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Retail Lease Accounting Change Less Likely in 2013

Takeaway: During our recent dinner with FNP, management noted that ‘not only will it not happen in 2013, but don’t hold your breath in 2014.'

One of the issues we had been watching in 2013 was the potential for the FASB to require retailers to capitalize operating leases. During our recent dinner with FNP, management noted that ‘not only will it not happen in 2013, but don’t hold your breath in 2014, and maybe not 2015 either’.


In the end, this issue really does not matter as it relates to cash flow as it is purely an accounting change. But the reality is that retailers have always given the false appearance of being high return businesses, as their largest asset (real estate) has been considered to be free from a balance sheet perspective.


But capitalizing leases would take up leverage ratios for retailers. Ratings agencies already look at EBITDAR, so it is unlikely that this would impact their ability to borrow. But traditional valuation characteristics would certainly change unfavorably for investors.


Unless FNP is wrong, it looks like we won’t have to worry about this for a while.

Go With The Growth


This week, Hedgeye held its Q1 2013 Macro Themes Call which focuses on three main topics: #GrowthStabilizing, #HousingsHammer, and #QuadrillYen.


In our video posted above, we discuss the first theme, #GrowthStabilizing. The US dollar has strengthened significantly since hitting a 40-year low in Q2 2012 and has helped drive growth in America which is ultimately bearish for bonds and gold and bullish for equities.


It has also helped to deflate the commodity bubble created by the Federal Reserve over the past five years. Right now, the biggest risk to growth is our political system and the upcoming debt ceiling debate in late February. 

MNST: Government Intervention

Monster Beverage (MNST) saw its shares slump yesterday and today on the Food and Drug Administration’s concerns over energy drinks. The offices of Sens. Durbin and Blumenthal and Rep. Markey sent a letter to Living Essentials, maker of the 5 Hour Energy drink, questioning the potential health risks associated with energy drinks and the way they’re advertised. Clearly, every other problem in the United States has been addressed so it’s good to see Congress turning their attention to energy drinks.


Hedgeye Consumer Staples Sector Head Rob Campagnino thinks that Coca-Cola (KO) should buy MNST and use their vast legal resources to fight this battle because KO’s products will soon be in the crosshairs of Congressional leaders. It happened in New York City with Bloomberg, so it’ll be interesting to see how this plays out over the next few months.


MNST: Government Intervention - MNST

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FQ1 could be a small beat but accelerating growth and better cash flow deployment the story



IGT will report earnings Tuesday night and while we’re not sure the print will itself be a big catalyst, we do expect a solid quarter with the potential for a beat.  The report and conference should confirm our positive thesis on this cheap stock.  EPS growth will be high in FQ1 and for all of FY2013 (20%+).  Cash flow remains strong and we expect IGT to maintain current leverage and potentially lever up somewhat through significant share repurchases.  The days of low ROI acquisitions appear to be over.




We estimate that IGT will report $530MM of total revenue and adjusted EPS of $0.25, 1% and 4% ahead of consensus, respectively.


Product sales of $224MM at a 53.5% gross margin

  • NA sales of $151MM and gross margin of $82MM
    • $105MM of NA box sales: 7,265 gaming machines at ASP of $14.5k
    • 6,055 replacements and 1,210 new units, ~2,000 shipments to Canada
    • ASP’s should be similar to last quarter with Canadian shipments down sequentially but IL VLT units should be up this quarter
    • Non box sales of $50MM - 1Q is almost typically weaker than 4Q since 4Q gets a spike from intellectual fees and settlements.
  • International sales of $68MM and gross margin of $34MM
    • $46MM of box sales: 3,000 units at an ASP of $15.5k
    • Non box sales of $22MM
    • 50% gross margins

Gaming operations revenue and gross margin of $306MM and $189MM, respectively

  • End of period install base of 57,632
  • Core gaming operations revenue of $250MM, implying an average win per day of $47/day
  • $57MM of interactive revenue
    • $37MM of DoubleDown revenue
    • $19MM of other interactive revenue

Other stuff:

  • SG&A: $105MM
  • R&D: $55MM
  • D&A: $21MM
  • Net interest expense: $20MM
  • 37% tax rate
  • Weighted average shares outstanding: 269MM

Land Of The QuadrillYen

The Bank of Japan has said it plans on curtailing the strength of the Yen by doing what the United States does best: printing money. As you can see over the last three months, the USD/JPY has appreciated quite a bit as the value of the Yen dropped. Unless the Japan decides to radically change its economic game plan, expect the Yen to devalue further.


Land Of The QuadrillYen - image001

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We believe there is a high likelihood that PNK's 26.50 bid for ASCA will be topped.  As evidenced by the huge increase in PNK's stock, ASCA left a lot on the table.  MGM Resorts International or Penn Resorts could offer a higher bid for ASCA.  ASCA would be hugely accretive for MGM, given MGM's large balance of tax loss carry-forwards. They could pay 8.5x ASCA's trailing 12-month EBITDA, which would equate to a $35 bid and still make it de-leveraging and very accretive from an EPS and cash flow perspective.  PENN could offer even higher since ASCA's integration with its planned REIT structure would instantly create value.  We believe ASCA could be worth up to $40 to PENN.



INTERMEDIATE TERM (the next 3 months or more)

The stock may trade in a tight range for the next month or so. Investors are waiting to see if a higher bid from MGM, PENN, or another operator surfaces. Fundamentally, ASCA remains relatively protected from new competition and, with the top in class assets in virtually all of its jurisdictions, is a defensive play in the space. LONG-TERM (the next 3 years or less) PNK's acquisition of ASCA is expected to close by 3Q 2013. However, we believe ASCA will receive a higher bid before that deadline. A bid of at least $35 (28% premium to current price) seems reasonable and doable given the relatively small breakup fee.


LONG-TERM (the next 3 years or less)

PNK's acquisition of ASCA is expected to close by 3Q 2013. However, we believe ASCA will receive a higher bid before that deadline. A bid of at least $35 (28% premium to current price) seems reasonable and doable given the relatively small breakup fee.



We Want Your Feedback - he bi ASCA chart



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