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Preliminary thoughts:


  • EPS of $0.15 beat our Street high estimate of $0.13 and the Street at $0.08
  • Solid top line and bottom line beat
  • Exceeded our EBITDA estimate at every property and region, except LV locals which was in-line
  • Numbers like this take the covenant issue out of play (BYD could still de-lever by buying back discounted bonds if they need to)
  • Forward commentary corroborates "less bad" thesis
  • "In our Las Vegas Locals region, we are beginning to see signs of stabilization" - cracks the last pole of the short thesis tent
  • Our FCF projection per share projection of $2.90 may go higher
  • Despite the huge run, a FCF yield of 25% suggests BYD's stock could still double from here

Willfully Blind

"I hear and I forget. I see and I remember. I do and I understand."

When you proactively prepare for fundamentals to turn out a certain way, and they end up doing so... one of the hardest things to do in this business is sell on the news. Now that our calls on housing, employment, and Chinese demand are no longer contrarian, this is where my head is at.

Whether it was Ben Bernanke echoing Howard Penney's Q2 US Housing bottom call yesterday, or the People's Bank of China reminding the world overnight that China has "ample liquidity" to keep their stock market ripping to higher YTD highs (+42.4% after last night's close), it's all one and the same - it's consensus finally catching up with The New Reality. These things take time. These are the days of our lives...

Pardon the American soap opera one-liner there; God knows you heard enough of it yesterday with Bernanke testifying in Washington - but we road warriors of the Canadian Junior Hockey travel circuit are resident pros in watching Days of Our Lives, The Young And The Restless, etc... I know... its embarrassing...

While I could say that this morning's top read story on Bloomberg is embarrassing, I think I can only summarize it as being sad: "Bank of America Said to Need $34 Billion in New Capital After Stress Tests" is the headline and, as importantly, the underpinning of the story is based on "a person familiar with the situation" - or, in commoner speak, someone who has inside information.

Reminding you that Kenny Lewis' lack of a leadership spine or John Thain taking advantage of a conflicted US Financial system that he and his boys In De Club created isn't what is incrementally disheartening anymore - America has been there, and been ashamed of that. What's saddening, on the margin, is as sad does... and that's quite simply having learned nothing from what got us in this royal mess in the first place - the compromise of the American Financial system's credibility.

This, sadly, is not a New Reality. People have made millions trading on inside information in this country for generations. The only difference between today and 90 years ago is that now we have a manic media that perpetuates it, and a community of moral-less "money makers" who profit from the media's ignorance. It's sad...

The world's YouTube isn't as deaf as the US Government is willfully blind. The world issues a global vote on this revelation of American malfeasance daily, selling the one thing that the United States of America has left in terms of global financial leadership - the US Dollar.

In a perverse way, the output of all this has been very bullish for the short term TRADE in the US stock market. As the Dollar breaks down, stocks breakout. Anything that's based in Dollars REFLATES. Even CNBC has figured that out at this point.

Whenever you want to understand why the moral code of conduct can be rendered fuzzier than someone living in the land of nod might hope, just follow the money. Follow who gets paid, and how.

So, who gets paid if the Dollar breaks down?

1.       Americans, via the value of their home and/or 401k
2.       Russians, Saudis, Canadians, etc. - anyone who is paid in petrodollars
3.       Debtors - over 53% of the world's debt is held in bucks

So when someone whines and stresses about these things that anyone operating professionally in global markets has always known to be the way that it is, tell them to wake up and smell the coffee - from Wall Street to Washington, the compromised of De Club have been highly compensated to "hear and forget"...

In the IMMEDIATE term, while "I see and I remember" and " I do and I understand", all I can really do is be aware of the game that I have willfully chosen to play in. I am aware that the rules of this game are made up as we go along. I am aware of who gets paid for being willfully blind.

In the IMMEDIATE term, I am cautious about "getting longer of" US stocks, because at the 911 resistance line of the SP500 I can proactively predict that I will be sending a note out to my clients that I will be a seller.

In the INTERMEDIATE term, do I think that we can continue to see higher lows and higher highs in the US stock market? For sure, particularly if our compromising the trust embedded in this country's handshake equates to lower lows in the US Dollar. That's just how REFLATION works.

In the LONG term, however, if we all don't stop what it is that the world is seeing us do here, the US Financial System will be dead.

Best of luck out there today,



VXX - iPath VIX- The VIX is inversely correlated to the performance of US stock markets. For a TRADE we bought some of the Street's emotion on 5/4, getting long their fear of being squeezed.

EWA - iShares Australia-EWA has a nice dividend yieldof 7.54% on the trailing 12-months.  With interest rates at 3.00% (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.

TIP - iShares TIPS-The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD - SPDR Gold-We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.  


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




EWW - iShares Mexico- We're short Mexico due in part to the media's manic Swine flu fear. The etf was up 7% on 5/4, giving us a great entry point.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. 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.

DIA  - Diamonds Trust- We shorted the Dow on 5/4 for a TRADE. Everything has a time and price. 

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.

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%.  


EWL - iShares Switzerland - We believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials.  Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.


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

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.51%
  • SHORT SIGNALS 78.32%

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


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

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