Tiger Time

“Always bear in mind that your own resolution to succeed is more important than any one thing.”
-Abraham Lincoln
As Tiger Woods walked down the 18th fairway at the Bridgestone Invitational yesterday afternoon, Americans saw a man with undeniable leverage to his own resolution to succeed – that’s the kind of leverage you want to be long in this market.
In addressing his missing the cut at the British Open, he stated plainly: “I don't think as bad as everyone thought it would have been. You've just got to not have those bad stretches, just clean it up a little bit.”
Rather than take my financial advice, I suggest you start off this week and the end of the Q2 earnings season with Tiger’s. “Just clean it up a little bit” – take all of your portfolio mistakes and look at them for what they are. Housing has bottomed; unemployment has peaked; and no matter where you go this morning, there you are.
On July the 6th, when I posted our Macro Chart of The Week (posted every week to Research Edge Macro subscribers) and titled it, “Unemployment's Double Top”, I knew almost immediately how right I was going to be on calling a top in the unemployment picture. Why? That’s easy  - no one, other than the math, agreed.
When no one agrees with you in this business, that usually implies some level of career risk. Luckily, I don’t work for anyone else anymore – and I can say what I think, whenever I want. This has proven to be a major competitive advantage in a Washington/Wall Street environment that is dominated by a generationally high level of groupthink.
Now that the market has absolutely smoked the Depressionistas last hope for immediate term raging double digit unemployment and savings rates. What are the top 3 groupthink “ideas” I see in the market this morning?
1.      China is a bubble

2.      Inflation isn’t going to be a problem

3.      The market is going up on low volume

Our take?
1.      China: We have been China bulls since December of 2008, and in our recently published “China Black Book” Andrew Barber outlined the probability of an initial -7% correction from the overbought highs. Last night, the Shanghai Composite closed down for the 4th consecutive day, taking the 4-day cumulative correction to -6.5%. We remain bullish on China, but at a price. This is not the time to call bubble, yet…

2.      Inflation: In the immediate term, I agree. The USA will report another deflationary CPI # for July on Friday and will print another deflationary # for August (because, at +5.3%, the August of 2008 y/y compare was the highest report of the last cycle). In the intermediate term, America is going to see a major sequential ramp in reported inflation come Q4. Just in time for political football season as Bernanke plays defense for his year end job security.

3.      Volume: While that may have been true 1 month ago, we have seen a major sequential ramp in both daily and weekly volume studies. In May-June, the market was going up on low volume; now the up days are on accelerating volume. Looking at this past Friday versus the Friday of 7/31/09, I had volume up +28%. Not a bad day for the bulls! The chase is on…

I’ll let the bubble watchers deal with their rear-view strategies of suggesting China could drop another -7% tomorrow. In the meantime, I think you buy China on down days and sell it on up ones from here. I’m going to start focusing my attention more acutely to groupthink item #2 – the forward looking call on Q4 inflation.
For our subscribers, our Macro team will be hosting our monthly strategy call this Wednesday. I’ll be giving an update on all three of our Q3 Macro Themes (Range Rover, Burning The Buck, and Reflation Rotation), and our Asia and Commodities strategists (Barber and Jones) will be diving into the drivers of the price of oil from here (if you’d like information on that call, please email . We remain bearish on the US Dollar; bullish on commodities; and bullish on Big Alberta’s (DJ’s nickname) oil.
When I was wrong on the high end of my Range Rover target, I changed my daily risk management strategy, immediately. With the exception of last week, where the US Dollar finally registered its first up week in the last five, the Buck has been Burning. Being wrong on the high side of my SP500 Q3 target was largely due to being right on the US government compromising the integrity of her currency at a more expeditious rate than even I thought possible.
From the MEGA Squeeze, to Housing’s Bottom, to Unemployment’s Double Top – those matches have been played. Next on this professional tour is Reflation’s Q4 Rotation. We’re looking forward to seeing competing opinions on the course. Bring your weather gear. When it’s raining out, we Macro guys believe you can get wet.
My immediate term TRADE target of resistance for the SP500 is 1,017, and I have downside support at 994. Buy low. Sell high.
Best of luck out there this week,


COW – iPath Livestock This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.  

EWG – iShares Germany Chancellor Merkel has shown leadership in the economic downturn, from a measured stimulus package and budget balance to timely incentives such as the auto rebate program. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; factory orders and production as well as business and consumer confidence have seen a steady rise over the last months, while internal demand appears to be improving with the low CPI/interest rate environment bolstering consumer spending. We expect slow but steady economic improvement for Europe’s largest economy.

XLV– SPDR Healthcare Healthcare has lagged the market as investors chase beta.  With consumer confidence down and the reform dialogue turning negative we like the re-entry point here.

CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

CYB – WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP– iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD – SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


XLI – SPDR Industrials
We don’t want to be long financial leverage, which is baked into Industrials.

DIA  – Diamonds Trust- We shorted the financial geared Dow on 7/10 and 8/3.

EWJ – iShares Japan –We’re short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY – iShares 1-3 Year Treasury Bonds – If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


Our FQ4 estimate is 2 cents ahead of consensus for EPS and $6MM above the street on revenues.  No call on the near-term stock action but the long term fundamentals are potentially explosive.


4Q09 Preview

We estimate that BYI will report $0.57 of EPS and $228MM when they report on August 12th.  Here’s the breakdown:

  • Casino operations: $10MM
  • Product sales: 5,400 new unit shipments at $14,300 a piece, total gaming equipment revenue of $89MM at a margin of 48%
  • Systems revenue of $55MM at a 75% margin
  • Gaming operations of $74MM at a 70% margin
  • SG&A of $60MM
  • R&D of $20MM
  • Interest expense of $3.6MM


2010FY Outlook


From the last conference call:


“The Company is in the early stages of planning for fiscal 2010; however, it currently believes that its strong base of recurring revenues and diversified business model will allow fiscal 2010 Diluted EPS to exceed levels expected to be achieved in fiscal 2009.”


“We expect several positives for our earnings per share compared to the start of last year. First, a higher level of gaming operations revenue; second, a higher level of system maintenance and services revenues; third, lower interest costs; fourth, more international jurisdictions in which to sell; and fifth, much broader and more exciting products in both games and systems. Plus, our recurring revenues for this last quarter were up 48% of total revenues, giving us better visibility”


We think that BYI will give a wide guidance range on the upcoming call, like last year… the kind you can drive a truck through.  As a reminder, consensus is at $2.37 per share.  We agree that FY2010 should be a year of growth for BYI, despite an anemic number of new casinos/expansions opening over the next 12 months.   That being said, we think that 2010 is simply a “bridge” year for BYI and the slot industry as a whole…. The real upside is 2011-2013.


Here’s how we get growth in 2010:

  • Annualizing our 4Q09 gaming operations revenues and assuming zero growth, we get 5% year-over-year-growth.   If you add some units here you get to more than 5% growth
  • We have North American units down about 11% next year because we are assuming some pickup in the replacement market (see “REPLACEMENT/NEW: A TALE OF TWO DEMANDS”, published July 1, 2009) and total new unit shipments down 7%.  However, some decrease in unit shipments is offset with an assumption of 3% ASP increases, which we think is conservative
  • To date, BYI has sold very few conversion kits.  However, conversions should be a pretty good opportunity given the 90% margins (this is WMS’s secret sauce of +50% product sales margin).  We’re not suggesting that conversion sales will approach WMS because BYI’s base of games is tilted toward mechanical reels, but even 1000 conversion kits at $3k would add 3 cents a share
  • Interest expense was over $5MM in 1Q09 and we think that it will be about $3.5MM in 4Q09, and continue to modestly decrease into 2010.  That’s about $0.07 cents a year.  As a reminder, BYI is levered less than 1x
  • Recurring maintenance fees on units hooked up to BYI’s system grew to $13.1MM in 3Q09 from $12MM in 1Q09, and we expect them to grow to over $13.5MM in 4Q09. These fees are basically at 100% margin.  As more bonusing software is deployed on the roughly 100,000 iVIEWS in the field, BYI should be able to continue to grow the fees they get, even if they don’t install a single new system.  If we simply annualize our 4Q09 estimate for recurring fees, that’s another 3 cents
  • BYI has already announced several new systems contracts for its windows bases system.  We think Windows based product will allow them to tap a huge market of smaller casinos.  They are by far the largest supplier of systems for casinos with over 2,000 units


YouTube from 3Q09

  • “We continue to expect that the margin on our game sales will increase into the high 40s over the next several quarters”
  • “We are becoming cautiously optimistic that gaming operators replacement game-buying demand will begin to improve in the fiscal year 2010”
  • “Our retool product portfolio, combined with a pipeline of exciting new products coming up, increasing customer's satisfaction levels and a very strong list of sales opportunities, allowed me to be optimistic about the Systems business during fiscal year 2010 and beyond”
  • “So going forward, we do feel that 45% on game sales can definitely increase two or three points in the short-term and as we sell more conversion kits, we think that we have the opportunity to get the 50% plus. Of course, our interest cost is coming down which drives down our pretax margin. We are taking some initiatives as well on international tax planning, but it's premature to project the lower tax rate at this point.”

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%


BYI reports its fiscal Q4 on Tuesday.  Earnings should be fine but, honestly, we have no idea how the stock will react. We do have an idea about the long-term though.



We would like to offer some longer term thoughts on the sector and BYI, in particular, worth bearing in mind any time the stock experiences weakness.  We’ll have a detailed EPS preview out a little later.


At $39, BYI is trading at 18x effectively trailing EPS, and 16x consensus forward EPS.  That doesn’t sound exciting, you say.  Well, we would argue that BYI and the entire sector deserves a premium multiple, given that they have managed to grow through one of the worst replacement cycles in history and are on the verge of a sizable replacement cycle.  As a reminder, BYI is on track to grow EPS 19% this year, and even consensus estimates expect 8% growth for FY2010 which is another awful year, cyclically, for the space.  How many companies in Gaming, Lodging or Leisure have achieved that kind – or any kind of growth this year?  How many will have another down year in 2010?


While BYI should be one of the few companies in our sector to actually grow its business in FY2010, that’s not one of our key thesis points.  We view FY2010 as a “bridge” year to the beginning of a huge replacement cycle and this is precisely why we like BYI and the slot space… a lot over the long term.


We entered this cyclical slowdown when gaming operators became so leveraged that every dollar went towards avoiding covenant breaches.  With Harrah’s, MGM, LVS, STN, and numerous other smaller players (Tropicana, Black Gaming, Twin Rivers, TRMP, Greektown, Herbst…) all in dire financial straits, the market for replacements simply dried out.  Since the big boys weren’t refreshing their floors, there was no reason for even better capitalized players to do so either.  Hence the downward spiral.


Fast forward to today and we’ve got expanded gaming coming in Maryland, Kansas, Illinois and Ohio.  Discussions are continuing in Iowa, Pennsylvania, Massachusetts, Arizona and other jurisdictions to expand gaming.   Aqueduct looks like it may actually get slots in the next 18 months, PNK is commencing construction in Louisiana, and Sugar House and Foxwoods are finally breaking ground in Philadelphia.  Our thesis is that incompetent politicians lay the groundwork for slots.  Slots beget slots.  States are on spending sprees, citizens are taxed almost to the max, and slots are again becoming the revenue answer. 


There are over 850,000 units in North America, but room for so many more.  New markets are great and provide a big boost to slot sales but they also grow and stabilize replacement demand.  Once the ball gets rolling we’ll get several years of 100,000 replacement units, up from the 31,000 units we’re estimating for 2009.


The thesis applies to all the slot players but BYI looks the most attractive to us:   

  • It’s a lot cheaper than WMS
  • BYI lacks the "hair" of IGT
  • Conservative accounting and high amounts of deferred revenues provides some visibility for next year
  • The systems business is a little lumpy, but is a great business that the Street under appreciates and clearly doesn’t understand.  BYI should fair very well in a networked world… whenever it happens.  In the meantime, products like iVIEW help deliver applications with high ROI to casinos
  • Already the lowest cost provider on the “participation side”
    • BYI offers many of its premium games on a fixed fee basis ($50-$60/day) vs taking a % of coin in or being on a 20/80 split.  Operators really like this and its one of IGT’s biggest gripes about BYI
    • Because so many of BYI games are either fixed fee or leased, they have less exposure to the economic headwinds of lower win per days
  • Large base of old spinning reel games that are past their depreciable lives
  • Low base internationally, making comps easier
  • Hadrill has sold companies before so a buyout at a premium is always a possibility
  • Litigation risk is at lowest level in years with the Wheel patent thrown out and the remaining litigation is really just a work around issue 


Family members have confirmed with us that Stanley Ho will recover.


That's good news for the Ho family and probably Macau gaming as a whole.  Uncertainty, at least over the near term, is rarely good.  However, Stanley Ho is 87 years old so we are going to have to cross that bridge at some point.  For now, status quo looks pretty good.


THE WEEK AHEAD: August 10-14


As usual, we have a full plate of critical economic data on deck for the upcoming week. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


Sunday/Monday August 10


Europe: June Industrial Production and Manufacturing Production data will be released in France on Monday morning. In the UK, July BRC Retail Sales, Same Store and House Prices data will be released.


Asia: Sunday evening will be eventful with Japanese Machinery Orders and Current Accounts data as well as July M2, Credit and Liquidity measures. Australian Housing Finance data for June –inclusive of financing for single family homes and multi-family units—will be released at 9:30PM. At 10PM Chinese PPI and CPI data for July will be released, followed by Korean PPI at 11:00. Singapore will release revised/final Q2 GDP in the evening.


On Monday, Chinese Fixed Investment data for July will be released. With the intense scrutiny of the roaring real estate and equity markets on the mainland by bubble watchers, all eyes will be focused on this data point as a potential precursor to tightening measures.


Tuesday August 11


US: The 2-day FMOC meeting begins on Tuesday. The treasury will be auctioning 3 year notes in the afternoon.  Weekly ICSC Redbook and ABC Consumer Comfort index data will be released, as will June Wholesale Inventory and Sales figures and DOL Q2 Productivity and Labor cost data. Goods and Services data for June will be released by the Census Bureau. Weekly MBA mortgage data will be scrutinized for more signs of recovery in the domestic housing market, while EIA stock measures for oil and gasoline are not expected to contain any major changes.


Europe: German CPI levels for July will be released on Tuesday, as will June UK Trade Balance data.


Asia: Chinese Trade data for July will be released on Tuesday morning while Industrial Output and Retail Sales figures for July will be released at 10PM. We will be watching this data closely –in particular looking for any signals of cooling demand from imports. Japanese Consumer Confidence and CGPI measures for July will also be released that day.


Wednesday August 12


US:  The second day of the FOMC meeting will culminate in a policy announcement at 2:15PM. Also on Wednesday afternoon, the July Treasury Budget will be released and a 10-year note auction will be held.


Europe: France and Italy will both release CPI Data on Wednesday while the UK will have a slew of data points released, including Claimants, Wage data and the BOE Inflation Report. Eurozone Industrial Production data for June will be released and a 10-year German Bunde auction will be held.


Asia:  After a busy Tuesday, Wednesday will be somewhat quiet on the economic release front in Asia, with Indian Industrial production data for June in the morning expected to test the ability of India bulls to put a positive spin on stagnation. Japanese final Industrial Production for June will also be released.


Thursday August 13


US:  Thursday morning will bring the release of July Retail Sales, July Export Price Index, July Import Price Index and June Business Inventories.  The Treasury will hold a 30-year bond auction at 1PM, with M2 data slated for release at 4:30PM. EIA weekly Natural Gas figures will be released.


Europe: On Thursday morning, German, French and Eurozone Q2 GDP releases will dominate headlines. Spanish Consumer Inflation data will also be released that morning.


Asia:  After last week’s sequential decline, the Indian Wholesale Price Index is expected to register higher.  RBA Governor Stevens delivers his Semi-Annual testimony to Parliament at 7:30PM, an opportunity for him to again outline his decision to begin raising rates as the robust Australian economy continues to maintain positive growth.  


Friday August 14


US: We will be focused on the July CPI release at 8:30AM as well as Industrial Production and Capacity Utilization data scheduled for 9:15. The preliminary Michigan Sentiment Index release for August is on the calendar for Friday morning as well.


Europe:  Spanish Q2 GDP will be released on Friday morning, while German, French and Eurozone Q2 GDP data will be released early on Saturday morning.  Other major economic data points going into the weekend include Eurozone July CP and FT House prices for July in the UK .


Asia: Hong Kong Q2 GDP will be released on Friday morning, while Japanese Q2 GDP will arrive at 7:50PM. Expect Chinese M2 data for July to reflect even greater liquidity last month.  

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