TODAY’S S&P 500 SET-UP – December 12, 2013
As we look at today's setup for the S&P 500, the range is 36 points or 0.18% downside to 1779 and 1.84% upside to 1815.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Big question for management.
Following up on our Hilton IPO presentation and call yesterday, we pose another question for management. How low would you go?
On July 3rd Blackstone announced that it would acquire Hilton Hotels for $26BN, writing an equity check for $6BN to seal the deal. Despite paying over 14x 2007E EBITDA for Hilton at the top of the market, Blackstone will still make a pretty penny on the IPO which was priced at $20.
While the IPO will provide Blackstone with a vehicle through which it can slowly sell its stock, BX will still be the majority shareholder of Hilton for several years to come. Post IPO, Blackstone and other insiders will own close to 80% of the stock. Blackstone’s lock-up expires in 1/3rd chunks over 6, 12 and 18 months, after which they will be subject to Rule 144A. While a large insider holder can sometimes be an overhang on the stock, we believe it also has a major benefit. BX is incentivized to keep something in the kitty to set the stage of several beat and raise quarters and potentially some assets sales.
At some point, Blackstone needs to return the $6BN+ of equity plus a preferred return they used to buy Hilton for their investors. Only after investors get their preferred return does BX’s promote become in the money. The questions HLT minority shareholders need to ask is this: If BX needs to return money to investors, at what price would they be willing to dump their shares in Hilton?
To answer this question we make several assumptions:
Assuming a $6.9BN of total equity and a 9% threshold, our analysis suggests that once BX’s lock up expires 18 months post IPO, its promote would be in the money as long as HLT’s stock price is above $14.60. The question is would Blackstone sell their stake above $15 bucks or do they have the ability to hold on to share longer to get a better price. Alternatively, can they spin shares out to their investors as a dividend? This is a very important question for management.
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Takeaway: “Good morning, Mr. Otis. Your mission, should you choose to accept it, involves the recovery of lost customers from your core business"
This note was originally published December 11, 2013 at 08:21 in Restaurants
“Turning around a failing restaurant is a daunting challenge under the best of circumstances.”
- Robert Irvine, Restaurant Impossible on the Food Network
To steal the structure of the opening line from Mission Impossible: “Good morning, Mr. Otis. Your mission, should you choose to accept it, involves the recovery of lost customers from your core business Olive Garden.”
Needless to say, fixing Olive Garden is going to be a daunting challenge. Will the introduction of a burger and fries to the menu make the challenge more or less daunting? In our opinion, it may very well be the final straw that breaks the camel’s back and drives shareholders to the tipping point.
In March 2013, our call was that an activist investor would get involved to make the necessary changes at Darden; many of which we’ve been chronicling. Since Barington filed on the company, nearly every research report written about Darden has focused on a breakup/real estate analysis and valuation.
None of these notes, however, focus on fixing the core business – Olive Garden. We believe the biggest upside in the stock today would come from the successful turnaround of Darden’s most important franchise in the portfolio. Yet, management has not even begun to outline a cohesive strategy to fix Olive Garden.
DRI will report 2QFY14 results on December 20th. This call will be the most important call of CEO Clarence Otis’ career. His choice of direction will determine if a dramatic shift in strategy is pursued at Darden to provide the necessary focus in order to achieve significant increases in shareholder value, or if the company will continue with the status quo. As we see it, the company could push forward in one of three different directions:
On some level, we believe the case for significant change at Darden could be strengthened when the company reports 2QFY14 results. An earnings miss is very likely. The street currently expects EPS to come in around $0.22, but we are modeling somewhere between $0.12-$0.15. Despite the string of recent disappointments, we could see management digging their heels in and sticking with the “change nothing” philosophy.
Their overall strategy is uncertain. What appears certain, however, is that we may not hear a comprehensive nor compelling plan to fix Olive Garden on this earnings call.
Olive Garden is a brand with tremendous future value if it were in the right hands. Olive Garden is no longer the “Italian” brand that made it so successful. If you recall, the brand was on the brink of extinction back in 1994, before it experienced an Italian Renaissance. This revival led to 57 consecutive quarters of same-restaurant sales increases and consistent margin improvement, leading to accretive value creation and substantial incremental value for all Darden shareholders.
Unfortunately, the brand has gone so inexplicably and destructively off course since this "industry leading performance." Once again, Olive Garden has moved so far away from its core vision of “Genuine Italian Dining,” to the point where it now feels more like an “Italian Applebee’s.” And this was before Olive Garden introduced a burger and fries to the menu!
Olive Garden is out of touch with the consumer base in aggregate, but has particularly lost its relevance as it pertains to Millennials. Where is the vision for this brand? Is it reasonable to believe that Millennials want 1990’s style Americanized food that is fried, overly stuffed with cheeses, covered in cream sauce and served with overcooked pasta?
And now on the heels of a “Buy One, Get One Free to Take Home” promotional offer, the recent roll-out of hamburgers will most likely turn out to be an act of desperation, and ultimately yet another mistake in a series of ill-advised decisions. The idea that this will lead to incremental customers is nothing short of facile, a futile hope that a burger and fries will recoup the lost authenticity of the concept’s roots, and a hope that the shine of a hamburger will blind the customer to the fact that there is a lack of progressive thinking anywhere in the company. There is an overall sense of fear and confusion that has led to a significant decline in consumer acceptance.
Olive Garden needs a talented team that can bring innovation back to the company. It needs “fresh eyes” that are forward looking to create positive change. It needs improved, more authentically Italian food. It needs leadership that will ensure consistency of execution to deliver the required financial results on an on-going basis.
Olive Garden is still a large and well-known brand. It once had a crystal clear and compelling vision that was executed flawlessly to achieve the largest turnaround in casual dining history. This performance can be realized again with the right team in charge. Shareholders deserve better.
Restaurant impossible will be possible with the right vision, the right leadership, and a management team that can look ahead of the legacy issues plaguing the company!
Hedgeye Managing Director/Restaurants Sector Head
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Takeaway: Monetary policy has consequences.
Inflation is essentially antidemocratic.
-Ludwig von Mises
After bottoming in mid-November, one proxy for global inflation (CRB Commodities Index) has put in a big +3% move off the year-to-date lows (the CRB Index was down -8% year-to-date on the lows, fueling real-consumption growth).
Almost every major economic region (other than Europe because they have #StrongCurrency) will see inflation pickup sequentially in Q1 verses Q4.
Yes – monetary policy has consequences. More to be revealed.
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Takeaway: There is some (potentially) positive and negative news for the ailing U.S. Dollar as flying pigs descend upon Washington.
This note was originally published December 11, 2013 at 11:30 in Macro
For the 99% of Americans who fail to find the vagaries of federal budget accounting and the interminable tragicomedy that is bipartisan budget negotiations scintillating, the following link provides a summary review of sequestration and the key provisions/budget impacts >> SEQUESTRATION 2014: WHAT'S THE IMPACT AGAIN?
Below we provide a quick update on how the emergent accord between Representative Ryan and Senator Murray impacts the numbers.
Late yesterday we got the latest (prospective) chapter in the budget debate and ongoing evolution of the Budget Control Act – the 2011 legislation which defined discretionary spending levels over the balance of the decade. The crux of the budget deal – ‘sequester relief’ via higher spending - is highlighted in the following table.
Summarily, the agreement proposes to raise spending levels by a combined $63B over FY2014 and FY2015. It would also provide for a net deficit reduction of $22.5B over ten years, stemming primarily from higher user fees (airlines), increased pension and benefit expenses for federal workers, and a 2Y extension of Medicare payment cuts.
In isolation, a budget agreement calling for higher spending is dollar bearish on the margin. However, to the extent that increased fiscal policy clarity pulls forward the tapering timeline, a multi-year accord could be viewed as a positive for the currency.
On balance, and if the Fed is, indeed, data dependent, the investment conclusion is somewhat equivocal. We’ll continue to let the market act as arbiter, using price as our signal. Investors have been net sellers of dollars for 5 consecutive weeks and, as it stands currently, the dollar remains broken on both TREND and TAIL durations with the next level of TRADE support at $79.67 on the DXY.
In the intermediate term, higher federal spending offers some potential upside to consumption growth. As we’ve highlighted (HERE), government sourced income has been a discrete drag on aggregate personal and disposable income growth as sequestration/furloughs and ongoing federal employment loss have driven negative income growth for ~17% of the national workforce.
If the decline in federal employment bases and government salary and wage growth goes positive (against easy compares) in 2014, consumption growth could see some moderate upside.
Christian B. Drake
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