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EPS was better but revs fell far short of expectations. The latter will likely impact the stock action. We see little in FQ2 to change our positive long-term thesis.



We like the set up.  The positive long-term thesis was teed up in our 8/9/09 note, “BYI: THE LONG (TERM) AND SHORT OF IT”.  We explicitly avoided making a call on the quarter even though we were two cents above the Street (they actually did 3c above).  The stock will likely be down today due to a big revenue shortfall.  We hope so.  There is little in the quarter’s numbers that dent our very favorable long-term view.  The only real negative takeaway was the decline in participation units which we need to get more color on.


After the close yesterday, Bally’s reported revenues of $205MM and EPS of $0.58.  They missed the Street revenue estimate by 8%, but beat Street EPS and ours by 3 cents and 1 cent, respectively.  Guidance of $2.25 - $2.50 was wide (as predicted) and in line with expectations.  We’re not sure the EPS beat will be enough to offset weak revenues in investors’ minds.




The revenue miss came primarily from gaming equipment and systems revenues, somewhat offset by better margins on gaming equipment sales and operations.  The lower revenues do not concern us as system sales and international slots are notoriously lumpy.  Lower SG&A bridged the gap of lower revenues.  Other income, lower tax rate, and lower R&D helped beat consensus.  Below is a detailed review of the quarter and some further thoughts.


Gaming Equipment Sales

  • BYI missed our revenue number by $11MM.  $5.6MM of the miss was due to new unit sales and the balance was due to lower used, parts, & other sales.
    • North American units were spot in line with our estimate, however, international units which were down 22% y-o-y, 306 units light of our estimate
    • Pricing was only a touch (60bps) below our estimate
  • Other revenues came in $5.3MM below our estimate, but the mix was heavily skewed to conversion kits.  Our best guess is that the margin on “other”  improved to 65% from a 20’s-40% margin over the last four to five quarters


  • Systems sales came in $8MM below our estimate.  However, to be fair, this is really the most difficult segment to model due to the timing of revenue recognition.  We feel good about management’s comments on the call regarding systems in FY2010. There is a six to nine month lag between when BYI wins a contract to when the system is installed, and it can take even longer to recognize revenues.
  • Maintenance revenues increased to $13.5MM and with the launch and ramp of new applications installed on its 130,000 iviews in the field, management expected a strong ramp of maintenance revenues to $58-62MM in FY2010
  • Management also expects a strong December 2009 quarter.  BYI will be doing LVS’s Marina Bay Singapore and PNK’s River City installation
  • We expect the September quarter to be better than the June quarter, but still below the mid 50’s recent run-rate

Gaming Operations

  • Gaming operations revenues where $3MM below our estimate but gross margin was only $0.4MM below our estimate due to higher margins
    • WAP/LAP units decreased by 211 units sequentially
    • Rental and daily fee games decreased by  616 units sequentially
    • Centrally determined games increased by 1,287
  • Decline in participation units is probably the only aspect from the quarter that could have negative longer term implication
    • Management seems committed to produce more Millionaire games which will help the WAP/LAP segment
    • Management must explain the rental and daily fee decline – we will have a follow up


  • SG&A was 54.3MM, below our estimate.
    • As a reminder, last year BYI had some “unusual” expenses including at least $10MM of legal expenses (mostly regarding the IGT litigation) as well as auditing expenses relating to their restatements
  • Other income was $2.7MM, mostly from FX – which we did not model
  • We thought it was odd that BYI didn’t break out 4Q09 financials and instead they only broke out 4Q09 financials for the slot business
  • Share count looks like it ticked up a bit, despite the buyback
  • Total debt decreased by $60MM sequentially, cash flow generation was strong with total operating cash flow net of investment spending equalling approximately $136MM for FY2009


  • BYI guided to $2.25-$2.50 per share, growth that will be driven by
    • Higher international units
    • Higher ASPs
    • Higher conversion kit sales, which mean higher margins for gaming equipment sales
    • Higher base of gaming operations units
  • EPS will be slightly more back-end loaded than expected, the street was projecting 46% of EPS in the 1H FY2010.
  • BYI does have some large systems installations coming with LVS’s Marina Bay Sands and PNK’s River City opening in calendar 4Q09/1Q2010
  • Deferred revenues were down sequentially again, even though the company says that deferred revenue isn’t a good proxy for forward revenues, we do find comfort in the a large backlog

Onto The Next

“You’ll miss 100% of the shots you don’t take.”
-Wayne Gretzky
We took the macro shot. Yesterday’s Game Time is now behind us. That’s it. Onto the next.
Predictably, Ben Bernanke pandered to the political pressures associated with getting a core constituency paid: Bankers, Debtors, and Politicians. He is hostage to his own personal history (studying depressions) and those savvy politicians who understand how to use that personal history as a backboard for their compromised agenda.
While, in the long run, this doesn’t end well for those paying the bills (US consumers via inflation and the Chinese holders of US Dollars), in the immediate term all you can do is focus on how you can get paid. Don’t get political or religious about this - just understand the dynamics of US Dollar Devaluation, and capitalize on it.
The Buck continues to Burn this morning, trading down another -0.35% to $78.51, taking its cumulative crash since March to -12%. In the face of the US Dollar’s rear-view mirror locking in yet another lower-high, the guys who shorted the double-butter-fly-wing-nut-top-formation in  whatever technical study Fast Money’s contra indicator (Guy Adami) was using Tuesday night are staring at the SP500 futures indicated up another 9 handles.
In all of my games of trading markets, I have never seen this level of groupthink. I’m not sure if it’s that a lot of people still don’t do macro, or if we are all just monkeys making stuff up – but the volume at this gong show continues to heighten.
Every time I make a “market call”, my inbox is rightly infused with opinions. We have been blessed with thousands of readers of this Early Look note every morning, and for that we are very thankful. One of the greatest advantages to my not running a hedge fund P&L anymore is that I get to sit at the heart of this exclusive network of information. The feedback mechanism is invaluable.
Most times, I know when I am making a call on the side of what we call the “pain trade.” That’s simply the trade that the hyper-side of the hedge fund community just cannot afford for me to get right. I can quantify this now, daily, by adding up the “McCullough you are going to get crushed” emails from people who don’t pay us. All of these emails have an agenda. The agenda, ostensibly, is to shake me like certain funds are always shaking the sell side banks. I don’t do banking. I don’t shake.
This all gets down to having a repeatable investment process that is your own. If you haven’t been able to evolve your investment process in the last 18 months, you’re probably not reading this email – and we’re all cool with that. This is the ultimate in Darwinian washouts. Those of us who are putting up positive absolute performance years here in the 2008-2009 seasons are going to live to play in this league another day.
Today is just that - another day. We can lose all of yesterday’s Game Time performance by getting too piggy. We can also miss out on the alpha associated with staying with what’s working. We are all hostage to our own emotions. The hardest thing for me to do every day is not book a gain too early.
So, let’s strap on those chin straps, and look at this morning’s US macro setup:
1.      US Dollar down

2.      US Equity Market futures up

3.      Immediate term TRADE upside in the SP500 to 1,015

4.      Immediate term TRADE downside in the SP500 at 1,001

5.      Top to bottom ranges in all markets continuing to narrow

6.      Volume studies continue to flash bullish (accelerating volume on up days; decelerating on down ones)

7.      Volatility (VIX) remains broken across durations (TRADE, TREND, and TAIL)

8.      SP Sector studies flashing bullish TRADE and TREND across all 9 sectors for the 19th consecutive day

9.      US Tech (XLK) led yesterday’s rally, and low beta Consumer Staples (XLP) lagged = bullish divergence

Extending our risk management view to where the puck is going as opposed to where it’s been, here’s the global view of the ice:
1.      China closed up for the 2nd day of in the last 3, taking the YTD gain in the Shanghai Composite to +72.5%

2.      Australian equities hit another fresh YTD high overnight (+21.2% YTD), proving the metal of the world’s best central banker

3.      Hong Kong +2.1%; India +3%; Thailand +1.6%; Indonesia +2.1%; Singapore +1.8%; the bull market in Asia continues…

4.      Western Europe trading up across the board after Germany and France showed sequentially improving GDP stats for Q2

5.      Germany trading +1.4% takes her YTD gains above those of the Dow and the SP500; one more country that doesn’t support the Bernanke view

6.      Turkey, a beacon for emerging market growth, trades up another +2.8%; the global free money rally continues to broaden

7.      Dr Copper busts as move to another new YTD high, trading up to $2.89/lb = +106% YTD, and telling Bernanke shame on you

8.      Oil prices are testing new YTD highs up at $71.30/barrel – yes, oil is priced in bucks, and Bernanke’s Bucks are burning

9.      2-year US Treasuries down at 1.15%; while the long end of the yield curve (10yr) is +257bps higher = politicized/socialized setup that’s great for banks

That last point out of the aforementioned 18 bullish points is the one that had the CNBC crew all in a heat last night. Charlie Gasparino couldn’t jump onto the Fast Money wire fast enough last night, literally panting into the phone that he saw John Paulson’s filing positions in Bank of America (BAC). McFly, that’s a June position. The date of today’s game is August 13, 2009.
Today is not a day to chase the manic media monkeys. Nor is it a day to chase other people’s “best ideas.” Today is one more opportunity to sit back, do your own work, and wait patiently for your opportunity to take the next big shot.
Best of luck out there today,


XLK – SPDR Technology Tech and Healthcare remain the two sectors most primed for accelerating M&A activity in Q4. Both look great from an intermediate term TREND perspective, but at a price.

EWC – iShares Canada We bought Canada on 8/11 ahead of Bernanke’s pandering. Canada has what THE client (China) needs, namely commodities, which we believe will reflate as the buck burns.   

USO – Oil FundWe bought USO on 8/10. With Bernanke as the catalyst for the USD breaking down we want to be long oil.

QQQQ – PowerShares NASDAQ 100 We bought Qs on 8/10 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.

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, which posted a positive Q2 GDP number.

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. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient 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.

UUP – U.S. Dollar Index
We believe that the US Dollar is a leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the US dollar.

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.


BYI missed on revenues but beat EPS expectations.  Net/net probably a negative for the stock today given the magnitude of the revenue shortfall.



BYI 2Q09 Earnings call:

  • 4Q game sales and ship share was back to “normal”
  • Revenues for gaming operations were at an all-time record
  • Cash flow $165.2MM for FY2009
  • Operating margins increased to 24.3% from 22.1% in FY2008
  • BYI saved $45MM per year through their employee base in India (from R&D and Systems developments)
  • The tax rate was a little lower than expected, expect 35-37% tax rate for FY 2010
  • They have $62MM remaining under their repurchase plan
  • Repaid the R/C to a zero balance at June 30th and have 0.7x leverage
  • BYI is assisting customers with some slot purchase activity
    • A/R days increased as a result
    • Expect customer financings to cause DSO’s to increase modestly over the next few quarters, although their DSOs are still below competitors
  • 4,001 units were shipped to NA
    • Estimate 21% ship share
  • Margins on game sales are expected to be in the high 40s over the next few quarters
  • Increase of conversion kits by 33% y-o-y
    • See this as a big opportunity
  • International markets are a big opportunity
    • See growth in the next 12 months (Singapore, Australia, and Italy)
  • Margins on gaming operations increased reflecting better management of games in the field and better management of working capital
  • Replacement cycle in NA continues to be sluggish, they are not predicting a big uptick in buying patterns over the next two quarters
  • Expanding in Mexico and BYI is excited about opportunities in Italy
  • They are re-entering Australia over the next few years
  • Systems maintenance revenues were $13.5MM in the quarter and expect them to grow to $58-62MM in FY 2010
  • Since April 2009, BYI has seen a significant pick up in systems purchases.  Many casinos replacing their legacy systems. Should see the benefit in Q2 2010 (remember the lag in this business)
  • New player tracking system is performing well across 10,000 devices
  • Two more casinos with more than 2,000 games each are replacing a competitor’s system with a BYI system, a new Macau casino (with relationship with a competitor for all their other systems business) will open with a BYI system
  • Server gaming initiatives should drive growth (business intelligence, iVIEW DM, etc)


FY 2010 outlook

  • Cautious optimism is returning to many casino operators
  • In the long term, they are very excited about opportunities for slot manufacturers – there is a perfect storm of new markets, pent up demand, and new products and initiatives
  • Less-than-perfect visibility in 2010,
    • Higher level of gaming operations and systems maintenance revenues
    • Larger footprint of games in the field to attack with conversion kits and replacements
    • In some new international markets that they weren’t previously in
    • The guidance of $2.25-$2.50 … does not include significant revenues from new jurisdictions



  • “Cautious optimism” applies to geographically diverse customers , not just Vegas centric customers
    • Seeing CEOs paying more attention to maintenance capex
  • Not forecasting unit sales (being up or down) but do think that margins will be 46-49%... with conversion kits helping them and margins going higher in the long term
  • Saw IGT cut deals on MegaJackpot with MGM and another deal with BYD – did IGT take share from them?
    • No
  • Pieces in game ops- what are the trends? WAP/LAP decreased – what happened there?
    • Had good growth in Class 2 and centrally determined, flat units in premium units – but better win per days
    • Tower series (over 100 placed in 45 days) and Jumbo series are doing great
    • Putting out more Wheel products in next 60-90 days
    • WAP/ LAP: Millionaire 7’s – launching a new game to replace that, and launching a few new replacements for Quarter Millions
      • Expect a rebound later this year (calendar)
  • Systems – what’s embedded in guidance?
    • It usually takes 6-9 months from when a deal enters their pipeline to when they recognize revenues, so the September quarter should be weaker than the 50’s(MMs) again but in April pipeline started to build … so you should see that by Dec Q
    • Have pretty good visibility here
    • Saw a drop off in orders in July 2008-March 2009, and saw a big pick up in April and thereafter
    • Think that systems business troughed in the June 2009 quarter – but don’t want to “guide” quarterly or to revenues for the business
    • Some of their benefit in systems is taking competitor business, but some of it is just a rebound in tech spending
  • Unit shipments? Tick up in shipments? What happened in the 3Q09?
    • March 2009 – lost some share because they were slower to do financings, not as aggressive discounting, and had 700 units get deferred
    • Feel like they are still in the low 20’s ship share for next 2Q’s then they’ll see
  • iVIEW DM surpassing iVIEW in FY2010?
    • No, have 130,000 iVIEWs sold… maybe they still sell more iVIEW s in 2010 vs DM but after that see DM as dominated
    • They think that iVIEW DM will be additive as some customers are getting both
  • Business Intelligence doesn’t require regulatory approval in most jurisdictions, power winners got approvals in most jurisdictions this past year and have a bunch of other applications getting approval this year
  • Several quarters ago, several operators removed participation games.  Now that they have cleared covenant hurdles are those participation games coming back?
    • Think that over the last year, participation as a % of floors has decreased a little
    • For BYI they have really focused on better management of their real estate and getting out new launches
  • Gross margins? Is above 70% sustainable?
    • High 60’s and low 70’s is the right margin going forward
  • Why didn’t they give investors a heads up in weakness of systems this quarter if they have such great visibility
    • Only guide toward earnings… so perhaps they should have been more clear about the lag in the systems pipeline
    • Excited about City Center – have iVIEW DMs there
  • Edge in Class 2 with WMS entering the market?
    • Game driven by a system – so the fact that they are dominant in systems there really helps them
  • International business
    • They went from single digit % of total unit shipments to low 20s now
    • Just got licensed in several African countries, Greece, Australia, etc
  • Used game sales were down, hence even though they had lower “other product sales”, the mix was skewed towards replacements
    • Remember that conversions have 90% margin vs used/ parts and others are much lower – maybe 40% on “average”
  • Don’t expect them to have 49% margins every quarter going forward
  • Other: FX and interest income


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It was no surprise when OEH missed estimates on last week.  We still think Street estimates are too high for the balance of the year, as well as for 2010 but what is the real value?



“The Company plans to make further disposals of non-core assets in the coming quarters as we continue to deleverage the Company in line with our target and reach a four to five times ratio of debt to average EBITDA by the end of 2011.” – OEH Management 


Despite another quarter of terrible numbers and a seemingly outrageous valuation of 18x 2009 EV/EBITDA, we believe that if the company is serious about monetizing some of its assets, the real value of the company may be higher.  As we wrote about in “NAV: WHO CARES?” on 06/10/2009, given the dearth of transactions at the upper upscale and luxury end, change in the “traditional” set of real estate buyers, lack of financing, and the uncertain timing of any recovery, per key (Net Asset) values are difficult to determine.  However, our best crack is that OEH’s NAV lies somewhere north of $11/share.


We think that potential buyers of trophy assets (like the Cipriani) would be willing to pay a price that provides a break-even scenario in the first few years as fundamentals recover.  On the 2Q09 call, OEH discussed selling up to 8 properties to help de-lever the company over the next 2 years.  Below is our attempt to try to quantify the proceeds of some potential assets sales. 


Windsor Court, which is under contract, and the Bora Bora asset are currently in the process of accepting bids.  OEH did not specify the sales price for Windsor Court other than stating that proceeds will materially exceed the $37MM mortgage on the property.  Our best guess is that Windsor Court will fetch $45MM -$50MM, or between $140-150k per key.  Bora Bora was purchased by Orient Express in March 2001 for $19.6MM.  We also believe that there is some land that comes with the asset.   We think that OEH should be able to get more than the initial purchase price - perhaps $30MM.


Other assets that we expect to come on the block include:

  • The Grand Hotel Europe
    • 2007 EBITDA of $21MM, 2008 EBITDA of $23.6MM, 2009E EBITDA of $13MM
    • Rates are in roubles, so the hotel took a huge hit this year after an unusually good year in 2008 when the rouble depreciated about 27.5% against the dollar in the 1H09
    • This is the largest EBITDA producing asset in OEH’s portfolio with 300 keys
    • Since the Russian economy is levered to oil, a recovery in prices could help them sell this asset at north of $200MM and perhaps closer to $230MM
    • Selling a majority stake in the asset is also a possibility
    • Given the volatility of the Russian market, we don’t think this asset is high on the list of for sale properties
  • Hotel de la Cité
    • With 61 keys located in Carcassonne, France, this asset is located in a “day trip” market which OEH mentioned was suffering the most in the current environment
    • 2007 EBITDA was $0.9MM, 2008 EBITDA was $0.1MM… our guess is that they are loss making this year
    • Our best guess is that this asset would fetch about $20-25MM
  • Keswick Hall & Inn at Perry Cabin
    • We believe that OEH would love to sell these assets, but the market just isn’t there now.   However, they fit the bill of “weekend getaway” markets
  •  Westcliff Hotel
    • Located in Johannesburg, South Africa, this asset is not key to the portfolio
    • Most of the customers that go on the OEH safaris stay at the airport hotel in Johannesburg so there’s not a lot of synergy with the Westcliff
    • We think OEH would sell this asset for a bid of $20-25MM
  • Lilianfels Hotel
    • Located just outside of Sydney, Australia in the Blue Mountains National Park
    • Another day tripper hotel
    • Best guess at value: $20MM
  • Pansea Porfolio               
    • We think that at least one of these assets will be up for sale in the next two years

What's Next? Monkey Time...

I love my banana.


Now the Fibonacci Monkeys are going to be chasing the 200-day Moving Monkeys and we’ll eventually get overbought.


What’s next?


The SP500’s immediate term resistance is 1,018 (a higher-high, and YTD high). After I we watch the monkeys fling’em at that line, we’ll make a new call from there. Provided that the US Dollar continues to be compromised, my intermediate term level of 1,041 resistance has every reason to be realized. The nightmare scenario for those who tried to call a crash again (AFTER the 4-day correction), is a SP500 futures picture of up 10-15 handles in the morning.



Keith R. McCullough
Chief Executive Officer


What's Next? Monkey Time...  - bananas

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