You already know our big picture view on HOT/lodging. 2010 estimates are still too high as cost cutting has played out and top line will continue to lag the economy. However, we’ve got insights on some important, but less obvious items.


American Express Deal

As Starwood disclosed in its release, American Express is paying them $250MM to buy “points”, which can exchange for rewards by American Express users.  This is basically an interest free loan that Starwood is getting, and in return they probably gave American Express a nice discounted rate.  When American Express customers redeem their points for a stay at a Starwood branded hotel, Starwood will pay the hotel owner for the stay.  There will be a liability on Starwood’s balance sheet to account for the $250MM in payment that they eventually will have to make.  However, these payments will never hit the income statement as one would expect and instead just flow through working capital.  Somehow the amortization of gains hits the income statement but the negative amortization of a realized liability does not.  At the end of the day, cash is cash and over a number of years Starwood will pay out $250MM of cash related to this advance.


Italian Tax Credit

Since the Italian government is in desperate need for cash, it struck a deal with property owners.  For a small upfront payment today (undisclosed of course- but I was told it was small), Starwood was able to buy $120MM worth of tax credits that they can use to defer any future capital gains should they sell any of their Italian trophy assets.  Not a bad move, since the basis on those assets is low and the Italian capital gains tax rate is 28%. This is probably a little signal from Starwood that they are trying to sell some of these assets.  The cash flows on these hotels are pretty de-minimis so the multiples will look great.  Whether there are there still buyers of trophy assets out there is the real question.


Non-core Asset Comment

HOT referred to non-core assets on its conference call.  My two cents is that they are looking into a possible sale of Bliss... it’s their only non-core non-lodging business.  They already license out the use of their brands for retail.


What’s in “Other Management & Franchise Revenues” and “Other (2)”?

You already know our belief that non-cash, non-recurring profits should not get the 15x multiple normally assigned to “Fee” profits just because they’ve thrown it in the “Fee” bucket.  Here is a clarification of what else was in those two line items:

  • Termination fees can appear in either bucket but this time it was behind door #2, lumped in with Bliss Spa income
    • Just as an FYI, Starwood doesn’t get the termination fee if it pushes hotels out of the system because they fail to maintain brand standards, they usually only get the fee when an asset changes hands
    • In a default scenario, we do not believe that many hotels will be de-flagged.  However, if they are de-flagged, the debtor can reject existing contracts and probably get away with paying pennies on the dollar as a termination fee
  • Not sure what the other $10MM of revenues are in the “Other Management & Franchise Revenues (1)” are.  However, changes on hedges are also recorded here.



Key data points for the week of July 27-31 will include the release of Second Quarter Advance GDP on Friday, a slew of housing data and a series of Treasury auctions.

Monday July 27:

  • U.S.: Census Bureau new home sale data for June will be released at 10 am with Forecasts predicting a modest improvement over May’s 342, 000. The Treasury will be auctioning 20 year TIPS at 1PM.
  • Europe:  German August Gfk Consumer Confidence and July CPI data will be released on Monday, as will Eurozone June M3 figures.
  • Asia: Hong Kong Trade Balance data for June will be released on Monday with forecasts indicating an expansion of last month’s 11 billion HKD deficit.

Tuesday July 28:

  • U.S. Case-Shiller home Prices for May will be release on Tuesday morning, as will ICSC retail chain store sales index and Redbook weekly data. Conference Board consumer confidence figures for July and ABC Consumer Comfort data will be released in the afternoon. The Treasury will be auctioning 2 year notes at 2PM. 
  • Europe: June PPI data for France and Consumer Confidence data for Italy will be released on Tuesday.
  • Asia: Japanese Retail Sales and South Korean Current Account figures for June will be released on Tuesday.

Wednesday July 29:

  • U.S.: Mortgage application figures will be released on Wednesday morning as will Census Bureau Durable Goods and Shipments data for June. Weekly EIA Oil Stocks will be announced at 10:35 am and the Treasury will hold a 5 year note auction at 1pm.
  • Europe: BOE June consumer credit, Mortgage and Mortgage approval figures will be released on Tuesday as will M4, while Business confidence data will be released in Italy.
  • Asia: Japan’s June industrial Production, Shipments and Trade balance data will arrive on Wednesday evening. 

 Thursday July 30:

  • U.S.: Weekly Initial Claims data will be released on Thursday –recall that the prior week’s increase which followed three consecutive declines.  EIA gas stocks will also be released on Thursday morning and the Treasury will hold a 7 year note auction at 1pm.
  • Europe: UK Nationwide House Prices and Gfk Consumer Confidence for July will be released on Thursday, as will German Unemployment figures and European Commission Confidence measures for July.
  • Asia: July CPI and PMI data will be released in Japan on Thursday but, with the LDP in a struggle for survival in the coming election, all eyes will be focused on June employment and personal income data also slated for release. Although the LDP has ruled Japan for almost the entire period since it was founded in 1955, the current economic stagnation has set the stage for a sweeping victory for the opposition Democratic Party.

Friday July 31:

  • U.S.: Q2 GDP advance data will be released by the BEA on Friday at 8:30.
  • Europe: July CPI data for the Eurozone and Italy will be released on Friday, as will Italian CPI and unemployment.  Swedish Q2 GDP will be announced on Friday, with consensus estimates anticipating a further decline from Q1’s measure of -6.5% Y/Y.
  • Asia: Thailand trade and production data for June will be released on Friday.

“Shoots” in Europe?

The July Purchasing Managers’ Index was released by Markit Economics today for the Eurozone, Germany, and France. While we believe that making an absolute call on Europe would be shortsighted due to the uncorrelated returns across the region based on unique underlying fundamentals, today’s report provides a useful metric for comparing the two largest individual EU economys’ performance on a relative basis.

According to the composite PMI index, Eurozone aggregate manufacturing and service industries rose to 46.8 in July from 44.6 in the previous month.

For Germany, the largest economy in the Europe, PMI improved on a monthly basis. The Manufacturing index rose to 45.2 from 40.9 in June and Services index rose to 48.4 from 45.2, just short of the 50 level that divides contraction from expansion. France’s PMI for manufacturing advanced to 47.9 from 45.9 while services declined to 45.5 from 47.2.

The Ifo Institute also reported today that the German business climate index for July rose to 87.3 from 85.9 in the previous month, exceeding an expected gain to 86.5, and notching a four straight months of improvement.

For Germany, a country that has been on a short list of Eurozone countries we’re bullish on, today’s PMI and business confidence numbers indicate a step in the right direction. From a fundamental set-up we’ve been positive on Chancellor Merkel’s leadership; she has balanced a stimulus package (85 Billion EUR) with timely incentives such as the cash-for-trash auto rebate. These initiatives now appear to be  supporting modest growth recovery, which we see making steady improvement into 2H ’09.   

Germany’s powerful manufacturing capacity remains a primary structural advantage, with recent positive (but lagging) production signals that show sequential improvement on a monthly and annual basis, as well as Factory Orders that were up 4.4% in May over April levels. While the internal demand picture appears to be improving with the low CPI/low interest rate environment bolstering consumer spending, exports have shown a faint sign of improvement at 0.3% in May M/M. Because exports make up nearly half of German GDP, they could remain a stumbling block for growth if we don’t see measureable improvement in Q3 with production trends reversing in the absence of external demand.  For now though, the positive catalysts appear to be gaining on the negative, making Germany the most attractive of the primary EU economies on a relative basis.  

As we continue to monitor the European patient we’ll be looking to pair off our short position in Italy (EWI). Germany was down today along with most Western European indices, capping 9 days straight of gains or a 12.9% move for the DAX since 7/10.  Stay tuned as we look to buy the German etf EWG on pullback.

Matthew Hedrick


“Shoots” in Europe? - GermanPMI

Squeezy's Return: SP500 Levels, Refreshed...

“I'm not going to waste my time arguing with a man who's lining up to be a hot lunch.”

-Hooper (Jaws, 1975)

Back by popular request (after getting my 954 level wrong) is the mascot we rode for the better part of Q2, Squeezy The Shark. Make no mistake, this market’s quantitative setup has changed, and unless you change with it, as Quint would say, “This shark, swallow you whole.”

When the market was on the lows this morning I bought the Nasdaq (QQQQ) as it’s fundamental setup is stronger (great balance sheets + liquidity) than that of the SP500 (financials, leverage, etc…). That said, the SP500 is Mr. Market, so that’s where I anchor our US equity risk management process.

In the chart below, Andrew Barber and I have outlined our new nautical map:

  1. TAIL = 954 (resistance now becomes support)
  2. TREND = 897 (way lower,  but higher than my Range Rover 871 which has held in nicely so far in Q3)
  3. TRADE = 948 (that’s the line that you need to watch-out for Squeezy at – trust the shorts, they are there)

Happy swimming,


Keith R. McCullough
Chief Executive Officer

Squeezy's Return: SP500 Levels, Refreshed...  - sharky22


Restaurants - Earnings Fatigue

Continuing the theme from Q1, restaurant companies are beating Q2 EPS expectations by cutting costs. Unlike Q1, a significant earnings beat is no longer driving stocks appreciably higher.  The cost cutting theme is becoming the consensus and not an investable theme that moves stocks. 

Restaurants - Earnings Fatigue - Q2 thus far stock price performance

Here is the drill from a typical company.

The good news:

“We’ve also identified other cost savings opportunities”

“The lower capital spending will go towards boosting our cash balance, further strengthening our balance sheet and increasing our future flexibility. And we will have even more time and resources to focus on operations and execution at our existing base of restaurants.”


“Despite a continued low level of visibility for the rest of the year due to both last year’s volatility and the ongoing economic uncertainty it’s very difficult to know where same-store sales will come in”

So far this earnings season, the stocks are not reacting to the better than expected earnings news.  Stocks performed well post calendar Q1 numbers because for most FSR companies it was the first quarter of operating margin growth in at least two years.  In Q1, restaurant operators proved they could cut costs to offset sales weakness and boost margins.  In Q2, investors seem to be expecting these cost savings and even when a company increases its cost saving projections, like CAKE did yesterday, it is not enough to get the stock moving higher. 

The bulk of the fat has been cut from these companies’ operating models so the obvious question is where do we go from here.  It will be impossible for these companies to continue to grow margins once they start to lap these savings initiatives if sales don’t pick up.  They can’t cut costs forever without hurting the customer experience and eroding their brands.  And, as I already pointed out, most companies are saying they have limited visibility about when sales might turn positive. 

This thought can best be shown by the chart below, which looks at FSR same-store sales growth trends, as reported by Malcolm Knapp, relative to the average YOY bp change in EBIT margin for DRI, RT, CAKE, PFCB and BJRI (FSR companies that have reported calendar 2Q earnings so far). 

Restaurants - Earnings Fatigue - Q2 thus far SSS vs EBIT Margins

Clearly this trend is not sustainable – these companies cannot continue to grow margins with negative same-store sales growth.  CAKE’s CFO Doug Benn highlighted this point in response to a question about if and when the company would recapture the margin level of yesteryear:

“Internally, the way that we are looking at it, we’re taking it one step at a time. If you go back to 2007 margins, operating margins they were around 8.5%, which is somewhere in the neighborhood of 250 to 300 basis points better than where we expect to end this year. And the scenario to get back there, some of it is going to be this cost-cutting and the cost initiatives and we’ve made some great progress there but the real avenue to get back is we have to have a plus sign in front of comparable store sales. And until we do that, we’re not going to be able to get all the way back.”

We all know that comparisons get very easy in 2H, particularly in Q4.  What if easy comparisons are not that easy? Minimum wage is now higher for the balance of 2009 and the benefits of lower commodity costs will diminish over the next six months. 

I don’t want to paint a bearish picture because nearly all the companies I follow are financially strong cash generators.  And, with little to no development plans in the near-term, their cash positions are only building.  What I’m struggling with is deciphering the catalyst (positive or negative) that will get these stocks moving in either direction.    




PNK just put out an 8K regarding a credit amendment that they entered into on July 21, 2009.  They got an increase of the leverage ratio / decrease of the interest coverage ratio to account for a later opening of River City.  In return the facility size was reduced by 15%, the spread was increased by 50bps and a LIBOR floor of 1% was introduced

Below are the details of the Fourth Amendment to its Credit Facility:

Increased the maximum permitted Consolidated Leverage Ratio to take into account the opening of River City which was originally expected to open earlier.


The new maximum leverage ratios are as follows, for the period ended:

June 30, 2009 to 6.5x (was 6.0x)

Sept 30, 2009 to 6.5x (was 5.5x)

Dec 31, 2009 to 6.75x (was 5.5x)

March 31, 2010 to 6.5x (was 5.0x)

June 30, 2010 to 6.0x (was 5.0x)

Thereafter to 5.0x (was 5.0x)

  • Decreased the minimum Consolidated Interest Coverage for the March & June 2010 ended periods to 1.75x from 2.0x
  • Increased the applicable Margin on the R/C by 50 bps
  • Company was permitted to issue senior unsecured notes, subject to covenant compliance
  • Retained permission to request an extension of its Credit Facility beyond the Dec 10, 2010 maturity
  • Broadened the definition of “Defaulting Lender” to include any lender which fails to fund its portion of the Loan required under the Credit Agreement, as well as any Lender who becomes subject to bankruptcy or insolvency or takeover by a regulatory authority. By broadening this definition it makes it easier to assign a lender’s interests, rights and obligations (at par) under the Credit Agreement - I’ve never seen this one before – interesting in light of the bank environment
  • Definition of Base Rate was changed to include a one-month LIBOR floor of 1%
  • Each Lender’s commitment was reduced by 15% so that the Aggregate commitment was downsized to $531.25MM from $625MM

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