The New Jersey Division of Gaming Enforcement determined that Pansy Ho, MGM's Joint Venture Partner in Macau, was unsuitable.  The Division can only make recommendations and the final determination will come from the New Jersey Gaming Commission.  While Nevada has already signed off on the deal, New Jersey is flexing its muscles.  This was always a risk for MGM but it seemed to matter more when expectations for MGM Macau were much higher. 


If the Commission follows the Division's recommendations, MGM will be forced to exit its JV in Macau or its JV in Atlantic City (The Borgata with BYD).  Exiting the former is more likely.  The good news for MGM is that MGM Macau generated less than $100 million in EBITDA over the past 12 months, well below initial expectations of $200-300 million.  The property is clearly worth much more than the current EBITDA run rate would suggest.  Due to the forced nature of the sale, MGM will likely receive less than the property is worth.  However, due to the depressed nature of the EBITDA, net proceeds will still be a large multiple of current EBITDA, meaning the transaction will likely be deleveraging. 


The negative for MGM is that they may have to give up future growth opportunities in Macau, same store revenue and new store growth.  However, it is doubtful that there is much Macau value residing in MGM's stock.

Buck Is Barking

"Here was neither peace, nor rest, nor a moment's safety. All was confusion and action, and every moment life and limb were in peril."
-Jack London, The Call of the Wild
One of America's finest novelists, Jack London, wrote this book in 1903. The story is basically about a dog named "Buck" who gets thrown into the wild. Gone were the days of his sheltered and pampered life. Ole Buck was thrown out into the cold of the northern Yukon, left to fight for himself amongst gold diggers and wild animals. What a metaphor for Wall Street in 2009...
As I was eating lunch yesterday, and saw CNBC flash "The Call Of the Wild" across the screen, I almost fell off my chair. I turned on the volume (I try to keep this channel perpetually on mute), and there was Larry Kudlow barking his political bias' under this banner... It's sad, but only fitting that this children's story is one of his networks new calling cards. Re-read the quote above - how perfectly that describes what someone who doesn't speak English must think when the volume is actually on listening to these people.
When all is "confusion and action" what is one to do? Pray? If one senselessly chases this tape without an investment process, that's actually not a bad idea. I'm thinking Buck's barking might have some value add here.
The real Buck that matters to this market is the US Dollar. Kudlow doesn't get this yet, but it will get harder and harder for him and his circus act to ignore as recognized economists like Ken Rogoff (former chief of the IMF) and Greg Mankiw (Washington advisor) get on board with my call to Break The Buck. Rogoff has written some fantastic economic history of crisis' as of late, and this morning Bloomberg has him in print saying he thinks the USA needs something on the order of 6% inflation "for at least a couple of years." Wow Kenny, if you weren't a Harvard man now, they might start saying this is The Call of the Wild!
The folks up in New Haven are quite accustomed to my barking about Breaking The Buck. As Washington/Wall Street groupthink is strangled by Keynesian thought, there is this Old Yeller of a Yale Economist by the name of Irving Fisher whose thoughts on ending deflation have been largely ignored. But as we macro men and women know all too well, because global economic facts (like say R-squares, inverse correlations, etc...) are ignored certainly doesn't mean that they cease to exist.
The New Reality is this: the price for compromising the American Financial System's credibility is expressed on a marked-to-market basis by her currency. As the US Dollar breaks down like it did intraday yesterday, asset prices from commodities to stocks that are priced in those fiat moneys REFLATE.
No, this doesn't end well. But for now, fiduciaries of other people's hard earned capital are tasked with trading the market that is in front of them. If you pressed the low volume lows from last Friday on the short side of the Financials (XLF) or Consumer Discretionary stocks (XLY), by yesterday's market close you rightly felt shame.
Managing risk in an interconnected global marketplace like we have here in 2009 is not to be done passively. Either proactively prepare for risk working both ways or suffer the Calls Of the Emotional Wild and react as markets melt-up/down.
Breaking The Buck will continue to pressure the shorts to cover. Yesterday's volume was up +26% on a day-over-day basis versus Friday's low volume selloff. The SP500 closed +3% yesterday, taking its rise from the ashes of the Depressionista March 9th consensus fear to +34.5%. If being long US Technology (XLK) or US Consumer Discretionary stocks (XLY) that are now +12% and +8%, respectively, for 2009 YTD, doesn't tickle your fancy, try Russia.
Russia? Yes, that big old freezing bear hunter of a country that was left for dead... just like Jack London's "Buck". It's not just Americans who are levered to the DOWN Boy! DOLLAR trade who get paid here. The Russians, Canadians, and Saudis all get paid in petrodollars don't forget. Russia's stock market is currently trading up another +4% so far in European trading this morning, taking it to +54.8% YTD!
Never forget that the US Dollar serving as the world's global currency reserve is not perpetual entitlement. In the FT this morning there's an article outlining how both China and Brazil are moving forward on settling their trade deals in their home currencies. In Hong Kong, both the Bank of East Asia and HSBC just won approval to issue Chinese Yuan based bonds. What does all this mean? Down boy! Down Buck, Down!
When you are measuring risk and the real stress that lies out on the tails of a legitimate global risk manager's sheets, don't get sucked into all that is born out of the manic media's "confusion and action." As the Buck breaks down, risk builds on the short side of your book and I, for one, will keep barking at you to understand that.
My immediate term upside target for the SP500 is the YTD high up at 934. With my downside support at 877 (a higher low), the immediate term risk/reward to owning stocks today is about even. Being long ahead of yesterday's meltup was the shot that we wanted you to take. As prices change, I will.
Best of luck out there today,



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.

XLE - SPDR Energy- We bought Energy on 5/13 with the dollar up. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

XLY - SPDR Consumer Discretionary-The TREND and TRADE are bullish for XLY.  The US economy is showing faint signs the steep plunge in economic activity that began last fall is starting to level off and things are better that toxic.  We've been saying since early January that housing will bottom in 2Q09 and that "free money" for the financial system will marginally improve the US economy in 2H09, allowing early cycle stocks to outperform.  The XLY is a great way to play the early cycle thesis.

CAF - Morgan Stanley China Fund- A close end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package.  To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

EWD - iShares Sweden-We bought Sweden on 5/11 with the etf down on the day and as a hedge against our Swiss short position. From a fundamental setup, we're bullish on Sweden. The country issued a large stimulus package to combat its economic downturn and the central bank has effectively used interest rate cuts to manage its economy. Sweden's sovereign debt holds a strong AAA rating despite Swedish banks being primary lenders to the Baltic states. We expect Sweden to benefit from export demand as global economies heat up.

XLK - SPDR Technology - Technology looks positive on a TREND and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last eight weeks.   As the world demand environment becomes more predictable, M&A should pick up given cash rich balance sheets in this sector (and the game changing ORCL-JAVA deal). The other big potential catalyst is that Technology benefits from various stimulus packages throughout the globe - from China to USA. Technology will benefit from direct and indirect investments.

XLV - SPDR Healthcare-Healthcare looks positive from a TRADE and TREND duration. We've been on the sidelines for the last few months, but bought XLV on a down day on 5/11 to get long the safety trade. 
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.  


UUP - U.S. Dollar Index -We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for thegreenback. The Euro is up versus the USD at $1.3624. The USD is up versus the Yen at 96.3400 and down versus the Pound at $1.5462 as of 6am today.
EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  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.
IFN -The India Fund-We have had a consistently negative bias on Indian equities since we launched the firm early last year. Despite recent election results likely proving to be a positive catalyst, long-term 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.



It's not all ball bearings these days, Fletch.  And it's not all Video Reel either.  As the following chart shows, almost 60% of the 950,000 slot machines on casino floor in North America are Reel Spinning and Video Poker machines.  Nobody is replacing the Steady Eddie Video Poker until the machine physically disintegrates.  Aside from video poker, the oldest machines are almost all Reel Spinning. 




The shelf life of Video Reels is less than half of a Reel Spinner.  I'm not talking about functional life, but life as a contributor above the house average play level.  Virtually all of the replacement demand we've seen in the last few years has been on the Video Reel side.  My contention is that once the operators' balance sheets are in order - they are on their way thanks to the opening of the credit/equity markets - the old Reel Spinners will be replaced fairly quickly.


The good news for IGT is that they dominate the Reel Spinning market.  It is likely that most of the old Reel Spinners will be replaced by new Reel Spinners.  Video Reels have probably replaced as close to all the Reel Spinners the will ever replace.  There remains player demand for Reel Spinners, especially now with the advent of 5 Reels versus the traditional 3 Reels.  Incidentally, the only video product that could replace a Reel Spinner is IGT's Multi Layer Display game that looks like a Reel Spinner.  We've gotten very good feedback on the performance of these products.


We've made the case that improving balance sheets should finally expedite the re-acceleration of the replacement cycle (5/15 - "IGT: MGM, CREDIT MARKETS, AND REPLACEMENT DEMAND").  The casino floor is as old as it has been since 2001 and the age is concentrated in the Reel Spinning category.  IGT could generate well above its normal share in a recovery.

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Lodging EV/EBITDA multiples appear to inversely track cost of capital more closely than for gaming operators.  Not only is the R Square higher but there is no lag on the causal relationship.  In other words, cost of capital changes get immediately reflected in the lodging multiple.  One explanation for this might be the real estate nature of the lodging business.  As bond yields rise, high dividend stocks tend to underperform.  REIT's pay large dividends.




So where does that leave the multiples?  As can be seen on the chart, at the end of April trailing EV/EBITDA multiples were close to historical lows.  This seems appropriate given the sharp rise in borrowing costs.  However, industry EBITDA may be down 35% in 2009 and another 10% in 2010 which renders the trailing EV/EBITDA somewhat irrelevant.  Here we defer to our prior analysis that found forward lodging multiples to be reasonable at best, even if 2009 is trough EBITDA (we don't think it is).  HOT and MAR are trading at 10.5x and 11.5 our 2010 EV/EBITDA estimates, respectively.

KONA: Penney Nails Another One!

The stock is up over +72% today on a takeout offer. Howard Penney is having what we call a BIG year!

Chart Of The Week: Consumption Candy


Lost in last week's noise was the context of this critical chart. Consumer Price Inflation (CPI) for the month of April hit its lowest year-over-year level since 1955. Been shopping for a house or pair of oven mitts lately?


Does it matter? Don't ask your local short seller of everything consensus on the US Consumer - ask the stocks - they don't lie. Inclusive of today's +3.75% short squeeze remix of the Consumer Discretionary dance (XLY), this sector is up +6.5% for 2009 to-date. Being right on this sector (not being short) has made for big years for plenty a Research Edge subscriber. We salute you!


So should I fear my own crash call that I used to make on this sector, or should I smile? Days like today are a stiff reminder to the consensus crowd that their ideas are just that; and quantified by nosebleed levels of short interest. The New Reality is that our bearish catalyst on Consumer stocks for most of 2007-2008 now becomes a bullish one - it's called an "easy compare."


The end of 64 consecutive quarters of positive US Consumer Spending is now way back in the rear view mirror and, importantly, the negative "comps" associated with that positive spending streak going negative (Q3 and Q4 of 2008) is front and center on our macro screens.


What could spoil a recovery in nominal consumer spending? That's easy - and anyone not sleeping under a rock right now has the answer = INFLATION.


When does the macro short seller of everything consumer on 1970's style inflation get paid? Mostly in 1979, and maybe in 2010... but not right here and now in 2009. I am an avid short seller, and I assure you that I will be there when I think the time is right.


Looking at the chart below should give one a real sense of where the deflationary numbers really are for the US consumer as opposed to the rhetorical and consensus fears. These consumer prices, to the strong and the brave who wear the red, white, and blue (sans le leverage), are what we call Consumption Candy.



Keith R. McCullough
Chief Executive Officer


Chart Of The Week: Consumption Candy - fed1

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