IGT should be releasing a (punchy?) response to the Ader Group soon.  Here we take a stab at what that response could include.



We have no idea whether shareholders will vote in favor of the Ader Group proposal but we are pretty sure of two things:  the process will be entertaining and should be good for the stock.  The presence of agitating shareholders is typically good for stocks, especially cheap stocks.


As we’ve discussed numerous times, IGT has made some questionable acquisitions but management appears to be on the right path.  We actually think the buyback was quite cleverly executed.  However, we like the idea of an agitator on the Board and we also think some capital markets experience and pure gaming experience could only help the Board focus management on creating shareholder value.  The stock is unnecessarily cheap and management deserves some blame for that.


Hedgeye is obviously not privy to the contents of IGT management’s response but that doesn’t mean we don’t have an educated guess.  The following is a point by point response that we think IGT could issue as soon as tonight:

  • ADER GROUP:  IGT has failed to focus on the core business
    • IGT:  Our share in North America been increasing for the last two years and our product pipeline is in great shape.  That’s more than we can say about the former management team which overspent on Server Based Gaming and contributed to a plummeting stock price.  Comparisons to 2004, when our market share exceeded 60%, is irrelevant since the competitive landscape is completely different. 
  • ADER GROUP: Our proposed Board members have the gaming experience that IGT’s current Board lacks
    • IGT:   The one person in Ader’s Group with great gaming experience is very old and was directly involved in the gaming industry at a very different time.
  • ADER GROUP:  IGT missed out on significant opportunities in the Asian EGT space
    • IGT:  The entire EGT market generates revenues in the ballpark of $200MM and has lower margins than our existing product sales business.  Even if IGT was able to garner 30-40% market share, this business would contribute a lot less than what Double Down is also doing.  Prior management made a strategic investment in DigiDeal, an electronic table game platform, back in April 2007.  Three years later, in May 2010, IGT ended our relationship with DigiDeal to focus on “core” products.  Reasons for terminating the partnership were part of a broader strategy of IGT exiting low ROI markets and products including Barcrest and Japan.  IGT still has a small domestic electronic table games business we were not interested in investments in low ROI product lines
  • ADER GROUP:  IGT overpaid for DoubleDown and could have created the same business for a fraction of the price. 
    • IGT:  We paid $250MM to date for the acquisition of Double with an additional $250MM to be paid out in retention and bonus payments over the next few years.  DD’s revenues are already doing over $165MM/ year on an annualized basis and the business should produce around $200MM by FY14.  Gross margins are 60% with room for upside. Operating margins should be north of 25% when the business is mature and by 2014 the deal will be accretive.  Unlike Zynga, our business is growing and did 31 cents of booking per average daily user compared to Zynga’s 6 cents.  This business will prove to be a high ROI acquisition for us.
  • ADER GROUP:  Key personnel departures and brain drain at the company - Joe Kaminkow specifically, the former head of one of IGT’s 5 internal game development labs.
    • IGT:  Kaminkow wanted to be the head of social gaming and wanted to do it himself.  He formed a company called “Spooky Cool Labs” ( ) which is focused “on creating cutting-edge social games built on great brands and industry-leading design for social networking services and mobile devices.”
  • ADER GROUP:  Entraction shut down just 18 months after purchase is a perfect example of IGT’s misallocation of capital
    • IGT:  Ok, Entraction wasn’t the greatest acquisition of all-time, but it’s not the only business that suffered after Italy and France ring-fenced online wagering.  We were also able to recognize a $40MM tax benefit in 2012 from the write-down of Entraction and still own the technology and know-how so it’s not a complete failure.
  • ADER GROUP:  Our Group will own 300x more stock than the existing Board
    • IGT:  It’s true that the current Board doesn’t own a lot of stock.  However, Ader’s group ownership is spread pretty thin.  75% of the stock they own comes from one long term investor, 9% is owned by an 84 year old former Chairman (Chuck Mathewson), 10% is owned by trusts controlled by the former Chairman, and only 6% is owned by Ader and Associates.  That 6% owned by Ader represents less than 20bps of the total shares outstanding.  Two of the 3 Board members that the Ader group has proposed directly own less than 0.5% of the stock.
  • ADER GROUP:  Accelerated buyback execution left a lot of money on the table
    • IGT:  We bought back the stock at an average price of $13.22, which is 16% below the current price.

Is Herbalife A Pyramid Scheme?

Takeaway: Here are highlights from this morning’s expert call on Herbalife, a stock we would stay away from for now.

Hedgeye’s Head of Consumer Staples sector research, Rob Campagnino, and Senior Macro Analyst, Matt Hedrick, co-hosted a conference call today for our institutional clients, featuring Dr. Jon Taylor, an academic expert on multi-level marketing and pyramid schemes.  Dr. Taylor has taught business at the university level and is a consultant to a broad range of clients on topics including multi-level marketing (MLM) and direct selling models.  Dr. Taylor has authored numerous articles and books on multi-level marketing and has analyzed over 500 MLM companies.


Dr. Taylor says illegitimate pyramid schemes share certain basic characteristics:


  • They set aside the basic laws of economics.  Pyramid schemes don’t make money from selling products.  Instead, they depend on unlimited recruitment of an endless chain of new salespersons.  Gullible “down-line” distributors are their “endless virgin market.” 
  • Those at the top recruit distributors with promises of lifetime revenues from their own “down-lines.”  Products are overpriced, and always contain some “secret ingredient” or unique characteristic that you can only obtain by buying through the MLM channel.  The unrealistic promise of lifelong wealth is the single biggest selling point – which is why pyramid schemes flourish during bad economic times.
  • On average, 99% of participants / distributors lose money.  They don’t complain to the authorities because (a) they feel stupid, and (b) by the time they realize they have been swindled, they have also swindled most of their family and best friends.
  • Pyramid scam companies fudge their financial reports.  Expenses and losses are incurred by individual distributors, so they never appear on the corporation’s books, making the companies look highly profitable – which they are, for a select few insiders.


What does this mean for Herbalife stock?


Herbalife is not for the faint of heart.  People are plenty jittery around this name.  Uncertainty leads to increased volatility, and lower stock prices, which means a nervous market is a self-fulfilling prophecy.


Consumer Staples head Campagnino notes that the FTC just announced it is investigating Fortune Hi-Tech marketing, another MLM company unrelated to Herbalife.  Herbalife shares dropped 8% on that announcement.  With all the noise in the media, Campagnino says regulatory agencies – the FTC, and possibly also the SEC, the FDA, or even the IRS – will have to look into Herbalife.  When that happens, Hedgeye thinks the stock will drop in price.


But, cautions Hedgeye CEO Keith McCullough, it’s what we call a binary outcome: either Herbalife is a scam, or it’s not.  If it’s a scam, it gets put out of business, in which case Game Over.  If, on the other hand, the regulators give Herbalife a clean bill of health, then price weakness could represent buying opportunities.  And it gives Herbalife management lower prices to buy back their own stock in the open market, raising the likelihood of a Short Squeeze in their battle with Bill Ackman (see Hedgeye definition here: What Is A Short Squeeze?)


Dr. Taylor cautions that, even if the FTC were to come after Herbalife, what he calls the “pyramid scheme lobby” in Washington is so strong, the worst outcome would most likely be a token fine and a requirement that Herbalife write stronger internal rules to protect their down-line distributors.  Note that we said “write” stronger rules, which is not the same as “apply” stronger rules.  Regulators typically take a cash settlement and force the company to make administrative changes.  We think it is unrealistic to expect any individual to be charged with wrongdoing.


Finally, Dr. Taylor points out, other pyramid scheme companies have shut down their US business, yet continued to flourish in overseas markets, where consumers are just as gullible, but where consumer protection laws are much more lax and where there is no strong tradition of an investigative press.  Says Dr. Taylor, some of the world’s most successful pyramid scams have left the US, never to return.



What’s Hedgeye’s bottom line?


Says Hedgeye’s Campagnino: we can’t know whether Herbalife is an illegitimate pyramid scheme.  Ackman’s team has spent 18 months analyzing HLF, and their short thesis still has missing data. 


That said, Campagnino believes it’s highly likely that some government agency will take a look at the company soon, which will cause a drop in the stock price – maybe a big drop.  


There’s also a “class warfare” component: pyramid schemes prey on people who are economically vulnerable – folks who are out of a job often flock to such businesses, drawn by the promise of a life-long stream of income.  In this environment it is politically compelling for government agencies to make a big show of investigating Herbalife.  We note that Herbalife has just retained rock-star corporate defender David Boies, one of the most expensive attorneys in the world.  This could make for quite a show, and we think ultimately the government will have neither the stomach, nor the resources for a fight.  We’re in for a long period of confusion and, unless a very large Smoking Gun surfaces, Herbalife may ultimately walk away unscathed.  


Bottom line:


Right now, Herbalife may be high drama, but it is not an investment we can recommend.  We believe this could be a lengthy process, one which we are watching closely.  Campagnino will be providing updates as the story unfolds. 


What Is a Short Squeeze?

Takeaway: We explain a short squeeze in an easy-to-understand way using a current example.

Bill Ackman rode his investment in JC Penney to a double, then down to a substantial loss.  After investing over $900 million to buy JCP shares at an average price of around $20 in 2010, Ackman watched as the price shot up to over $43 in early 2012 – only to see it drop to $16.50 by November.  In less than one year a paper profit estimated at over $400 million had evaporated.  What bailed Ackman out by year end was attributed, at least in part, to a Short Squeeze among traders who had shorted over 26% of JCP’s outstanding shares.  Profit taking by short sellers drove to cover their short positions, and suddenly the stock had rebounded to over $20 a share.  Bill Ackman was able to breathe a sigh of relief by year-end, as his Pershing Square fund’s position came back from the dead.


What is a Short Squeeze?  Remember, a short seller has sold borrowed stock and to get out of the position has to – has to – buy the stock back in the open market.  When a lot of people sell the same stock it creates Momentum, which attracts market action traders, who short even more shares.  These Momentum traders will be the first to buy back their shares when the Momentum fades, and the more they buy back, the more it causes the price to rise.  Soon, the short sellers get margin calls and if they don’t cover, their brokerage firms will automatically buy back shares, which sends the price still higher.  If they really want to pile on, the owners of the borrowed shares instruct their brokers to pull them off margin – this is known as Calling The Shorts – which forces the short sellers to return the borrowed shares.  As the supply shrinks, more short sellers have to scramble to buy shares and soon the price skyrockets out of control.  This is a good time to remind you that the buyer of a stock can lose 100% of the money they invest, but for a short seller the losses are hypothetically infinite. 

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

REPLAY: Multi-Level Marketing, Pyramid Schemes & Herbalife

To access the replay for today’s Consumer Staples call, "An Expert's Opinion on Multi-Level Marketing, Pyramid Schemes and Herbalife" follow the link below:






  • What is a pyramid scheme?
  • Contextualizing Herbalife (HLF) and its peers within the history of multi-level marketing
  • What is the likelihood that the FTC will take significant action against HLF?
  • If in fact HLF is a pyramid scheme, as Ackman claims, how long can it continue its growth pattern before collapsing?



Dr. Taylor has dedicated a majority of his career to researching multi-level marketing (MLM) and its impact on consumers. He has authored books and numerous analytical reports on profitability, viability, ethics and abuses of "product-based pyramid schemes" including The Network Marketing Game and The Case (for and) Against Multi-level Marketing. Through his research Dr. Taylor developed tools for evaluating MLMs and their profitability (or lack thereof).  


His Five-step Do-it-Yourself Evaluation of MLM Programs is an interactive program for visitors to his website - His research has been confirmed by the analysis of over 400 MLMs and feedback from thousands of consumers. Dr. Taylor received an MBA degree from BYU and a Ph.D. in Applied Psychology from the University of Utah. He is currently President of the Consumer Awareness Institute and President of the Jon Taylor & Co., Inc.



Below is a quick account of our stance on restaurant stocks reporting earnings over the next three weeks.

2/4 – YUM is the worst performing QSR stock YTD, underperforming the S&P 500 by over 700 bps.  The concerns about business trends in China are pervasive and not helping business trends in China. We believe that the company has made amends with the Chinese government and are past the issues that have plagued the share price.  The US business is strong and we would be long going into the quarter.  Expectations have been bombed out and the company is likely to be aggressive in using its balance sheet and cash flow to buy back stock in 2013.


2/5 – CMG has underperformed the market by 200 bps YTD.  The stock has rallied recently on the hope that the company’s pricing strategy will save the day.  We think it is unlikely that the company has pricing power.  Recent menu introductions and testing suggest to us that the company is struggling to stay top-of-mind with consumers.  We are bearish, and would be short, ahead of the quarter.


2/5 – PNRA is a name we want to like but it is difficult to get comfortable at this price.  Panera is the second worst performing QSR stock, year-to-date, underperforming the S&P 500 by almost 500 basis points.  We published on this stock yesterday and our macro team’s quantitative analysis indicates that the share price is in a negative formation. 


2/6  - GMCR is a stock that we do not have a high degree of conviction on but retain a bearish bias due to our concerns about the sustainability of the business model.  The new CEO’s articulation of his vision for the company’s future will be important for our view on the stock going forward.


2/7 – BLMN is a stock being supported by high expectations.  Outperforming the market by over 1,200 bps year-to-date, BLMN has little upside heading into earnings, in our view.  We would not pay a premium for 6% revenue growth and 8% earnings growth in FY13.  The lack of leverage in the business model, compounded by the casual dining price wars and red meat inflation, is a red flag for us.  If we had to take a position, we would be short heading into the quarter.  PE firms will be unloading their shares soon!


2/12 – BWLD is our favorite short in the group.  Its shares have underperformed by more than 450 bps year-to-date but we believe that 2013 will be a difficult year for Buffalo Wild Wings. 


2/15 –DPZ is facing a very challenging 4Q SRS compare, but is one of the few restaurant companies that does not face a difficult comp in 1Q13.  The headlines from the 4Q12 press release could pressure the stock price but we would be buyers on weakness.


2/15 –BKW has outperformed the S&P 500 by 320bps YTD.  To some degree, BKW has benefited from MCD’s trends decelerating but there is little in BKW’s strategy, that we know of, that gives us confidence in the sustainability of current top-line trends.  Same-restaurant sales in 4Q12 will likely look strong but we don’t expect subsequent quarters to impress from a headline perspective.  We would be looking to short this name following 4Q12 earnings.


2/15 – BJRI reported 4Q12 same-restaurant sales of 3% during the ICR conference.  Much of the impact has already been taken out of the upcoming release.  Chili’s has launched pizza nationally and is looking to heavily promote this item for the balance of the fiscal year.  We continue to believe that a resurgent Chili’s is negatively impacting BJ’s business.  We are awaiting an entry point to short BJRI. 


2/18 – JACK is still an attractive to investors looking for a longer-term story.  The stock has underperformed the market by over 400 bps year-to-date but we believe the upside remains greatly underappreciated.   We are buyers on weakness.


2/20 – CAKE will likely report 4Q12 results in line with expectations.  We see risk to guidance for 1H13 versus expectations as the Street is modeling significant margin expansion in the face of dairy prices running far ahead of year-ago prices. 


2/21 – TXRH has underperformed the S&P 500 by 150 bps YTD.  We would steer clear of this stock on the long side, given difficult compares during 2013 and the likelihood of higher red meat impacting margins. 



Howard Penney

Managing Director


Rory Green

Senior Analyst







DOJ Sues to Block Anheuser-Busch InBev's Acquisition of Modelo

Moments ago, the Department of Justice filed suit in Federal Court to block Anheuser-Busch InBev's (ABI) purchase of Grupo Modelo.  Constellation Brands (STZ) has moved precipitously lower on the news.

We view the decision to go to litigation as part of the dance, although admittedly an aggressive move.  While aggressive, it is certainly not the end of the process.  For some perspective, the DOJ also filed suit to block ABI’s purchase of BUD.  It isn’t an uncommon step in the more contentious mergers, but while this certainly represents a delay in the closing of the transaction (no longer Q1), it does not mean that the transaction will not close.

The parties will now move to litigation or, alternatively, additional concessions can be made by ABI to satisfy the concerns expressed by the DOJ in the complaint.

Our view remains consistent – this transaction represents significant value to ABI, and therefore we believe that additional concessions are very likely.

While the move down is painful, we continue to see substantial value to Constellation Brands should the transaction close, an event that we continue to see as likely, though delayed.


Call with questions. Email me if you'd like a copy of the complaint.




Robert  Campagnino

Managing Director





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