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Retail Chart of the Week

Check out the consumption divergence below. Apparel and footwear continues to recover nicely, but furniture and household equipment flat-out tanked. The soft goods component of the Home category remains strong (BBBY, WSM), but the higher-ticket durables and furniture took a meaningful step-down. There are so many 'what if' scenarios. With tax checks coming earlier this year on top of deferred wardrobe upgrading and an early Easter, perhaps apparel is seeing disproportionate share gain in total PCE. Perhaps beneath all the noise people remain flat-out afraid to spend on high ticket items. Either way, this is something to watch.


Retail Chart of the Week - 5 17 2009 9 19 15 PM

Don’t Look Through This!

The latest month's data (March) shows the greatest diversion we've seen in cost vs. consumer price in almost four years. A measly $0.35 per garment might not seem like much. But For an industry that sells 19bn units per year, that extra $0.35 per unit comes out to an incremental $560mm in profit that was freed up in the apparel retail supply chain. This was not a onetime event, and plays into our 2H margin call.


There are two components of the CPI that are misunderstood.


1) The yy change in CPI for a given category is meaningless without looking at the cost side of the equation to manufacture and import. The rate at which one changes compared to the other is what is the primary margin driver is for the supply chain. (I.e. I am fine with a given increase in costs as long as the consumer is willing to pay for it and then some).


2) Wall Street looks at CPI based on a yy % change. This is flat-out wrong - at least in retail. Why? In apparel, for example, the average import cost is $3.50, while the average retail price is around $10. We'd need roughly 3x the % change in import costs to equal the same percent change at retail. This makes the positive divergence in the chart below even more noteworthy.


Don’t Look Through This!  - 5 17 2009 9 22 04 PM


January 2007, it was a glorious time.  The stock market was coming off a 14% gain in 2006.  The credit markets were wide open.  IGT's stock almost reached $50, a near double in a little over a year.  Optimism was effusive.  SBG (that's Server Based Gaming for those of you who've forgotten already) was going to revolutionize the slot business and spark another massive replacement cycle, mostly to the benefit of IGT.  Investors ignored IGT's declining market share and lack of actual, concrete visibility on the timing of SBG.


Fast forward to the present and SBG discussions are nowhere to be found.  IGT's stock has plummeted to $13.60.  Market share degradation and a lack of replacement demand dominate the IGT discourse. We think we've found reason to change that discourse.  As we wrote about in our 5/15/09 note, "IGT: MGM, CREDIT MARKETS, AND REPLACEMENT DEMAND", the improving balance sheets of the operators should expedite the re-acceleration of replacement demand.  This note focuses on our old friend SBG and its potential impact on market share.


Conceptually, it makes sense for casinos to want the ability to extend the functional life of expensive hardware and only "replace" the software.  The flexibility afforded the operator in terms of game and denominational choice should be a revenue driver and a cost cutter.  I don't know when and how deep SBG will penetrate casino floors.  I do have some thoughts on the impact of SBG on market share, however.


SBG could be a positive for IGT's market share.  In a SBG world, an IGT game will only be downloadable to an IGT box, a WMS game will only be downloadable to a WMS box, etc.  If I'm a casino operator, do I want to give more of my casino floor to a niche, hit-driven game developer such as WMS?  That is a risky strategy given the lack of breadth in that company's game library.  With IGT, I know there'll always be some "hot" titles and some "not so hot".  There will be more frequent game introductions from IGT.  In other words, the casino probably doesn't want to lock into a niche developer for more than a niche floor share.  This should have the effect of at least stabilizing IGT's share and probably increasing it, as the bill acceptor and ticket-in/ticket-out technology changers did in the years prior.


SBG remains a long-term positive catalyst for the industry.  We haven't addressed all of the reasons why, such as higher margins, lower capital intensity, more consistent revenues, etc. which will benefit all of the slot technology companies.  In terms of market share though, SBG should favor the big guy.

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Proposed Derivatives Rules Seen As Change Equation For Banks

Right Said Ted


When I mentioned that I wanted to write a note on the Ted Spread to my Macro colleagues this morning, Andrew Barber rightly questioned whether it was a unique thought given that it was a top story on Bloomberg this morning.  I'm not necessarily sure it is a unique thought, but I do think it is important for all equity investors to be well aware where this key measure of risk is trading. 


As of today, the Ted Spread had narrowed to 69 basis points, which is a level not last seen since August 9th, 2007 (and we've outlined in the chart below).  We cannot say enough times, while the patient (being global equity markets) may still be in the hospital, the world is a dramatically different place than November of 2008 when the Ted Spread was over 400 basis points.


The Ted Spread and the steepening yield curve chart we showed earlier this week are most relevant for one sector, financials.   As was noted in our Sector View this morning, financials are in a positive TREND.  As Keith pointedly said, "I won't short them."  We might not be long, but not being short is a signal in and of itself. 


The rate at which commercial banks can borrow money is at a multi-year low and the yield curve is at a multi-year high in terms of steepness, which enables banks to borrow long and lend short for a reasonable profit.  While I'm certainly no financials analyst, both the Ted Spread and shape of the yield curve are fundamental positives that anyone trying to short the financials should have front and center.


We borrowed the title from English pop band, Right Said Fred, who were best known for their hit, "I'm Too Sexy."  The Ted Spread is speaking loud and clear and while looking at credit spreads may not be sexy or unique, when they speak, we listen.


Daryl G. Jones

Managing Director


Right Said Ted - ted1


Right Said Ted - ted2


Press reports indicate that LVS is pursuing a Macau IPO on Hong Kong exchange through Goldman Sachs.  As we pointed out in our 5/7 LVS note, "LVS: DON'T EXPECT A NEAR TERM ASSET SALE", we've been hearing that asset sales are not imminent, so an IPO announcement would confirm that to some extent.  We've had discussions with LVS management regarding this very topic over the last two months.  It was always an option but valuations were too low.  That may no longer be the case.  However, our sources indicate that the IPO timing may not be imminent either.  There are still quite a few legal hurdles to cross.


Here is our quick analysis.



  • Pro-rata allocation of corporate overhead
  • 9x EBITDA multiple on 2010
  • No value for undeveloped parcels (Sites 5, 6, 7, 8, 3)


We have $724MM of EBITDAR, net of corporate expense, equating to $6.5BN of enterprise value. Subtracting $3.2 BN of debt, less $525MM of estimated cash at the Macau entity, gets us to $3.8BN of equity value or $5.84 per share or $5/share on a present value basis. 


To avoid a covenant breach in 2010, when the leverage covenant steps down to 3.0x, LVS needs at least $250MM of cash (even if they used all their cash on hand to reduce debt).  However, they cannot really leave themselves without liquidity, so realistically they need about $500MM.  If they want to resume construction on Sites 5 and 6, they need about $750MM.   We also have them breaching in 3Q09 and 4Q09 - however, they have enough cash on hand to cure the breach - despite leaving themselves with low liquidity.


If you assume they need to raise about $750MM, that equates to a 20% IPO of the Macau entity (using our numbers).  We assume this will simply show up as minority interest although they can do a variety of different structures, including spinning off the entire entity and issuing shares back to current holders...  In any event, if they create a separate trading vehicle for LVS Macau, then it may "unlock some value" at that entity.  However, this was obviously a more relevant catalyst for the stock when it was trading at $2 vs its current price.  There are other examples of stub equities that haven't done anything for a company's valuation (like MPEL/242 HK) as well as a host of other examples where it doesn't matter.  We think that this is just another way for LVS to avoid a covenant breach/incremental interest in Macau, but more importantly it will provide them with enough liquidity to resume construction and perhaps salvage some of their sunk costs.

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