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IGT BLACK BOOK CALL TOMORROW: THE CASE FOR GOING PRIVATE

IGT BLACK BOOK CALL TOMORROW: THE CASE FOR GOING PRIVATE - IGT COVER

 

Please join the Hedgeye Gaming, Lodging, and Leisure Team led by Sector Head Todd Jordan for a Black Book call on International Game Technology (IGT) - the case for going private. This insightful call is scheduled for tomorrow, Tuesday, June 10th at 1:00pm EDT.   

 

We are fast tracking this call due to this afternoon's news headline relating to IGT retaining a financial advisor to explore strategic alternatives.  A call had previously been planned for later this week to discuss Hedgeye's long term investment thesis on IGT.

 

Todd Jordan previously served as Audit Chair on the Shuffle Master Board of Directors.  As such he was licensed in many jurisdictions and is able to provide invaluable insight into any go private transactions.

 

CALL DETAILS

Attendance on this call is limited. Please contact for the dial in information and presentation slides. 


Poll of the Day Recap: 56% Are Concerned About The 'Crash' in Volatility

Takeaway: 56% said YES; 44% said NO.

As Hedgeye CEO Keith McCullough observed in today’s Morning Newsletter, the VIX officially crashed last week, down -5.7% to -21.6% YTD. “If you want to fail really, really, fast in this business,” McCullough wrote, “get your clients levered-long the US stock market at 10 VIX (US Equity Volatility Index).”

 

We asked: Are you concerned about the ‘crash’ in volatility? Here’s what you thought.

 

Poll of the Day Recap: 56% Are Concerned About The 'Crash' in Volatility  - concerned 

 

At the time of this post, 56% said YES; 44% said NO.

 

A voter who is concerned about the ‘crash’ in volatility answered YES because:

  • My timeframe is intermediate to longer term. The way I read it, extreme low levels on the VIX are, at a minimum, bearish intermediate term. Extreme highs are bullish same timeframe. Margin debt, Investors Intelligence bullish %, Speculation in penny stocks, and the length of time without a moderate correction of 8 - 10% only add to that concern.

 

Conversely, voters who voted NO had this to say:

  • "concerned" implies something has gone wrong. volatility is increasingly... well..,. volatile and has become an independent factor in the marketplace.  if it "crashed," it will be back
  • Who's buying? HM's PM's - as long as they are, little else matters except a news catalyst. Therein lies the rub. Low volume and you could knock this market over with a feather.

 


MCD: Time For A Change

Every month we read the MCD press release on monthly sales trends expecting to see something more.  Typically, the opening comments from CEO Don Thompson consist of a few feel good statements that do little to convince us that the company is effectively addressing its issues.

 

This month, the opening statement is no different: “Around the world we are pursuing opportunities to provide our customers with their favorite food and drink, create memorable experiences, offer unparalleled convenience and become an even more trusted brand,” said McDonald’s President and Chief Executive Officer Don Thompson.  “We are intensifying our commitment to place the customer at the center of everything we do and are determined to create experiences that deliver the most meaningful impact for our customers and our business.”

 

Given the 1% decline in same-store sales this month in the U.S. and a seventh straight monthly decline, the company is trending to levels not seen since 2002 (see chart below).  The company also failed to drive positive traffic in this region, despite focusing the marketing calendar on its value message.  This reinforces what CEO Don Thompson said at a conference last month, inasmuch as “MCD is all about increasing top line sales and transactions, and not based on optimizing profitability.”  While the current trend isn’t nearly as bad globally, we believe the company still faces a significant uphill battle.

 

The stock has gained 6.2% over the last three months with the hope that the company would use its balance sheet to create shareholder value.  Management did announce a shareholder friendly move, but this is old news.  We believe the street will now turn its focus back to current business trends and the underlying issues that remain.

 

Industry conditions are difficult for a number of companies, but there are others that are thriving in this environment.  MCD’s core customers are in the lower-to-middle class cohort, which continues to feel the effects of limited income growth and a benign job environment.

 

While MCD has the marketing muscle and cash flow to muddle along for a few years, it will be constantly fighting an uphill battle against macro trends and the consumers’ shift away from traditional fast food.  In the end, we believe MCD will face a major restructuring to once again take share in the global QSR market.

 

MCD: Time For A Change - 111

 

MCD: Time For A Change - 222

 

MCD: Time For A Change - 333

 

MCD: Time For A Change - 444

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


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RH – Where Can We Be Wrong?

Takeaway: RH is our favorite idea. It remains massively misunderstood. But let’s keep it real and vet all the areas we could be wrong near term.

RH is our top long idea in Retail by a country mile, and we remain convinced that the company will see earnings grow from $1.71 last year to near $11.00 in five years time. If we’re right on that earnings number, which we think we are, we think that this is ultimately a $200 stock.  We don’t think this is just a square footage growth story (which is impressive in its own right), but rather one of the biggest market share stories in retail today. In effect, we think that RH is doing to the high-end home furnishings space what Ralph Lauren did to apparel on 1980. The parallels are staggering. For more details on the long term opportunity, check out our latest Black Book.

 

Looking more near-term, we feel really good about RH heading into the 6/11 print. Demand remains strong, the Sourcebook appears to be well executed, the May/June store openings are on track (Greenwich/NYC), the company’s on-line business appears to be tracking quite well, and EPS expectations for the quarter appear very doable (we’re at $0.16 vs the Street at $0.11).

 

Given our comfort level around the print and the year, at this point we’re hyperfocused on one thing…where can we be wrong?

 

Here are some factors that we think about as it relates to the print and guidance. To be clear, after vetting these factors we still come out positive. But let’s lay it all on the table such that there are as few surprises as possible.

 

  1. Buying shallow.  When the company launches a Sourcebook, it usually does so with a redesigned product line, which is exactly what it did with its goliath 16-lb book that was distributed to customers via UPS from mid-May through early-June. But given the ever-growing breadth of RH’s product line – the company has a tendency to go very shallow with inventory around the book. The strategy  is simple…let consumers tell you over the course of 2-3 months which items they like the best, and then go very heavy on inventory for those items in the subsequent three quarters. But that could mean lighter guidance on revenue in the upcoming quarter. For the year, it is a strategy that clearly maximizes gross profit dollars and ROIC. But there could be a shift between 2Q and 3Q.
  2. Deferred Revenue. The RH-haters out there love to talk about the company’s deferred revenue as customers wait 10-weeks or more for custom items (keeping in mind that RH does not get paid until the customer takes delivery).  In 2Q14 we could see an uptick in deferred revenue around non-custom items due to the strategy around buying shallow that we outlined in point #1.  It could provide ammo for those RH bears who want to poke holes in the company’s revenue recognition. We’re not worried about the economic reality -- -but just the perception based on how some people will take it.
  3. Margin Weakness. With any new assortment, margins will usually be lower given that the company will not have hit its own costing hurdles to lower its COGS on high volume. The margins will be better on the product 3-4 quarters out when RH focuses its inventory spend on key items and gets additional volume discounts. Initially, it will be buying some items that might not be as popular as it otherwise planned. That leads us to think that there’s the potential for a margin ramp throughout the year – though they could potentially be lighter this quarter. 
  4. Dead Rent. RH is officially in growth mode. It opened the Greenwich store successfully in May, and will open the FlatIron store in NYC in a few weeks. Then there’s Atlanta and Chicago in 2H followed by a meaningful acceleration in 2015. It takes between 6-12 months to complete a store. The bigger the store, the more time it will take. And make no mistake, the stores are getting bigger. While the company is overseeing construction, it is paying rent – and a lot of it. It’s known as Dead Rent, and it has never been a part of the RH equation as it has been in store shrinking mode. But there will be a meaningful ramp in rent over the next 12-18 months, and we’ll see some of it this quarter. The company is getting great deals, which helps. For example, the Greenwich store just opened up at $1.1mm in annual rent. That seems like a lot, but it is replacing a store up the street that is 1/3 the size where they pay $1mm in rent. That’s only $100k extra for about 15,000 extra square feet. The ROI is astounding. But as it relates to quarterly occupancy costs, there is clearly some overlap. We think we’re accounting for all this correctly. But it is an area where we could be wrong on the near-term earnings flow.
  5. Flatiron Comp. The store that is ‘opening’ in the Flatiron district is really not opening at all. It’s a renovation of the most profitable store in the fleet. As this store opens up with an extra 13,000 square feet attached to it (on a base of 9,000), it’ll be yanked out of the comp base for 14 months. Sales will still be recorded, of course, and will show up on the top and bottom line. But the reported ‘brand comp’ will not include this store. That has the potential to cause some confusion in comp guidance.
  6. Amortization of Sourcebook Costs. The company amortizes its Source Book costs on a 12 month time period over the expected ramp in revenue of the book. This is a meaningful number – our best estimate is that it’s about $50mm this year, or about $0.75 per share (not disclosed). That dwarfs the ‘Dead Rent’ costs. The ROI on this book remains extremely high. But any change in accounting – from a curve to straight-line, or even to a longer duration than 12 months – would muddy the numbers. Karen Boone (CFO) is borderline religious about this accounting, so we’d be floored to see any change. But if there was, it would certainly be outside the realm of things we’re expecting.

RH – Where Can We Be Wrong? - RH Financials


This Is One of the Strangest Tweets We've Ever Seen from a Company

Takeaway: Hedgeye retail analyst Brian McGough is scratching his head over a recent tweet from this king of commerce.

This tweet from Wal-Mart (WMT) is one of the strangest tweets we've ever seen from a company.

 

This Is One of the Strangest Tweets We've Ever Seen from a Company - wmt

 

We're not sure how Wal-Mart thinks its customers will react to it touting how much information it has on their shopping behavior. From our perch, it makes a lot more sense for them to pipe down and use the information to optimize the pricing part of equation around the type of product it has in its stores. It's presumably doing that already -- which we'd argue makes this a bearish statement by the company.

 

It has 30 petabytes of shopping information and still can't comp?

 

Wal-Mart’s new CEO Doug McMillon should not have signed his name to this tweet.


European Banking Monitor: Swaps Tighten Substantially On ECB Rate Decision

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

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European Financial CDS - European bank swaps tightened aggressively last week on the heels of the ECB's decision to crank additional stimulus in the Eurozone. The average move was -17 bps (median -10 bps) and was led (again) by Greek banks, which dropped by an average of 82 bps w/w.

 

European Banking Monitor: Swaps Tighten Substantially On ECB Rate Decision   - chart 1 CDS

 

Sovereign CDS – Sovereign swaps tightened around the globe last week. Italy, Portugal, and Spain all compressed by 17-21 bps. The US and Germany were both tighter by one basis point to 16 and 20 bps, respectively. 

 

European Banking Monitor: Swaps Tighten Substantially On ECB Rate Decision   - chart2 sovereign CDS

 

European Banking Monitor: Swaps Tighten Substantially On ECB Rate Decision   - chart 3 sovereign CDS

 

European Banking Monitor: Swaps Tighten Substantially On ECB Rate Decision   - chart 4  sovereign CDS

 

Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 20 bps w/w.

 

European Banking Monitor: Swaps Tighten Substantially On ECB Rate Decision   - chart 5 euribor ois spread

 

 

Matthew Hedrick

Associate

 

Ben Ryan

Analyst

 

 


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