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Removing Long LO from Best Ideas List

RAI Announces LO Acquisition; Surprise on Share Price and Sale of blu E-cigs!

Today we are removing long LO from our Best Ideas list.  After adding LO on 2/26/14 at $47.74 and months of rumors that it would be taken out, this morning RAI announced its intention to buy LO in a cash-and-stock transaction currently valued at $68.88, or a total of $27.4B (including debt). 


The price is significantly below our share target of $80, and it’s worth note that there is significant runway before the deal is expected to close in 1H 2015. That said, this has been a fantastic position for us.  Based on last night’s closing price the stock is up over 40% from where we added it as a Best Idea.


Before we dive into the specifics of the announcement, we want to underline that beyond RAI we do not see another competitive bidder for LO. Further, given that we expect a lengthy regulatory approval process on anti-trust considerations this deal is still a long way from closed and may present a further investment opportunity.


As the market expected, Imperial was transformative in aiding this deal.  It’s committed (pending shareholder approval) to buy RAI’s menthol brands of KOOL, Salem, and Winston, and well as LO’s Maverick and e-cig business blu for $7.1B or $4.4B after tax. This would make Imperial the third largest U.S. tobacco company. 


The menthol divestiture is seen as a key consideration for regulatory approval (FTC is the main governing body), however the willingness of RAI to part with blu caught us by surprise.  As we outlined in our Best Idea call in early March, we viewed blu as a key driver lifting the total company’s sales growth and accounting for 31% of EPS by 2018. The e-cig business therefore significantly factored into our share price estimates for an RAI acquisition.


Given blu’s leading U.S. market share in e-cigs (~ 45%), we believe that RAI is telling the market that 1) it squarely believes in its own e-vapor business (VUSE) and 2) is showing regulators that its portfolio is pro competitive (across both combustible and non-combustible).  RAI’s VUSE is still in its infancy – the company launched in initial test state markets earlier in the year, and is in the process of national distribution in its first phase to roll out in 15,000 stores.


So what are the hurdles that remain?

  • LO and RAI shareholder approval remain outstanding.  BAT appears to be a very committed partner - it agreed to maintain its 42% ownership in RAI through an investment of ~ $4.7B, agreed to vote its shares in favor of the transaction, and with RAI has agreed in principle to pursue an ongoing technology-sharing initiative for the development and commercialization of next-generation tobacco products, including heat-not-burn cigarettes and vapor products.
  • Regulatory.  the FTC will decide on anti-competitive regulatory issues, however we think RAI took appropriate steps to divest its menthol exposure, create a viable U.S. competitor in Imperial, and signals a pro-competitive stance on the e-cig/e-vapor category by selling blu.  The process by which the FTC makes a judgment may be drawn out (hence RAI targeting 1H 2015). We maintain that menthol presents a minimal regulatory risk, assigning less than a 20% over the longer term, and believe that RAI’s acquisition proves out an environment of limited risk.


RAI + LO Boost Market Share to 34%

We are bullish on the combined power of RAI + LO as the 2nd largest U.S. tobacco company to compete with #1 MO (~51% share).  RAI + LO will compete for the top spot across industry categories:

  • Newport, Camel, Pall Mall and Natural American Spirit in combustible cigarettes
  • Grizzly in smokeless tobacco
  • VUSE in the e-cigarette market

As was central to our Long LO call we continue to like menthol’s superior fundamentals to traditional tobacco. Newport Menthol is the #1 U.S. menthol brand (37.4%) and is the #2 U.S. cigarette brand, with overexposure to urban areas and the eastern U.S.  RAI expects to reap $800M in cost savings over two years and we think the strong sales and brand equity of LO’s portfolio is complemented well by the strength in RAI’s non-menthol brands like Camel, and its more western U.S. geographic exposure.  The combined company’s ability to leverage a larger sales force, attain more shelf space and compete for higher margin (premium and above premium cigarettes and smokeless) should prove very profitable.


Removing Long LO from Best Ideas List - RAI 1

Removing Long LO from Best Ideas List - RAI 2


Additional Acquisition Details

  • Under the terms of the transaction, which has been approved by the boards of directors of both companies, Lorillard shareholders will receive, for each Lorillard share, $50.50 in cash and 0.2909 of a share in RAI stock at closing, representing $68.88 per share based on RAI's closing share price yesterday. Upon closing, Lorillard shareholders will own approximately 15% of RAI.
  • Following the transaction, RAI is projected to have over $11B in revenues and approximately $5B in operating income
  • RAI expects the transaction to be accretive to earnings in the first full year, with strong double-digit accretion in the second year and beyond (on a percentage basis).
  • As part of the divestiture, Imperial will acquire certain assets owned by Lorillard including its manufacturing and R&D facilities in Greensboro, N.C., and approximately 2,900 employees, including a national sales force.
  • Once the transaction is completed, a transition period will commence during which R.J. Reynolds will contract manufacture KOOL, Salem and Winston for Imperial and Imperial will contract manufacture Newport for R.J. Reynolds.
  • The RAI/Lorillard transaction and the Imperial transaction are scheduled to close substantially at the same time, 1H 2015.
  • Lorillard will continue its existing dividend policy until the deal closes. RAI plans to maintain its current dividend policy until the transaction closes (~80%) and is targeting a dividend payout ratio of 75% going forward.
  • RAI will generate significant cash flows and expects to maintain its investment grade credit rating following the transaction.
  • RAI has secured fully-committed bridge financing and expects to issue permanent financing for the transaction.
  • Susan Cameron will remain RAI's president and CEO after completion of the acquisition while LO CEO Murray Kessler will join RAI's board after the transaction closes.


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta



What is Retail Sales?


It’s a trivial, but not an insignificant question.


In casual conversations with investors, particularly those who aren’t Macro centric, I’d say a majority don’t technically know what Retail Sales encompasses.   Superficially, the term “Retail Sales” kind of connotes that it’s a broad measure of the 70% of the economy that is consumer spending – and most people take it that way.  


In fact, retail sales is an estimate of spending at department stores, food service providers, auto dealers, and gas stations.  In other words, it is largely an estimate of spending on goods


In other, other words, while it’s a timely, insightful barometer of the prevailing state of domestic consumerism, it doesn’t include spending on services, which comprises the lion’s share of consumption at ~2/3 or household spending and ~45% of GDP


The numbers are also volatile on a month-to-month basis, subject to significant revision and reported on a nominal basis – making it difficult at times to distinguish whether sales trend changes are due to prices or volumes.  





Retail sales in June rose 0.3% MoM, decelerating -30bps sequentially to +4.3% YoY.  Strong reported auto sales in June again buttressed headline growth, although the miss vs expectations suggests pricing was probably weak. 


Under the headline, the Retail Sales Control Group (Retail Sales ex Food, Auto Dealers, Building Materials & Gas Stations, which feeds GDP) accelerated modestly on a MoM, 1Y, and 2Y basis after decelerating across all three measures in May. 


General Merchandise, Personal Care, and Nonstore/Electronic Sales (the E-sales proxy) led gainers while 9 of 13 categories improved MoM.


Overall, “decent” is probably an apt descriptor for the June data, particularly in the wake of negative MoM growth in Real Consumer spending in both April and May. 




VAPID ACCELERATION:  JUNE RETAIL SALES - Retail Sales control Group June





Relatedly, Consumer Credit Growth Continues To Improve….


We previously highlighted the Fed G.19 Data from April which showed US revolving consumer credit balances rose at a month-over-month annualized rate of +12.3%, the fastest rate of growth since 2001 and a positive inflection relative to the steady, ~0-1% growth reported the last few years. 


On the back of the jump in revolving credit in April, the recently released May data showed a +2.1% MoM annualized increase, the third straight month of sequential, above-trend growth.   


So, credit growth (credit cards, autos, C&I) is showing some positive mojo of late and the ever increasing reality of our modern, consumption economy remains:  credit = spending = the marginal driver of growth.


Whether the nascent credit acceleration can support and/or catalyze a breakout in domestic growth remains to be seen. 


With #InflationAccelerating, Real Wages decelerating, and the consumption data middling-to-slowing, the early read through appears to be that consumers are tapping credit to maintain consumption levels in the face of compressing household margins. 









Christian B. Drake



Staying Long of Gold

Gold tested its long-term TAIL Line of resistance at $1324/oz. at the end of last week. Spot contracts backed-off yesterday fueled by Goldman’s call for a move off the highs by the end of the year. Their prediction induced some big selling in front-month COMEX futures ahead of their earnings report today and Yellen’s testimony:


Spot Volume:

  • +28% vs. 5-Day Avg.
  • +57% vs. 1-Month Avg.

Like us, they cited growth, and consequently interest rates as a driver. We will look for some read-through on the Fed’s expectations with Yellen’s commentary today at her semi-annual testimony to the Senate Banking Committee. We continue to be of the view that she will be forced to echo a more dovish tone as we progress towards the September meeting:


Hedgeye Position:

  • #Inflation Accelerating continuing to be consumer headwind; growth miss warranting easier policy on the margin:
    • Commodities catch a bid perpetuating the consumer headwinds already manifest (long-gold, short USD bias)
    • Yield spread compression reflects forward-looking growth expectations
    • Top-line pressure on high-multiple, early cycle consumer stocks (consumer based-sectors)
    • Sector variances observed in growth-slowing sectors outperforming to the upside (Energy, Utilities, REITs, TIPS, Long-End of the Treasury curve)

Because of this bearish set-up on rates (for now), we remain long of Gold into the second half of the year (TREND Support = $1272):

  • Front-Month COMEX Futures +30 bps today off the down move
  • Yield Spread: -30 bps day-over-day 

We re-entered on the long-side in real-time alerts yesterday on the oversold signal.  


Staying Long of Gold - Levels Chart


To further clarify our bullish position, the thesis stems from our view that growth would likely turn from accelerating to decelerating moving into Q1 2014. A link to the full write-up from Darius Dale along with a summary review of his main points is included below. We will stick with the same position here with the willingness to change our view with the relevant catalyst:


From November 26th, 2013:

  1. “#GrowthSlowing: We think monetary and fiscal policy uncertainty (mostly monetary policy uncertainty) will weigh on consumer and business confidence. Furthermore, GDP comps get difficult as CPI/GDP deflator comps get easier, at the margins.
  2. #InflationAccelerating: We think domestic disinflation is now a rear-view phenomenon as easy comps and a weak dollar provide upward pressure on CPI and PPI readings.
  3. #IndefinitelyDovish Monetary Policy: We are increasingly of the view that the Fed is aware of the systemic risk present in the bond market and is potentially setting up to never commence tapering. They will likely accomplish this by setting far-too-aggressive targets for GDP growth and shifting their focus to combating a perceived risk of deflation, at the margins.

Historically, moves by the US into Quad #3 have been bullish for the price of gold, as both the US dollar and real interest rates tend to decline in this economic “state”; the opposite holds true on a move into Quad #1 (i.e. #GrowthAccelerating as #InflationAccelerates), which is where both the reported data and consensus expectations have tracked throughout much of 2013. Given where we’ve been on growth and inflation for much of the year, it would be modest to say that we are not surprised to see gold down almost -26% YTD (we’ve been the bears on gold for much of the past 12-18M).”


Gold: Is it Time To Get Back In on the Long Side?      


With the gold outperformance year-to-date, has the bull market run its course over the last six months?


We still like it on the long-side for the same reasons and will continue to buy at the low end of our immediate-term TRADE risk-range on the signal that selling has been exhausted to the downside.


Full-year growth expectations from the Fed have already been downwardly revised since we made the call moving into this year (GLD +11% YTD) and are still likely too optimistic:


Staying Long of Gold - U.S. GIP Model


Staying Long of Gold - U.S. Hedgeye vs. consensus growth estimates


The markets expectation of fed tapering leaned on an improving growth outlook moving into the year. This expectation for a steepening in the long-end of the yield curve has reversed as growth has slowed:

  • 10-year Treasury Net Futures and Options Contracts at CBOT from the CFTC:
    • December 31, 2013: -176K (Tapering expectations putting upward pressure on rates)
    • May 20, 2014: +49K (Capitulation on Q1 GDP print, #inflation accelerating)
    • July 8, 2014: -68K (rates can’t go any lower)
  • Yield Spread YTD: (10yr – 2yr): -22% YTD to +206 bps wide
  • Actual and/or rhetorical easing of policy relative to previous expectations
  • The USD is expected to weaken under the feds predictable, linear model for countering high-frequency economic data points. Below is a squeeze of real-purchasing power despite a flat dollar YTD:
    • USD Index: +23 bps
    • CRB commodity Index: +5.6%
  • Investors choose gold over a depreciating currency:

The GIP model (Growth, Inflation, Policy) which predicts forward-looking growth and inflation indicates growth expectations from both the fed and consensus macro are still too optimistic…


The policy response should our predictive model play-out is key to #Dollar Devaluation driving the upward pressure on Gold. Growth will miss relative to expectations (although the predictive gap has tightened), and, in now Pavlovian fashion, investors will move to hedge a devaluing currency (rotation into Gold Over dollars).


On the growth miss, the fed responds with more money in the system and #dollar devaluation squeezes consumer margins. Inflation expectations still set-up to miss vs. Hedgeye estimates:


Staying Long of Gold - U.S. Hedgeye vs. consensus inflation estimates


Using 2013 as a case study, the relationship between the relative convexity of growth and inflation influencing a monetary policy response with U.S. dollar implications can be observed under both upside and downside surprises.   

From the time we wrote the following positive note on the USD and consumer vs. bearish gold call on March 1st, 2013 to our bullish gold call on November 26th 2013 gold decreased -21%. We took this stance in observation of the exact same catalyst:


The growth and inflation outlook influencing the forward-looking expectation for the dollar


A few points to highlight from Christian Drake’s March 1st, 2013 note are included below along with a link the full article:

  • “Positioning: 
    • Short Basic Materials:  Materials is the worst looking sector across the S&P from a quantitative perspective and has direct negative leverage to commodity deflation
    • Long Consumption:  A Real-time tax cut via energy deflation is positive for real earnings growth and discretionary income.  We like Consumption oriented/Consumer Facing equities in the U.S.  and select Asian equity markets (China, Hong Kong)
    • Short Gold:  To the extent that U.S. dollar strength is reflective of growth and interest rate expectations (or just the expectation for a cessation in easing) we think gold holds further downside over the intermediate term.”

USD Redux: 3 Ways The Dollar Wins  

The relationship between the price of gold vs. forward growth/policy expectations and the change in the Fed balance sheet discretely illustrates the point. 


Staying Long of Gold - Fed Balance Sheet vs. Gold Price


Staying Long of Gold - USD vs. Gold and GIP


To re-iterate our position, we continue to be short of the U.S. consumer and long of defensive and late cycle sectors which outperform as growth decelerates and inflation accelerates. The divergence below appears to have more room to run in the third quarter.


2014 YTD:


  • SPX: +7.0%


Underperformers: Consumption-Driven  

  • RUSSELL 2000: 0.3%
  • Consumer Discretionary (XLY) : +1.1%



  • GLD: +8.4%
  • Treasuries (TLT): +10.8%
  • Utilities (XLU): +11.8%
  • REITs (REIT Index): +17.9%
  • Energy (XLE): +12.0%       


Ben Ryan





Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

LEISURE LETTER (07/15/2014)



  • July 15-17: Pre-RCL earnings Hedgeye Cruise pricing survey
  • July 16:  LVS 2Q call (430pm)
  • July 23:  TRIP 2Q call (430pm)
  • July 24:  
    • WYN 2Q call (830am)
    • PNK 2Q call (9am)
    • LHO 2Q call (930am)
    • PENN 2Q call (10am)
    • HOT 2Q call (1030am)
    • AWAY 2Q call (430pm)
  • July 25:
    • PEB 2Q call (9am)


CZR (Las Vegas Review Journal) An FBI-led raid has shut down a multi-million dollar illegal sports betting operation at Caesars Palace that authorities say was run by Malaysian and Chinese nationals who were taking wagers on the World Cup soccer tournament. Caesars Palace was not a target of the Las Vegas investigation and cooperated with authorities. The Nevada Gaming Control Board and the U.S. Department of Homeland Security assisted the FBI in a raid last week at the Strip resort. It was unclear how much money the illegal bookmaking ring took in here. All eight defendants were each charged with one count of illegal transmission of wagering information and one count of operating an illegal gambling business, both felonies.

Takeaway: Another illegal World Cup gambling operation. 

AHT – signed a definitive agreement to acquire the 357-room Fremont Marriott Silicon Valley hotel.  The Fremont Marriott Silicon Valley features 357 guestrooms and approximately 15,000 square feet of meeting space.  Ashford intends to finance the property with $37.5M of non-recourse mortgage debt.

Takeaway: Interesting to us was the lack of any details regarding actual purchase price as well as trailing 12 month NOI or EBITDA.  As of March 31, 2014, AHT had more than $154 million of cash and cash equivalents on its balance sheet as well as more than $33 million of marketable securities. These amounts do not include the additional $88 million in proceeds from the early April equity offering.


NCLH – reached an agreement with Meyer Werft to build two new Breakaway-Plus class cruise ships for delivery in 2Q 2018 and 4Q 2019.  Each ship will be 164,600 gross tons and include 4,200 passenger berths.  The contract price for both ships is approximately euro 1.6 billion. The Company has export credit financing in place for each ship, arranged and underwritten by KfW IPEX-Bank GmbH of Germany.

Takeaway: The cost/berth is ~US$259k per new ship, a 15% premium over Escape/Bliss.  By historical standards, this seems like a long lead time for delivery.  Maybe they just want a taste of the public frenzy from RCL's new ships.


CCL – (Seatrade Insider) Cunard offers NA agents 5% bonus for Med bookings on Queen Victoria.  


Insider Transaction

HOT – Director Bruce W. Duncan sold 21,813 shares on Thursday, July 10th at an average price of $84.36 and now owns 37,684 shares.

Takeaway: Another Starwood insider selling shares.


Chinese Lottery Sales – According to the Chinese Ministry of Finance, Lottery sales in mainland China reached RMB178.41 billion (US$28.74 billion) in the first six months of the year, up 19.2% YoY.  The growth was partially fueled by a jump of 45.7% YoY in lottery sales during June, to MOP36.05 billion due to a 83% YoY rise in sports lottery sales to RMB19.24 billion, fuelled by the FIFA World Cup.

Takeaway: Could Chinese lottery sales benefited at the expense of June Macau GGR?


Philippines e-Gaming Parlors – Premiere Horizon Alliance Corp said its shareholders had approved Leisure & Resorts World’s offer to buy all of Premiere Horizon’s stake in Digiwave Solutions Inc. Digiwave operates Pagcor-licensed e-Games outlets in Metro Manila and nearby provinces. e-Games outlets are parlors or cafes dedicated to online casino-style games and are licensed by the Philippine Amusement and Gaming Corp (Pagcor).  

Takeaway: The build up of Leisure & Resorts World continues.


China Infrastructure Catastrophe – A portion of the (currently under construction) 710 kilometer tunnel, known locally as the Funing No 1 tunnel which will Kunming with Nanning collapsed on Monday trapping 15 workers who are trapped in the debris from the collapsed railway tunnel.

Takeaway: If the Chinese government conducts a full scale investigation and concludes safety measures were not followed, this could result in a delayed completion of the North/South high speed railway - which would be a negative for Macau mass play.


Philippines Weather – Typhoon Rammasun’s a Category 3 storm with sustained winds of 115 mph made land fall this morning in the eastern Philippines and is expected to impact Manila later today and will be over the capital by tomorrow before moving into the South China Sea through either Bataan or Zambales province in the northwest. Rammasun will be out of Philippine territory by Thursday, moving toward southern China.

Takeaway: Rammasun could cause property damage to the Manila-based casinos.



China June New Yuan Loans – CNY1.08T vs consensus CNY950B and CNY870.8B in May for loan growth +14.0% year/year vs +13.9% in May

Takeaway: The improved credit trends could be a harbinger of better VIP play in Macau in six to nine months from now. 



  • 482 new home units were sold in June, compared to 1,806 in June 2013 and 1,488 units in May 2014. Government data indicates about 4,500 units sold in the first six months of 2014. 
  • Q2 prices of private residential property dropped 1.1% YoY, following a 1.3% drop during Q1 2014. 
  • Singapore hotel RevPAR dropped 4% to SGD240.85 based on occupancy falling 2.5% to 82.5% and a 1.5% reduction in average daily rate to SGD291.79. Singapore room supply increased 2.8% year/year.

Takeaway: More macro headwinds for Singapore market


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.

We’ll Gladly Take the Other Side of Goldman Sachs on Gold $GLD

Takeaway: Buy more Gold.

Editor's note: This is an excerpt from Hedgeye morning research by CEO Keith McCullough. Click here to learn more and how to become a subscriber.


We’ll Gladly Take the Other Side of Goldman Sachs on Gold $GLD - ben gold


Goldman Sachs grabbed headlines yesterday reiterating what’s been the wrong call (bearish on Gold) in 2014. Gold futures/options contract volume was +27% versus the 5-day average on that, but neither my TRADE line of $1301 support, nor implied volatility (still -2% on a 1 month basis) confirmed the 1-day fear.


In other words, buy more.


Incidentally, if you asked the bond market about Goldman’s call on Gold, or consensus US growth acceleration hopes in Q3, it doesn’t care – the 10-year yield is right back to 2.53% this morning with immediate-term downside to 2.49% into Janet Yellen’s testimony.


We’re sticking with #GoldBond.


We’ll Gladly Take the Other Side of Goldman Sachs on Gold $GLD - Gold Bond cartoon 07.10.2014


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