Takeaway: Nothing gold can stay.
"Show me a hero and I'll write you a tragedy."
- F. Scott Fitzgerald
Along with the likes of T.S. Elliott and Ernest Hemingway, F. Scott Fitzgerald is widely regarded as one of the most recognized young American writers of the “Lost Generation” of young Americans who fought in and emerged disillusioned out of WWI.
With the time-tested truths of human nature, we are forced to accept the unconscious anchoring biases and contextual frame of references shaped by our experiences. We then observe and perceive through this ever-changing lens.
Consequently, Fitzgerald’s frame of reference stems out of some epic undulations in popularity and wealth:
- Two world wars
- Jazz Age (a term he coined)
- Currency and Wealth Destruction:
- Great Depression
- Weimer Republic Collapse; followed by
- Ascension and destruction of Hitler’s rule
Without searching for self-proclaimed similarities between the two of us, I can say without a doubt Fitzgerald and I have one thing in common:
We spent a large part of our early years in a cold climate.
Walking across Notre Dame's campus during my junior year for a morning Econometrics class (the subject matter of the class reserved for a future "Early Look"), making a stop for breakfast and coffee was a ritual. Unfortunately, in the dead of winter in South Bend, Indiana, this stop required a small detour, and it was cold!
Now I've heard it was even colder this winter. Even so, convincing me I would not have taken a detour this past winter for a little breakfast and coffee given the colder weather is highly unlikely.
Back to the Global Macro Grind…
Here we are at the midpoint of 2014, a year that has been full of surprises relative to consensus expectations moving into the year.
- Growth (miss): -2.9% Q1 final GDP revision (miss and seventh consecutive year of downward revision from the Fed)
- Inflation (surprise): Headline CPI +0.4% vs. +0.2% expected for May
- Yield Spread: -50 bps (Net Short contracts in the ten-year down to 2.4K from 175K in the first week of January)
- Commodities: CRB (+9.6%); CRB Food (+23.3%)
- VIX: 10-handle; Hovering at all-time lows
So where do we go from here?
The Financial Times published an article yesterday on Hedge Fund beta tracking at all-time highs. Hedge Funds are levered long and yield chasing. Our team consumes and analyzes high-frequency data points across the globe to generate alpha. Alluding to the risks inherent in the market does not mean we are preparing for an epic crash. Sure it could happen, but front-running the sector variances that manifest as growth slows and inflation accelerates is the goal.
- XLU (+13%); CRB (+9%); GLD (+10%) YTD
- XLY (+1.08%); IWM (+3.2%) YTD
- SPX (+7%)
Rather than predicting third and fourth quarter consequences, we absorb the ever-changing landscape and re-adjust the inherent risk across durations in real-time. As 2H growth comps indicate a consensus miss to the downside, we believe the following sequence of events is a probable in today’s centrally-planned environment:
- A Fed revision for 2014 full-year GDP from 3.0% to 2.1 - 2.3% at the last FOMC meeting will likely face a further downward revision after a -2.9% Final Q1 print last week (hint: not weather-related)
- The Fed gets more dovish with the data
- The bond market adjusts for growth expectations and the prospect for future dollar devaluation perpetuates the yield spread compression
- Commodities as a complex, which are priced in U.S. dollars globally, face continued pressure to the upside net of unpredictable external factors
As the outlook changes, we will contextualize the data and be forced to change. After all, we are paid to be right on both sides of the tape.
With growth DECELERATING and inflation ACCELERATING central planners will try to convince you there’s no inflation in our everyday consumption habits. That coffee and breakfast would have been more expensive this year, but we all have to eat (bad weather or not). Just last year, the central bank adjusted its model for allowing a longer grace period for wage growth to catch up with commodity inflation. Now this seems like a rather convenient way to keep the accommodative power at the expense of the middle class.
F. Scott Fitzgerald could probably pencil quite a symbolic ending to this story. Give Janet Yellen a break for her nervousness. She is new to the scene. However, as you can see in today’s Chart of the Day below, the ECB's Mario Draghi has mastered that red carpet stoicism.
Our immediate-term Global Macro Risk Ranges are now:
WTI Oil 104.01-107.12
Good luck out there today and Happy 4th!
Tickers: BYD, MGM, WYNN, WYN, LQ
678:HK Genting Hong Kong Ltd – announced David Chua Ming Huat tendered his resignation with effect from January 2, 2015. But in the interim, his ultimate boss, Lim Kok Thay, the chairman of Genting Hong Kong’s parent, Malaysia’s Genting Bhd, takes over as acting president with immediate effect
Takeaway: A seemingly unexpected departure for the senior executive.
BYD & MGM – A magistrate judge has announced there will be an Aug. 5 scheduling conference in the matter of Borgata casino vs. Phil Ivey, the legendary poker player, over the $9.8 million that Ivey won playing mini-baccarat during four visits to Atlantic City in 2012. The suit alleges that the some of the cards used in the marathon mini-baccarat sessions turned out to not have a perfectly symmetrical design on the back of the card. Ivey, the suit claims, was able to figure out fairly precisely what the first card to be dealt in each hand was – giving him a significant advantage over the “house,” or casino. Ivey wants to keep his whole $9.8 million and Borgata says he should give it all back.
Takeaway: We again ponder why Borgata is not pursuing a case against the card manufacturer... However, such an effort might be the fallback plan in the event Borgata is unsuccessful against Ivey.
MGM – the Aria casino has agreed to pay $100,000 to settle allegations that a supervisor shooed away state agents who were watching a high-stakes roulette table, even though state law requires all gambling to be open to the public.
Takeaway: All games are public
Tropicana Entertainment – Tropicana Entertainment sold the 1,000-room River Palms casino in Laughlin, NV, for $6.75 million in cash to Nevada Restaurant Services and Laughlin Hotel LLC. The land based casino-resort has more than 1,000 slot machines, a poker room and a bingo club.
Takeaway: A small price for a once vibrant destination casino, Sam's Town Gold River.
WYNN & 1128:HK – announce that the Wynn Macau Employee Ownership Scheme was formally adopted on 30 June 2014 and the trust deed between the Company and the Trustee was entered into on 30 June 2014. In approving the Limited Employee Ownership Scheme, shareholders granted a mandate to the directors of the Company to allot, issue, procure the transfer of and otherwise deal with up to 50,000,000 Shares in connection with the Scheme during the Relevant Period were passed at the 2014 AGM. Additionally, the Board has also supplemented the Scheme to provide that as an alternative to issuing Award Shares to the Trustee, the Trustee will also be able to receive funds from the Company to acquire Shares through on-market transactions at the prevailing market price to hold on Trust for Selected Participants of the Scheme.
LQ & WYN – the former Wyndham O'Hare, located in Rosemount, Illinois, left for dead after the global financial crisis is rising again as two hotels - a 200-room La Quinta Inn and a 200-room Hyatt Place. The hotel was recently acquired by an investor group who paid $5.1 million for the property and expect to invest an additional $20 million in conversion capital expenditures. The capital was primarily raised from Chinese investors through the US Government's EB-5 visa program.
Takeaway: Two more limited service hotels in an already very crowded O'Hare sub-market.
Sands Chief Supports Non-Gaming Options – (MacauBusiness) The chairman and chief executive of casino operator Las Vegas Sands Corp, Sheldon Adelson, has praised the efforts of the Macau government to give tourists a greater variety of reasons to visit. “The government wants to diminish the reliance upon gaming and they want to attract leisure customers that will come there for sightseeing,” Mr Adelson said. “We’ve done a lot of surveys and the surveys show that, particularly in Asia, people travel for two reasons: one is sightseeing and the other is shopping,” he said.
Takeaway: Singing the government party line.
Chinese Mainlanders More Discerning – (Bloomberg) The co-chairman of Macau casino operator MGM China Holdings Ltd, Pansy Ho, has said Chinese visitors to the city are becoming more discerning. “We’re already beginning to see that the customers walking through our doors are more demanding. They now know how to differentiate,” Ms Ho said.
Takeaway: The impact of affluence on the Chinese middle class...higher expectations.
Hedgeye remains negative on consumer spending and believes in more inflation. Following a great call on rising housing prices, the Hedgeye
Macro/Financials team is turning decidedly less positive.
Takeaway: We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.
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Takeaway: Buyout speculation makes sense but far less likely than a Strategic Buyer. Most likely, and best, outcome is Chip selling stock outright.
This noise in the press about Chip Wilson lobbying for a Buyout of LULU is right in line with our thesis that we outlined in our call on June 25th (see notes below). But let's be clear about something, though we're confident that we'll see meaningful change at LULU, we think that Buyout is one of the lowest probability outcomes. We give it about 10%, at best. We think a strategic buyer is more likely (20%). The only thing that is a lower probability than a Buyout is Wilson regaining control of the company. If he cannot get it sold, then we think we'll see him sell all his stock, which is probably the best and highest-return outcome for shareholders (yes, even better than a deal). All in, Wilson's efforts, and the subsequent noise in the press is right in line with why this stock will work. Our rationale is outlined below.
HERE'S OUR NOTE FROM JUNE 25th ON WHY WE ADDED LULU TO OUR BEST IDEAS LIST AS A LONG
Conclusion: Today we hosted a conference call to discuss the rationale behind why we added LULU to our Best Ideas list as a long after the stock’s latest collapse. As we’ve said before, the call right now has nothing to do with our confidence in the business or the team running it. This is a company in a defendable category with an outstanding brand, a $95bn addressable market, and a realizable $4-$5bn revenue stream over 5-years. But the catch is that it’s still sitting on a $500mm management team and operating structure. The good news is that never in LULU’s history has there ever been a path to creating value, and that’s due to the sometimes painful, and usually embarrassing presence of its founder, Chip Wilson. But we think that the Board structure that he created will ultimately lead to him outright failing in his current attempt to regain control of the company. That is likely to be a catalyst for one of many forms of change, which we explored in our presentation and deck. We plucked out a few of the more salient slides that we think are worth considering. Let us know if you’d like the replay and the full materials.
The LULU Bracket
This diagram is noisy. It’s supposed to be. Start reading it on the left with the decision of whether or not Chip Wilson wins control of the Board We very generously gave him 20% probability. But in reality he’ll be lucky to get 10%. If he loses, which he will, we think that one of two outcomes is most likely; a) he sells his stock (35% chance) – representing 27.7% of shares outstanding, or b) there’s a deal – 10% likelihood of a buyout, or 20% chance of an acquisition. When all is said and done, about 80% of the outcomes get us to a price well above $41.
Outcomes, As We See Them
1) Management Team Upgrade (49% probability): Each scenario results in a potential management upgrade, but the biggest likelihood is if Wilson sells his stock. All in, we get to a 49% chance of a meaningful change in management (including putting in place a high caliber CEO). This company needs better executives, and a lot more of them. This is a team that we think would proactively invest in systems needed to more appropriately discount product – something LULU sorely needs – and tackle its competitors head on instead of clinging on to a ridiculous hope of a perma 55% Gross Margin. The way it is being run today, the company is on its way to becoming Coach. We firmly believe changing that path is not a very difficult one. All in, this scenario gets us back to the discussion of $3-$4 in earnings power, or a $60-$100 stock (20x $3.00, and 25x $4.00).
2) Deal (30% probability): The biggest barrier to a deal getting done in the past has been that Chip didn’t want it to happen. Now he’s likely searching for one. Our sense on Wilson is that he feels handcuffed by LULU. He’s not allowed to participate in anything having to do with the company aside from attend Board meetings, but he’s too big a shareholder to go off and start another brand (something he’s actually very good at) due to his non-compete. If he can’t gain control, he could look to get the company sold. We think that a buyout with a PE partner is not very likely – as there’s not a ton of private buyers that would take out a high margin company at 15x EBITDA. But we think that the set of strategic buyers is a) far more expansive and b) less price-sensitive.
3) Status Quo (21% probability): This outcome pretty much stinks. The reality for LULU is that a status quo management team and status quo operating plan results in a far less than status quo stock price. We see about $10 downside to $30-32 if this is the case ($1.50 in EPS – 15x p/e and 10x EBITDA). This is the outcome that would cause us to pull the plug on our call – though we don’t think this will come to fruition.
There’s a few reasons why Chip will likely not regain control of the Board.
1) Giving up the title of Chairman in late 2013 is the worst thing Chip could have done. We think that was one of the final moves in a game of chess the real Board was playing with him. He agrees to step down from being Chairman if Laurent Potdevin gets the green light to be CEO. Potdevin is likely not the guy for this job, but it was a great move in hindsight by the Board.
2) Why? Only the CEO, Chairman or a majority of the Board can call a special vote at LULU. Chip cannot do it. He literally has a better shot at selling the company outright than he does in calling a simple special Board meeting.
3) There are 10 Board members, and three are clearly on ‘Team Chip’. But the Board has an offensive weapon in that it is authorized to have between 3 and 15 Board seats. All the Board needs is a simple majority (which Chip likely will not be included in) and it can appoint up to five new Directors -- none of whom are likely to be aligned with Wilson.
4) Better yet, there are staggered seats with three year terms. So if Board members are appointed today, he or she doesn't have to be voted on by shareholders until 2017.
5) All in, Chip’s ownership has been steadily shrinking, but his influence has been shrinking faster. He knows this. All the more reason to make a move to get out.
Who’s A Buyer?
We think that there’s a lot of companies that want to own LULU, but unfortunately, not a lot of companies can afford to do the deal at $8bn. We calculated the leverage for a host of suitors pre and post transaction, and also looked at year 1 accretion and dilution for each company. The punchline for us is that LULU is not likely to be bought by an American company. We’re thinking German, French or Japanese.
a) Nike: NKE won’t buy what it thinks it can build for less money. Whether you agree with them or not is irrelevant. They think they can beat LULU organically, so they won’t buy it.
b) Adidas: AdiBok needs it, can afford it, and couldn’t care less about near-term dilution. This makes a ton of sense.
c) UnderArmour: This makes zero sense strategically or financially. I’m surprised I’m asked this so often.
d) VFC: This would be a big nut for VFC to digest, but they could afford it – barely. VFC has gotten less value-conscious in recent years (i.e. TBL) so maybe it’s a possibility. But a dark horse for sure.
e) PVH: This is a company that needs a deal like LULU, but it would crush PVH financially. Tough luck Manny.
f) Fast Retailing: The Japanese owner of Uniqlo is looking to aggressively expand into the US, and needs to diversify away from its mall retail fashion push. The fit makes sense, the accretion is a no brainer even past $70, and let’s not forget that Fast was almost on the hook for buying J Crew in March for $5bn until it saw how bad Mickey’s business was trending.
g) Kering: CEO is on the tape saying he wants to buy sports brands to augment Puma, Tretorn and Volcom. KER could digest LULU in a heartbeat. French company might keep Laurent on board, as well.
h) GPS: This one is another consideration – albeit a long shot. It would take GPS’ debt to total capital to about 65%, which is likely far above the Fisher family’s comfort level. Perhaps GPS will be content chipping away at LULU with Athleta, which is crushing it.
This note was originally published at 8am on June 19, 2014 for Hedgeye subscribers.
“And John bare record, saying, I saw the Spirit descending from heaven like a dove…”
God called Janet Yellen and told her to cut her US growth forecast and devalue the Dollar again yesterday. Thank goodness for that. What would we do without her?
Back to the Global Macro Grind…
As ridiculous as doing the same thing over and over and over again (and expecting a different economic outcome) sounds, the un-elected-economic-central-planning-authority did just that (again), targeting rates lower (and inflation higher), yesterday.
Not that anyone should hold them accountable to why, but here’s what the Fed did yesterday:
- Cut its 2014 US GDP Growth forecast from 3% to 2.1%-2.3%
- But kept its 2015 GDP Growth forecast at 3.0-3.2%
Ah, so doing more of what is slowing real-inflation-adjusted growth is the answer, eh? Cool. Maybe if you’re long slow-growth #YieldChasing assets like bonds (or anything that looks like a bond – Utilities (XLU) led the rally yesterday, closing at fresh new highs of +15.2% YTD).
If you’re the poor bastard living on $60,000 US or less (i.e. the median consumer in America)… Well, you can eat the all-time highs in cost of living, and like it. Because these doves are going to kill your real-wages.
As you can see in the Chart of The Day, before the Oil spike in June (this is a May number), American real-wages (what you get paid in terms of wage growth minus made-up government inflation) just went negative for the 1st time in 2 years. That’s gotta be good.
BREAKING: “Fed Fueled Stocks Fly, Dollar Sags, Oil 9 Month Highs” –Reuters
That’s a pretty cool headline too, right? Notwithstanding that US Consumer Discretionary (XLY) stocks are still DOWN year-to-date and Energy (XLE) +12.6% and Utilities are leading the rally, who cares about the details.
In other news, divine intervention took the VIX back to 10 yesterday. As a friendly reminder:
- The VIX (US stock market fear index) has never (ever) held below 10 in US history
- Never, ever, is a very long time
“So”, with bond yields falling fast (again) and Gold rising (again), what do I think you should do now?
- Keep doing the same thing we have been saying all year (buy #InflationAccelerating and slow-growth #YieldChasing assets)
- And add more frequent prayer to your daily process on days that the VIX has a 10 handle
Even if you’re not religious, I think you should think outside the box here and just do it. Because this is not going to end well.
As opposed to making a backward looking call that the US is going to repeat the prior credit crisis, I think the next economic crisis is going to be perpetuated by Fed policy. These ideological doves are going to kill 70% of US GDP (consumption) with a Policy To Inflate.
Our immediate-term Global Macro Risk Ranges are now (with intermediate-term @Hedgeye TREND signal in brackets):
UST 10yr Yield 2.46-2.64% (bearish)
SPX 1928-1960 (bullish)
RUT 1155-1185 (neutral)
VIX 10.14-12.15 (bearish)
USD 80.07-80.63 (bearish)
EUR/USD 1.35-1.36 (bullish)
Pound 1.68-1.70 (bullish)
WTI Oil 105.14-108.28 (bullish)
Gold 1260-1286 (bullish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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