WTW: Beggars on the Street (2Q14)

Takeaway: Management fired a warning shot for 2015, reinforcing our call that 2015 will be ugly. Consensus STILL doesn't get it, so we'll stay short


  1. 2Q14 SHOWED SOME IMPROVEMENT: WTW beat revenue estimates by a little over 2%, largely driven some pricing improvements internationally and some mild improvement on churn rate.  Adjusted EPS came in $0.98 vs. Consensus of $0.77, but much of that upside came from slashing marketing expense, which is where the company can't afford to be cutting if it wants to revive its business.  Total membership declines moderated from -18.6% in 1Q14 to -14.8% in 2Q14.  The company raised its EPS guidance to $1.65-$1.85 from $1.40-$1.85.  In short, the quarter came in better than expected, but wasn't all that impressive.  
  2. BUT NOT ENOUGH: In any given year, the first quarter is everything for WTW given seasonal attrition patterns.  After 1Q, we are monitoring attrition patterns to see what kind of a winter season is necessary to hit consensus estimates for the following year.  While we did see some improvement in its 2Q attrition rate, as it stands now, WTW will still need one of its strongest selling season on record in order to achieve 2015 consensus estimates.  Given that member acquisition costs have more than tripled in the last 3 years and the company is scaling back on marketing to preserve profitability, the prospects of that occurring are particularly slim.  In fact, if management doesn't plan to drastically increase its marketing spend, we would suspect that WTW may be heading for another all-time low in winter recruitment next year.  
  3. BEGGARS ON THE STREET: WTW told the street there is a $0.60 headwind to 2015; that is a massive number considering 2014 guidance is  $1.75 at the midpoint.  A significant driver of the headwind is management's expectation that both Monthly Pass and Online subscribers will decline in the mid-teens %.  In short, management is telling the street what we've been saying for some time now: 2015 will be an ugly year.  By announcing this on its 2Q14 call, management appears to be begging analysts to bring down their numbers before the company announces 2015 guidance.  Consensus 2015 revenue estimates have increased following the print, with expected revenue growth holding steady at -2.2% for 2015.  With consensus asleep behind the wheel, we see no problem riding the short from here.


Let us know if you have any questions, or would like to discuss in more detail


Hesham Shaaban, CFA



Thomas Tobin


Have You Been Watching the Russell 2000?

Takeaway: This correction in U.S. growth expectations is real.

The Russell 2000 is down -3.7% year-to-date (and down -7.2% since the VIX bottomed July 7th).


This correction in U.S. growth expectations is real. Yesterday’s PMI print of 52.6 JUL (vs 62.6 JUN) was a friendly reminder that its not Q2 GDP that matters - #Q3Slowing does.


Have You Been Watching the Russell 2000? - Russell 2000 Chart


Editor's note: This is a brief excerpt from CEO Keith McCullough's morning research.


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Wow! A shocking transaction that, along with the IGT/GTECH transactions, should transform the industry.




  • Immediately accretive to cash flow and EPS
  • Deal was done in 3 weeks and 1 day
  • Expect to close transaction quickly - early 2015
  • EBITDA multiple:  10.2x excluding synergies; with synergies, 6.8x LTM multiple
  • 80% of $220m cost synergies will be achieved by end of 1st year
    • $220m breakout
      • COGS: $33m
      • R&D: $43m
      • SG&A: $144m
  • Financing with 3 banks: BofA, JPM, and DB
  • Pro-forma combined rev (LTM ending 3/31/2014):  SGMS:  $1.649bn, BYI $1.363bn
  • Pro-forma EBITDA: SGMS $544m (not including $73m unrealized WMS synergies) BYI: $466m adjusted EBITDA (not including $30m from Shuffle Masters acquisition)
  • Combined pro-forma EBITDA  $1.366bn EBITDA
  • $25m on capex synergies on an annual basis in 2nd yr after completion of deal
  • Over $1bn in cash flow
  • Tax benefits:  SGMS has large net operating losses.  Can shelter $144m in US taxes by fully utilizing its NOLs.
  • BYI will realize full $30m synergies by end of June period


Q & A

  • SGMS:  approached BYI and they agreed
  • Disagree that number of suppliers shrinking.  Industry getting broader and broader.  Consolidation doesn't affect landscape.  Plenty of competition.
  • Leverage:  would like to return leverage ratio in the mid 4s
  • Comfortable with debt maturities
  • $220m synergies doesn't include the WMS synergies
  • Capex:  area of opportunity
  • SGMS will report 2Q earnings on Tuesday. 
  • Possible revenue synergies:  social gaming content across WMS, SciGames, and BYI.  Lottery systems and BYI systems integration opportunities.
  • SGMS and BYI:  excellent standing with regulators; not concerned with potential issues with SEC
    • SGMS+BYI market share still not as big as IGT
  • IGT/GTECH:   synergies complementary with SGMS/WMS deal
  • SGMS/BYI:  more overlap than IGT/GTECH
  • No changes with bond covenants
  • Intend to keep all the brands
  • Will file a 8k merger agreement shortly
  • Current Sales force:  one for slots, one for lottery systems


Client Talking Points


The phase transition in volatility (from bearish to bullish TREND) was already manifesting (11.94 was our TREND breakout signal line), so now we’ll get the immediate-term TRADE overbought volatility signal (see our Q3 Macro Theme of #VolatilityAsymmetry for longer-term context).


The Russell 2000 is down -3.7% year-to-date (and down -7.2% since the VIX bottomed July 7th) - this correction in U.S. growth expectations is real. Yesterday’s PMI print of 52.6 JUL (vs 62.6 JUN) was a friendly reminder that its not Q2 GDP that matters - #Q3Slowing does.


The bullish to bearish TREND reversals across all of the major European indices continues this morning – DAX down hard -1.9% remains bearish TREND – Portugal -3.3% continues to lead losers as it moves towards -10% year-to-date.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.



Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.


Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road


Long-Bond $TLT +11.6% YTD vs Russell 2000 -3.7% YTD #timestamped



It's the price of leadership to do the thing you believe has to be done at the time it must be done.

-Lyndon B. Johnson


Five year changes in the following; Live Cattle is up +88%, and Lean Hogs are up +115%.

LEISURE LETTER (08/01/2014)



  • Aug 1:
    • BYI/SGMS call 8:30am:  , pw: SGMS
    • HLT 2Q call 10am: , pw: 67361605
  • Aug 5:
    • BEE 2Q call 10am:
    • RHP 2Q call 10am
    • MGM 2Q call11am:  , pw: 1985444


SGMS/BYI– SciGames will acquire Bally for $83.30 in cash per share or $5.1 billion in transaction value, including refi of ~$1.8bn of existing Bally net debt.  The combined company expect to realize $220m in annual cost synergies and $25m of annual capex savings by end of 2nd year following closing of transaction.  Scientific Games anticipates incurring $75 million of investment to achieve the cost synergies and $40 million in capital costs to complete the integration of the companies.  Upon closing of the transaction, Gavin Isaacs will continue as President and CEO of SGMS, and it is anticipated that Mr. Haddrill and David Robbins, Chairman of the Board of  Directors of BYI, will join the board of directors of SGMS, with Mr. Haddrill anticipated to serve as Vice Chairman.

Takeaway:  What a deal!  After hearing about consolidation since the 90s, two giants now control the North American slot space - GTECH/IGT and BYI/WMS/SGMS?


CCL- Princess Cruises reached an agreement with Fincantieri to build a ship to enter service in 2017. The 143,000gt vessel will be built at an all-in cost of €600m.  It will have 3,560 lower berths, and features the design platform introduced by sister ships Royal Princess in 2013 and Regal Princess, which entered service in May.  The €600m translates into $804m or $226,000 per berth. 

Takeaway:  Similiar to recent new ship deals from its competitors, the per berth is a little higher than previous years' orders, including the Regal/Royal Princess orders in 2010 (~$202k per berth).


Cruise promotions 

  • RCL – Royal Caribbean is bringing back two very popular sales starting August 1, 2014: Buy One, Get One 50% off or Third and Fourth passengers sail free.  The new sales are good for bookings made between August 1 and September 15, 2014 on all ships excluding Quantum of the Seas and Anthem of the Seas.  The deal applies to all sailings departing on or after October 15, 2014, excluding all sailings between December 15-31, 2014


Macau GGR (DSEC) – July GGR was down 3.6% YoY to 28.415 BN MOP (27.587 BN HKD, 3.56 BN USD).

Takeaway:  We estimate the last 4 days saw table revenue growth close to 15% in line with our expectations.


Russians (Macau Business) – Reuters says representatives of Russian banks have had meetings with potential investors in Macau, Hong Kong and Singapore about issuing bonds denominated in yuan.  But it quotes international bankers and authorities on the finance industry as saying banks and investors in Asia are reluctant to get involved.

 Takeaway:  Macau as a last resort financing destination


Packer (Macau Daily Times) – Australian casino operator James Packer is in supposed talks to develop a Las Vegas Strip resort on land once occupied by the New Frontier Hotel & Casino.  Packer bought a piece of a loan backed by the property and is negotiating a potential deal with other creditors including Oaktree Capital Group LLC.  Oaktree purchased the debt at a discount after plans by Israeli businessmen Nochi Dankner and Yitzhak Tshuva to build a Plaza casino resort there stalled.

Takeaway:  Packer has failed before, he will try try again.  Las Vegas gaming metrics have been healthy lately.


Light Rail Terminal (Macau News) – Macau’s long-delayed Light Rail Transit (LRT) system will only be fully ready in 2022 said Transportation Infrastructure Office (GIT) Deputy Director Andre Ritchie 

Takeaway:  It's a shame how long this project has taken.

Iowa – Gaming commission says no new casinos for 3 years

Takeaway:  You can't blame them.  The regional markets are too saturated.


Trump (New York Post) – If Trump wins the bid to buy NFL Buffalo Bills for over $1 billion, he will sell his minority stake in Trump Entertainment.  Trump has effectively been out of the casino business for several years as financial restructurings have left him with just a small percentage of Trump Entertainment.

Takeaway: The sale might just be enough to fund new uniforms...


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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