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Margins drive a small beat. Not enough confidence in FQ4 - you can fit the Fed balance sheet in the guidance range




  • NA Machine sales outperformed; continue to capture Canadian VLT market share.
  • DoubleDown recently surpassed Zynga Poker as the top grossing social casino app on Facebook
    • Had the highest grossing social casino app on the iPad
  • 39% increase in NA replacement unit shipments; confident maintained leading ship share in past quarter
  • 4% increase in international sales due to lower mix of used machines sales.  Despite ongoing challenges in certain regions, there is still significant potential.
  • Gaming Ops:  
    • GGR trends were lower  
    • Installed base flat with some mix shift away from megaJackpots into leased operations
    • Positive interest rates have a favorable impact on margins and jackpot expenses
    • Initiatives: Increasing megaJackpot team, introducing game changers
  • DoubleDown monetizing at awesome rates; mobile revenues up 41% sequentially.  DoubleDown will be GAAP accretive in F1Q 2014.
  • Repurchases 345,000 shares ($6MM); suspended stock buyback in the quarter due to 'technical reasons' - IGT was probably involved in bidding for WMS and SHFL

Q & A

  • Product Sales:  2Q Canadian VLT units: 3,300; Illinois VGT units: 1,300
  • 2014 opportunities:  Oregon and some other new states 
  • DoubleDown:  As they enter international markets, bookings rate may be pressured but it didn't materialize in F3Q
  • Wide range of F4Q guidance:  some lumpiness in timing of international orders for F4Q
  • Stock buyback restrictions in Q?  Refuse to elaborate.  $520MM in stock available; continue to target using that authorization over next 2-4 years.
  • Leverage:  a little underleveraged at the moment
  • Will not comment on whether they continue to be restricted in the stock buyback program
  • Will look at opportunities to expand installed base but will not chase yield
  • GGR trends:  calendar 2H 2013 - haven't seen much change in operators' comments in terms of budget volume. 
  • Last major shipment to Canada will conclude next quarter.  Expect FQ4 will be less robust than FQ3.
  • Would not say that 1,300 a quarter in Illinois is a good run rate because last quarter, IGT saw a significant contraction in demand.
  • GGR is having most significant pressure on yield #s. Nothing significant has changed in this part of the business.
  • Canadian/Illinois VLT units mainly drove down ASPs; there was some mix shift out of MLD product which is a higher priced product.
  • Online New Jersey:  waiting for the operators to start up; purely in a B-to-B model with a revenue share model
  • Upgraded DoubleDown poker product and done well with tournaments.
  • International market monetizes at a lower rate than domestic market but will try to convert players at the same level in domestic market.  The launch of new languages will be a tailwind.
  • Mobile growth has been fantastic.  IGT has spent equal time commitment on desktop and mobile platforms. 
  • MegaJackpot G2E lineup will be exciting and diverse e.g. bonus features, new maps, new display format.
  • International:  optimistic on seeing the 6% growth in ASP and growth in installed base
  • South America could be a great opportunity if they can solve the structural issues of getting a product there
  • Asia:  early games have been a success
  • Europe: growing the slowest among the international opportunities;  'very spotty' and depends on the country and product type.  VLTs seem to be growing a bit faster than the traditional casino business. Remain bullish on the international markets.


Last week Hedgeye presented its Q3 2013 Macro Themes call for institutional clients, introducing the three major themes our Macro team has identified as significant drivers of investment strategy for the current quarter.



As a review, our Q2 Macro themes were:

  • #StrongDollar – The Dollar continues to reverse what has been a forty-year slide.  Renewed strength in the currency keeps pushing ahead despite Bernanke’s policy statements designed to weaken the Buck.
  • #GrowthAccelerating – Hedgeye has tracked significant growth in a number of key sectors, including declining unemployment, strength in the housing market, and an upturn in the birth rate, reversing a forty-year decline and leading to a boost in new household formation.
  • #EmergingOutflows – The BRICs are BROKEN, even “stable” countries like Turkey are in the grip of unrest.  The US is once again the safe haven.

The Macro View

Macro trends are sensitive to government policy.  When governments meddle in the financial markets, they compress natural market and economic cycles.  This causes volatility to spike – free money for short-term high-frequency traders (especially those who get economic news a few seconds early), and a trigger for waves of nausea for the individual investor.


But while high-frequency traders focus on specific economic numbers, scalping a few pennies on a short-term lift in Financial stocks when the Fed looks dovish, Hedgeye’s broad Macro work focuses on rates of change in the economy.  A public statement from Ben Bernanke may provide shot term profits for algorithmic traders, but it’s not a signpost to America’s economic future.  Nor is it anything the individual investor can rely on. 


Our analysis focuses on rates of change – we look at theslope of the line, the cumulative rate of change over time in key economic indicators.  If you track rates of change, you will see where the growth comes from – or fails to come from.  If you know where the growth is in the economy, you can position yourself to succeed as a long-term investor.

Hedgeye’s  Macro Themes for Q3 2013:

  • #RatesRising
  • #DebtDeflation
  • #AsianContagion

Our themes are simple.  The dollar has been strengthening.  Meanwhile housing, employment and consumption have all been surprising to the upside – not major blow-out numbers, but the slope of the line is definitely in the direction of Growth.  In this environment, Fed “tapering” is a pathetically weak dog wagged by a potent tail: interest rates are rising, the Dollar doesn’t want to go down, and growth has taken root in key areas of the economy.


Throughout the Middle Ages, the most educated people in Europe were convinced the sun rotated around the earth.  Today we chuckle derisively at how they could reject proofs from the likes of Copernicus and Galileo.  In the face of real signs of accelerating growth, Bernanke is behaving like the Defender of the Faith, as though he had the authority to direct gravity.  He needs to have his King Canute moment and publicly allow the sea to wash over him.  We’re convinced the waves are about to break.


Here we offer the first of our three Macro Themes, Rates Rising.  



‘POP!’ goes the bubble as interest rates start to rise, reversing the most asymmetrical set of relationships on our Macro screen.  The gradual decline in rates that has prevailed for forty years is turning.  Like the Queen Mary, it turns ponderously – so slowly that at times you can’t tell it’s reversing course.  As the slope for interest rates turns up, so much that has been tied to declining rates will unravel.  Hedgeye continues to emphasize this on our bearish call on commodities.


Keith went out on a Macro limb and said we are not likely to see the 2012 lows on ten-year bond yields again.  Not soon, and maybe not ever.  With longer-term historical rates averaging over 6%, there’s more than four hundred basis points – over four full percentage points – for rates to reflate as the 40-year bonds bubble pops without entering the historical Danger Zone for inflation.  Hedgeye expects the bond bubble to melt over the coming 3-5 years.


What’s an Investor to Do?

Keith digs into the historical record and shows that rising interest rates are not the enemy of economic growth.  To the contrary, historically there is a high coincidence of rising bond yields during periods of high economic growth.  Mr. Bernanke’s fear mongering notwithstanding, there’s no reason to believe it has to be any different today.


In a growth environment, as characterized by rising 10-year bond yields and a strengthening Dollar, Consumer Discretionary and Financial stocks tend to perform well, along with Industrials and, to a lesser extent, Energy.  Yield plays – notably Utilities – are at a disadvantage, as increases in current yields are offset by declines in the price of the stocks.


But Growth isn’t Good News yet, as too many major investors have large portfolios based on declining rates – and short-term traders are enamored of the volatility created by Fed uncertainty.


To us, the problem continues to be political.  Wall Street boasts many of Washington’s biggest donors, money managers and bankers whose largesse in recent years has come from the built-in guaranteed profits of declining rates, as they repeatedly locked in the spread between 10-year Treasurys and 2-years.  Like the Fed, a lot of these folks hold an awful lot of fixed income paper – Treasurys, but also corporate, and even mortgages – all of which will decline in price as rates climb.  Unlike the Fed, they can’t print their own money to remain liquid.  Write-downs on these bond portfolios could get ugly.  Even if managed right, it won’t be easy to get out of billions of dollars’ worth of bonds without getting spanked.


So Bernanke keeps the myth alive, the sun continues to revolve around the earth, and the house of cards stands firm as the Inchcape Rock.  Until it doesn’t.  Meanwhile, volatility in your portfolio will likely be the order of the day.  That, and uncertainty about the future.


You weren’t planning on retiring any time soon…?



If there's one data point that makes us feel like we’re not bearish enough on emerging market asset classes it’s this one:


“In the four years through 2012, investors poured $3.9 trillion into emerging markets, outstripping the $3.1 trillion they added in the same period leading up to the global financial crisis, said SLJ Macro’s Jen, citing data from Institute for International Finance Inc.


When the liquidity starts to reverse, investors start to find out just how [il]liquid EM debt and equity capital markets really can be! 





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#RatesRising - Stage 5: Acceptance?

Takeaway: Interest rate volatility is declining as investors accept economic reality and the positive implications of #RatesRising.

What the *&%! Just Happened” headlined yesterday’s release of GMO’s quarterly investment letter.   While the title is probably accurate in capturing the prevailing, post-Taper announcement sentiment of the larger investment community, that the initial inflection in a bond bubble 30Y’s in the making occurred with some price convexity, and not a wimper, shouldn’t be particularly surprising.  


In fact, if you have been long U.S. growth for the last 8 months, the Taper announcement itself was more a confirmation of economic reality than a prodigious central planning event.  The acceleration in the domestic macro data since late November and the slow creep higher in the 10-2 spread were heralding some measure of a policy shift.


In so much as a widening in the yield spread <--> expectations for QE Taper <--> Improving Domestic Macro, is a transitive relationship, the recent “bear steepening” in rates should be taken as positive confirmation of an improving domestic growth outlook.  This first step function move higher in yields is simply the market adjusting to the positive gravity of the domestic economic data and the implications of a sober policy response. 


In essence, the initial move in rates represents the ball under water moving towards being only half-submerged. 


From here, particularly given the Fed’s much communicated ‘data dependency’, the next 100+ bps higher should be viewed more as a growth dependent return to interest rate normalcy than a tightening in the conventional sense.  If the fundamental data is such that the controlling, dovish contingent at the fed is willing to signal a rate increase - even a small, gestural increase  -  we’d argue that pro-growth exposure should continue to outperform in the run-up to that event.


As we’ve moved past the acute response phase, the market has seemingly come to accept and price in a reduced flow of fed stimulus.   We detailed the implications of #RatesRising on our 3Q13 Macro Themes call last week (replay>> HERE, materials >> HERE).  We’d highlight a couple of incremental events of the last week:  


ACCEPTING REALITY:  Measures of implied interest rate volatility in the options markets have dropped precipitously over the last couple weeks.  Seemingly, the market has absorbed the acute impacts of the initial announcement with investor angst ebbing alongside initial portfolio re-adjustments.


#RatesRising -  Stage 5: Acceptance? - Treasury Volatility


TAPER TIMELINE:  Alongside lower volatility and a newly range-bound 10Y, today’s main policy related headline from Bloomberg that the consensus expectation of economists for Fed tapering (to the tune of $20B) to begin in September is further evidence that the market is getting comfortable in delineating the impacts of tapering vs. tightening.    


Given the practical aspects of implementing a tapering which, practically, means they will reduce the flow of purchases and subsequently monitor the impact before implementing incremental reductions, a September start makes sense.  With Bernanke likely stepping down come January, initiating the reversal of unprecedented policy initiatives which he captained makes sense from a continuity and (Bernanke) legacy perspective.   It also gives policy makers sufficient runway for scaling back purchases with an early eye towards a complete cessation come mid 2014. 


Also, implicit in the reduction in QE purchases is that QE was, in some manner, successful in its objective. This gives the FED and QE as a policy some credibility should they need to re-accelerate easing at some point in the future.   


SEASONALITY REMINDER:  As it relates to the expectation for tapering to begin in September - recall that the seasonal distortion present in the reported employment and economic data will build as a headwind thru August before again flipping to a tailwind over the Sept-March period.   Any prospective delay in tapering due to perceived/optical weakening in the data over the next 6 weeks should be short-lived as the impact of the distortion reverses come September.  Further, any negative drag associated with reduced stimulus may be partially masked by the positive seasonal tailwind as we move towards year-end and through 1Q14. 


(Not So) LATENT RISK:  Duration (price sensitivity to interest rate movement) on 10Y treasuries remains near peak levels while high yield and IG spreads remain near trough levels.  Despite the recent diminuendo in interest rate volatility, risk associated with another expedited back-up in yields remains very much alive across the fixed income spectrum.


#RatesRising -  Stage 5: Acceptance? - Duration   corporate Spreads


Quantitative Setup:  10Y Treasury Yields remain in Bullish Formation (Bullish across TRADE, TREND, & TAIL Durations) with immediate support and resistance at 2.45% and 2.75%, respectively. 


#RatesRising -  Stage 5: Acceptance? - 10Y levels



Christian B. Drake

Senior Analyst 


HEDGEYE TV Presents #RATESRISING Q3 2013 Macro Theme


"POP!" goes the bubble as interest rates start to rise, reversing the most asymmetrical set of relationships on our Macro screen. Hedgeye CEO Keith McCullough goes out a macro limb and says we are not likely to see the 2012 lows on 10-year bond yields ever again. Moreover, McCullough shows that as the slope for interest rates turns up, so much that has been tied to declining rates will unravel.


"Miami Vice" Meets the SEC?

Takeaway: Are we witnessing the coming of a tougher SEC?

This note was originally published July 23, 2013 at 15:18 in Compliance

The SEC’s new chair, Mary Jo White, was a high-profile prosecutor as head of the Office of the United States Attorney for the Southern District of New York (known to its occupants as simply “the Office”).  She then became a rock-star white collar defense attorney, heading the litigation practice at Debevoise & Plimpton, from whence President Obama plucked her in January and tossed her into the lions’ den of Congressional confirmation hearings  (see our piece on the nomination in Fortune).  There was hand-wringing aplenty over concerns she might be soft on her former clients.  Now there appears to be a glimmer of hope that she may be a tough sheriff after all.


"Miami Vice" Meets the SEC? - mjw


The Good Part

Last week the SEC accused the city of Miami of misleading investors in a series of muni bond offerings.  The SEC charged the city and its former budget director with fraud in three 2009 bond offerings totaling $153.5 million, saying budget director Michael Boudreaux made false statements and material omissions regarding the city’s finances, orchestrating fraudulent transfers of funds “to mask increasing deficits in the General Fund, which is viewed by investors and bond rating agencies as a key indicator of financial health.”  The SEC says this caused the bond offerings to receive favorable ratings from the rating agencies, until the city’s Office of Independent Auditor General flagged the improper transfers, causing them to be unwound.  This led in turn to an across-the-board downgrade of the city’s debt.


SEC Co-Director of Enforcement George Canellos says “we will hold accountable not only municipalities, but also individual municipal officials for fraudulent disclosures to investors.”



The Really Good Part

One short paragraph in the SEC release has sparked considerable interest: “The SEC’s action also charges Miami with violating a cease-and-desist order that was entered against the city in 2003 based on similar misconduct.  This is the first time the SEC has alleged further wrongdoing by a municipality subject to an existing SEC cease-and-desist order.” [Emphasis added]


One of the biggest criticisms of the SEC has been its rush to settle enforcement cases, rather than trying them (see our Hedgeye e-book Fixing A Broken Wall Street for detailed analysis of this, and of other nasty stuff about Wall Street you will wish you had never found out.)  In settlements, finance professionals who may have been guilty of fraud generally walk away unscathed.  Even under rough-and-tumble former federal prosecutor Robert Khuzami – himself a former White protégé at “the Office” – the SEC settled for some big numbers, from Goldman Sachs for example, but did little in the area of identifying bankers who had significantly contributed to the financial meltdown.


Enforcement settlements with individuals routinely contain the expression “neither admit nor deny,” while settlements with companies almost never name individuals, as though fraud, negligence and rampant greed arose like some mysterious vapor from the earth.  This has perpetuated an aura of invincibility around the very worst practices in our industry, protecting Bad Actors from ever having to pay the piper.


Alongside the “neither admit nor deny wrongdoing” bit, there’s routinely a clause that says, “Even though we don’t admit that we did anything wrong, whatever it is we’re not admitting to, we promise we will never do it again.”  A reasonable command of English should enable you to see that piece will never be applied.  How do you charge someone with a repeat offense when you accepted them “neither admitting nor denying” the first offense?


For the first time, the SEC is acting as though a prior cease-and-desist order had teeth.  Critics are saying White does not go far enough, that she should go after “a real Wall Street insider,” instead of a non-financial player like the City of Miami.  We recognize that wheels turn very slowly in the world of regulation.  Indeed, if Congress gets its way, those wheels are likely to turn not at all, as we saw White valiantly taking up the case for increased funding for the Commission – a case her predecessor made in vain to a Congress whose election campaigns are paid for by the investment banks.  (Yep, it really is that simple.)


We would like to believe this is a first engagement in what will become a revolution in the way the SEC approaches cases.  We have been highly critical of the SEC’s culture of compromise, the “rush to settlement” mentality, but we also realize that big changes must be wrought incrementally.  We agree with the on-line posters, bloggers and other commentators who say that, while she is about going after repeat offenders, White should withdraw the SEC’s objections to Judge Jed Rackoff’s ruling that ordered Citigroup and the SEC to try their case over a $1 billion fraud.  This case was put on ice when the judge rejected a proposed settlement, saying the lack of specificity – no individuals named, no admission of wrongdoing or even negligence – made it impossible to determine whether the settlement was in the public interest.  “You are asking me to exercise my authority, but not my judgment,” said Rackoff.  In an utterly bizarre turn of events, Citi and the SEC joined forces asking a higher court to set aside Judge Rackoff’s ruling, leaving Rackoff to watch from the sidelines, as judicial procedure prohibits him from appearing to defend his own ruling in the appeals court.


As we wrote at the time – and wrote, and wrote, and wrote – Citigroup was the deformed phoenix that rose from the ashes of Glass Steagall.  Under President Clinton, the law of the land was eviscerated to enable Sanford Weill to consummate a merger that created a financial behemoth.  In the heat of the financial crisis, FDIC chair Sheila Bair persistently railed that Citi was terribly managed and dangerously unstable and in need of being broken up to avoid further disaster.


The rationale for settlements in the legal system is judicial economy: you can’t throw all the resources of the courts at every case.  As slowly as the wheels of justice now turn, they would instantly grind to a halt if all the resources of lawyers, judges, juries and courtroom personnel had to roll into motion every time someone was accused of an offense.


In the Citi case, this makes no sense.  The courts push for settlements in order to save their resources for Really Big Cases with particularly high stakes, cases that will establish game-changing precedents.  If ever there was a case deserving of the court’s full attention, it is SEC v. Citi.  The nation’s securities watchdog pitted against a titanic financial firm – the very firm whose existence caused the protections of Glass Steagall to be shunted aside.  This is the very case for which judicial economy was created.  For all the inconvenience it may have created for Sandy Weill, Glass Steagall had the overwhelming advantage of being simple: do this, don’t do that.  Markets can live with unreasonable regulations, but they can’t live with uncertainty.  Dodd Frank is a recipe for a decade of haggling.  Glass Steagall is simple.


White should finish what she started, moving expeditiously from the City of Miami to the courtrooms of lower Manhattan.  The best thing that could happen to restore confidence in America’s ability to regulate its markets would be for the SEC to withdraw the objection and try the case.  With Ms. White at the head of the team, we have the utmost confidence that the government’s case will be well prepared.  And for all that we don’t much like Citi, we are by no means certain the SEC’s case would be a slam-dunk.


But whatever the outcome, it would send the message that the days of shadowy dealings between regulators and regulatees are over, that justice isn’t for sale, and that market transparency is more important that winning or losing big cases.


We strongly urge Chairman White to take on the Citi case.  Whatever the outcome, we must declare Too Big To Fail also means Too Big To Settle.



Moshe Silver

Managing Director / Chief Compliance Officer






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