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Given that Trian controls the company, I initially came to the conclusion that the use of proceeds from the bond offering will be used to pay a special dividend. Why? It's a classic move by a private equity firm that wants to get paid. While a dividend is still possible, it's less likely. If they do end up paying a dividend, it would be a long-term negative and would limit the operational flexibility of the company.

Without fully understanding the use of proceeds, the offering is likely dilutive annually by $0.04-$0.05; the announced $550 million of unsecured debt will likely carry a coupon of approximately 9%. To answer the question as to why do an offering now, Andrew Barber's June 12 post titled "RATES, VOLATILITY AND LINES IN THE SAND" provides an interesting perspective. It's probably because they can - the credit markets are open and it might not last. As Andrew pointed out, "In today's environment, the reality for mid and lower grade issuers is simple: they are simply taking liquidity whenever and wherever they can find it after a long drought, and are likely more focused on their cash needs in 2 months than prevailing rates in 2 years."

Given this thought and the background of the principles at Trian, speculation is rampant that WEN is going to make an acquisition. I guess it could, but an acquisition would be viewed as bad for the stock; this partially explains why the company traded massive amounts of volume last week. Right now WEN is a turnaround story; the company needs to fix what it has before it takes on another concept.

I view an acquisition as unlikely and of course, the company line is that there is "nothing imminent." The biggest opportunity for WEN is to fix the margins on its current assets. Layering in a dual brand at Wendy's to help breakfast and or dinner sales are a very complicated process and are a very high risk proposition.

Importantly, it could take years to have an impact on profitability. Every dollar of capital the company has needs to be reinvested into fixing the existing asset base. This management team needs to prove to the street that it can execute its current business plan before the street will accept additional risk.

In the minds of senior management it's not a question of whether margins can be restored, but instead, management is confident they will be fixed by 2011. With margins being fixed in two years time, management needs to be thinking now about restarting the organic growth engine by that time. Organic growth for WEN is going to come from domestic and international unit growth, dual branding of the Wendy's and Arby's brands and growing the breakfast day part. None of this will come easy and there will be skeptics about the company's ability to grow internationally, but the planning process needs to start now if it going to be in the 2011 business plan.

I am very skeptical about WEN's international opportunities, given that I have witnessed the company fail multiple times. The excuse provided for the company's failure to execute internationally in the past was not bad management, but failure of the brand to perform at the same level as it does in the United States. That being the case, there is no need right now for massive amounts of capital to fund the international growth initiatives. Aspects of these growth initiatives are in contrast to the company's cost cutting story as they require "infrastructure investment" to lay the ground work for growth.

Absent of buying a "breakfast" concept, there is no need for capital beyond the company's current capabilities to grow the breakfast day part. In the short run, WEN will be replacing the horrid Folgers brand they are currently selling by testing new products that hopefully will resonate with consumers. While there are huge opportunities for breakfast within the Wendy's system, the concept's real estate strategy never contemplated selling breakfast, leaving some units incapable of executing the daypart properly due to poor locations.

WEN needs to upgrade its asset base, particularly Arby's, but this needs to be done systematically. Remodels are not easy to execute and need to be done in a thoughtful way that enhances returns. Not all remodel programs are created equal and WEN does not need a war chest of cash to do this.

Lastly, we can't rule out buying back stock. Adding leverage to WEN's balance sheet just to give the money back to shareholders is a big mistake. Leveraging up the balance sheet WILL NOT create shareholder value and limits the company flexibility to navigate a difficult environment. The money WEN is borrowing is not cheap and needs to be reinvested in a way that will generate incremental returns to shareholders. Right now, it is difficult to see where the ROI is going to come from.

The uncertainty of the debt offering throws into question the direction of the company. WEN's business plan had relied on a cost cutting strategy to fix margins by 2011, but the company's decision to raise capital to fund future growth initiatives goes against that very strategy. Same-store sales trends ate stagnant, and there is limited visibility to what is going to put Wendy's products and marketing initiatives on the map. Arby's is also suffering from a consumer identity crisis.

Despite the fact that senior management feels comfortable working with Peltz and team, the recent services agreements reek of corporate excess in a challenged economic environment. This relationship only adds to the discounted valuation the company is currently getting.

Trading at 6.4x NTM EV/EBITDA, WEN is undervalued relative to its global restaurant peer group trading at 9.0x NTM EV/EBITDA but is trading in line with its small-cap domestic peers. Roland Smith and team now have a bigger hurdle to leap to gain confidence that they can execute on a business plan that creates value for shareholders.




CHUI SAI WILL BE NEXT CHIEF EXECUTIVE MacauNews.com.mo, Destination-Macau.com

Fernando Chui Sai On is set to be the only candidate in the upcoming election for CE.  Ho Chiu Meng had been his main rival, but he announced to the Macau Daily News that he would not stand in next month's CE election. In order to run for the position, Ho Chiu Meng was required to resign from his current position as chief prosecutor and he has not done so.

It is said that Chui Sai was not Beijing's preferred candidate for the position. However, it seems unlikely that the changing of the guard in Macau will alter current laws regarding visas and the curbing of junk visitation in the near-term.


CITY OF DREAMS  Destination-Macau.com

City of Dreams has had a less impactful first week than had been anticipated.  While it was known that VIP and premium mass market play would take some time to get up to speed, there has been some surprise at unofficial marketshare numbers suggesting no meaningful sequential gain on the part of Melco-Crown. 


MAY ROLLING-CHIP  Destination-Macau.com

Two major takeaways from the May gaming revenue numbers:

  • 1) SJM and WYNN gained considerably in terms of volume, as the number of rolling chips purchased overall was the highest since last August.
  • 2) The gap between SJM and LVS (31% to 21%) has widened as a result of higher volumes for SJM and lower win-hold rate for LVS.


FLU PANIC  Destination-Macau.com

The Macanese government has pledged to spend MOP100m on at least two flu shots for each resident. This comes as Hong Kong's chief has closed schools and nurseries to prevent the spread of the flu.  This has caused some concern among casino operators, fearful that their business will be impacted by flu fears.




The Macau Daily Blog posted an article outlining four "big phenomenons" [sic] hurting Macau.

  • 1) Dropping EBITDA margins.
  • 2) Mass Market has been squeezed
  • 3) The product mix being put out is the same across the board. No "wow" factor
  • 4) Junk tourism. Low value, low yield, for operators.



Macau is enjoying a taste of Bollywood magic with a galaxy of Indian stars arriving in the city for one of Asia's most-watched film awards. Oscar winning composer A.R. Rahman, who wrote the score for Slumdog Millionaire, superstar Amitabh Bachchan and Bollywood's leading couple Aishwarya and Abhishek Bachchan, are among those visiting the Las Vegas of the east for the 10th International Indian Film Academy (IIFA) awards.



MGM Mirage, the casino company controlled by Kirk Kerkorian, and Malaysia's Genting Bhd. are considering a possible partnership, spokesmen from both companies said.



High rollers in Macau are increasingly playing the slots.  Slot machines remain a minor segment of the market, at 6% of total revenue. However, in Q109 slots accounted for some $743m in revenue vs $81.5m of revenue in Q104.


City of Dreams has only been opened for two weeks but we thought we'd give you some initial impressions from our guys on the ground.  Warning:  these insights are early and anecdotal in nature.  We are actively attempting to corroborate all of the following.

  • Weak Rolling Chip (RC) turnover at City of Dreams - MPEL acknowledges it will take a while to ramp up the RC segment. We are hearing CoD only did HK$4BN in Rolling Chip turnover over first 10 days, or HK$400MM per day. By contrast, Venetian and Wynn Macau average approximately HK$700MM and HK$900MM per day, respectively, during the summer months. All three properties maintain approximately 140 RC tables.
  • Traffic strong at CoD- indicative of the mass market focus. Uncertain of the turnover per customer but hearing it is somewhat low.
  • CoD may be experiencing low hold
  • Venetian Rolling Chip business holding up - the junkets are reporting that RC turnover at Venetian hasn't been impacted much.
  • Venetian traffic down - see chart below
  • Wynn losing MM and RC customers to MGM? - Something is going on here. We've heard it from multiple industry sources.

We'll have more to report this week and next.  I will be in Macau on 6/22-26 visiting the operators, suppliers, junkets, developers, etc.  Stay tuned.


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Consumer sentiment continued to improve in the month of June, although the University of Michigan index rose by less than expected, it was certainly not a bad number.   The index rose to 69 in mid-June from 68.7 in May, up sharply from the 28-year low of 55.3 in November, but still below the 88.2 ten year average.


As I said in the Early look, it appears the numbers ARE peaking. The market forecasts were for a higher number, in the area code of 69.5.

It not clear to me that it's prudent to plan for a strong summer season for the consumer.  From where I sit a cautious consumer still prevails and most remain resolute about becoming more practical when making purchasing decisions.

As we head into the key summer driving season the price of gas at the pump is surging.  While the relative "affordability" compared to last year's $4+/gal price tag has most consumer feeling less of a pinch, the 63% increase year-to-date will put the brakes on incremental spending.  Especially with the sequential increase that is outlined in the chart below.

Howard Penney

Managing Director




Research Edge Position: Short XLU

We are short XLU currently; this is a trade that has set up nicely from a technical standpoint and ties in with our reflation theme.  With rising fuel costs and increased rate regulation the utility sector is looking at a potential squeeze on margins on the horizen, not to mention the anticipation that emission costs will increase as control measures (or caps) come into play.

Our model portfolio does not allow for options, and we are outright short.  For those of you that trade options and are looking to capture premium, the near month calls might be attractive.

Currently the implied volatility levels for XLU have remained high compared to the broad market on a historical basis; with at-the-money July calls showing levels in the 24 to 25 range, vs. a 30 day realized volatility of 24.5 and a VIX at 28. This volatility could in part reflect some of the bond market action we commented on this morning due to the sectors rate sensitivity.

For those brave souls who are looking to harvest premium here a short call look position looks relatively attractive as the macro and technical factors intersect with decent premiums  -particularly as broad market volatility  levels continue to trend down. Note also that this ETF goes ex-dividend in the coming week, another positive for the play.

Andrew Barber




Research Edge Portfolio Positions: LONG TIP/SHORT SHY

With no indication that the Fed has any intention of changing rate policy in the near term, the current spike in interest rate volatility is being largely viewed as a measure of fear in the face declining global confidence in the US balance sheet colliding with the reflation trade head on.  The replacement rhetoric in advance of next week's BRIC summit may become louder over the weekend as the manic media refines its hysteria.

Yesterday's $11 billion 30-year auction drove volatile trading as the highest yields since 2007 drew in anxious buyers causing the futures to swing sharply back into firmly positive territory intraday .  The prevailing perception that this buying was committed longs who agree with the Japanese finance minister's assessment of the US balance sheet is tempting, but the post auction yield also presented spread players already short the short end of the curve like us a chance to get off the bench at a lower low. With relentless supply  showing no signs of letting up anytime soon it will be critical to us  to see if buying can sustain through today's session into next week. 


Currently, the implied volatility on July  at-the-money options on TLT, the Barclays 20+ year treasury ETF, are registering at 20/21 -down slightly from levels earlier this week but still close to the VIX, which closed at 28.  These converging volatility levels are visible in historical measures as well -as illustrated in the chart below, which shows realized 30 day volatility on TLT vs. the S&P 500.  Clearly the jitters in the market support higher absolute yield levels in the intermediate term.



Although the spread between investment grade debt and treasuries have now contracted to pre-Lehman levels, the chart below illustrates what a 450 basis point premium looks like in historical context. While it would be tempting to view the decision by management to issue bonds at these levels as an indication that their view is that absolute rates can rise faster than spreads will contract, but the reality for mid and lower grade issuers is probably much simpler: they are simply taking liquidity whenever and wherever they can find it after a long drought, and are likely more focused on their cash needs in 2 months than prevailing rates in 2 years. 



We remain of a mind that absolute rates can begin to rise in advance of any sentiment shift by Bernanke & co. as the market puts a premium on liquidity and discounts rhetoric, and also that the widening spread between the 10-year and the target is the beginning of a intermediate period trend that will see a flattening of the curve regardless of policy.


Currently we are short the short end of the curve via SHY and long reflation via TIP.  

Andrew Barber


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