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US GAMING VERSUS POPULISM

(previously posted under Keith McCullough: 06/10/08 2:24 PM EST)


US Gaming Versus Populism:

There was a WSJ article this today detailing increasing federal scrutiny of MGM's CityCenter construction site in Las Vegas. There should be. Six workers have died since commencement of the project in 2006.

The article is actually fairly balanced but wait until the rest of the Main Street media gets a hold of this one. Greedy corporation risking workers' lives to collect a $100 million bonus from a Middle Eastern Sovereign Fund (Dubai World) to finish construction on time.

I'll be waiting to pick up my NY Times one morning to see the headline:

"MGM, Oil Money, and The Value of Union Lives"

EYE ON POPULISM: WOULD THIS VOTE HAVE GONE THIS WAY UNDER THE EMPLOYEE FREE CHOICE ACT ?

(previously posted under Keith McCullough: 06/19/08 6:38 PM EST)


At Research Edge we have our Eye on a potential Union comeback in this country. In a close vote, security guards at MGM's Mandalay Bay in Las Vegas voted against the International Union of Security, Police and Fire Professionals of America. Of course, consistent with our democratic traditions, the vote was conducted through the secret ballot. Obama and a majority in Congress have indicated they would pass the Employee Free Choice Act which would effectively replace the secret ballot with an open petition. My view is that union elections become less free under this measure and in this case the vote would've been radically different.

ORIENT EXPRESS (OEH): LOOKS LIKE KOPIN TAN MISSED THE BOAT

(previously posted under Keith McCullough: 06/09/08 10:22 AM EST)


We're fascinated with how some of the Barron's reporters gather their "information." But we have our EYE's on them. Barron's reporter, Kopin Tan, looks to be getting no "pop" from his buy OEH note this weekend. The stock is actually down on the open here. Why?

OEH maintains all the characteristics of a Wall Street darling and, indeed, Barron's Tan is now swimming downstream with the crowd. Anyone fishing for the usual Wall Street bait can find it here.

A beaten down stock, smart and activist involvement, hidden assets, and a very high end product that appeals to the tastes of the wealthy Wall Street crowd.

Haven't we heard these fish stories before? The facts are that almost every lodging stock is down significantly more than OEH. OEH is currently yielding the smallest dividend and free cash flow in the entire sector. Oh yeah, it is also the most levered.

Sure there is some untapped real estate value but at a multiple of almost 14x 2009 EBITDA I think we can safely say that it's in the stock. Besides, reeling in real estate value in this credit environment is not quite like shooting fish in a barrel.

If there is a play in lodging right now it is a global one, but not the kind that OEH offers. The only global growth story is hotel brand penetration and unit growth, not RevPAR growth. Last I checked, OEH didn't have a brand. Let's face it. Global growth is slowing. This is not good for OEH's future RevPAR.

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3 in 9 = Pain

Not sure if anyone is paying attention, but India's inflation rate has gone parabolic. India only represents 5% of US apparel, but is a huge margin buffer when China holds firm on price. That buffer is officially gone.

India's wholesale price index jumped from 8% to 11% over the past 9 weeks - its steepest increase in years. Since the 'buy Ch-India' trade started its implosion in October, wholesale prices went from 3% to 11% -- and GDP is now rolling the other way. So it was in a mode for 3 full years where nominal GDP outpaced inflation by a solid 3 points. That's changing.

While this is flat-out bad for India, I'm still of the view that the impact on the apparel industry of the culmination of events in China, Thailand, Indonesia and India will fly under Wall Street's radar. That is -- until CEOs admit that industry margins are 2-3 points too high. Certain models are prepared for this -- like Ralph Lauren and Liz Claiborne. Others, like Guess? Warnaco and a host of others, are not.
  • The first Exhibit shows that over the past 7 years, China's share of US apparel imports went from 8% to 30%. That was a seismic event for the industry. The share gain was very steady, with one major exception - the first 3 quarters of 2006. During that time period, China began to hold firm on price, subsequently lost share, and it went right into India's pocket.
  • Now, China is holding firm on price again, simply because it can. But with rampant inflation in India and Singh fighting to tame social unrest to secure re-election, I'm not so sure if India will be there to bail out US apparel importers by hacking prices and eating the margin pinch like it did in 2006.
  • Yet more proof that the US apparel industry needs to pick one of three options; a) either succumb to the prospect of sustained higher prices out of Asia, b) find some ingenious way to grow margins in a slow growth, high-cost environment (i.e. M&A), or c) attempt to pass through higher prices to consumers, and likely take it on the chin with unit demand.

MORE MARGIN CONTEXT FROM A SLIGHTLY OLDER ANALYST

Mean reversion in Las Vegas margins scares me. Unfortunately, that may be a best case scenario for Las Vegas Operators.
  • Margin mean reversion is a scary thought. Revenues get all the attention since they are released monthly. However, I do not believe enough focus has been placed on the margin side of the equation. Hotel margins in Las Vegas have expanded almost 10% in 15 years while F&B margins increased 15%. We all know hotels and restaurants are two of the most cyclical industries out there in consumer land. In fact, other than in 1998, the only other year that hotel margins contracted were during the 9/11 induced travel slowdown in 2002. While casino revenues are certainly not recession proof, they have proven to be somewhat recession resistant. Hotel and F&B margins were significantly above their 15 year mean in 2007 while casino margins were less than 1% above.
  • Some on the sell side have defended the recent only modest drop in Las Vegas' monthly casino revenues. The fact that casino revenues are down just slightly is not terribly surprising considering the historical resiliency of the casino to economic cycles. However, the revenue and margin contribution of Hotel and F&B has never been higher than now. That is terrific in an expanding economy, but last I checked the US consumer was facing stronger headwinds than they have in the past 15 years. I am obviously concerned about falling airline capacity, the rising airfares to Las Vegas, housing, inflation, etc but I'll leave that analysis for a later posting. Here I've looked at what happens if margins revert to the average of the last 15 years. F&B contribution falls by 67%, hotel contribution by 10%, and total EBITDA by $869 million or 17%. Take it a step further and assume 2002 margins, EBITDA for the industry in Las Vegas would fall by a whopping $1.9 billion or 37%.
  • Gaming companies have done a phenomenal job transforming the product and developing other profitable revenue sources. The downside is that they have tied the industry much more to the economy. I'm really showing my age here but I still remember when Las Vegas was the city of great deals: $3.99 buffets, $75 hotel rooms, and $0.25 craps. Those days are long gone and good riddance. There hasn't been a time over the last 5 years that I've gone to Las Vegas and haven't been astonished at how expensive everything is. Indeed, hotel and F&B margins expanded 590 and 400bps in the last 5 years alone, all due to pricing. How will pricing and margins hold up with the US consumer under siege? We haven't had a consumer recession in 15 years but I have a feeling we are going to find out.

Macau Junket Commissions Approaching Junk Bond Yields?

Only the government can save them now. VIP junket commissions up again, crimping margins. Short of government intervention, commissions may bump up against the break even rate of 1.5%.
  • This is a gross exaggeration I know, but I am increasingly alarmed by the junket price war. Our sources indicate that LVS may have boosted its commission again, from 1.25% of roll to 1.3%, and I think that MGM may have moved even higher than LVS. No indication on Crown but if I had to guess I'd say MPEL will or already has followed suit. The first exhibit examines the relationship between escalating junket commission rates and declining theoretical EBITDA margins on VIP revenues. I estimate the casino's break even on VIP business around a commission rate of 1.5%.
  • No word yet on WYNN but I'm skeptical that they can hold out any longer. WYNN has proven to be the best operator in Macau and their performance resilient despite an uncompetitive junket rate. At some junket rate, price will win over product, at least with some junkets and players. I'm not sure we are there yet but any market share loss or softening of its junket position could be a major dent to this Bugatti. WYNN's stock has been a massive outperformer relative to the group and deservedly so. Could WYNN's stock become a victim of its own success? Follow the junket rates and market share.
  • Todd Jordan Managing Director Gaming/Lodging/Leisure

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