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MAR RESIDUAL RISK

The economic environment is destroying real value in MAR’s timeshare business that is not being captured in adjusted earnings

Before 2008, there was no need for MAR to over-collateralize their timeshare note sales.  MAR was forced to over-collateralize its last two deals (one in 2008 and in March of this year) by 18% and 28%, respectively.  So what exactly did they write off this quarter since they retained no interests in the older deal?

When MAR books a gain on a note sale, the gain is equal to the NPV of the interest the company collects (~13%) and the interest on the notes (~7.5%).  If there is a “trigger event” caused by elevated defaults, MAR doesn’t get that “excess” cash flow and has to write down the value of the residual on their balance sheet as a result of having to use a higher discount rate.  Once a trigger event occurs, this accelerates payment to the senior pieces of the debt structure and MAR no longer gets paid any interest on its “residual”.

In Q1 the company didn’t actually hit the triggers, but were very close so they increased the discount rate used in the NPV to value the excess stream up to 25%.  In Q2 they hit the triggers, wrote down the residual and took the cash flow hit.  Once the hit was taken, MAR was able to decrease the discount rate to 18% because the risk was already reflected across the portfolio. MAR also made the assumption that the triggers cure in 6 months, since the few months during which they experienced heighted delinquencies will roll out (test is on a 3 month rolling basis) if delinquencies stay at currently observed rates of around 10%.

Of course, now that MAR retains the actual over-collateralized pieces, they just take a direct hit when defaults occur, but also reap the benefit of defaults that are lower than projected.  Risk levels are enhanced.  Year to date, MAR has taken $25 million in residual write-offs and $43 million in charges related to loan loss reserves.  This is real value being lost here that cannot simply be discarded as irrelevant, one-time charges. 


THE MACAU METRO MONITOR

LAS VEGAS SANDS SAID TO PLAN HONG KONG IPO FILING Bloomberg.com

Citing, “a person with knowledge in the matter”, Bloomberg.com released a story stating that LVS plans to file an IPO of shares in its Macau casinos with Hong Kong regulators early next month to raise up to $4BN.  The gaming company is also seeking amendments to its Macau bank loan, including covenant relief (as the maximum permitted leverage steps down in 3Q09) and permission to issue as much as $US1.5 billion in new debt according to an unidentified source.

LVS is seeking to raise capital to restart work on its US$12 billion projects on the Cotai strip.  LVS hired Goldman Sachs to help it buy back as much as US$800 million of bank loans via modified Dutch auctions as permitted by its last credit amendment which could allow LVS to get its total leverage beneath the covenant step down in 3Q09.  LVS President Michael Leven said on July 8th that the company could raise at least US$2 billion selling a minority stake in its Macau business in Hong Kong.

 

MACAO’S TOURIST PRICE INDEX (TPI) ROSE BY 1.77% IN Q2 macaudailyblog.com

Macau’s Tourist Price Index for the second quarter of 2009 rose by 1.77% year-over-year, according to the city’s Statistics and Census Service.

The indices of Restaurants service and food, Alcoholic drinks and tobacco increased notably by 6.29% and 6.1% respectively.  Accommodation saw a 4.75% decrease year-over-year.  On a trailing four quarters basis, the TPI for the period ending 2Q09 increased by 5.33%, with significant increases of the indices of Clothing and footwear (11.28%), Restaurant service (10.24%) and Food, alcoholic drinks and tobacco (9.45%).


THE UPSIDE OF A DOWNTURN

 “Never allow a crisis to go to waste” – Rahm Emanuel

An ever expanding list of states look to expand gaming. In the unlikely event of a v-shaped economic recovery, a state(s) of fiscal desperation will still prevail. We’re entering an extended bull market for slots.

Hopefully, the slot companies are heeding Mr. Emanuel’s advice and pushing their lobbying efforts at maximum effort.  There are plenty of dominoes yet to fall while many are already tilting.  Prospects for expanded gaming in Ohio, Iowa, Illinois, and Pennsylvania look decent.  With the pressing need for cash, states may step on the accelerator.  Long timelines experienced in Pennsylvania and Maryland are unlikely in these desperate times.

Here’s the state by state summary:

  • Ohio - Governor Strickland signed a directive instructing the director of the Ohio Lottery to immediately begin the process of implementing VLT’s at racetracks.  More details will become available today as the budget is released.  The approved legislation permits a maximum of 2,500 video lottery terminals at each of Ohio’s seven racetracks.  Requirements for each of the racetracks include a $100,000 application fee, a $65 million licensing fee, 50% of all net revenue being retained by the state, and capex requirements of at least $80 million in the first five years of operation with at least $20 million of that in the first year.  The proposal to open the door to four new casinos in downtown Cincinnati, Columbus, Cleveland, and Toledo could be back on the table. The Ohio Jobs and Growth Plan (OJGP) petition to have casinos voted on again in November collected more than twice the necessary amount of signatures required by the state government (400,000).  The Secretary of State is expected to give a final ruling on whether there is a sufficient number of valid signatures on the petition.  Despite the racetracks directive from Gov. Strickland, the OJGP plans to continue its campaign for four new casinos in Ohio.

 

  • Illinois - The Video Gaming Act was signed into law as part of House Bill 255.  The Act creates a new video poker market under the control of the Illinois Lottery Commission.  The Illinois Coin Machine Operators Association believes the number will end up being around 45,000 to 50,000 units.  The machines will be placed in licensed establishments (bars, taverns), licensed truck-stops, licensed fraternal establishments, and licensed veteran establishments.  The Illinois Gaming Board anticipates that it will be at least a year before gamblers in the Prairie State can legally play video poker.

 

  • Iowa - In light of Illinois approving video poker, Iowa is trying to decide how best to maintain its gaming market. The Iowa Gaming Commission held a public meeting on Thursday and, after some public comment, unanimously agreed to consider licensing new casinos.  Commissioners’ comments seem to indicate that they will be protective of casinos that are already open and that this process for granting new licenses will be more complicated than it was in the past.   The deadline for applications for licenses is October 1st and the commission is expecting five applications.  Press reports indicate that it could take up to a year for the commission to make any final decision.  Lyon County, in northwestern Iowa, could have a strong chance; the market is underserved and so cannibalization of other casinos’ revenue would not be an issue.  It would also draw from the Sioux Falls, South Dakota, market.  It seems likely that at least two new casino licenses will be granted with 2,000-3,000 slots.

 

  • Pennsylvania - A Pennsylvania state House panel has approved, on the second attempt, a bill that would legalize and tax video gambling machines in bars.  The proposal is designed to generate grants for tuition costs at one of the fourteen state-owned universities or the fourteen community colleges in Pennsylvania.  Some of the votes for the bill were more tepid than others.  Rep. Curtis Thomas voted yes but still wants to make major changes to the bill when it comes up for action on the House floor.  Even if the House passes the bill before the summer break, Senate action is unlikely before the fall. 

 

IGT is the obvious play on new gaming jurisdictions since it is the largest slot provider in the world and tends to garner a larger market share in new casinos and expansions (60% vs 40% in replacements).  IGT generates about $0.015 in EPS per 1,000 slots sold.  Indeed, the stock has performed well recently due in part to the potential for new markets.  The long term takeaway is that there will be expanded gaming, the fiscal crisis will dictate that.  The only question is which states and when?  The right trading strategy might be to fade optimism of new legislation and buy into pessimism.  Either way, slots could be at the cusp of a huge bull market as replacement demand is troughing and state fiscal desperation opens new markets across the country.


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Casual Dining - June Knapp Track

Malcolm Knapp reported that June same-store sales declined 7.7% with traffic down 7.2%.  For the second consecutive month, comparable guest count results were better than sales, which points to the significant discounting in the industry.  Even with companies trying to drive traffic at the expense of average check and margins, traffic trends decelerated sequentially from May on a 1-year, 2-year and 3-year basis. 

These June numbers do not reflect the same level of decline that we witnessed back in December, but the Q2 numbers overall are worse than Q1.  Same-store sales declined 6.6% on average in Q2 versus -4.2% in Q1.  We will learn more about company-specific Q2 results over the next couple of weeks and the winners will be those companies that have been able to offset these soft sales results with continued cost cutting.


MCD – JUNE SAME-STORE SALES SURVEY

McDonald’s plans to release its June same-store sales figures as part of the second-quarter earnings release, which is scheduled to be published before the market open on Thursday, July 23.

The latest proprietary McDonald’s Franchisee Survey asked respondents about their June same-store sales results. For the 35 domestic franchisees -- representing roughly 227 restaurants -- who responded, the aggregate June same-store sales figure is 2.7%.

This survey marks the 39th time that a McDonald’s Franchisee Survey has been published. In the prior 38 times, the actual U.S. same-store sales number reported by McDonald’s has been within 100 basis points of the survey results on 26 occasions, and within 200 basis points of the survey results on 33 occasions. 

The average magnitude of the difference between the survey and the actual result reported by McDonald’s is about one percentage point.

Assuming about 4% pricing, MCD continues to experience negative traffic trends.  Given the extreme discounting we are seeing from MCD, margin pressure can only follow at some point.

These numbers support out favorable position on SBUX and cautious stance on MCD.

 



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