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The Brink

“We have taken this economy back from the brink.”
-President Obama (September 9th, 2009)
Time stamp and YouTube it. Last night’s US Presidential speech will surely find its place in US History. Every one of them does. Rarely, in the moment, do we know how prescient or shortsighted Presidential conclusions really are. Particularly when it comes to immediate term economic prognostications, Presidents have an awful historical batting average.
Have we taken this economy bank from the brink? Or have we taken Wall Street back from the brink? Are they one and the same? What about a country’s currency? Does a crashing currency signal coming back from, or going toward, The Brink?
Hope may be part of this President’s process, but it is not an investment process. That isn’t a politically partisan point. It is, as our President likes to say, “the truth.” It’s the Research Edge truth at least!
Our Managing Director of Healthcare, Tom Tobin, often says that the US Government’s plan is to “create a crisis, so that they can solve it.” Again, from Bush to Obama, Tobin has said the same thing. One created “weapons of mass destruction”, the other went with “great depression.” Politicians get paid to fear-monger. It’s the sad “truth.”
My greatest fear, when analyzing the global economy, is that the United States of America’s political leaders don’t get it. Again, from Paulson to Geithner, this isn’t about being politically partisan  - it’s about America’s economic policy becoming as politicized as it has ever been.
For those of you who aren’t economically paid and politically scored on being willfully blind, let me remind you of something that’s been happening in America this week. The United States of America’s currency is crashing.
Dear Mr. President,
I am not going to yell at you from a cheap Congressional seat, but I am going to say that one more time. Under your administration’s watch, like President Bush’s, you are Burning The Buck. I can only “hope” that you don’t write me back saying “that’s not true”…
Keith R. McCullough
New Haven, CT
So what do we do with that this morning Mr. Righteous Mucker? Good question. Everything in investing starts with asking the right question at the right time. I think THE question this morning should be: Have we taken the US economy back from the brink, or are we about to go right back over it?

In order to attempt to answer THE question that only we “macro” guys care about (i.e. what’s the market going to do today), let’s consider 3 major events that occurred in the real-time US economy yesterday:
1.      At 1033, the SP500 made a higher-high for the YTD

2.      At $77.01, the US Dollar Index made a lower-low for the YTD

3.      President Obama defined the economy’s scorecard by only 1 of these 2 factors

To ignore “the truth”, of course, does not mean that it ceases to exist. Someone needs to pass someone in Washington an economic history book that dates back more than the last 200 minutes on their crackberry. Try the last 200 years. Maybe throw in another country or two. Maybe get the Great Depressionista Professor, Ben Bernanke, to order up the required reading.
The “truth” is that there has never been an economy that has sustained itself with her currency being on The Brink. Never. The US Federal Reserve monetizing the nation’s debt is no different than the government of Zimbabwe doing so. It’s country balance sheet bearish. It’s country currency bearish. It’s country credibility bearish. If you revert to doing it consistently enough, creating free moneys from the heavens will provide you a bridge to economic hell.
Those who have been critical of my Burning the Buck investment theme for 2009 are now losing a lot of money. Since March, the “truth” is in the math. The SP500 is up +52.8% and the US Dollar Index is down -13.5%. The political leverage that the US Government thought they would get by betting on the stock market being the “economy” has been almost 4:1 (Dollar crash versus Wall Street reflation).
So, if the US economy’s “Brink” is defined only by her stock market price, why is it that Obama’s Administration continues to see lower-lows in their approval ratings?
The “truth” is that Americans aren’t as stupid as Washington/Wall Street keeps telling them they are. The “truth” is that this isn’t new. For hundreds of years a citizenry of savers and consumers look to their currency as a barometer of their own personal Brink!
I’ve said my piece this morning. If I just marked the YTD bottom in the US Dollar, so be it. Take it from me, the Burning Buck Boy, to call what his own bottom looks like in the rear view mirror. Dollar up will = everything priced in Dollars down. That’s why I have been selling for the 3 out of the last 4-days of this rally. President Obama is too smart not to understand this investment thesis. The Chinese get it. They’ll force him to get it too. China is The Creditor of this mess.
My intermediate term TREND target for the SP500 remains my Range Rover target of 1041. My first line of immediate term TRADE support is 1016. As opposed to the last 2 trading days, my risk management model is saying that the risk in the US stock market finally overrides the reward.
Best of luck out there today,


VXX – iPath VIX We bought volatility on its lows on 9/3 ahead of last Friday’s employment report.

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

EWH – iShares Hong Kong
The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  

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.

EWU – iShares UK We’re bearish on the UK’s leadership and monetary policy to weather its economic downturn. Although we’re seeing improved fundamentals within the country and across Europe we continue to see the country’s financial leverage as a headwind and increasingly the data suggests that inflation is getting ahead of growth. With the FTSE reaching a YTD high on 9/9, we shorted EWU.

DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. 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.


CEO will hit the Street for financing in Q4 to resume construction on Revel by Jan. A May 2011 opening is targeted which could provide a small shot in the arm for the slot makers but wreak further havoc on the AC operators.



CEO Kevin DeSanctis made public comments that indicate he will pursue the remaining Revel financing in Q4 for the Atlantic City hotel casino.  If successful, construction would restart in January with a targeted opening in May 2011.  Initial specs for Revel included 3,000 slot machines and 1,900 hotel rooms (with the potential for a second hotel tower coming online at a later date).


For the slot guys this is good news and part of the long-term bull market of new markets/casinos.  2011 should be the first year of significant growth in the new/expansion segment and probably the second year of an improving replacement cycle.  While 3,000 slots is not overly significant in and of itself, there is a backlog of new casinos in AC and elsewhere that may be back on the front burner, particularly if Revel proves the financing markets are once again willing to fund new casino construction.


The existing casino operators in AC will talk a good game about new supply being a positive for the market, but given the wilting demand, they should be a little worried.  Borgata may be at risk considering the likely price point similarities with Revel and a possible mini Boardwalk resurgence.



Genting Singapore PLC said it will raise up to S$1.63 billion (US$1.14 billion) in a rights issue to boost its capital position and further develop its business.  The company estimates that the majority of the capital, 60%, will be used for “future strategic opportunities” while the remaining 40% will be used for working capital purposes. 


The operator’s S$6.59 billion resort-casino project on Sentosa island is due to open in 2010.  The company maintains that the project is adequately financed and will be completed on time.  Commentators speculate that some of the proceeds of the rights issue could be used to invest in casinos in Macau.  Genting Singapore, which owns 45 casinos in the U.K., is 54.3% owned by Malaysia's Genting Bhd.

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I continue to believe that the casual dining industry is not out of the woods yet from a demand perspective and that 4Q comparisons might not be as easy as they look.


The Federal Reserve reported Tuesday that consumers ratcheted back their credit by a larger-than-anticipated $21.6 billion from June, the most on records dating to 1943. Economists expected credit to drop by $4 billion.  Clearly consumers are spending less and some could argue that banks are cutting back on lending.  Either way, lees credit available suggests a lower level of spending overall.  For most Full Service restaurants, 70-80% of transactions are done using a credit card.  The less credit available, the less money there is to spend on discretionary items like eating out. 


This chart clearly tells that story!



Sorry to knock the regionals again but are there any catalysts to get these stocks to reverse fortune?  The numbers look bad and that’s with a gas tailwind.



Illinois, Indiana, and Michigan are all out for August and they look like crap.  Same store revenue fell 10%, 12%, and 5%, respectively, and the moving average line is negative and trending downward for each state.  If this is recovery, I’d hate to see a depressed environment.

                                                                     REGIONAL ROLL - Illinois August Revenue

                                                                     REGIONAL ROLL - Indiana Delta Chart


Here are the catalysts.  Try and find a positive one among them.

  • ISLE did not provide any comfort on their 8/26/09 conference call:
    • “Cost reductions may be over”
    • “Discounting accelerating”
    • July no better than May and June
    • No improvement in August other than an easier comparison


  • Gas price tailwind reversal – this is a biggie
    • Despite 50% lower gas prices year-over-year, gaming revenues look terrible.  We’ve shown that every 10% change in gas prices has a 1.5% inverse impact on regional gaming revenue.  What happens when gas prices are up 50% in December and into 2010?  See our recent note “GAMING REGIONALS: NOT YET IN THE RECOVERY ROOM” (08/23/09)


  • The Consumer – Housing, the “wealth effect”, need vs want
    • We and our macro team have written extensively on the long-term structural issues facing the American consumer


  • Regression to the mean
    • Casino revenue as a percentage of PCE keeps falling from its mid-2008 peak.  We’ll have more on this in a later post


So why do the analysts show 2H09 growth in revenues for most of the regional gaming companies (see below)?  Growth in 2010 might even be a stretch, especially considering the gas headwind in the first half of 2010.  A recovery thesis looks very premature.  Look for estimates to come down for most of the regionals.



                                                                     REGIONAL ROLL - REGIONALS 2010 2H09




SHFL reported 3Q09 results, handily beating Street EBITDA and EPS expectations.



Shuffle Master reported $45.1MM of revenues and $15.6MM of EBITDA, slightly ahead of Street revenue expectations of $44.3MM and handily beating EBITDA estimates of $14.2MM.


"We are continuing to see the real impact on our bottom line of specific cost containment measures initiated earlier this year and are confident that regional expansions, new openings in Asia, increased momentum in the shuffler replacement cycle and the i-Table roll-out this fall are all milestones on the path toward future top line improvements as well."


3Q09 Highlights

  • 967 installed iDeal shufflers replaced old Ace shufflers which are being phased out; 133 of which were installed in the 3Q09, 3000 (of the total 4500 in the field) Aces are expected to be converted to iDeal by the end of 2010
  • Proprietary table game revenue increased primarily due to Texas Hold Em
  • New Rapid concept - Rapid 37 for Indian Gaming markets where roulette isn't legal
  • Customers expressing interest in paying for shufflers based on usage; however, determining/tracking usage is a challenge
  • Continue to acquire and develop properietary table games - newest game incorporates iDeal into the game, still in preliminary testing stages
  • Stronger USD has caused their top-line results to look weaker, however, bottom line impact is very small
    • 3Q09 gross margins where impacted by FX though - Australia and EGM, ex FX GM would have been 59% (unchanged y-o-y)
  • Leasing products (iDeal) negatively impacted gross margins since they were initially rolled out under "introductory" discount pricing
    • Will continue to focus on emphasizing this business
  • Utility sales declined (shifting to lease); however pricing increased
  • Proprietary table games revenue increase was driven by sales activity
    • Margins were down as a result of higher depreciation
  • Electronic Table Systems - majority of tables sold in the quarter were in Australia
    • Higher lease prices were offset by higher amortization
  • Electronic Gaming Machines margin increase driven by higher conversions
  • Cost containment has generated 8.7MM of non-FX related savings
  • SG&A reduced by 2.6MM (ex FX)
  • Leverage was 1.8x
  • Expected full year tax rate is 28-33%
  • Working capital - inventory is the largest tangible asset on the balance sheet. Increase related to ramp of utility projects going to openings in Asia and products close to completion to be shipped in the 4Q09
  • $55MM available on RC
  • Openings of Genting and LVS Marina Bay - nice opportunity for them. City Center will also have some of their products.  Delaware & PA table game introductions will present an opportunity to ship shufflers


  • 3Q09 level of stock comp is a good run rate to use going forward
  • Internal goal for operating margin as they move their mix more towards lease?
    • Taking advantage of cost efficiencies to not always need to raise rates, but want to get to remain in the high 50's maybe eventually low 60's
  • Use of free cash
    • Nothing obvious on the M&A front - just add on products and game titles
    • Look to paydown debt as their primary use of cash
    • As they continue to increase leases they will need to spend money on inventory
  • Expecting to replace over 3,000 of the 4,500 old Ace shufflers over of the next 14 months or so
  • Trying to become more "build to order" and improve supply chain management
  • Shipping to Singapore in F1Q2010 (their FY), both lease and sales

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