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WMS: CONF CALL HIGHLIGHTS

We are bullish on the slot supplier segment, not so much based on 2010 but more so because there is a visible and developing domino effect with new markets, leading to neighboring jurisdictions needing to “keep up with the Joneses”.  It is fair to argue that WMS deserves a premium valuation given its stellar performance.  However, we believe that there are cheaper ways to play this trade, with stocks that have lower embedded expectations.

 

WMS 2Q09 EARNINGS CALL

  • 13th consecutive quarter of meeting or beating guidance
  • Over the last 3 years WMS’s net income tripled, despite the decline in industry shipments
  • Results were achieved in the midst of the worst replacement market and weak new openings
  • Capital investment is targeted towards high ROI initiatives
  • Activity in multiple new jurisdictions and eventual replacement cycle makes them optimistic
  • Increased share repurchase program
  • High performing games is helping their gaming operations through more units and higher win per days
    • WAP footprint grew 38%
    • 171MM of gross profit
  • Estimate ship share will be higher than 21% achieved last year
  • International new unit revenue grew 5% for the year
  • CFFO was 179MM
  • Bluebird 2 platform saw some success  - 62% of new shipments, with 25% being mechanical reels (22% for the year), 20% higher price
    • Same gross profit margin % achieved in BB2 as BB1
    • They expect to further increase margins with cost decreases and price increases
    • Can deliver units faster, saving money
    • Aria – 23% of floor will be blue bird 2 – highest flow share for Vegas strip opening
    • 23% in Rivers Pittsburg, and 24% in River City – PNK (shares)

Outlook/ new products:

  • Growth from new international jurisdictions
    • Already shipped first units into Mexico and expect to recognize revenue in New Wales by 1H2010
  • Growth from new platforms like Helios (value oriented cabinets for international markets)
  • Growth from networked gaming contribution
    • Log on feature- player recognition
    • Time machine game/ monopoly games – first participation game on BB cabinet
  • Higher selling prices, despite depressed unit shipments domestically
  • Higher install base and higher average daily win per day in 2010
  • Entry into centrally determined markets – WMS games are already in those markets (like Oklahoma) through 3rd party distributors. Already shipped first units to Washington
  • They have a monopoly license through 2016 (and extension available through 2019)
  • Opened new lab in Seattle – to demonstrate new network gaming products
    • Launch wage-net enable products over the next 6 months (Aria & other casinos)
      • Received approval in Mississippi to conduct trials for downloadable
  • WMS assumes lower Native American expansion opportunities in 2010
  • They aren’t including any new markets that still have a lot of uncertainty around them
  • Lower margin on game ops from higher mix of WAP units
  • Benefit from higher mix of BB2, hurt by higher mix of lower margin product sales like used games and lower # of conversion kits –resulting in lower gross product margins
  • R&D: will continue to grow – ~14% of revenues
  • SG&A:  (June reflected higher headcount from global growth)
  • D&A:  increase modestly and decline as a % of revenues
  • Effective tax rate will be 36-38% (after R&D tax credit expires this year)
  • Remain optimistic given:
    • 18 consecutive quarters of double digit EPS growth
    • 2 week customer order turn around
    • Innovative culture and pipeline = special sauce for boosting demand for products in challenging times
    • “Future ready” for networked gaming

Quarterly highlights:

  • Other product sales (used) created a small drag on margins
  • Operating cash flow in 2009 was same as 2008   
    • Provided financing for more customers in the quarter
  • Inventory turns improved 35% to 4.2x from 3.1x turns
  • Cash grew despite $27MM used in investing activities

Q&A:

  • What are they seeing with their install base, is there more price resistance?
    • No – they continue to see pricing leverage
    • Units – tremendous success with Wizard of Oz not sure that they can replicate that growth
    • “There could be some upside if games are success”
    • Expecting a decline the rate of growth for participation business to slow
  • Assumptions for domestic / international
    • International mix to remain constant next year
    • See first 6 months of 2010 to continue current trends and pick up in back half
  • Why are they comfortable that back half replacements will help them in 2H2010?
    • Had a number of dialogues pre G2E and see a resurgence in demand from some clients that haven’t bought in a while (big players)
    • “loosening of purse strings”
    • Some of it is because there was pent up demand
      • I’m sure that the refinancings are driving this
  • Used games?
    • Great demand for BB1 product – not a lot of inventory so great demand for them… may start to see the BB1 come back to them and go to 2nd tier markets (internationally) so when their customers upgrade to BB2 they get more BB1’s back
    • No used games in their inventory today
    • Used games vs conversions kits moving in the opposite direction
      • NO
      • They are to venues outside the US vs. conversions are to US
  • Is IGT’s increased WAP footprint (BYD/MGM) impacting their guidance –NO
  • Growing excess FCF – above R&D needs – where are the opportunities to deploy that
    • Scour the globe for new technologies/ IT
    • Acquiring a company…
    • Board increased the buyback program by $75MM have $150MM under the program
    • Reinvest in the same range as 09 into gaming operations
  • Backlog?
    •  “healthy”
    • Very comfortable with their guidance
  • Class 2 & Australia cheaper… than BB2 – hence lower ASP growth given higher BB mix
  • Think they had a mid-high 20’s share – mid 30s replacement share
  • Majority of replacement units are competitor units- particularly in mechanical product – fresh market share for them
  • Taking “Price is Right” brand from a competitor
    • Thought they could leverage the brand – not about stealing competitor brands – it came to them  - given server based capabilities
  • Outperformance in operating margins driven by the gaming operations business- that’s where the beat can come from in 2010. On the product sales side, could have upside from new markets.  Replacement cycle improvement would be huge too.
  • Expanding video poker platform
    • Exciting opportunity in IL – but it’s not going to be just video poker. Expect to participate and have a commensurate share of that market
  • Idea behind internal casino Seattle to help sell their server based games – hard to sell on paper –easier to demonstrate
  • Are they sandbagging win per day for 2010?
    • July was the best month ever (June & Sept are seasonally the strongest quarter) but hard to forecast super strong trends continuing
    • Wizard of Oz – new placements – unclear if win per days will hold
      •  typically participation games have falling off win per days as games on the floor age
  • Any chance they get same share of games for new openings as replacements?
    • People forget that existing floor share is in the teens so 30% is getting them closer to new opening share in the low to mid 20s
  • Regional operations have been aggressively  replacing their  machines, and Native American casinos are on a normal 5/6 year cycle… it’s really the multi-property/ strip players  that haven’t been holding up orders
  • Comparing Wizard of Oz to Wheel of Fortune is a stretch …
    • I don’t think people realize how many WoF games are out there… probably about 25,000… whole other league – not to take anything away from WMS
  • Long term – where can margins go:
    • 60% product margins (will depend on conversion kits and software success of “networked gaming”)
    • 25% operating margins

Reflation's Rotation: ISM Prices Paid

If there is one question I have been getting most consistently from investors as of late, its ‘why do you think we see inflation in Q4?’…

 

Generally speaking, until macro numbers are on the tape, “private forecasters” won’t believe they are possible. Maybe that’s because groupthink is so dominant right now. Maybe it’s because you can’t get these forecasts with in a “one on one” with your favorite economist. Otherwise, I have no idea. This call isn’t that complicated.

 

When I measure risk, I measure ranges, deltas, and spreads. One way to measure the risk of reflation rotating into inflation in Q4 is through the delta of the Prices Paid component of the ISM Manufacturing survey. Last month I called this out as an eye opener. This month’s number is a flat out moon-shot (see chart).

 

A lot of economists are calling for perpetual deflation because that’s what the lagging indicators (reported CPI and PPI) are telling them. Looking at the smack-down of this chart from July of 2008 until the end of Q408’ will give you a great summary of what’s in that rear-view mirror.

 

At a reading of 55 for July of 2009, this horse has already left the barn. If these price levels hold, year-over-year inflation accelerating in Q4 is as close to a mathematical certainty as I can find. People have to pay for things in US Dollars – the Buck is Burning.

 

And Reflation’s Rotation is finally underway…

KM

 

Keith R. McCullough
Chief Executive Officer

 

Reflation's Rotation: ISM Prices Paid - ISMCHART

 


Obama Down, Market Up

As we were going through our weekend reading, the cover of the Economist jumped out at us.  For those of you who didn’t get a chance to read the Economist, the cover had a picture of President Obama with the title, “Crunch time”.  We typically consider the covers of most major financial publications as contrary indicators, or at least derivatives of such.  This cover actually seems to be an apt description of the President’s current predicament.

 

As the Economist notes:

 

“If the opinion polls are to be believed, Barack Obama is now, six months into his presidency, no more popular than George Bush or Richard Nixon were at the same stage in theirs.  His ratings are sagging particularly badly with electorally vital independent voters: two-thirds of them think he wants to spend too much of their money.”

 

We have previewed this shift of the middle moving away from President Obama, and it now seems to be occurring in a substantial way.  We have inserted a chart below of the Rasmussen Daily Presidential Tracking Index (difference between strongly approve and strongly disapprove), which shows the inverse relationship between President Obama’s approval rating and the stock market.  The internals of the Rasmussen highlight a number of key points in regards to President Obama:

 

  • Only 11% of voters believe taxes will go down under President Obama;
  • Only 29% of voters trust President Obama on the economic crisis; and
  • Almost 76% of voters believe President Obama is too liberal.

Rightly or wrongly, President Obama is very vigorously being categorized as a leftist President who will raise taxes and can’t handle the economy.  These characteristics are what seem to be directing Obama’s weak polling numbers as of late.  Two additional polls from Rasmussen offer evidence as to why this is the case:

 

  • 30% of voters believe that increases in government spending will help the economy and 50% believe that it will hurt the economy; and
  • 54% of voters believe tax cuts will help the economy and 19% believe they will hurt the economy.

Unfortunately, for his approval rating, President Obama is doing the one thing that voters broadly disapprove of, which is he is increasing government spending.  The implication of this increase in government spending is that taxes will likely have to go up.   According to Associated Press reports over the weekend:

 

“Treasury Secretary Timothy Geithner and National Economic Council Director Larry Summers both sidestepped questions on Obama's intentions about taxes. Geithner said the White House was not ready to rule out a tax hike to lower the federal deficit; Summers said Obama's proposed health care overhaul needs funding from somewhere.”

 

It doesn’t take a group of knucklehead hockey players from Yale to figure out the obvious here, taxes are going higher, which is what President Obama’s approval rating is starting to discount.

 

Perversely, the benefit of a declining Presidential approval rating is that it is positive for the stock market.  Ned Davis Research has done extensive work on this idea, and we conceptualize it in the chart below, but “in weeks when the presidential approval rating sagged below 50 percent, stocks rose at an annual rate of 9 percent -- versus only 2 ½ percent when the president in office sported a wildly popular 65 percent approval rating in the polls.”  No surprise, that when a President’s approvals declines too far, typically below 38%, stocks tend to fall on average 2% annually. This is not unlike our thesis on the dollar, which is that a weak US$ is positive for the stock market, to a point.

 

President Obama’s Chief of Staff Rahm Emmanuel famously said, “Never let a serious crisis go to waste.”  For investors, the rule may be more aptly characterized: never let a serious crisis in Presidential approval go to waste.

 

Daryl G. Jones
Managing Director

 

Obama Down, Market Up - djchart2

 


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Chart of The Week: Volatility Breakdown

One of the main lessons from what is becoming as forceful an up move as we had on the way down is that Wall Street continues manages risk on a revisionist basis. This is not a proactive investment process. It’s reactive, and you should capitalize on its outputs.

 

Prior to Q2 of 2008, for most 30-year old hedge fund managers a VIX above 30 was unheard of. Although I’m using that age to be cute, the reality is that there are very few institutional managers who managed their portfolios in a 30-80 VIX environment prior to 2008. Today, there are equally as many PM’s who are being told to manage their exposures towards a 30-80 environment AFTER the fact.

 

The probabilities of seeing a VIX over 30 anytime in the immediate term are very slim. That, of course, makes the 30-80 range a tail risk that we should perpetually consider. But it also means that you’ll get crushed on 97% of the days in this current trading environment by hedging towards that tail risk scenario. Tail risk is exactly that – not in the heart of the bell curve of daily price distributions.

 

Across all three of our key durations, the VIX remains broken. While it’s nowhere near as nasty as the US Dollar chart, this is one of the most bearish charts in all of global macro right now.

 

The long term TAIL line = $41.29 and the intermediate term TREND line = $30.57. Until you see these lines penetrated to the upside, you’ll be paid to buy low and sell high.

 

Trade the range confidently, rather than in fear. The days of calling for crashes and squeezes are behind us… for now…  simply because everyone continues to look for them.

KM

 

Keith R. McCullough
Chief Executive Officer

Chart of The Week: Volatility Breakdown - kmchart1


Slouching Towards Wall Street… Notes for the Week Ending Friday, July 31, 2009

A Flash In The Pan

 

An appeaser is one who feeds a crocodile, hoping it will eat him last.

                             - Winston Churchill

 

Senator Chuck Schumer has warned the SEC that, if the Commission does not act to halt the new “flash orders”, he will introduce legislation to ban the practice.  The New York Times obligingly ran a front-page story (23 July, “Stock Traders Find Speed Pays, In Milliseconds”) and followed up with stories about Senator Schumer’s assault.

 

Flash trading takes to a new level the algorithm-driven model known as “High Frequency / Low Latency” trading.  Traders with the most powerful computers and the most sophisticated algorithms – “algos” in trader-ese – capture significant advantage by identifying patterns of buying and selling literally as they emerge, and in many cases before trades are even printed.

 

Free markets are predicated on the notion that those who are smarter, faster and more diligent than the rest also get to make more money, even at the expense of the rest.  No one compels us to trade stocks, and we do so with eyes open to the risks.  Including especially the risk of trading against someone smarter than ourselves.

 

But the flash order double-dips the advantage already enjoyed by the smart guys.  First, the market venue where you enter your trade attempts to fill your order by sweeping available inside bids or offers – preferencing its own members – then they flash the unfilled portion to their biggest customers.  Only then does it get routed out to the broad market.  We always knew that money talks.  Now we learn that it also front runs your order.

 

The Times reports that on July 15, trading in the shares of Broadcom surged.  The Times story indicates that buy orders in Broadcom were flashed to the Star Wars crowd for 30 milliseconds.  This 0.03 of a second was enough for the algos to determine out not only the direction of interest, but the upper and lower price limits, and to scale their orders accordingly.  The times reports “the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.”

 

A profit of $7,800 on transactions valued at $1.4 million may not seem like a lot of money, especially when factored over all the High Frequency / Low Latency guys in the flash realm.  It is a return of 0.0056, or a little over one-half of one percent of the total amount that changed hands.

 

Multiply that by the billions of shares that trade in the markets every day, factor in the news stories, rumors or just plain market momentum that drives trading swells, and you see this can add up.

 

As a random example, for trade date 30 June of this year, NYSE Group daily dollar volume was reported as $45.6 billion.  One-half of one percent of numbers of that magnitude – $228 million – adds up quickly.  How quickly?  The Times article cites a report indicating the high frequency traders as a group took in $21 billion in profits in 2008. 

 

At the time of this writing, the SEC is looking at flash orders and it looks like the kibosh will soon be applied.

 

Buried in the Times story, almost as a throwaway, is the following:

 

“High-frequency traders also benefit from competition among the various exchanges, which pay small fees that are often collected by the biggest and most active traders — typically a quarter of a cent per share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss.”

 

The exchanges, in an attempt to attract business, pay incentive fees to traders who execute on their facilities.  Everyone in the business acknowledges this practice. It even has crept into trader-ese, where they call it “incenting.”  For those of you who have forgotten, this practice – Payment For Order Flow – is how Bernie Madoff built his business.  It worked for him, and it has certainly worked for the exchanges.  NYSE average daily volume is up some 164% since 2005, even as other exchanges and trading venues have proliferated.  By some estimates the Star Wars guys account for over half of all trading volume on all exchanges.

 

This is touted as being good for everybody.  Markets need depth.  All other things being equal, the more volume on an exchange, the more robust that market should be.  But by paying for order flow the exchanges induce firms to place orders in trading venues, regardless of the quality of execution.  Exchanges are supposed to offer depth, liquidity, transparency, and protection of customer orders.  Firms should trade based on the robustness of that venue – not on the basis of who pays them for their business.  By “incenting”, exchanges create a false impression of market activity – the activity is real; what is false is the underlying reason for that activity.

 

When this type of activity occurs in individual securities, it is called Painting the Tape.  Traders buy and sell the same securities repeatedly, artificially pumping the trading volume in order to create public interest in a security.  When individuals do it, it is a criminal activity.  When an exchange does it, it is called promoting liquidity and market depth.  Now, even incentive fees are not enough to hold onto the Star Wars traders, but they need an early peek into the order book to top it off.  The bigger they are, the more clout they have, and the more the exchanges have to offer them to stay.  Some traders even have algos that calculate maximum loss scenarios, then enter losing orders as long as the incentive fee will be more than the loss on the trades themselves.

 

In a reversal that should take no one by surprise, the NASDAQ Stock market, which introduced Flash Orders on 3 June, now characterizes these types of orders as “order types that do not support price formation” (Reuters, 28 July, “Nasdaq Backs Ban On “Flash” Trading: Schumer”).  For the lay person: we tried to give an excess unfair advantage to our biggest players, because try as we might, we couldn’t incent them enough, but too many people figured it out too quickly.

 

So it looks as though the flash order will end up as a flash in the pan.  This looks like the regulators once again giving away the store, then making a big fuss about taking back a little, while still leaving the big boys free rein to dominate the marketplace. 

 

The Star Wars world of high frequency trading is here to stay.  Anyone doubting this need only look at the Wall Street Journal report (WSJ, 31 July, “”NYSE’s Fast-Trade Hub Rises Up In New Jersey”).  The NYSE is creating a 400,000 square foot mega trading starship at a secret (we’re not making this up) location in Mahwah, NJ, to house Star Wars traders.  The physical proximity to the NYSE trading floor, we are told, will make a difference in time of order transmissions, as traders are now executing not in milliseconds – thousandths of a second – but in microseconds – millionths of a second.

 

Winston Churchill once observed that no government in history has ever gone to the vast logistical trouble and financial expense of a broad military mobilization without subsequently going to war.  Once the armies are massed on the border, too much money has been spent – and too much political capital – to ask that they stand down.

 

The NYSE is betting on the future of Star Wars, and it looks a safe bet – though whether the NYSE’s Starship Frequency will be the fleet’s flagship is anybody’s guess.  The article says the NYSE hopes to attract certain established players in the high frequency world.  “Worries about high-frequency trading aren’t focused on” Goldman or hedge fund Citadel.  No surprise there.  Indeed, the only thing the NYSE is worried about is whether Goldman and citadel will actually book aboard their starship, or if they will be off on someone else’s DeathStar.  Count on the NYSE to offer free rent – otherwise known as “soft dollars” – as another way to “incent” the big boys, at the risk of undermining the integrity of the marketplace.

 

As Senator Schumer leads the charge, the flash order may look like a dead issue.  But have no fear: the Empire will strike back.

 

 

 

Got Them By The Shorts

 

If you’re gonna set somebody up, it’s gotta be a surprise, you got that?

-         Chili Palmer, “Get Shorty”

 

What a surprise!

 

It isn’t every day we get to praise securities regulators, so let us not let pass this opportunity to congratulate SEC Chair Mary Schapiro on the announcement of new initiatives on short selling.  The high points of SEC Release 2009-172 (27 July, “SEC Takes Steps To Curtail Abusive Short Sales And Increase Market Transparency”) are: a requirement to deliver stock, and enhanced transparency by making short interest data more widely available. 

 

In addition, there are significant political offerings.  These include “a public roundtable… to discuss securities lending, pre-borrowing, and possible additional short sale disclosures…”, and assurance that the Commission is “continuing to actively consider proposals on short sale price test and circuit breaker restrictions.”

 

The SEC’s brief is market integrity, and investor protection.  Anyone who ever earned their living selling anything to anybody will tell you that the incidence of truly informed consumers is statistically insignificant.  Therefore, the best any market regulator can possibly do is require maximum market transparency.  Added to that, it would be helpful if every brokerage account statement came with a warning similar to those displayed on Canadian cigarette packages, which feature large full-color photographs of gangrenous limbs and active cancer tumors.

 

Chairman Schapiro has not always contented herself with hoping for the best.  She has acted affirmatively in the public interest before.  While at the NASD she oversaw the creation of the Investor Education program – you may remember the silly photos from the NASD website, like the pudgy gent wearing a tiny hat under the caption “Small Cap”.  The pictures were goofy but memorable, and they were right there on the NASD’s home page under a header that shouted INVESTOR EDUCATION.  If you got as far as typing in NASDR.COM you couldn’t miss it.

 

Of course, even Mary Schapiro could not force you to read the material – but until she came along, no one else had even bothered to publicize it.

 

We now get to watch Chairman Schapiro as she joins the cast of Get Shorty, where people who are harder working, more focused, and better informed than average investors get punished for being… well… harder working, more focused, and better informed.  This has been true of hedge funds, and its latest targets are the High Frequency / Low Latency traders.  But there has always been a special place in the hearts of the American public – and legislators – for the Shorts.

 

Chairman Schapiro, herself no stranger to the Politics of Politics – to coin a phrase – has neatly thrown the short sellers into the briar patch by calling for a roundtable and promising “ongoing” and “active” consideration of other proposals.  With any luck, the political process – the septic interface where Hill and Street meet – will slow this debate down to a 16 RPM screaming match that will drag on until nature takes its course: either speculative frenzy will overtake the markets and no one will care about silly things like short sellers and hedge funds, or we will forget about short sales as we queue up to swap our dollars for Yuan, meanwhile hoarding water, bread and bullets.

 

It would be nonsensical to make a type of transaction illegal.  Cocaine is illegal and is distributed through a sales network.  Would it be a stretch to think the way to halt the widespread use of cocaine was to introduce legislation making it a crime to buy something?  (We may regret suggesting that – please don’t forward this to anyone in Washington!)

 

No politician will defend short selling against all the nonsense coming down the pike – that would make them look like they were in the pocket of the hedge funds.  But we note the issues Chairman Schapiro chooses to avoid. 

 

It is well and good to make delivery mandatory.  We expect there to be a few high-visibility and hard-hitting cases brought in short order, where firms will be punished for not making timely delivery.  Thus will the SEC show the press it Means Business.

 

Our market, large and complex as it is, runs on certain presuppositions.  At any given time, there is not enough stock available for borrowing in the marketplace to support all the short sales that are done on any given day.  Active traders in a volatile market may recycle a short multiple times in one day, shorting, covering and re-shorting stock against the same locate.  Would a “hard borrow” require them to make multiple deliveries, even if their position is flat at the close of business?  (Don’t send that to Washington either…)

 

We all know that the Easy To Borrow lists make unrealistic quantities of stock available for shorting, and that at any given moment there are phantom shares in the marketplace as a result of aggregate short sales that exceed prime broker Easy To Borrow lists.  But the probability is that not all these shares will be required for delivery at the same time.  To introduce a hard locate, or pre-borrow and deliver requirement would be to clamp down on volume and liquidity in the market so drastically, the US would no longer be the marketplace of choice for equity traders.  Talk about reneging on your handshake.

 

This aspect of the market appears to be here to stay.  If you had any doubts, footnote 29 of the Release quotes several Exchange Act Releases regarding issuers’ attempts to protect their shares from naked shorting.  Issuers have tried issuing shares that are only available in physical certificate and can not be “held” electronically, or simply withdrawing from the industry-wide DTC clearinghouse, making their securities no longer available for book-entry transfer.  “Withdrawing securities from DTC or requiring custody-only transfers would undermine the goal of a national clearance and settlement system designed to reduce the physical movement of certificates in the trading markets.”  Translation: self-help is not available to issuers.  Liquidity of the markets is more important than the woes of individual issuers; short selling is here to stay.

 

Even the absolute delivery requirement, which reads great in the press, is not absolutely absolute.  We note that the expression “ex clearing” does not appear in the SEC document.  What does appear is an immediate close-out and deliver position “if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency…”

 

Outside of the registered clearinghouses, there appears to be no record of how many trades remain uncompared at any given time.  Thus, there seems to be no clear way to challenge those corporate executives who rant in public about collusion between firms to run up and maintain invisible short positions in their stock.  If the SEC were serious about rooting out naked shorting and other abuses, they would require firms to record ex clearing contracts, to mark them to market, and charge them against regulatory capital. 

 

Thus, the new short selling release accomplishes a measurable increase in transparency – a good thing.  Outside of that, it makes permanent a prohibition against naked short selling – no one will argue there.  For the rest, as one market participant said, this monumental exercise appears to be “a fix in search of a problem.”

 

Or, to put it another way: this is the way the markets work.  You got a problem with that?

 

 

 

The Congressional Meddle Of Honor

 

Politics are very much like war.  We may even need to use poison gas at times.

- Winston Churchill

 

He’s Baaaaack!  Barney Frank, who once said it was worth taking on unknown risks in order to spur growth in the housing market, has now said it is advisable “to err on the side of caution” in imposing regulation and restrictions on the commodities, futures and derivatives markets.

 

The ban on naked trading of Credit Default Swaps (CDS) now under consideration may have the incidental effect of dramatically increasing the costs of borrowing.  To the extent the overblown CS markets represent an aberration – and even dramatically increased costs going forward would therefore be merely reversion to the mean – this is almost a a non-event.  For those who earn their living pushing these things around, though, it is big, big news.

 

As frightened as we are of as yet undiscovered abuses in the markets, we are far more scared of Washington.

 

Consider: our colleague, Andrew Barber, points out that, unlike securities regulations, “once you allow the camel’s nose into the tent on commodities, it gets international and global real fast.”  It is bad enough watching as Washington sinks its meathooks into the securities markets.  As anecdotal evidence that those charged with making our markets function properly do not understand those markets, we offer the latest news reports of Fed Chairman Bernanke’s net worth, which has fallen to perhaps under a million, from a reported range up to $2.5 million in 2007.  This is along the lines of our CEO Keith McCullough’s observation this morning (3 August) highlighting Nouriel Roubini now going bullish on commodities – copper is up over 90% year to date.

 

If Ben Bernanke can not parlay his market smarts into a substantial seven-figure portfolio – or if he can not parlay his banking and Wall Street connections into eight, or even nine figures – then why are we entrusting the world’s money supply to him and contemplating handing him an unprecedented level of control over the nation’s financial system?  Hank Paulson, now there was a guy who understood how money and markets function.  Why should a tyro be entrusted with the keys to the vault?

 

Following up on Andrew’s “nose of the camel” metaphor, it is now zero hour – midnight at the oasis.  We may want to instruct Sheikh Barney to send his camel to bed before it’s too late.

 

We watched Venezuela nationalize oil.  Will Chairman Frank give Chavez the opportunity to nationalize oil futures as well?  One thing we are comfortable predicting: once the Capitol Hill Pitchfork Brigade forces standardization and exchange trading of derivatives contracts, these contracts will become the next big product.  Watch for billions of dollars of issuance of derivative contracts aimed at the retail investor.  You were uncomfortable with Grandma buying oil and gas ETFs?  Wait until her broker puts her into CDS based on commercial mortgages. 

 

FINRA finally came forward with a timidly worded warning that certain ETFs are fiendishly complicated and possibly not appropriate for private investors.  They better start sharpening their pencils against the day when Series 7 registered stockbrokers start pitching CDS.  Many an average customer does not understand how a margin account works – alas, many an average broker either never bothered to explain, or can not explain to their customers.  Hands up, how many of you want these guys pitching derivatives to the public?

 

 

 

Gotcha?

 

For the record, since January we have been raising questions about ETFs.  In addition, our conspiracy theorist paranoia has led us into speculation tying these sometimes complex critters to the political tension – between, say, the US and Switzerland, which was not playing ball.  We don’t mean that Switzerland was not playing ball about tax cheats – that’s old news, and we wonder whether some lawmakers have had to scramble to shift their accounts to Liechtenstein or Vanuatu in advance of the assault on bank secrecy.

 

If you recall, our theory was that the US was leaning on Switzerland because they were dramatically under-invested in US Treasurys, at a time when our debt needed all the bolstering it could get.  Once launched, we speculate the tax inquiry took on a life of its own.  The announcement this week that UBS reached a settlement with the IRS came on the heels of the announcement that UBS was discontinuing the marketing of leveraged and inverse ETFs.

 

Not a moment too soon, as Massachusetts state regulators have started issuing subpoenas requesting (Wall Street Journal, 1-2  August, “Subpoenas Put Pressure On ETFs With A Twist”) “requesting information on sales of products, the revenues generated from those sales, and broker training and marketing materials.”  Followers of this Screed will recall, this is exactly what we have been warning about.

 

Tough break, UBS.  If only we could convince Barney Frank that these things are a good idea…

 

Moshe Silver

Chief Compliance Officer

 


RETAIL FIRST LOOK: "THESE GO TO 11"

RETAIL FIRST LOOK: "THESE GO TO 11"

03 AUGUST 2009

 

TODAY’S CALL OUT

We’ve seen forward earnings growth expectations go from 6-11% over the past month.  Yes the group has run meaningfully. But 11 to 20% over 3 months is not out of the question. Do you want to be short into that? Be my guest.

 

For those of you that have never seen the parody about the 1970s fictional metal band, go to YouTube and search for ‘these go to 11.’  It kind of speaks for itself.  Unlike Nigel Tufnel, I am not focused right now on modified Marshall amps, but on consensus earnings growth expectations for the next 12-months.

 

Why? Well, because it matters more than ever with a 15% run in the MVR vs. a 10% run in the market over the last month. Is the outperformance justified? My opinion is that it definitely is. Math does not lie. We’re seeing the rate of earnings growth accelerate into the back half. We can all say ‘yeah the market already knows this, and the group is trading at a 15x p/e.’  But the reality is that we’ve seen forward earnings growth expectations go from 6% to 11% over the past month.  Yes, the market knows this, but here’s a novel thought… With excess SG&A cuts, ridiculously easy comps, and fall/holiday ordering plans down in the double digit range (setting up for firm inventory position and higher GM%), can forward growth expectations pierce 20% within 3 months?  The answer is Yes.

 

These go to 20? 

 

That, my friends, is not yet in the stocks today. Do not get me wrong. McGough is not a blind bull oblivious to the factors impacting consumer spending (and retrenchment) over the next 2-3 years. But we’ve got more good news to come from the EPS picture before any big downside calls on the group make sense to me.

RETAIL FIRST LOOK: "THESE GO TO 11" - Conensus EPS NTM chart short term

RETAIL FIRST LOOK: "THESE GO TO 11" - 90 Day stock revisions long term

 

LEVINE’S LOW DOWN

Some Notable Call Outs

- In a move sure to challenge Wal-Mart’s low-price leadership, Kmart is selling a 24-count box of Crayola Crayons for $0.20 this back to school season. Kmart’s price is 20% below Wal-Mart’s price of $0.25! If you’re not into the buying the iconic yellow and green box, then head to Office Max for a box of Schoolio von Hulio crayons for $0.01 (yes, a penny). This certainly seems like the making of “crayon wars” to me.

 

- While many bankruptcy cases in the retail sector have resulted in liquidation, there are a few exceptions. On Friday, after just four months of Chapter 11 protection, Sportsman’s Warehouse announced the court approved the company’s reorganization plan. The outdoor retailer’s emergence from bankruptcy is a result of a capital infusion from private equity firm, Seidler Equity Partners. Interestingly, Cabela’s mentioned last week that it was gaining market share from a competitor operating under Chapter 11.

 

- Over the past few weeks, I’ve highlighted several companies that are experimenting and using social media sites/Twitter to promote brands and to connect directly with target consumers. However, the power of the Internet and “crowdsourcing” is now being used in a new way. Let me draw your attention to Groupon, a marketing company uses the power of the masses on the Internet. Groupon sends out daily e-mails with a deal that offers a product or service at a discounted price. The business relies on the collective purchasing power of a group of interested consumers, hence the name Groupon. Participating merchants pay a commission, which makes the service a viable business at a time when so many online ideas are interesting but not profitable. For the deal of the day to work, a minimum number of people have to buy it. That “crowdsourcing” encourages subscribers to tell their friends, family and co-workers. As word spreads, the selected business gains exposure. While the service currently operates in about 14 cities, expect the “buzz” on this one to grow quickly. After all, the viral nature of the Internet and the consumers’ appetite for a deal could not intersect at a better time than now.

 

MORNING NEWS 

- Vendors can perhaps breathe a little easier over CIT - The group’s profitable factoring business, Trade Finance, on Friday got a boost when $1 billion was earmarked to fund the operation, a move aimed at proving to vendors that CIT has the money to fund clients’ needs.  In a letter to clients, John Daly, president of Trade Finance, wrote that “CIT Trade Finance is one of the nation’s oldest providers of factoring and financing services. The companies that have placed their confidence in us — our clients — range from family-owned and -operated manufacturers to global publicly traded corporations. We believe we have sufficient liquidity to meet our obligations and our clients’ needs while our parent company implements its restructuring plan.” CIT Trade Finance “remains open for business. We are actively reaching out to and working with our clients to ensure they continue to access our services needed to run their business. Credit is being checked, invoices are being collected and funds are being remitted,” Daly emphasized. <wwd.com/business-news>

- Vietnam apparel industry to improve working conditions - Better Work Vietnam has begun offering new services to apparel enterprises in Vietnam’s southern provinces, helping them improve working conditions for more than 700,000 workers and boost the competitiveness. Tara Rangarajan, Program Manager of Better Work Vietnam, said: "Better Work Vietnam looks forward to working as partners with Vietnamese apparel enterprises, workers, and the Government of Vietnam to make sustainable improvements in labor conditions. The goal of our work is to find practical solutions that will decrease costs for project participants, enhance factory competitiveness in international markets, and reduce poverty among Vietnamese apparel workers, their families, and communities". Initially targeting apparel factories with more than 200 workers located in Ho Chi Minh City and neighboring provinces," said Nguyen Van Tien, chief labor inspectorate of MoLISA and chair of Better Work Vietnam’s Project Advisory Committee. <fashionnetasia.com>

- British retail organization giants combine - The British Fashion Council (BFC) is the latest organization to become a member of the trade association UK Fashion and Textile Association(UKFT). "UKFT’s aim is to be the ‘single voice’ of the fashion and textile industry, representing businesses of all sizes – whether they be a small design-led company or a multi-million pound organization. Having the BFC on board adds further depth on the design side and enables us to work more closely on initiatives that will help designers be better placed to develop sales both in the UK and overseas and receive first-hand guidance on national and international issues that will affect them," said Peter Lucas, chairman, UKFT. Harold Tillman, chairman, BFC, added: "The BFC promotes leading British fashion designers in a global market, supports emerging talent to showcase and develop their businesses and organizes events, including London Fashion Week and the British Fashion Awards, to support these goals and strengthen the UK’s reputation for developing design excellence. <fashionnetasia.com>

- Annual report of sport participation - The annual report is out from the Sporting Goods Manufacturers Association. The report details participation trends in sports and provides insight into what sports are growing and what sports are hurting. Here are some interesting figures: (1)  The biggest increase in participation in team sports in 2008 was ultimate Frisbee, up 20.8%. (2) Hunting and target shooting with a handgun was up 10.7% and 13.9%, respectively, this year. (3)  There were 17 million people playing table tennis last year, a 15.5% increase from 2007. (4)  The worst decline in participation in team sports in 2008 was roller hockey, down 15.4%. (5)  Last year, 15% of cheerleaders and 29% of gymnasts were male. (6)  Last year, 6% of tackle football players and 18% of paintball players were female. (7)  Archery participation was up 7.7 percent. (8)  Skateboarding participation was down 7.4% in 2008 and is now down 20.8% since 2000. (9) Interest in the UFC might be skyrocketing, but mixed martial arts participation actually went don 1.4% last year. That has nothing on boxing, which is down 42.3% as compared to participation in the sport eight years ago. (10) Lacrosse has long been called the fastest growing sport in America, as it has grown 117% since 2000. Still, only 1.9 million people played lacrosse in 2008 compared to something like slow pitch softball, which had 9.8 million participants. <cnbc.com>

- Footwear companies saw shares plummet in 2008, so for many in 2009, there’s been nowhere to go but up - But even as shares grew in percentage, few firms saw their stock prices return to the levels seen at the beginning of last year. Here’s how the retailers tracked by Footwear News stacked up in the first half of 2009, ranked by percentage of change: Dillards 133%, Sears Holdings Corp. 72%, TJX Cos. 54%, Nordstrom Inc. 49%, JC Penny 45%, Bakers Footwear Group 39%, Foot Locker 39%, Collective Brands 24%, Shoe Carnival 23%, Dick's Sporting Goods 22%. <wwd.com/footwear-news>

- German Retail Sales Unexpectedly Slump for Second Month on Unemployment  - Retail sales in Germany, Europe’s largest economy, unexpectedly dropped for a second month in June as rising unemployment prompted consumers to trim spending. <bloomberg.com>

 - A Gap and Levi Strauss jean factory in Africa is illegally dumping chemicals - A factory that makes jeans for Gap and Levi Strauss is illegally dumping chemical waste in a river and two unsecured tips where it poses a hazard to children. The scandal was uncovered by a Sunday Times investigation into pollution caused by a plant in Lesotho, southern Africa, which supplies denim to the two companies. Dark blue effluent from the factory of Nien Hsing, a Taiwanese firm, was pouring into a river from which people draw water for cooking and bathing. The firm was also dumping needles, razors and harmful chemicals such as caustic soda at municipal dumps that have attracted child rag-pickers as young as five in search of cloth fragments to sell for fuel. Many of the children, who work for up to 10 hours a day, complain of breathing difficulties, weeping eyes and rashes. <theretailbulletin.com/news>

- Van Heusen looks to expand retail presence in India - Apparel brand Van Heusen from the Madura Garments group is looking to implement an extensive retail expansion plan by opening 25 exclusive stores this year and 65 more stores by the end of financial year 2012. The brand wants to have a pan-India presence and reach 50 tier-I and tier-II cities. The average size of the stores will be 200 square feet and the flagship stores will cover 7,000 square feet. The company is planning most of its stores on high street locations because it does not want to be dependent on malls. The company will have stores in four different formats – men, women, V Dot for youngsters and a combination of all of these.  <indiaretailing.com>

- Private label beauty manufacturer purchases large stake in Lucy B Cosmetics - Absolute Amenities Inc., a Riverside, Calif.-based private-label beauty manufacturer headed by Jackie Applebaum, has purchased a stake in Lucy B Cosmetics for an undisclosed sum. Baldock and Sacchi are remaining with the brand and are creative directors as well as president and vice president, respectively. “The creative person really has to be free to be creative, and then there is the other side of how do you make the business run,” said Applebaum. “You can’t build a house unless you have a strong foundation. That is my job to build the foundation. It’s Lucy’s job to build the beautiful house.” Applebaum said she could provide Lucy B Cosmetics with the back end and financing needed to grow the brand beyond its current distribution of roughly 270 U.S. doors, including Anthropologie and QVC. She added the brand’s focus on specialty stores wouldn’t change and estimated it would generate $3 million in retail sales in the first year of her involvement. The Lucy B Cosmetics assortment contains 22 stockkeeping units that use ingredients from Australian flowers and colorful graphics evocative of the Australian landscape. <wwd.com/business-news>

- Sport Supply Group, Inc. said it has acquired certain team sports assets from Har-Bell Athletic Goods of Springfield, MO - Bryan Tucker, Owner of Har-Bell, will be employed by SSG as will his existing sales force in Missouri. Sport Supply did not assume any liabilities in the transaction. Terms were not disclosed. <sportsonesource.com>

- Highline United making progress in footwear - Executives at Highline United may have stepped into the footwear arena quietly with soft launches in 2008, but they are now gearing up to draw major attention to their portfolio of brands. The New York-based firm, whose brand roster includes United Nude, Ash and Luxury Rebel, along with licensing agreements with Miss Sixty and Tracy Reese, formally debuted in June with a launch party at its 7,600-sq.-ft. Chelsea showroom and is making a concentrated push to attract department stores and better independents with its mix of bridge women’s footwear.“June was our coming out party,” said Highline United President Matt Joyce, who has held top sales and merchandising roles at Nordstrom, Via Spiga, Kenneth Cole, Nine West and Steve Madden. “We wanted to make sure we brought in the product correctly, are taking care of our customers and have [footwear] that is viable for the future.”The company, named after New York’s newest city park, an elevated and out-of-service railway called the High Line, began showing capsule collections at last summer’s FFANY and WSA shows and has spent the last year building a mix of brands targeted at retailers looking for bridge-priced footwear that has been designed and sourced globally.“We have people in Italy, France, China, the U.K. and Russia,” Joyce said. “It’s a global mentality [and] it gives us the opportunity to get a broader view rather than just see what’s happening in [one place].” Early goals for the company, said VP of sales Scott Kaminsky, include building each of the brands and positioning the firm to become a long-term and dominant player in the industry. <wwd.com/footwear-news>

 

MACRO SECTOR VIEW AND TRADING CALL OUTS:

RETAIL FIRST LOOK: "THESE GO TO 11" - SV 8 3 09

 

 


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