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Financial Fallout: Analysis of JP Morgan's $2B Trading Loss

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THE M3: LVS MISTAKES; MGM COTAI; CHINA APRIL LOANS FALL

The Macau Metro Monitor, May 10, 2012

 

 

LVS MADE HISTORY BUT WRONG CONFERENCE CALL-MIKE LEVEN Macau Daily Times

President and COO of LVS, Mike Leven said, “We made a few mistakes in the conference call. Namely we did not disclose specifically the results of Sands Cotai Central…We should have said we were pleased with the early GOI [Gross Operating Income]. SCC is doing great, always crowded, with excellent restaurants, shops and services."

 

Mr Leven said that the relationship with the Macau government is on excellent terms and that “the presence of Chief Executive Dr Chui Sai On at the opening of Cotai Central is proof enough of that…I and Ed Tracy here, are in constant contact with the officials.”  Leven said that the Macau government assured the granting of the remaining 200 tables for phase 2 of SCC and if “there would be eventually any delay, we are talking of a maximum of a couple of months which doesn’t worry me at all.” 

 

'NOT WORRIED' Macau Business

MGM China chairperson Pansy Ho says its Cotai land application is being finalised and she's not worried.  She also says that the government “must give special attention” to future projects in Macau as the non-gaming aspect should also be taken into consideration.

 

CHINA APRIL BANK LENDING WEAKER THAN EXPECTED Reuters

Chinese banks wound down their lending in April from 14-month highs to extend 681.8 billion yuan (US$107.98 billion) worth of loans, missing analysts' expectations of 800 billion yuan.

 

 



GENTING Q1 - IT COULD'VE BEEN SO MUCH BETTER

Gross revenue blowout comes at a high cost

 

 

Sky high rebates, low non-gaming revenues, and higher fixed costs took away from what was a great top line quarter.  It's clear that the flow through on GGR to net revenues at RWS is simply inferior to MBS.  This quarter, net gaming revenue was only 66% of GGR at RWS (a record low flow through for the property) vs 81% at MBS.

 

The Good

  • At S$999MM, GGR was S$90MM better than we estimated and likely higher than any sell side estimates.  There was volume growth across all segments of the business QoQ.
  • VIP:  RC volume of S$15.5BN was 4% higher than we estimated.  Gross win was S$527MM (S$78MM above our estimate).
  • Gaming machines: we estimate that win was S$178MM on handle of S$3,717MM, a 10% sequential increase

 

The Bad

  • Non-Gaming Revenues Should Have Been higher: 
    • Non-gaming revenues were down QoQ when they really should have been at least flat given the addition of 200 rooms
    • Room revenue should have been up S$3.5MM QoQ with the increase in RevPAR and room count.  
    • USS revenue was down S$7MM QoQ, which implies an S$8MM decline in F&B and other which is odd since those revenues are usually correlated with room revenues.
  • Holy rebates Batman!
    • While Genting management stated that was no change in their rebate policy aside from giving some breaks from early payments of receivables, the numbers tell a different story
    • We saw a huge spike in rebates (including GST and gaming points) in the quarter, which are simply the difference between gross gaming revenue of S$999MM and reported net casino revenues of S$655MM
    • Rebates were S$344MM in 1Q or 34% of GGR. As a point of reference, the rebates as a % of GGR have averaged 29% at RWS so this is a big spike.  In comparison, MBS's rebates were only 19% of GGR.  Put another way, the property's GGR increased S$96MM QoQ but net gaming revenues only increased S$11MM.
      • Here is our estimate of the rebate breakout in the quarter:
        • VIP:  S$239MM or 1.75%
        • GST:  S$47.5MM
        • Mass gaming points:  S$25MM or 1.9% of drop
  • Higher fixed costs
    • It looks like fixed costs increased to S$202.5MM, about S$17MM sequentially.  Some of this is for the hotel rooms coming online.  Unfortunately, non-gaming revenues were down QoQ while costs were up.

 


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Invisible Gorillas

This note was originally published at 8am on April 27, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Miracles happen everyday, change your perception of what a miracle is and you'll see them all around you.”

-Jon Bon Jovi

 

The Invisible Gorilla was an experiment performed by Professors Christopher Chabris and Daniel Simons at Harvard University in 2004.  In the experiment, candidates were asked to watch a short video of six people, three in white shirts and three in black shirts, pass a basketball around and count the passes. At a point in the video, a gorilla wanders into the action, faces the camera and pounds its chest.  In total, the gorilla is on screen for almost 9 seconds.

 

In theory, a gorilla wandering into the middle of an otherwise normal scene sounds like an event that would be relatively easy to notice.  The results, on the other hand, suggest otherwise.  Professors Chabris and Simons found that almost 50% of the people that watched the video did not notice the gorilla.  In fact, it was as if the gorilla was completely invisible. 

 

There are two key takeaways from the experiment.  First, we miss a great deal of what happens around us.  Second, we actually do not even realize that we miss things.  As stock market operators, we obviously pride ourselves in attention to detail and acute analytical skills.  The fact remains that both your and my skills of perception are just not as strong as we believe them to be.

 

As I think about this experiment, the scariest thing to me is the idea of overconfidence.  I would imagine that most of you believe that if you were to watch the video, you would see the gorilla.  The reality, though, is that only 50% would see it.  You may believe you have great skills of perception, but the facts suggest otherwise.  But, if you know just that, then you have a leg up on the competition.

 

I will give you an example of a hidden gorilla in the investing world.  Apple recently reported earnings and while Hedgeye currently doesn’t have a technology analyst, we had a healthy debate in our morning meeting on the stock.  On one side there were the bears who basically opined that Apple was a product cycle company and was only as good as its next product, that margins on its hardware sales inevitably had to revert to the mean, and, basically, that Apple couldn’t justify its valuation longer term.

 

On the other side of the debate was the Hidden Gorilla argument.  In effect, the proponents of Apple in our morning meeting argued that it is somewhat irrelevant to argue about price points on Apple hardware products or fret over the number of iPhones that were sold in the quarter because Apple is actually a software company.  Specifically, via its iTunes online store Apple has become the go-to marketplace for all critical digital content on the internet (from movies to music to books to TV shows to games).  In that business, Apple keeps 30% of the revenue and the publisher keeps 70% of the revenue, but unlike other ecommerce businesses, like say Amazon, Apple has no physical infrastructure costs so the business in theory generates very high and sustainable returns on capital.

 

Yesterday, Jeff Gundlach gave a really interesting presentation on his general view of the global economy.  He had one slide that discussed Apple and made a comparison between Google’s rapid rise and decline with the conjecture that as Apple effectively “becomes the market” it may have a similar path in the future.   Gundlach may be right on Apple, or in fact he may be missing the Invisible Gorilla, which is that Apple is a much better long term business than its valuation suggests. 

 

In the Chart of the Day today (yes it incorporates a picture of a gorilla), we compare the overall unemployment rate in the United States versus the unemployment rate for those aged 16 – 24.  In the U.S., the unemployment rate is currently 8.2% and the unemployment rate for the youngest demographic is double that at 16.4%.  This is perhaps the hidden gorilla in the U.S. economy, which is that the youngest demographic is massively underemployed.

 

In Europe, the unemployed ratio of the youngest demographic versus the average is even more extreme.  Spain exemplifies this more than any major European economy.  This morning Spanish unemployment ticked up to 24.4%.  Youth unemployment in Spain also ticked up, to a staggering 52.0%.  Trust me when I say this: a generation of unemployed is not a positive leading indicator for the outlook of any nation or region.

 

So, not surprisingly given the employment data the Spanish 10-year yield is back up testing the 6% line this morning. The only real positive indicator I have found as of late is that the perpetual contra indicator Standard & Poor’s cut Spain’s credit rating for the second time this year from A to BBB+ “citing struggling banks and deficit concerns”. Of course, it does beg the question . . . why was Spain rated A to being with?  But, who knows, perhaps the Invisible Gorilla in Europe is that rating agencies will get this one right . . .

 

While we are on the topic of European sovereign debt, Italy held a debt auction overnight.  In fact, Italy sold €5.95 billion of BTPs with 4-10 years maturity versus a maximum target of €6.25 billion. The 10-year average yield was 5.84% versus 5.24% prior and the bid-to-cover was 1.48 versus 1.65 prior.  Not even the Invisible Gorillas were buying at this auction.

 

Before winding this note down, I wanted to flag a call out from my colleague Darius Dale in a research note on Japan yesterday.  He wrote:

 

“As it stands now, Ozawa, who remains one of the most influential members of the ruling Democratic Party of Japan (w/ influence over up to a third of the party by some estimates), opposes the DPJ’s VAT hike bill. His exoneration means he is now free to stir the pot and rally support to defeat the bill from within. Further, his platform centers on expansionary fiscal policy, which, in addition to wanting a shot at regaining full control of the Diet via a snap election, is preventing the LDP from coming to the table to negotiate with the DPJ on its VAT hike proposal.”

 

Ichiro Ozawa has gone from being the Invisible Gorilla to being the 1,000 pound gorilla in the room, which according to Darius increases the risk that the VAT tax may not get passed and Japanese debt gets downgraded.

 

Perhaps the miracle that Jon Bon Jovi speaks of in the quote at the start is that we will get out of this global sovereign debt mess unscathed, or, at the very least, that it won’t end all that poorly.  Personally, I remain skeptical.

 

Keep your eyes out for invisible gorillas,

 

Daryl G. Jones

Director of Research

 

Invisible Gorillas - Chart of the Day

 

Invisible Gorillas - Virtual Portfolio



Optimistic Bias

“The optimistic bias may well be the most significant of the cognitive biases.”

-Daniel Kahneman

 

If I had to pick three books that have been the most influential in my learning process in the last few years, they would be: 1. This Time Is Different (Reinhart & Rogoff) 2. The Road To Serfdom (Hayek), and 3. Thinking, Fast and Slow (Kahneman).

 

The only way out of getting caught off-sides by the groupthink of our profession is to get into books. I think it’s critical to remove your mind from the daily dose of hope and get real with what’s not only happened across generations of economic history, but what’s developing in terms of what we’re learning about ourselves.

 

I call this being Duration Agnostic in my risk management approach. Long-term mean reversions in big Global Macro data and immediate-term behavioral factors in our heads matter, all at the same time. Embrace Uncertainty.

 

Back to the Global Macro Grind

 

If you loved the US stock market 7 trading days ago, you’re going to get married to it this morning. Or are you? Do you have to keep buying on the way down? When the facts change, do you? I don’t marry markets.

 

I can’t imagine anyone telling me with a straight face that they thought that JPM reporting a $2B loss on the eve of Durbin taking the Volcker Rule implementation to the Senate floor was either expected or reason to be optimistic. With both JPM and the Financials (XLF) having already broken my intermediate-term TREND lines of $41.14 and $14.99 support, respectively, timing here matters.

 

I’m not dog-piling bad news. In fact, from a leadership perspective, Dimon showed his stripes as being the real deal in terms of transparency and accountability last night. That doesn’t make this a ‘buy the Financials’ day though (see Chart of The Day).

 

On the margin, the fundamental news for the US Financials has been worsening for at least 2 months. As one of our top performing Risk Manager clients asked last night – “So, what do you think is already priced in?”

 

The short answer is I don’t know. We let the market tell us what to do next.

 

The more well rounded research and risk managed answer is something that our Managing Director of everything Financials, Josh Steiner, and I will host a conference call on at 830AM EST (email if you’d like to join).

 

What else do we know?

  1. The concept of the US “de-coupling” is as loose as Keynesian economic forecasting
  2. Globally Interconnected risk, across currencies, countries, and commodities, continues to flag bearish
  3. Whatever your bottom-up view is on the Financials, it has to be considered within the context of the top-down

We do Top-Down in 2-ways:

  1. Global Macro Top Down
  2. Industry Top Down

On the Global Macro front, here’s what I see across currencies, countries, and commodities right now:

  1. US Dollar Index up for the 8thconsecutive day to $80.20; EUR/USD moves back into a Bearish Formation
  2. US Dollar Index immediate-term correlations: SP500 = -0.91, EuroStoxx600 = -0.95, CRB Commodities Index = -0.95
  3. US Dollar Index  immediate-term correlation to the US Financials Sector ETF (XLF) = -0.92

In other words, the Correlation Risk is moving towards -1.0, again – and if you don’t remember how this movie tends to climax, you are definitely hostage to a serious Optimistic Bias. This is not a time to be recklessly long on a gross or net basis.

 

The Correlation Risk to the world’s reserve currency doesn’t always matter. But when you are in the soup like this, it’s basically all that matters. That’s the lesson of the 2008, 2010, 2011 Q1 peaks to the ultimate draw-down lows established sometime in Q3.

 

Valuation is not a catalyst right now. Events are. From a Top Down Industry perspective for the Financials, here’s what’s next:

  1. Morgan Stanley’s pending multiple notch ratings downgrade (May)
  2. Volcker Rule implementation (July)
  3. Europe (ongoing)

Notwithstanding that the US Money-Center banks are going to have to also report earnings in July – and that one of the main drivers of those cash earnings, Net Interest Margin (NIM), has seen the Yield Spread (10yr minus 2yr yield) compress by 21% since it topped in mid-March, there’s a lot to think about here.

 

If every single major Global Equity market hadn’t already put in a lower long-term high in late-Feb to early April, I would answer my client’s question with a maybe (in whether or not I think this is all priced in). But they have. So my answer is not maybe. You don’t pay me to be optimistic – you pay me to be realistic about real-time risk.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Financials (XLF), JP Morgan (JPM), and the SP500 are now $1, $109.71-113.87, $79.42-80.39, $13.87-14.99, $36.83-41.14, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Optimistic Bias - Chart of the Day

 

Optimistic Bias - Virtual Portfolio


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