe’s filing as a potential opportunity to move into that area and hinted at another in distress (i.e. Sportsman’s). With several states “up for grabs” in terms of a market share leader, we could see a return of the Wild West as Big 5, TSA and Dick’s grab for share.

As a sidenote, among the list of unsecured creditors is Columbia at #22 with $628k at risk, or just over $0.01 per share. We note that the company also has roughly $0.02 at risk related to the G.I. Joe’s filing in a quarter where it guided to $0.06. We have earnings closer to $0.20.

Casey Flavin
Sportsman Warehouse Locations (67): The company plans to operate 29 stores during the restructuring process recently sold 15 stores, and plans to close another 23 stores.
G.I. Joe’s Locations (31):

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