10 AUGUST 2009




We continue to see things move and shake in the e-commerce world. Last week Amazon unveiled that along with the Zappos deal they also acquired the domain for ‘’ (which Zappos bought for $4.9mm in May of ’08). Clearly, with a price tag of $847mm for $30mm in EBITDA, AMZN has bigger and better plans for the category. Note that 2 weeks prior to the deal, it opened an Outdoor/Sporting Goods store.


At the same time, we see Target draw a line in the sand and state that it will be building and relying on its own ecommerce site, and will stop using Amazon. Target will have rebranded and redesigned the site in time to handle marketing and fulfillment in time for the 2011 holiday season. The seemingly long duration between decision and functionality shows that implementing such a strategy takes a lot more time than most people think.


In the end, this all plays into one of our key industry themes that assets will escalate in value as the bankruptcy cycle progresses and CEOs realize that they’ve overinvested in wholesale and retail, and underinvested in .com. Valuations for those companies with superior non-retail consumer-direct businesses (WSM, JCG, and even LULU, to name a few) will command a premium as strategic buyers eye both their brands as well as fulfillment assets.



Some Notable Call Outs


  • In addition to the comments on Zappos’ purchase of ‘’ in 2008, it’s worth noting that the price paid for the URL was the second most expensive in 2008, behind “” which sold for $10 million.


  • A couple of weeks ago there was a WSJ article discussing the “Christmas in July” trend. In particular, Sears and Kmart were promoting toys in an effort to boost sales and give consumers a shot at getting their holiday shopping underway a whopping 3-4 months in advance. The whole concept to me seems a bit ridiculous and out of place, especially when seen first-hand. This weekend I witnessed two examples of pushing products well in advance of their intended use. First, I saw red velvet Christmas ribbon stacked high at Costco. It looked very out of place only a few aisles away from beach chairs and pool accessories. Second, I witnessed a huge Halloween candy display at a Wegman’s. Now I realize Halloween is two months before Christmas, but again merchandising bulk candy (cob web display and all) seemed very out of place next to the ketchup, mustard, and relish display! We’ve heard retailers talk about taking earlier shipments with inventory being managed so tightly, but this appears to be borderline laughable. Maybe if it wasn’t 90 degrees and humid it would make more sense.


  • Gap is launching a new denim line this week, aimed at competing with premium denim lines priced at $125-$500. The new line is focused on fit, a key distinction in an effort to be competitive in the crowded designer denim space. Despite an attempt to take share from the higher end designers, the women’s line will top out at $69.50 and the men’s at $88. The product will officially be launched on August 13th although a pop-up shop opened in LA to generate buzz ahead of the national rollout.




-The apparel retail sector seems to be lagging behind signs of recovery in the job market - Amid moderating national job losses and a lowering of the unemployment rate, fashion stores eliminated 15,000 jobs in July, with specialty stores cutting 7,400 positions to employ 1.42 million last month, while department stores cut 7,600 jobs to employ 1.52 million. Retailers, particularly specialty and department stores, have struggled in recent months with weak same-store sales and flagging consumer confidence levels. Shoppers have favored discount retailers during the recession and have tended toward necessity purchases. In the manufacturing sector, textile mills, which produce apparel fabric, cut 2,000 jobs to employ 121,900. Textile product mills, which make home furnishing fabric, eliminated 800 jobs to 125,700. Apparel manufacturers added 1,000 jobs to employ 166,800. <>


-UK Homewear Sales experience 1st improvement in 12 months - Sales of homewares saw their first improvement in 12 months during July, according to the latest edition of the BDO Stoy Hayward High Street Sales Tracker. However, fashion declined steeply, reflecting the fact that consumers were reluctant to buy summer ranges given the unsettled weather. The change of focus towards new full priced lines also had a negative effect, while uncertainty over the swine flu outbreak may have impacted footfall. In other areas, sales of non-fashion items grew modestly. Overall, like-for-like sales across mid-market retailers retreated by 2.5 per cent in July compared to last year.  Homewares: +1.2% After 12 months of uninterrupted decline, homewares like-for-likes rose by 1.2 per cent. This is an excellent outcome, given the real weakness in demand last year did not start until September. Demand was up in most areas, with furniture and textiles the most positive, helped by movement in the housing market as well as generous discounts.  <>


-LaCrosse Footwear made a strategic decision to discontinue END Footwear as a standalone outdoor and running brand - LaCrosse plans to leverage the END platform of innovative lightweight designs into the LaCrosse and Danner product lines and distribution channels for Fall 2010.  The Company does not anticipate incurring material expenses associated with this action. <>


-Sperry Top-Sider and Sebago have some milestones to mark this spring - Both are using the important dates;  for Sperry, the company’s 75th anniversary; for Sebago, the 40th anniversary of its iconic Docksides style; to enhance their image, solidify their market share and engage new accounts. At Lexington, Mass.-based Sperry, recognizing the brand’s founding by Paul Sperry in 1935 is a chance to connect with customers by highlighting its heritage, which plays a key part in its consumer positioning. Calling the occasion a “tremendous opportunity to celebrate the lifestyle enjoyed in, on and around the sea,” Sperry President Craig Reingold said that turning 75 “allows us to speak to the authenticity and equity of our classic brand at a time when consumers are embracing quality and trusted companies.” According to Karen Pitts, VP of marketing for Sperry, limited-edition product and retro packaging will be rolled out to allow the brand to partner with key accounts — and raise awareness with customers, or, as Pitts put it, to help them “rekindle their relationship with the brand.” Next February, two styles for men and women — a $75 canvas vulcanized oxford and a $95 double-sole version of Sperry’s flagship Authentic Original boat shoe — will deliver to select retailers, Pitts said. For those styles, the brand also will offer shoe boxes that mimic the originals, with a new anniversary logo that calls out the date.  In addition, an online microsite is under development that will communicate directly to customers, but Sperry also is focused on reaching out to retailers. Pitts said the brand was still in planning mode, but hopes to have in-store displays featuring anniversary-themed items and gift-with-purchase promotions, as well as in-store events and custom programs that “really connect the dots for these smaller independent stores.” <>


-Former JJB Sports CEO attempted to take company private - Chris Ronnie, the former JJB Sports chief executive, who was sacked after being held responsible for the retailer’s demise, has claimed executive chairman Sir David Jones considered taking the business private. <>


-The protracted, complicated purchase of Hartmarx is finally a done deal - Emerisque Brands U.K. Ltd. and SKNL North America B.V. breathed a sigh of relief Friday as they completed the acquisition of the assets of bankrupt Hartmarx Corp. And Hartmarx employees, or at least the majority of them, now can look forward to holding onto their jobs. The assets of Hartmarx are now under the newly formed company Hartmarx Operating Co. LLC.  “We are delighted to have completed this acquisition,” said Nitin Kasliwal, chairman of SKNL, who on Friday was named to the same post at the new Hartmarx. “This is an important step forward towards our ambition of being ‘clothiers to the world.’”  <>


-David Conn, previously executive vice president of Iconix Brand Group Inc., has joined VF Corp. as president of VF retail licensed brands - In this new post within the VF Services Inc. subsidiary, Conn will be responsible for “identifying new business opportunities with key retailers under a licensed business model,” VF said. “Partnering with leading retailers is one of the cornerstones of VF’s growth strategy,” said Mike Gannaway, vice president of VF direct-consumer teams. “Beyond our core national brand strategy, we see additional opportunities for growth with key partners through the introduction of new brands under a licensed business model. David brings a unique set of skills, capabilities and brand licensing experience to VF that will prove effective in leading our efforts in this new endeavor.” <>


-Gucci America Inc. battles counterfeiters by attacking their financial backings - Gucci America Inc. took a novel approach to combating knockoffs on the Web last week when it sued three companies it alleges provided trade services to counterfeiters.  The lawsuit, filed Aug. 5 in U.S. District Court in Manhattan, claims that Houston, Tex.-based Woodforest National Bank; Bozeman, Mont.-based Frontline Processing Corp., and Colorado-based Durango Merchant Services all profited by doing business with Laurette Co. Inc., owner of  The fashion house won a $5.2 million judgment from Laurette last year after its owners admitted to selling counterfeit Gucci wares. In the new lawsuit, Gucci alleges one or more of the defendants had some part in processing more than $500,000 in bank and credit card payments made to Laurette by its customers. Lawyers for the luxury firm charge the defendants knew Laurette was selling fakes, as they labeled it a “replica” business and “high risk” account. By processing the transactions, the defendants “enjoyed a substantial financial benefit,” the suit alleges.  <>


-Kenneth Cole is tackling a huge hurdle by fusing fashion and comfort that many a fashion brand has attempted - More than 1,500 people lined up outside the firm’s Rockefeller Center store in Manhattan on Friday morning to purchase shoes from the brand’s shoe collection featuring 925 Technology cushion technology incorporating materials such as deerskin, Poron foam, cork and flaxseed. The new styles will be sold exclusively at Kenneth Cole stores until next year, when the company will begin wholesaling the line. Bloomingdale’s chairman and chief executive officer Michael Gould perused the collection alongside Kenneth Cole ceo Jill Granoff, while Cole autographed shoes and took pictures with a long line of fans. Going forward all of the brand’s shoes will feature 925 Technology.  <>


-Best Buy is best in traffic to computer and consumer electronics sites - Although its traffic declined 19% from a year ago, Best Buy still had more than twice the number of unique visitors in June than its nearest competitor in the computer and consumer electronics category. <>


-Though retailers are still buying cautiously, their interest in bolder footwear styles is surging - Nine West Creative Director Fred Allard said buyers showed excitement for product in proven silhouettes — from wedges and kitten heels to strappy sandals and peep-toe pumps — and styles with bold design treatments. He said looks with bright leopard and zebra patterns, unique textures and shaped demi-wedge or kitten heels had top billing with retailers. Neon coloring mixed with neutrals — an important color palette for the season — lets the retailer experiment without going too far, said Allard. Prices remain a key issue, he added, and Nine West is aiming to keep opening prices at $49 and limit the peak to $95. <>


-EU's Commission Decision reviews and adjusts eco-footwear criteria - EU's Commission Decision has carried out a review of the existing criteria for the community eco-label for footwear and decided to not only modify the definition of the product group but also to establish new criteria. The new Decision emphasizes that the product group "footwear" comprises all articles of clothing designed to protect or cover the foot, with a fixed outer sole which comes into contact with the ground. Moreover, in order to fall within this product group, footwear shall not contain any electric or electronic components. In order to be awarded the Community ecolabel, footwear must comply with the criteria set out in the Annex to the new Decision.  <>


-Japan's Merchant Sentiment Reaches 22-Month High on Stimulus Optimism - Confidence among Japanese merchants rose to a 22-month high in July, adding to signs that the world’s second-largest economy is heading for a recovery. <>


-After multiple garment factory closures, Nigerian Union demands government assistance - Nigeria's National Union of Textile Garment and Tailoring Workers of Nigeria (NUTGTWN) has urged the government to revive the industry in the wake of continuous closures of factories over the last twelve months. The Secretary General of NUTGTWN, Mr Aremu said that smuggling of goods is rampant in the country and have now dislodged the industrial sector by taking away the space for manufacturing. He said that the textile revival fund had been announced more than five years ago and apart from raising the quantum of the fund from N70 billion to N100 billion, nothing concrete has been achieved. <>


-Angola seeks aid from Japan and other countries to revive its textile industry - The Industry Ministry in Angola is in discussion with various countries, mainly with Japan, to revive the textile industry, according to the country's Deputy Minister Kiala Gabriel. Some concrete proposals are being negotiated with Japan and will be analyzed and approved by the government. In view of the current economic situation, the government has initiated an Executive Recovery Program for the industrial sector for the period 2009-12 which is a document to revive different sectors, said Gabriel. Recovery of at least three textile factories, such as Africa Textile and Satec in Benguela province and Textang II in Luanda will be made possible through this program. The government is also planning to build three factories in the period of 2009-12 to gin cotton in the provinces of Malange, Benguela and Kwanza Sul and one more in Benguela. <>




 Is it time to revisit Sketchers as a short? Probably not yet, as numbers seem doable. But Sterne Agee upgraded it this morning. Check out the historical chart below.









Michelle Leder of highlighted a PNRA filing last Friday.  Interesting new disclosure in PNRA Q filed LATE Friday that has something happening TODAY.   Says outcome could potentially be material, but it’s probably not big deal. 


The following is the key part of the filing:


“On January 25, 2008 and February 26, 2008, purported class action lawsuits were filed against us and three of our current or former executive officers by the Western Washington Laborers-Employers Pension Trust and by Sue Trachet, respectively, on behalf of investors who purchased our common stock during the period between November 1, 2005 and July 26, 2006. Both lawsuits were filed in the United States District Court for the Eastern District of Missouri, St. Louis Division. Each complaint alleges that we and the other defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and Rule 10b-5 under the Exchange Act in connection with our disclosure of system-wide sales and earnings guidance during the period from November 1, 2005 through July 26, 2006. Each complaint seeks, among other relief, class certification of the lawsuit, unspecified damages, costs and expenses, including attorneys’ and experts’ fees, and such other relief as the court might find just and proper. On June 23, 2008, the lawsuits were consolidated and the Western Washington Laborers-Employers Pension Trust was appointed lead plaintiff in the lawsuit. On August 7, 2008, the plaintiffs filed an amended complaint, which extended the class period to November 1, 2005 through July 26, 2007. We believe we and the other defendants have meritorious defenses to each of the claims in the lawsuit and we are prepared to vigorously defend the lawsuit. On October 6, 2008, we filed a motion to dismiss all of the claims in the lawsuit. On November 20, 2008, the plaintiffs filed an opposition to our motion to dismiss, and on December 3, 2008, we filed a reply memorandum in support of our motion to dismiss. On June 25, 2009, the Court converted our motion to one for summary judgment and denied it without prejudice. The Court simultaneously gave us until July 20, 2009 to file a new motion for summary judgment, which deadline the Court subsequently extended until August 10, 2009. There can be no assurance that we will be successful, and an adverse resolution of the lawsuit could have a material adverse effect on our consolidated financial position and results of operations in the period in which the lawsuit is resolved. We are not presently able to reasonably estimate potential losses, if any, related to the lawsuit and as such, have not recorded a liability in our Consolidated Balance Sheets.” 

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.

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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.”


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 

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