Takeaway: Management comments at a competitor's conference introduce new risk to the story. A much bigger risk is yet to emerge. We remain short.
- WHAT'S NEW: Management suggested at a competitor's Healthcare conference that it hasn't seen much improvement in fixing its technical issues interfacing with the government exchanges, and this issue may not be resolved before the next Open Enrollment period. If true, this will only exasperate its retention/attrition issues, which is the central part of our thesis.
- WHAT'S NOT SO NEW: Management also said 2Q14/3Q14 applications will be a “fraction” of what they were a year ago. Management already alluded to this during its last earnings call, suggesting applications will be down y/y. We previously highlighted this as risk to consensus estimates, but this isn’t central to our thesis since applications were accelerated into the 4Q13/1Q14 period because of Open Enrollment.
- WHAT'S COMING: What no one on the sell-side is talking about is Individual & Family Plan (IFP) commission rates next year. The private exchanges (e.g. EHTH) are becoming more obsolete now the government exchanges are operational, which wasn’t the case heading into the 2014 Open Enrollment period. The mix of new lives on the exchanges in 2014 are older (costlier) than historical experience, meaning Managed Care Companies (MCOs) need to find ways to recoup profitability next year. Of all options available to MCOs, cutting IFP commission rates will be the path of least resistance.
See notes below for more detail on our thesis. Let us know if you would like to see additional notes, have any questions, or would like to discuss further.
Hesham Shaaban, CFA
EHTH: Déjà vu
03/04/14 02:15 PM EST
EHTH: Initiating Short
01/29/14 10:38 AM EST
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Takeaway: ICSC #'s starting to stabilize in 2Q. NKE goes to the Space Jam vault for WC. TGT announces more 'changes'. Uniqlo raising prices in Japan.
EVENTS TO WATCH
- ULTA - Earnings Call: 5:00pm
- RH - Earnings Call: 5:00pm
- LULU - Earnings Call: 9:00am
ICSC - Chain Store Sales Index
Takeaway: +3% compared to 2.2% in 2013. YTD growth rate is equal 1.96% YY compared to 2.4% in 2013. But, numbers in 2Q-to-date are down just 6 bps compared to the 2.4% growth rate in '13. Nothing spectacular, but a little stability after a tough start to the year.
NKE - NIKE FOOTBALL LAUNCHES "THE LAST GAME"
- "Today Nike Football released part three of its #riskeverything campaign. The film – 'The Last Game' – is a five-minute animated feature starring some of the world's greatest footballers on a mission to save football from the hands of a villainous mastermind, The Scientist."
Takeaway: NKE taking a page out of the Space Jam playbook in the last part of its #riskeverything campaign for the World Cup. We're surprised we haven't seen more product and marketing from brands leading up to the World Cup in Rio.
TGT - Target CEO Memo: Less Committee, More Leadership
- "The retailer is relocating all of its top executives to same floor in its Minneapolis headquarters, part of a several changes announced Monday by Target interim Chief Executive John Mulligan as the company tries to move on from the era of former CEO Gregg Steinhafel."
- "Target’s renaming its executive committee the 'leadership team.' It is modernizing or eliminating four its longstanding groups — the supply chain council, the prototype committee, design committee and capital expenditure committee — removing a layer of approval."
- “'All across Target, we need more ‘leadership’ and less ‘committee,’ Mr. Mulligan said in the letter reviewed by the Wall Street Journal."
- "The top executives like Chief Marketing Officer Jeffrey Jones and Chief Information Officer Robert DeRodes will be relocating to the 26th floor in Target Plaza South, where Mr. Mulligan and Executive Vice President Kathryn Tesija currently have their offices. The floor will be getting a more open plan than its current layout of office and hallways, aimed at fostering greater collaboration."
Takeaway: The reality is that the narrative on this name will change dramatically over the next 12 months after a real CEO is hired and major strategic decisions. We’ll be talking about a new CEO’s vision to both transform the company, and fix all the mistakes made over the past 5 years. That might sound like great news, but it will be expensive news.
9983 - Uniqlo Raises Japan Prices by 5%
- "Uniqlo is raising its pre-tax retail prices in Japan by an average of about 5 percent this fall to combat rising material costs and the depreciation of the yen."
- "A spokesman for Fast Retailing specified that the price hikes are only applicable to Japan. Uniqlo's prices in international markets will not be affected as they are set on a market by market basis, he said."
Takeaway: Damned if you do, damned if you don't scenario for Uniqlo in Japan. With 60% of its store base in Japan, the company had to do something to offset the margin squeeze from FX. But, the 5% price increase coupled with the country's 3% tax hike means that consumers have to pay an extra 8% at the register. The fact is that everyone is likely feeling the squeeze in Japan from both FX and the uncertainty surrounding the tax hike, but its much more pronounced for a brand like Uniqlo who is much more dependent on the Japanese economy.
JCP - Stephen Sadove Joins Traub Associates
- "Stephen I. Sadove, the former chairman and chief executive officer of Saks Inc., has joined Marvin Traub Associates as cofounder and head of Traub Accelerator, a new division focused on technology and innovation."
Takeaway: Scratch another name off the potential CEO list at JCP. Sadove is on the board, and if he were interested in the full-time gig it would have happened by now. Based on the 1Q14 conference call, it does not sound like Ullman plans on going anywhere anytime soon. While we think that's negative at face value, let's give the guy credit…he's getting it done. If he could keep this momentum going, then maybe he should stay.
Toms - Shoemaker Toms put up for sale
- "Toms...has hired bankers and is working on a sale, according to several people familiar with the matter."
- "The exact value of Toms...is unclear. However, people who have viewed the prospectus said it could fetch as much as $600m."
- Toms had estimated revenue of $250m in 2013, with 30 per cent of sales coming from its website
- "In November [Tom's founder and CEO] Mr Myckoskie launched Marketplace, an online department store showcasing 200 products from 30 fashion brands with a charitable component to the business model."
GPS - Gap Inc. to Produce Apparel in Myanmar
- "Gap Inc. plans to produce apparel at two factories in Myanmar, making it the first American retailer of note to enter the market since the U.S. lifted a nine-year ban on imports from the country last year."
- "...U.S. retailers and brands have been exploring the new opening in the country, which could be a potential fresh apparel-sourcing destination for companies that have been grappling with rising labor costs in China and turmoil in other Asian countries. However, many industry officials have said investment and sourcing will be a slow-moving process because serious concerns remain about workers’ rights and safety. Apparel imports to the U.S. from Myanmar were $5.6 million for the year ending April 30."
WMT - Walmart.com CEO Joel Anderson to Step Down
- "Joel Anderson, chief executive of Walmart.com in the U.S., is leaving the world's largest retailer later this month for a job at a new company, according to a memo sent to Wal-Mart Stores Inc. employees on Monday."
- "Fernando Madeira, who is currently president and CEO of Latin America at Walmart eCommerce,will replace Mr. Anderson and take on a broader role to lead Walmart.com in the U.S., Latin America and other growth areas, according to the memo, which was written by Neil Ashe, who runs Wal-Mart's e-commerce business, and reviewed by The Wall Street Journal."
- "Mr. Anderson's last day at Wal-Mart is June 20. The memo didn't say which company Mr. Anderson was joining."
FIVE - Former President and CEO of Walmart.com, Joel Anderson, Named President
- "Joel Anderson has been named President, bringing more than 20 years of experience in the retail sector, most recently as President and CEO of Walmart.com, the multi-billion dollar U.S. dotcom business unit of Wal-Mart. In his new role, he will lead all aspects of merchandising, stores and marketing."
URBN - 2Q15 sales updated (10-Q)
- "Thus far during the second quarter of fiscal 2015, comparable Retail segment net sales are approximately flat."
CHS - Chico’s explores sale to private equity
- "Chico’s, the US womenswear chain, is exploring a sale to private equity and has discussed a deal with potential suitors that could lead to one of the largest take-private transactions so far this year.
- The final asking price could not be ascertained but one industry source said Chico’s would likely command a premium of about 30 per cent to its $2.36bn market capitalization."
A takeout price much higher can still make PE (and current shareholders) a lot of money. Stay tuned for Hedgeye's 1pm EDT conference call.
THE CALL TO ACTION
IGT could be worth $18-22 to a private equity firm which would yield an IRR of 21%-33% by our estimation. The stock closed at $14.31, up 14% but considerable upside remains to our target valuation. Of course, no deal has been announced, nor has IGT made any announcement – only a Reuters article citing a source that IGT has hired an investment banking firm to sell the company.
Moreover, tragically low replacement demand could put near-term earnings slightly at risk with little relief in overall slot demand until 2016. Finally, regulatory impediments would likely result in a year-long closing process. Nevertheless, there is real cash flow and real value in the name, in our opinion, and private equity could make this a profitable deal for itself and current shareholders.
A Reuters article yesterday suggested IGT had hired Morgan Stanley to pursue the sale of the company. There were enough details in the article to conclude that where there is smoke, there is fire. It makes sense to us - Hedgeye had already planned a BlackBook report and conference call for later this week analyzing a potential LBO scenario.
We’ve revisited the private equity option many times over the years. IGT’s cash flow and low capital intensive business model always seemed to be a candidate for the private marketplace, especially at low points in the cycle similar to now. The main hurdle has always been regulatory in nature. As someone who has been through the licensing process in 200 jurisdictions through my Board affiliation with Shuffle Master, I can speak to the uphill battle private equity would face.
However, we have seen private equity more involved in the gaming space in the last 8 years: HET and STN went private and Fortress pulled the plug, expensively, on a deal to bring PENN public in 2008. More recently and more directly, at least 4 private equity firms bid on WMS with 1 making it to the final round.
Other private equity/gaming relationships include Blackstone buying Cosmopolitan and the firm was involved in The Cromwell as well as Caesars; Fortress is the sponsor of GLPI; Icahn Enterprises sponsorship of Tropicana Entertainment; and, MacAndrew & Forbes has an ongoing interest in Scientific Games.
So what’s the play for PE? Buying a high cash flow generative company, despite secular and cyclical issues, at the low end of the slot cycle for a relatively cheap multiple. Bring IGT public again in 4-5 years when international demand should be humming and more domestic jurisdictions should be open or in the process of opening. Oh and there is a social gaming asset that may not be core and carries a multiple higher than the core business. A coincident sale of Interactive could pay for much of the equity contribution for the LBO.
PE would likely affect a management change, improve employee morale, and stem the brain drain of the last few years. We do not believe PE would value current CEO Patti Hart’s skill set. However, John Vandemere, CFO, could be a candidate for the role to keep some continuity. We have grown an appreciation for Mr. Vandemere’s cash flow focus and ability to cut costs – 2 skills necessary for an LBO CEO.
What’s the play for another manufacturer? Well, it would almost have to be an international slot manufacturer such as Aristocrat or Lottomatica. However, we believe this outcome is less likely than a private equity bid.
HEDGEYE CONFERENCE CALL
I will be hosting a 1:00 pm EDT conference call today to discuss Hedgeye’s thoughts and analysis on IGT as a private equity play. We will also discuss the near and long term issues facing IGT and look at potential catalysts should a sale not reach fruition.
Client Talking Points
Front month VIX has never stayed below 10, so yesterday’s bounce off 10.51 long-term support isn’t a surprise; at first volatility comes on slowly, then all at once – this is a very asymmetric point in the U.S. Equity market.
Played Jedi mind tricks with us yesterday getting back above our TREND line of 1169, but that A) didn’t happen on volume and B) needs to hold – stay tuned; no support to 1133 and remains our favorite U.S. Equity macro hedge.
Rips humanity a new one again yesterday and WTI charges to $104.63 this morning, finally signaling immediate-term TRADE overbought; adding oil #InflationAccelerating to a food basket that’s already +21% year-to-date should perpetuate more #ConsumerSlowing.
|FIXED INCOME||28%||INTL CURRENCIES||22%|
Top Long Ideas
Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration. The first survey tool measures 3-D Mammography placements every month. Recently we have detected acceleration in month over month placements. When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner. With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.
Construction activity remains cyclically depressed, but has likely begun the long process of recovery. A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating. Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms. As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.
Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.
Three for the Road
TWEET OF THE DAY
#StrongPound = Strong UK; Industrial Production growth rips +3% y/y
QUOTE OF THE DAY
“Mistakes are part of the game. It's how well you recover from them, that's the mark of a great player.”
STAT OF THE DAY
Last night in Game 3 of the Stanley Cup Finals L.A. King’s Jonathan Quick earned the first Stanley Cup Final shutout at Madison Square Garden since 1972.
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