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Property EBITDAR of $260MM missed our Street high estimate by $20MM, but was higher than the Street.  For details please see the table below.  The quarter itself was fairly uneventful but the takeaways were not.




The key takeaways came from the forward commentary:

  • Total expected cost cuts remain at $470MM. Progress should accelerate at a faster pace as we move through the year.
  • Management does not expect any covenant issues. In our model we had projected a tight Q3. However, significant progress on the $470MM in cost cuts could quickly take a covenant breach out of play. Besides, LVS maintains the bank debt buyback option to de-lever quickly in a pinch.
  • March was the best month of the quarter and April is improving on March in Las Vegas. Business is getting "less bad", making the numbers more believable.


For those of you that like detail, please note the following:


Las Vegas

  • Las Vegas Revenues came in 4.4MM below our estimate, while EBITDAR came in 7.3MM light
    • Part of this was because we assume slightly higher hold % (22%)
  • Operating expenses at the two properties decreased 58 bps - not enough to offset the drop in revenues, although at least according to LVS we will see a bigger drop in expenses going forward once we lap the ramp up in Palazzo in 1Q08 comps
  • Venetian: table drop was down 26% y-o-y while slot handle fell 19%, total revenues estimated at $166 with EBITDAR margins of 29%
  • Palazzo: table drop was up 46% y-o-y closing the gap of table performance with Venetian, while slot handle fell 19%, total revenues estimated at $151MM with EBITDAR margins of 27%
  • Looks like both properties were fairly flat with 4Q08 EBITDAR results
  • Overall - there was nothing really unusual here... table hold was a little light while slot hold was at the high end of their historical range


Venetian Macau

  • Venetian revenues came in 20MM light of our estimate and 17.5MM light of our EBITDA estimate
  • We estimate that higher than normal hold helped revenues by $30MM and EBITDA by $8MM
    • Mass win came in better than expected, due to slightly higher hold 21.9% vs our 20% estimate, positively impacting revenues by $16MM & EBITDA by $5MM
    • VIP hold was 16 bps higher than "normal" 3% hold, positively affecting revenue and EBITDA by $14MM and $3MM lower, respectively
  • Looks like one of the ways they are reducing expenses is by continuously "right-sizing" their casino
    • Tables are down to 616 from 808 a year ago, and down from 666 last quarter... that means a lot less dealers
    • LVS also removed 547 slot machines since 1Q08
  • Fixed expenses looked fairly flat y-o-y, but the company mentioned that we should see reductions going forward since 1Q08 still had ramping expenses for Venetian
  • Reduced the loss on the ferry operations by 1MM, y-o-y, and by 8MM sequentially


Sands Macau

  • Sands revenues came in line with our estimate and EBITDA was 1MM better
  • Sands has slightly lower hold of 2.59%, normal hold is about 2.75%, adjusted for low hold, revenues and EBITDA would have been 8MM and 1.6MM higher than reported
  • Like the Venetian, Sands also reduced their casino capacity
    • Tables are down to 443 from 626 a year ago, and down from 500 last quarter... that means a lot less dealers
    • LVS also removed 255 slot machines since 1Q08
  • Total costs decreased 14%, although we estimate that most of that is variable cost and that fixed costs have only come down moderately

KONA - Kona Storms are Seasonal


On the KONA 1Q08 earnings conference call, Thomas Lynch of Mill Road Capital publically flogged the management of KONA grill.  What did he accomplish?  I’m sure he feels better about himself today, but he is not living up to the investor he claims to be – a Berkshire Hathaway for small companies!  It’s very clear Thomas Lynch is no Warren Buffet! To me his behavior only highlighted that he is down $3.6 million on his initial KONA investment. 


In June 2008 Mill Road filed a 13D stating their belief that KONA represents an attractive investment opportunity.  Further, they thought KONA would be better able to realize its full value as a private entity and submitted a non-binding offer to acquire all the company a cash price of $10.75 per share.


I can tell you one thing; Mill Road does not do MACRO.  In June 2008, Mill Road Capital thought it would be a great idea to take KONA private!  Are you kidding me, they should be happy they only lost $4 million on the KONA investment.   


In addition to the public flogging of management, Mill Road is now causing KONA to spend hundreds of thousands of dollars in legal fees.  Again, for what purpose?  A shareholder is destroying shareholder value!  Stupid!


From what I have read, I don’t necessarily think management has handled everything perfectly, with respect to the capital raise.  It’s unlikely that I will ever know what the real story is, but who cares?  Mill Road Capital is bitter because they skewed up – get over it. 


Getting past all the nonsense and how is the business doing, is there a real opportunity?  I see three key issues, none of which have terminal consequences.  First, KONA’s market cap is small at $15 million and relatively illiquid.  Second, the capital raise and disgruntled shareholders are keeping potential shareholders away.  Third, like all Restaurant businesses, trends are soft but getting less bad - April trends confirm this thesis.   KONA currently operate 21 restaurants in 13 states, with 22% of the restaurant located in Arizona and Nevada.


KONA - Kona Storms are Seasonal - kona1


Given the current trends the company is seeing now, general industry conditions and the comparisons is 2H09, KONA same-store sales will show continued improvement during the balance of 2009.  The improvement in sales trends, coupled with lower commodity prices, will allow KONA to show margin improvement in 3Q09 and 4Q09.


As I see it, two of the three negatives will go diminish over time.  Once the company closes on the rights offering on May 22nd, the company capital needs go away completely.  As a result, the focus will then shift to the company ability to generate cash.  The current plans call for KONA will build out two more stores in fiscal 2009 and one in fiscal 2010.  We estimate that the company will generate $2-3 million and $5-6 million of free cash flow in 2010 and 2011, respectively.  In total the company will generate 50%+ of the current enterprise value in free cash flow over the next two years. 


KONA - Kona Storms are Seasonal - kona2


Right now, KONA is trading at 3.1x NTM EV/EBITDA; significantly below the peer group at 6.5x NTM EV/EBITDA.  Based on my estimates, every multiple improvement in KONA’s valuation represents $0.77 of upside.


KONA - Kona Storms are Seasonal - kona3


The Hindenburg of Footwear

Am I the only one who is floored that Adi only traded down 11% on the earnings release?  This quarter was U-G-L-Y.  Sales -2% and Inventories +28% with an 80% decline in operating profit?  Closing stores in what was its fastest growing market (China)? Restructuring Reebok - again?  It's been a long time since I've seen such a large company lose control of its business so quickly. So many of the issues here are Adidas-specific, but although Adi is a speck in the US market, its global market share is meaningful (US$15bn in sales vs. Nike at $18.6).  Adi is on the ropes, and future moves of desperation will put some unwanted pressure on NKE. Keep an eye on this one.


Here are a few notable margin drivers...  


Gross Margins:

  • ~200bps due to higher input costs - raw material and wages.
  • o Expected to ease in 2H, but not positive until 2010.
  • o NKE noted a similar expectation for visible improvement on its March earnings call.


  • ~150bps due to the impact of foreign currency - particularly the devaluation of the Russian Ruble.
  • o Over 90% of ADI's Russian business is through owned retail stores
  • o Price increases will be used to offset this impact though only minor
  • o We estimate that Russia represents ~10% of the NKE's EMEA sales equating to <3% of total sales.


  • ~50bps due to the promotional environment
  • o 50% of this is a company specific issue related to bloated inventories in China


Higher operating expenses were entirely company specific as detailed in the slide below. As it relates to sales, ADI announced on their Q2 F2008 call in March that they are no longer providing backlog numbers limiting read through on a regional basis (convenient when business is tanking); However, management remarked that emerging markets (up 16%) are expected to outperform all other markets in 2009. Not tough for emerging markets to outperform when major markets like the US are down double digits.


The Hindenburg of Footwear - ADI Rest.


The Hindenburg of Footwear - ADS S 5 09


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The Yield Curve


Position: post the most recent weakness in the Treasury market, we covered the etf SHY today, but will re-short Treasuries on strength


The yield curve has been flashing in our notebooks over the last few months, especially relative to where it was at the start of the year.  We focus on the spread between 10s and 2s, which has widened from 158 basis points to 221 basis points from January 2nd 2009 to May 2st 2009.  As interestingly, the long end of the curve, specifically 30-years, has risen from 2.83% to 4.09%, or 126 basis points since the start of the year.


Historically, the 20-year Treasury bond yield averages approximately 200 bps above three-month Treasury bills.  At the start of the year, this spread was 316 bps and is now 398 bps, or an increase of 26%.  The standard interpretation of this steepening is that an economic recovery has become more likely and with this recovery there is an increased expectation of inflation.  Interestingly, the SP500 closed January 2nd at 929.6 versus its current price of 899, despite the fact that the yield curve is actually signaling that an economic recovery is more likely within a shorter duration.  In effect, the bond market is signaling an economic recovery, while the equity market is more uncertain. (Hint: Equity usually isn't the leading indicator.)


Aside from an expectation of an economic recovery and the related inflationary impacts, there has been a massive increase in the issuance of U.S. government debt over the last 6-months, which are naturally driving up rates.  According to Wrightson ICAP, the federal deficit is running at $956.8BN, or nearly one seventh of GDP, which is a level last seen in the mid 1940s.  In addition, according to the New York Times on May 3, 2009, "for all of 2009, the administration probably needs to borrow about $2 trillion." However we slice the numbers, the increase of U.S. government debt in 2009 will be massive and will come only with higher interest rates.


From a purely supply / demand perspective, the Federal Reserve announced in their March 18th release that they intend to purchase $300 billion of 2 and 10-year treasuries over the next 6 months to "improve conditions in private credit markets". To put this in context, the largest foreign owner of U.S. treasuries (China, or The Client) owns ~$750BN, so this is massive incremental demand.  The implication of this is that rates will be held artificially low while this purchasing program is being undertaken, but should naturally increase after its completion.  This incremental demand from the government is the lever that has likely kept rates at such low levels despite the dramatic increase in U.S. government debt that is anticipated. 


From a pure risk/reward perspective, it is hard to imagine that there is much downside to being short the short end of the yield curve with rates at all time low levels.  There is only one direction that these short term rates can go from a rate that is effectively zero - UP!  Now I know gentleman prefer bonds, but I also know that when interest rates go up, bonds go down.


Daryl Jones
Managing Director


The Yield Curve - a1


WYNN 1Q09 Earnings call:


Vegas commentary:


"I'm still going to be a little reticent... I'm not sure if the stimulus package is in effect yet"

  • "I am cautiously optimistic that we have reached the bottom"
  • "Booking window used to be 60-90, then collapsed, then in April they saw it begin to widen"
  • Back in the 90s occupancy
  • Avoided the rampant layoffs that competitors have done, instead WYNN has adopted a shared pain approach that was more gradual to take out 75-100MM of expenses, and we're seeing it in the results
  • How long will this downturn last? He thinks that people will want to go back to their normal behavior and that things need to get worse from here for things not to get better
  • Job creation / unemployment is the #1 driver of Vegas visitation once that stabilizes and starts getting better, Vegas will rebound
  • In January they were really focused on launching Encore and once they got that done they focused on cost savings and operations in Feb & March
  • In March they focused on business mix and trialed a bunch of different strategies to see what works and are evaluating that. But think that if you look at March as a normalized level - they would have reported approx 70MM of EBITDA
  • Things have been stable for the last six weeks
  • Hotel booking window is still a lot shorter than last year, so they still have very limited visibility


General Commentary:

  • Seeing very strong weekends in both Macau & Vegas - this past weekend. In general weekends aren't bad for them



  • Holding in better than the US
  • Junket operators are being more conservative in their lending
  • Things are trending up in terms of volume
  • Slot programs are going from strength to strength
  • May should be strong from a calendar standpoint
  • Overall things have been steady there
  • Think that the first quarter was also hurt by a pullback in credit extension (also in Vegas)
  • The customers in China are still coming and spending - just being more careful with their spend
  • Macau Encore - will receive the building permit in April 30, 2010 - wants to open everything at once, so plan a grand opening in May. 405 all suite rooms - smallest room is 1000 SQFT - completely contained space with casino, hotel, restaurants, retail.



  • Think that a normalized March would amount to 72MM EBITDA for the quarter
  • Macau hold impact on EBITDA - just apply the junket margin at 3% to get a normalized EBITDA
  • Wouldn't describe themselves as aggressive shoppers unless there is a transaction that is clearly attractive to shareholders (right price & right fit or totally not competitive with their current product)
    • Thinks that the whole Bellagio article from the Milken conference was exaggerate
    • There is no transaction in the works now
  • Was Encore positive cash flow on its own this quarter?
    • Decided to treat Nevada as a group - same as for Macau
  • No change in the April rate, more focused on getting people to spend money at the hotel once they are there
  • Once the weekends start selling out it is a sign that things are getting better but the convention side is still weak and don't expect it to change until the end of the year
  • Affect of stimulus in China - It hits way faster in China
    • Lower tier of Guandong were out of work and now they are getting better
    • Visitors / Visa - no formal visa change - but signs of relaxation. No shortage of people coming - line takes hours to get through
    • There has been a formal relaxation from Shenguen and Hong Kong
  • Raised equity to make sure that they can focus their efforts on everything but the balance sheet
  • Effect of CityCenter: Aria
    • Isn't worried about what goes on outside his building

Bidding For A Bernanke Buck?

Until they finally let Volcker speak on May 20th, Ben Bernanke is literally the only person that the US Government  can put on the You Tubes right now with the end result of the US Dollar arresting it's decline.


The more we see the likes of Timmy Geithner, Hank Paulson, Kenny Lewis, etc... (basically anyone who is conflicted and compromised by their long standing membership in de Club) the lower the US Dollar will go.


Today, Bernanke is back on the Tube, issuing the world some long awaited American credibility. As a result, the US Dollar stops going down, and stocks stop going up.


I know, its perverse... and I know, every time I write this I get the customary "that doesn't sound right" feedback... But know this - the inverse correlation between the US Dollar and US stocks is as relevant in 2009 as any inverse correlation in global macro.


Can Bernanke Break the Buck? Sure - he needs to buy a mother load of bonds though in order to accomplish that from here because the Chinese don't look to be as excited about "investing alongside" the USA as they used to be... would you be?


China selling Treasuries (or not buying them) and Bernanke buying them back are not 1:1 offsetting factors either. This is very complicated and will continue to be as long as the Chinese continue with this US Dollar Replacement Rhetoric. Rhetoric and reality are often two very different things...


Economic recovery, and the associated raising of interest rates here in the USA can also provide the Buck a bid. For now, on the American side of the ledger at least, I am not comfortable saying that this morning's ISM Non-Manufacturing recovery (see chart below) is going to be sustained through the summer months. 


Where does this chart and the US stock market go from here? I am, data dependent. As the facts roll onto the tape, fully loaded from moves in the US Dollar to the yield curve, I will adjust my positioning. For now, the best position is to have sold yesterday's rally, and wait...


Keith R. McCullough
Chief Executive Officer


Bidding For A Bernanke Buck?  - bus