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LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR

Only a 560 bps margin decline on a 26% decline in RevPAR? Are these guys great mechanics or is something else going on?

 

When MAR reported only a 560 bps margin decline on a 26% drop in RevPAR this past Thursday, it seemed almost heroic.  This masterful cost cutting spurred several analyst questions of whether this kind of massive property level cost cutting can continue. 

If you look under the hood there’s a lot of “other stuff” in Owned, Leased, Corporate Housing & Other.  The “Other” bucket skews the margins and doesn’t exactly paint a true picture of what’s really going on from a cost cutting standpoint. “Other” includes branding fees and termination fees, which have zero associated expenses.  “Other” also includes some application fees which franchisees pay to procure a contract, and re-licensing fees which get paid on properties when ownership changes but the MAR flag is retained.  Marriot doesn’t disclose application or re-licensing fees, so for the purpose of this note we will just ignore them.

Branding fees come from two primary sources: affinity fees on Marriott rewards credit cards and licensing fees on branded Ritz Carlton residences developed in conjunction with Ritz hotels.  As can be seen below, branding fees have become a larger portion of profits from Owned, Leased, Corporate Housing & Other each year since 2006, accounting for 47% in 2008 and 90.5% in 2Q09. 

LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR - mar exposure to brand fees

Termination fees on managed and franchised hotels are typically collected when MAR branded hotels trade hands and the new owners want to reflag or simply terminate the existing management or franchise contract.  Termination fees have been declining as the transaction environment for hotels has cooled.  MAR recognized $26MM, $19MM, and $15MM of termination fees respectively in 2006, 2007, and 2008.  MAR does not disclose termination fees on a quarterly basis but they did disclose that they were down y-o-y for the first two quarters of 2009. 

On a combined basis, branding and termination fees accounted for 58% of Owned, Leased, Corporate Housing & Other profit in 2008, up from 47% in 2007.  In 1Q09, MAR reported branding fees of $14MM and some small amount of termination fees.  When you strip those out, it implies that Owned, Leased, & Corporate Housing profits were actually negative and declined around 500bps vs the reported 370 bps decline.  This past quarter MAR reported $19MM of branding fees out of $21MM of total profit for Owned, Leased, Corporate Housing & Other.  Even if there were no termination fees, margin excluding branding fees was less than 1%, implying around an 800-900 bps decline in margins (net of fees). 

Affinity fees are pretty stable and most likely growing.  However, we would wager that branding fees on Ritz condos are at best likely to slow along with the entire condo market.  Termination and re-licensing fees are also likely to be down for 2009 and 2010 unless you believe transactions will accelerate.  Finally, application fees should also be on the decline as new builds come to a grinding halt.  As the cost cuts comps become more difficult we expect some negative margins for this business net of fees. 

LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR - mar margin chart



PSS: Point/Counterpoint

Keith: PSS looking to breakout again from its TRADE line 13.99.

 

Brian

  • The consensus is off by a buck next year – no kidding.
  • PSS was investing in SG&A and PP&E while comps were down, product costs were heading up, and cost of capital was turning unfavorably.
  • 96% China exposure is Big. Yes it hurt while costs were rising, but we’re going the other way as capacity opens up again in China.
  • Leverage is still a concern. I don’t like it one bit. But comps are stabilizing, and both FOB and rent is coming down dramatically.
  • On a flat comp, these 2 items result in $0.55 in EPS over 12 months.
  • I buy into the ‘white space’ argument, meaning that the company can take up ASP to the high teens as it improves product mix.  Opportunities at Sperry and Saucony are gravy.
  • Tough to find a company with this much earnings upside.

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Chart of the Day: Burning The Buck

While it is somewhat amusing to watch all of the perpetually bullish talking heads find the microphone again today, please don’t confuse our amusement with the math.

Today’s move wasn’t about the US stock market’s “great valuation.” Assuming that something you could have purchased 4 months ago 40% cheaper was actually cheap, you get the point. Valuation is a Wall Street narrative that ebbs and flows with price momentum.

Ultimately, today’s US market hitting fresh YTD highs is all about what’s been happening since March. The US Government is perfectly willing to Burn The Buck. I have outlined the levels of TRADE, TREND, and TAIL that support this view (see chart). No matter what your investment time horizon, the US Dollar remains as broken as the US Financial system’s credibility.

In the immediate term, this is REFLATIONARY.

In the intermediate term, this will morph into INFLATION.

In the long term, the American commoner and her government’s creditors, will be dead.

KM

Keith R. McCullough
Chief Executive Officer

Chart of the Day: Burning The Buck - km45


Natural Gas: Where Art Thou Reflation?

We’ve phrased the title for this note in olde English, much as our competitor Dennis Gartman might use.  No, don’t worry, we aren’t going to give Dennis a hard time today.  He’s already had a tough time lately (we hear down -2.2% in July in his retirement and personal accounts) and, to be honest, we find him a likeable sort, despite his dependency on one factor models such as the 200-day moving average.  For those that have missed the commodity reflation theme in the year-to-date, the question above remains an interesting one.  That is, is natural gas the next commodity to make a big move?

The pricing for natural gas is much more locally based then its global brethren, such as oil and copper.  Therefore, a weak US dollar and an increase in Chinese demand will not necessarily sway the price of natural gas in the United States.  These are the primary factors as to why natural gas has been a laggard in the year-to-date.  In fact, prices at the Henry Hub are down 40% year-to-date from $5.63 per MMBtu at the start of the year and 70% from the year-ago closing price from $11.15 per MMBtu.  The natural derivative of this decline in gas prices, is the decline in drilling.  According to Baker Hughes, gas rotary rig count is down 47% from the start of the year to 672 currently and at their lowest level since May 10th, 2002, which obviously should lead to supply declines in the future.

The major bearish factor continues to be supply.  Natural gas in storage is 25.6% above inventories of 2,297 BCF from one year ago, and 18.7% above inventories for the 5-year average.  In fact, according to the Energy Information Administration, “natural gas in storage is now at its highest level for any week in the month of July since collection of weekly storage began in 1994.”  This is obviously bearish, but is also a backward looking indicator.  As always, what will drive natural gas futures will be the next marginal change, even if only bullish on the margin.

The next marginal bullish shift will likely be a sustainable decline in the rate of the building of storage, which will be a function of weather being warmer than expected, which lead to demand for more cooling, or an eventual declining in production due to declining drilling rates.  While the rate of storage growth y-o-y has wavered from week-to-week, in aggregate we have seen a consistent build throughout the year.  Of course November 1st will be the key date to watch on storage levels, as it marks the end of the 7-month injection season.

According to Keith the quantitative set up is as follows (see chart):

“TAIL, broken = $5.45. TREND and TRADE = the same level, $3.82 (ie right where it closed on Friday. The setup is for a big move next (failure to breakout or a big time breakout)… if we see the breakdown, there is zero support until $3.11; breakout resistance is the TAIL line.”

On a percentage basis, this commodity has the potential for pin action and while the fundamentals favor an overly loose market at this point, a bullish shift in fundamentals could lead the potential for a test of the TAIL line at $5.45, which is 42% upside.

Daryl G. Jones

Managing Director

Natural Gas:  Where Art Thou Reflation? - gas

 


Slouching Towards Wall Street… Notes for the Week Ending Friday, July 17, 2009

ETF Update

The ETF marches on.  Traders Magazine Online (14 July) reports that the volume in ETFs is exploding.  According to the article, from last September through May, “ETF consolidated volume averaged almost 49 billion shares a month. That compared to almost 20.5 billion a month on average from the same period one year earlier.” 

This 150% jump follows a report where the NYSE found ETF consolidated volume on average doubled in comparable nine-month periods.

In other words, not only is ETF volume growing tremendously, it is growing at an accelerating pace.  We hold no degrees in rocket science – nor in any science – but we wrote earlier that the entry of such behemoths as PIMCO in to the ETF space all but guarantee that this market will soon top one trillion in assets.  Now, according to the Traders Magazine article, it appears that even the sky may not be the limit.

The article reports that Knight Capital has hired a team of fifteen ETF sales-traders to take advantage of “a tidal wave of volume and liquidity in the ETF space.”  In fact, Knight is going after a whole new customer base.

“We're seeing more traditional mutual fund managers converting more into ETF format for the lower cost structure and transparency that ETFs provide,” says a co-head of Knight’s ETF group.

Traditional asset managers have been steadily increasing their ETF exposure, using them for “core holdings, beta exposure, alpha generation, various hedging strategies. Whether you're bottom-up or top-down, they can be very useful.”

Something for everyone, it would seem.

Indeed, the article makes the following observation: “a traditional asset manager with money for a new account may want to be invested right away. Simultaneously, he also wants to wait two weeks to do some research on some stocks. While doing that research, he can invest the money in a value ETF and, at least, get the exposure until he has the individual stocks he wants to buy.”

This means that money managers who haven’t yet figured out what stocks to buy are sticking cash into an index, while figuring out what to do.  All right, we already admitted to not holding a degree in rocket science, but we wonder whether this lax approach to managing money is “demand-pull” or “supply-push”.  Did some smart money manager figure out that this is a good way to buy time while he does his homework, or are smart salesfolks hitting up money managers with hot new ideas?

In today’s interest rate environment, it makes little sense to park in cash while making an allocation decision.  Thus, an investor might assume that a money manager had ideas at the ready – the notion of being 100% invested, 100% of the time is a key selling point to private investors.  We will content ourselves here with smacking the same bell we have been ringing all year: the ETF trade risks becoming very crowded, very quickly.

ETFs and ETNs appear to trade based on two levels of price insensitivity.  First, the ETF sponsor does not care at what price the individual components are bought for the Fund or Note – their concern is having sufficient holdings in the underlying instrument to be able to issue their shares.  Secondly, the ETF buyer in the marketplace is looking, not at the price of the share, but at the action in the underlying index.  Thus, Best Execution appears to go out the window.

Brokerage firms have written best execution procedures for ETF trading, but the ones we have seen are just retreads of their procedures for best execution of stock trades.  This begs a big question: if the floor traders are scooping up stocks, indexes, oil, gas, and gold based purely on size and timing – with no consideration for price – and if the customer is buying the ETF based on the price of the underlying instruments, on what basis would anyone ever request price improvement?

While this looks like a facetious question, we call your attention to the CFTC’s new initiative to impose speculative position limits on all commodities “of finite supply.”  This means all natural resources, and much hoopla erupted in the last two weeks about shares of the ETF UNG – the natural gas contract – which literally ran out of supply when the SEC did not authorize new notes to be issued.

This has created a situation where the ETF becomes sensitive to actual market demand on the offer side – more buyers of the now-finite ETF will actually drive up the price beyond its intended relationship to the underlying contract.  The bid side of the market might hypothetically remain tied to the underlying natural gas contract; the problem here is maintaining a fair and orderly market.  If a buying panic develops – not impossible in a world where Russia needs to spike the price of oil and gas just to keep making bread and vodka – the market makers may find themselves forced to chase the offer, raising the bid beyond its relationship to the contract.

But it gets better – because if the market regulators see the natural resource ETFs and ETNs spiraling out of control, they will beat their chests and say how very right they were.  The introduction of position limits in the actual corn, gas, soybean and pork markets should be something most professional traders can get used to.  What the locals will miss, once the shackles are on, is the free money they were scooping up filling price-insensitive orders for the ETF managers.

After that, we think SEC Chairman Schapiro starts applying the same logic to the stock market and the indexes – perhaps not the broad ones, but the narrow-based sector tracking indexes, most probably.

Earlier this year, there was a great outcry by the senior executives of REITs who complained that their shares were being whipsawed in the marketplace by ETF creation and liquidation trades.

Public companies have fixed numbers of shares outstanding, and even under a shelf registration, new shares are not issued intraday.  We think CFTC Chairman Gensler’s proposed position limits are a done deal.  The Next Big Thing, though, may be similar restrictions in the equities markets.  In short: the ETF marketplace is big and growing – for the time being, though, it is decidedly messy.

We keep coming back to our old conclusion: Goldman bowed out of the bidding for iShares.  Could Goldman have won, if they really wanted to?  We think so.

Is it safe to assume Goldman knows something we don’t?

Count on it.

 

Cuban Embargo – Lifted!

My old pals from the 1980’s wouldn’t recognize me now.

- Ross Mandell

In the same week the judge dismissed insider trading charges against Mark Cuban, the SEC has issued insider trading rules for agency staffers.

The rules require pre-clearance of all trades by agency employees, prohibit the trading of securities of corporations under investigation, and require SEC employees to certify that they don't have non-public information about the companies whose securities they are trading in.

In a related matter, the House Financial Services Subcommittee is taking up an SEC report examining “alleged inappropriate trading” by government officials, and legislation has been introduced in the House to prohibit insider trading by members of Congress or their staff. The bill is known as the Stop Trading on Congressional Knowledge, or STOCK Act.

Compliance officers in the audience will recognize that introducing these rules is only ten percent of the task – the SEC staff are held to no more rigorous standard than employees of banking and brokerage firms.  The whole exercise smells too much of government, and not enough of ethics and common sense.  This is another case of a political institution taking a political step to fix a political image problem.

The entire industry remains on the honor system.  Will this enhance public protection?  Will this enhance the transparency and proper functioning of our markets?

Only time – one resource we have in pitifully short supply – will tell.

 

Nails In The Coffin

How are the mighty fall’n!

- 2 Samuel, 1:19                                                       

Just like in the Bible, there are no coincidences in real life.  The past weeks saw the Icarus-like plummeting of two high-flying financial Daedaluses.  Far apart as their stories may seem, we find far more similarities than differences in these twin cautionary tales.

News media can be misleading.  Thus, one might be forgiven if, upon reading the Financial Times headline (10 July) – “The Storms That Swept Away Meriwether’s Flagship Fund” – one formed the impression that John Meriwether was the victim of an irrational market. 

We ask that you refrain from pointing out the unerring acuity of hindsight.  Hindsight was staring us in the face in the avatar of Long Term Capital Management.

Among our favorite financial media moments is the excellent segment of Public TV’s “Nova”, dedicated to the rise and demise of LCTM (PBS airdate: February 8, 2000).  LCTM, staffed by the rocketingest of rocket scientists, and supported not by one, but two Nobel prizewinning economists – Robert C. Merton and Myron  Scholes – managed to create one of the greatest pools of risk in the history of finance.  We keep being reminded of the fundamental truths we learned from the successful old-time stockbrokers.  Those who strive belly-to-belly in the trench warfare of money are most sensitive to the true driver of economic forces: emotion.

Andrew Racz, he of the Eraserhead hairdo and staccato Hungarian accent, told us years ago, “Smart people never buy.  They only sell.”  Meriwether & Co sold risk.  The banks, the brokers, the investors – even the regulators all bought it.

The denouement of the Nova segment includes clips of a Who’s Who of the “Models Model” of market economics – Paul Samuelson, Myron Scholes, Alan Greenspan and others – musing on the humbling of the “model” model of market economics.

Here is Merton Miller: “Models that they were using, not just Black-Scholes models, but other kinds of models, were based on normal behavior in the markets and when the behavior got wild, no models were able to put up with it.”

Peter Fisher, Executive VP at the New York Fed during the LTCM crisis, says “I don’t yet know the balance between whether this was a random event or whether this was negligence on theirs and their creditors’ parts. If a random bolt of lightning hits you when you're standing in the middle of the field, that feels like a random event. But if your business is to stand in random fields during lightning storms, then you should anticipate, perhaps a little more robustly, the risks you're taking on.”

Fade to the past couple of weeks, where another icon was toppled as unceremoniously as the statue of Saddam Hussein.  Former baseball star Len Dykstra – whom Jim Cramer described in glowing terms as a stock picking Wunderkind – filed for bankruptcy, leaving in his wake a Hall Of Fame list of lawsuits.

In rebutting allegations that Dykstra was a beard for a scrum of no-name stockpickers who used Dykstra’s name recognition for marketing purposes, Wall Street pro Richard Suttmeier wrote (quoted in Silicon Alley Insider, 16 June 2008, “Lenny Dykstra makes His Own Stock Picks, Says Pro Who Helps Him”) “Lenny makes his own picks after reading tons of research notes from the most respected independent minds. He has become one of the best stock pickers after doing several years of homework. I can’t even explain how he uses his deep in the money call strategies.”

We especially like that last sentence.  Suttmeier devotes half his piece to bristling at being characterized as “a little-known strategist”, detailing his own professional resume, and his many television appearances.  He finishes with a flourish: “It was after one of these CNN ‘Talking Stock’ shows when Lenny Dykstra called me and said, ‘Hey Dude, can you teach me how to read a stock chart?’”

As our CEO, Keith McCullough, points out, running a P&L is not the same as running a business.  And – in his former capacity as Captain of the Yale hockey team – we are sure he would agree that even a .310 season batting average does not qualify one to handle investments.  Not one’s own, and not someone else’s.

The fault, to paraphrase Shakespeare, lies not in our markets, but in ourselves.  Markets, like computers, give us back what we provide: Garbage In, Garbage Out.

The traditional Wall Street management model consistently promotes excess over good sense.  In many firms the most successful salesmen are routinely turned into managers.  The apotheosis of this process is perhaps the elevation of Jimmy Cayne to head of Bear Stearns – accounts of the demise of that once-great firm - but it has deep and untouchable roots.  The finance business is, after all, about getting other people’s money – not about making money for other people. 

Superstar traders like Meriwether are able to generate outlandish profits for their firms for a number of reasons.  Not the least among those reasons, to be sure, is their own unique market acumen.  But running a profitable trading desk uses one skill set, while running a successful financial company uses a different one.

Meriwether was an all-star at Salomon Brothers, where he was Head of Fixed Income Arbitrage.   Traders who worked under him there credited Meriwether with applying a “yield-to-worst” analysis to their positions, trying to gauge the effect on their positions of, as one trader put, “the world going down.”

Here’s the rub: this is the right process for a trading desk manager to apply to protect his P&L.  In the meantime, he needs pay no attention to the cost of his office rent, light fixtures, telephone lines, or the expensive lunches he caters to feed the traders on his desk.  One would think that a well-run firm would charge these items back to the profit center.  But on Wall Street, the profit centers, to paraphrase the old management saw, walk out the door at the close of business every day.  Come year end, the same conversation takes place in every boardroom, when the heads of the profitable desks sit down with senior management.  We can just see Meriwether sitting across from Gutfreund.  Gutfreund is holding a gigantic cigar and gazing with his impassive basilisk stare as Meriwether, red pencil in hand, cuts expense items from his desk’s P&L.

In good times, firms end up eating the lion’s share of the expenses of their profitable departments.  The most profitable department – and Meriwether was a super-duper-star – gets first crack at ramming expenses back down the throat of the shareholders.  By the time this exercise is done and bonuses paid, the company ends up with a winnowed-down profit number, and the traders get new Porsches.

Who shoulders the burden of business decision-making at these hedge funds?  Managers who run world-class desks at major financial institutions find themselves paralyzed by having to face personnel decisions, by having to make decisions on compliance procedures, by having to negotiate with portfolio managers who insist on hiring staff.  Never mind the year-end bonus discussions.  High-profile traders at major firms are insulated from serious business decisions, and frequently falter when they must take them on in running their own firms.

Just like Lenny Dykstra.  “One of the great ones in this business,” according to Jim Cramer.  Dykstra’s options newsletter on TheStreet.com reportedly netted him $1 million a year until being discontinued earlier this year.  In a sad denouement reminiscent of “Requiem For A Heavyweight”, the public is ghoulishly watching as Dykstra’s former sports glory, his second career, his personal life, and the respect he once enjoyed from colleagues, friends and teammates all go down in flames.  Clearly, Dykstra was “one of the great ones”… until he wasn’t.

Both Meriwether and Dykstra represent what’s wrong with this system.  Both men were outstanding at their chosen vocations – and both appeared untouchable in their first careers.  In their second careers, they have fallen victim to the ultimate Wall Street sin: they believed their own hype.

Worse yet, the rest of the world believed it too.

 

Split Personality

I seem to be what I’m not, you see…

- “The Great Pretender”

GM shares shot up 35% in value on the news that the company is emerging from bankruptcy. Last Friday, when the announcement hit, the stock traded as high as $1.15.  Oh, by the way… that was not General Motors stock.  Not really.

The Wall Street Journal (16 July, Marketbeat, “Stock Split: New GM vs. Old GM”) scratches its journalistic head over aggressive trading in the shares of General Motors, particularly the 35% surge in the price of the shares in the wake of the announcement that the company is emerging from bankruptcy.

What’s odd about this market action is, the trading is in ticker symbol GMGMQ – the designation for the old GM shares that still trade in the Pink Sheets, the home of delisted public companies.  These shares – as the Journal correctly points out – “represent ownership stakes in the GM assets that remain in bankruptcy court, a company named Motors Liquidation Co., assets that the new GM didn’t want.”

This is the industrial version of the Good Bank / Bad Bank model.  It has been around for a long time, as it is a standard part of the bankruptcy process.  In the public markets, there is invariably a rush of buying in the delisted company around the times of filing for, and emergence from bankruptcy. 

Over the years, retail investors have erroneously believed that they were buying the “new” company for pennies on the dollar, when what they were actually buying was the abandoned assets.  Now – lo and behold – FINRA actually has exercised its Investor Protection responsibility.  Last Friday it acted to halt trading in GMGMQ.  FINRA issued a public statement saying there may be “potentially misleading” information in the marketplace, and that investors should not assume that the mere fact of a security trading in the market should not be interpreted “as indicating that the shares have any value.”

With so many companies in danger of filing bankruptcy, why haven’t the SEC and FINRA – both in their primary capacity, which is investor protection – issued statements advising investors that the common stock of companies in bankruptcy is not the same as the common stock of companies emerging from bankruptcy?

We have not forgotten that last year FINRA – with Mary Schapiro still in the saddle – suspended delistings on the basis of price.  Their logic was that there were many companies whose stock price was unrealistically depressed due to market conditions, and it would cause unreasonable pressure in the markets if they were to delist every company whose price collapsed.  The NYSE followed suit some time thereafter. 

In the midst of all this incompetence – and just in time for the potential bankruptcy of CIT Group – FINRA has suddenly discovered its investor protection roots.

Hear the applause?  It is the sound of one hand clapping,

 

A Final Reflection

Esse Quam Videre (“To Be, Rather Than To Seem”)

- North Carolina State Motto

To much front-page fanfare, Bernard Madoff has driven the last five hundred miles (Wall Street Journal, 16 July, “Sins And Admissions: Getting Into The Top Prisons”).  Against the recommendation of defence attorney Ira Sorkin, Madoff is now an inmate at Butner Federal Correction Center, a medium-security facility in North Carolina.  The WSJ article mentions that the Rigas boys – pere and fils – are doing their time at Butner for their fraud convictions relating to their tenure at Adelphia Communications.

But of all the places Madoff could have been sent, it is a twisted irony that he is now housed at the same facility as Jonathan Pollard, serving a life sentence for passing US Naval Intelligence information to the Israelis.  Pollard, who violated the laws of the United States, believing his actions would save the Jewish people, is paying the price for what he believed was right.  Madoff, who ruthlessly exploited his close ties to the Jewish community, breaking the laws of the United States to satisfy his own irrational greed, will now pay a price of his own.

Welcome to North Carolina, Bernie.  “First In Flight” – but not for you.

Bernie Madoff, today is the first day of the rest of your life.

 

Moshe Silver

Chief Compliance Officer

 


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