On Sunday, Sunstone REIT (SHO) provided a business update and discussed an "elective default" on their W San Diego property after failing to come to an agreement with their CMBS special servicer.  The company expects to "pursue similar options with certain of its other mortgaged hotels" where the mortgages exceed the value of the property.  We expect to see other REITs and private owners follow suit and hand back the keys on many properties over the next three years, mostly on mortgages underwritten at the peak of the market.


Back on May 20th, SHO amended its exchangeable notes indenture to increase the permissible basket of defaults on non-recourse indebtedness from $25MM to $300MM, before triggering an acceleration of payment.  This amendment was specifically aimed at increasing SHO's ability to exercise its option to walk away from "over-leveraged" assets.  We haven't seen this type of amendment pursued by other lodging companies yet, but expect that those that have limited baskets on non-recourse defaults to pursue similar strategies in the future.


This particular asset faced a more extreme situation than most hotels.  Deteriorating fundamentals in the San Diego upper upscale hotel market assets and increased supply created one of the worst hotel environments in the country.  Still, the W San Diego outcome provides another data point on the fallacy of using "NAV" to support valuations.  The confluence of the supply/demand issues led to the determination by SHO management that the asset was permanently impaired.  It no longer made sense to fund the negative cash flows of this asset ($4MM of interest expense vs 2009E EBITDA of $2MM).  Interestingly, the mortgage still had 8.5 years left before maturity and an attractive rate of 6.25%, so this was truly a proactive default.  


Sunstone acquired this asset in 2006 for $96MM or $372k per key and handed the keys to the lenders at $252k per key.  They concluded that the asset was worth "much less" than the $65MM mortgage on it.  Generating just $2MM in estimated EBITDA, the company made the accretive choice surrendering this asset at 32x EBITDA.  We're not sure how much less SHO thinks this asset is worth but we would guess somewhere in the $30MM range is more reasonable, a staggering 70% below where it was acquired just 3 years ago.

ZQK: Beware of Thesis Morph

My gut (and math) tell me that ZQK’s decision to accept a pe investment and restructure its debt was probably the right call. The downside is that monetization of other assets is off the table. Now you need to own for the base business, which is a call for a different duration.


To say that there were fireworks in Quiksilver’s 2Q is probably an understatement. The direction of operating results was never a major source of discussion over the past few months – it was all about whether the company would sell DC Shoes, and what price would be needed to fix the balance sheet without diluting cash flow.


Well… The conversation just changed. ZQK restructured its balance sheet with a $150mm private equity investment, a $200mm term loan, and a European debt restructuring to be finalized in the coming weeks. This likely puts the lid on a DC sale in the near term. It would be highly unlikely that the new private equity partner would have gotten involved with a $150 million term loan (5 years) with detachable warrants representing 20% of shares outstanding (7 year expiration) if the company was going to offload its prized asset. ZQK is now back to a cost reduction and rightsizing exercise that won’t begin to bear fruit until the very least 2010.


This might have been the exact move that the company needed to protect its long term brand equity and maximize NPV. But my concern is that most investors buying the stock from $1 up to $3.60 were not as focused on the fundamentals as they were a potential deal.


But hey, on a positive note, it took McKnight over 1,000 words of his prepped remarks to get to any remark about Kelley Slater.


Eric Levine/Brian McGough


ZQK: Beware of Thesis Morph - ZQK SIGMA

The World Cup of Unemployment: Canada versus United States



Position: We currently are long Canada via the etf, EWC


We reinitiated our long position in Canada late last week on the back of some extensive work we had been doing comparing the fiscal health of Canada versus the United States.  We also wanted to make a quick call out highlighting comparative unemployment trajectories between the two countries.


Our Lead Desk Analyst, Andrew Barber, looked at unemployment rates going back in both Canada and the United States about thirty years to 1979.  Over that entire time period, the United States has, on average, been 2.51% more employed.  That is, the unemployment ratio has been lower by 2.51%.  The chart comparing these long term rates is attached below.


For the past nine months, unemployment in the United States has been higher than in Canada.  The only other period in which that was the case was from 1, which was a period in which Canada was between 0.1% and 0.4% more employed.  As of the most recent data points, Canada is currently 1.0% more employed, which is a full 3.51% above the thirty year average between the countries. 


Historically, unemployment in Canada and the United States has been very close.  The first key divergence occurred in the recession of 1 and was attributed primarily to differing fiscal responses to the recession in both countries and a greater dependence of the U.S. on foreign oil.  The unemployment rates of both countries effectively entered the 1980s in lock step until 1982 when the U.S. began a long and sustained period of lower unemployment.


A key factor that led to this divergence was outlined by David Card from Princeton University in a 1995 paper entitled, "Unemployment in Canada and the United States: A Further Analysis".  According to Card:


"The relatively low UI qualification thresholds in Canada create a variety of incentives for individuals to change their annual work patterns . . . Other individuals who might, in the absence of UI, have worked a substantially larger fraction of the year have an incentive to reduce their annual weeks of work, since once the individual is qualified for UI the net income per week of work is equal to the weekly wage minus the UN benefit that the individual is entitled to."


In effect, the Canadian unemployment system is, and has been, set up to potentially incentivize certain segments of the population to remain unemployed longer and for certain parts of the year.


The two countries also classify unemployed workers slightly differently.  Primarily, this difference relates to the treatment of passive job seekers.  This is a group whose job is to find a job.  In Canada, this group is categorized as unemployed and in the unemployment statistics, while in the United States this group is shifted out of the labor force.  This is estimated to account for up to 1/5 the employment difference between the two countries.


In summary, while unemployment is inherently a backward looking indicator, the divergence in unemployment rates between Canada and the United States is noteworthy, especially given that Canada by way of classification and incentivizes should have a higher unemployment rate.  To the extent that commodities continue to re-flate it is exceedingly likely that Canada continues to widen the unemployment spread and relative GDP growth rates should reflect this.


Daryl G. Jones
Managing Director


The World Cup of Unemployment: Canada versus United States - can1

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The following delta chart shows that year-over-year declines in Macau have stabilized.  Mass Market (MM) continues to hang in despite the much discussed visa restrictions.  In fact, MM actually grew 4% in May.  Rolling Chip (RC) fell double digit (17%) again due to the tough, liquidity driven comparisons of last year.  The moving average has flattened but should begin to turn positive after as comparisons ease in September.


MAY MACAU MARKET SHARES - macau may delta chart 


Market Share commentary:



  • Big loser in May, as share fell to 20.4% from April's at 26% share, the lowest share since April 2008
  • Weakness was driven by RC down 8% y-o-y for LVS's properties on a combined basis and weak hold at Venetian
  • Jack Lam's room at the Mandarin stole a lot of share from Venetian in May



  • Up to 17.3% from an 12 month average of 16.3%, and its highest share month since Sept 2008
  • Some of this uptick was due to higher hold but WYNN's VIP chips share also increased to 16.5% from a 12 month average of 15.6%
  • We think this month was an anomaly and Wynn will lose VIP and mass share



  • Crown's market share increased to 10.4% from 9% last month
  • Hold was better in May than March & April, driving higher share



  • Down to 7.4% vs 8.3% last month, and 9.8% in March
  • Hold was once again the culprit, as MGM has actually been gaining share on a rolling chip basis



  • Up slightly from April to 12.7%
  • Some of the lift is due to better hold



  • Ticked up to at 31.7% from 31.5% in April


MAY MACAU MARKET SHARES - macau may mass market


MAY MACAU MARKET SHARES - macau may rc turnover


Y-o-Y Win comments:



  • Sands down 34% driven by a 47% decrease in VIP with Mass down 12%
  • Venetian & FS down 25% driven by a 45% decrease in VIP
  • Total table revenue from Macau down 28% at $212MM



  • Down 12%, with VIP down 14% and Mass down 3%, total table revenue: $179MM



  • Down 32%, total table revenue $108MM



  • Up 36%, with VIP up 53% and Mass down 28%, total table revenue: $132MM
  • Growth driven by Starworld which had table revenues grow 32% to $75MM

The Client Comes First: China/Taiwan


Taiwan export data indicates that Chinese buyers are still shopping...


Position: Long China via CAF


At -31.4%, Taiwanese export data for May released earlier today showed a sequential improvement on a year-over-year basis from April's figures. As anticipated, a major factor was an increase in shipments bound for the mainland, with PRC exports improving to -32.45 Y/Y,  a massive improvement over January's bottom but still well below the single digit decline registered in February when the floodgates were initially opened by Beijing. Exports to the mainland accounted for 27.64% of total shipments for the month.


The Client Comes First: China/Taiwan - taiw1



As expected after multiple companies reported increased orders for flat screen panels and other components in the wake of Beijing's consumer rebate program aimed at rural residents, electronics producers continued to see increased shipments in may.  Total electronics exports, a critical component at 28% of the national total, showed an improvement to   -18.67% Y/Y. Information and Communication products -a modest component of the total at just 4.5% of total exports for the month, leapt to -5.38 Y/Y and actually crossed into positive growth territory on a 2 year basis.


The Client Comes First: China/Taiwan - taiw2



Less eye popping but still worthy of note were the heavy and light industrial categories, which also registered modest improvements for the month -signaling that improving external demand has broadened beyond just consumer electronics.


This latest data continues to support our bullish thesis on Chinese demand recovery, while also supporting our conviction that Taiwan and South Korea are positioned to recover more rapidly than Japan as Chinese buyers take advantage of currency valuation and political goodwill.


Andrew Barber


Due to the way IGT funds jackpot expenses, higher prevailing interest rates actually expand the company's margins.  IGT's margins have recently been punished by the precipitous drop in rates.  A 1% increase in general interest rates increases EPS generated by the Gaming Operations segment by approximately $0.04 annually.  The Gaming Ops boost more than offsets the higher interest expense on the credit facility which detracts from EPS by about $0.03 annually per 1% hike in rates.


IGT appears to be a more defensive play than most consumer discretionary stocks for a variety of reasons including pent up demand, low debt, low capital intensity, high free cash flow, and short payback of its product.  The positive margin correlation to interest rates adds to the defensive thesis.

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