DKS: Update from our HQ Visit



We came away from our meeting at HQ incrementally upbeat about DKS' sales/GM trajectory and and levers it has to pull ahead of the Street's number for the quarter and year.  This is not earth shattering, as DKS was one of the few retailers linked to this space that registered a positive inflection this past quarter.  But our sense is that the trends have continued (supported by outperformance of ths sporting goods channel in third party market share data).


Looking out a bit further, it is clear that DKS would like to resume a more normalized mid-teens square footage growth rate but will not do so until the real estate development pipeline begins to build.  In the interim, second-use sites and one-off real estate acquisitions are likely. We were particularly intrigued to learn that less than 10% of its leases come up for renewal over each of the next 4 years (DKS has a 10 yr target duration for its portfolio). We just heard from Finish Line that 40% of its leases are due within 18 months. Yes, the box economics are different between the two as FINL averages about a 5-year duration. But that definitely makes us question if DKS will benefit from the current property cost environment as much as others. In other words, has its aggressive plan to lock up property terms duriing the '-03--'07 bubble coming back to haunt them?


Here are some other notables...


Competitive Environment

- One of the more notable comments of the meeting was in response to a question about the macro environment and its current impact on the industry to which mgmt responded something to the effect of “from our perspective, we would have preferred for the rebound to have come later, it would have resulted in further shakeout within the industry.”


- TSA:

   - status of TSA’s financial health unknown within the industry

   - continue to add stores at same relative pace to prior years

   - not seeing any changes with in-store environment or promotional cadence

   - only competitor with similar box size out west (~50k sq. ft.) – most comparable competitor


- Academy Sports: 110 stores – 73 in TX

   - 80-100k sq. ft. footprint

   - Everyday low price

   - Moving eastward into TN, NC, KY (overlapping more with HIBB)

   - Approaching $2Bn in annual sales


- Hibbetts: much smaller format, not competing much if at all head-to-head


Market /Regional Trends

- All regions performing similarly, no standouts to note. 

- Target market size has/will not change

   - not considering utilizing a smaller format to pursue smaller markets (i.e. HIBB no interest)

   - minimum box size remains ~40k sq. ft.


Store Additions

- Westward growth – have secured 10 of 32 Joes locations

   - (6 to open in Oct, 4 in 2010)

   - Was watching Joes for 2-3 years before sites came on market.

- Chicks acq primarily driven by box size – have built 2 additional DKS stores around these in CA

- Regions of greatest growth opportunity:

   - FL, TX, AZ, CA, Pacific Northwest

- Will build out in 1-5 location groupings, not 10+ chunks

- Priority towards vacant, build out (Greenfield), and second use (in that order)

   - Activity from a developer standpoint still very slow – is capping rate of growth via Greenfield opporty’s

   - Barring further filings, upside to expectations of 24 stores in 2010 is limited

   - Co-tennancy remains key factor in growth plans.  Won’t open sites unless tenants in strips are preferred retailers (i.e  

     BBY, BBBY, TGT, WMT, etc…)

- Mall 20% (~75-80k sq ft), off-mall 80% (~50k sq. ft)

- Unlikely to see any additional specialty concept acquisitions in near-term. 

- Will need to add a West Coast distribution facility in 2 years to support expansion.


Lease/Rent Terms

- Ability to negotiate rents is greater with new build outs with greater upfront capital commitment from DKS

- Don’t have a meaningful % of portfolio coming up for renewal over the next 4yrs, renewals become significant after then

- Typical lease is 10yr term with 4-5 options at 5yrs each. ($0.50 bump in yr 5)

   - Joes slightly different – DKS put up more capital upfront that usual to get them up and running faster

   - Much more favorable rents offset higher capital costs.


Store Economics

- $870k of CapEx / store

- $800-$900k of inventory expenses

- $200-$250k of opening costs

  = ~$2mm cash investment

- Expectation of cash on cash returns of 50%+ by Yr2

- On ~$9-$10mm in sales (~10%+ FCF margin)


Brand/Category Extensions

- Jordan shop-in-shops and yoga concepts are past testing phase and in the process of being rolled out into more stores

  (Jordan in 60+)

- Self service concept test in footwear has been a success (see pictures below), being rolled out in all new stores, retrofit

  will happen overtime.

   - Essentially inventory made available on floor – has enhanced customer satisfaction and conversion

   - Not translating into meaningful labor savings (has been largely reallocated in store)


DKS: Update from our HQ Visit - DKS 2 9 09


Figure 1: New self-service concept in the Footwear department.


- The North Face is now in ~80% of all DKS stores

   - While nearing full penetration, there is room to flex footprint within the store

   - DKS growing Nike ACG private brand within store (competes directly with TNF)

- Product mix (hardline 50%, apparel 30%, footwear 16%) unlikely to change materially

   - Hardline moving away from bigger ticket items (weights, machines, etc.) towards exercise balls & bands

- Private label and private brand continues to grow (last cited as 15% of total sales back in 2006)

   - Both have similar margins ~600-800bps better than product being replaced

   - Private label direct sourced

   - When asked if savings from sourcing will be reflected in pricing, commented that more likely to drop to the bottom line

   - Over the last 12 months, DKS has had more opportunity to purchase branded off-price product

   - Less in the way of exclusive product this year compared to last


Guns & Ammo

- Guns and ammo has buoyed several players in the industry – GMTN was “thrown a lifeline”

- Benefit will be anniversaried 11/15

- Traffic and demand remains strong to date

- Did not specify what % of sales G&A accounted for

- Stressed that was very much in initial stages of growth – “really in startup mode”

- Expected to be neutral to the P&L in 2009, positive in 2010

   - $25mm+ investment in F09


Golf Business

- Trends are improving visibly 

- Has been undoubtedly the most significant drag on GMs 

- Pointed out several times that clearance activity related to merchandise errors in golf will be complete in 3Q and the associated margin drag will end immediately as inventory is cleaned up.

- Considered an attractive growth engine 

- Own ~20% of golf market; ~4x greater than next largest competitor (Golfsmith at ~5%) 

- Vendor pricing advantageous due to size and stability relative to Mom&Pops 

- 3 key issues related to GG integration have been: 

   - Macro environment  

      - beginning to stabilize 

   - Competitive (historically adversarial) cultures 

      - DKS mgmt took control of Golf Galaxy as of 1/09 

   - Product  

      - too much private label; balancing with more private brand

      - reducing overall inventory

Marketing/Advertising Strategy

- Greatest allocation of spend is tabs – will continue to be

- Overall, print continues to shrink – moving towards direct to consumer (e.g. mobile, online, etc.)

- Using more spot network TV advertising, but not material to spend. 


Acquisition Outlook

- DKS: no plan to be acquisitive over next 18-24 months

- When asked about interest in other specialty brands, assured there is no interest – commented to the effect that following

  the recent integration of both Chicks and GG they “could use a breather”


Operating Margins:

- Most significant drag on gross margins (Golf Galaxy & Chicks integration and promotional environment) beginning to ease


- SG&A plans largely fixed for balance of 2009 and 2010 with investments in, new HQ, and merchandising and

  marketing systems


Inventory Control

- Plans to get inventory turns back to 2000-2002 levels over the next 3-years

- Considering a realignment of executive compensation tied to specific inventory turns/mgmt targets

- DKS continuing to push for and get better terms from vendors



DKS: Update from our HQ Visit - DKS Store KSWS 9 09

Figure 2: KSWS prominent end cap display.


There is a substantial high-end business in Las Vegas but it is slots and mid-level table play that comprise the bulk of gaming revenues.  Thus, we can derive a pretty good guess of gaming revenues given the visitation figures and even the airport traffic numbers.  Indeed, the correlation between the number of monthly Las Vegas visitors and gaming volume is 0.66.


Macau is a whole different environment.  Visitation has very little correlation to gaming volumes and revenue.  That may not be a surprise when considering the VIP segment.  However, even the Mass business has shown an immaterial correlation, R Square, and T-stat in the regressions, albeit slightly more correlated to visition than VIP.  The VIP and Mass segments continue to be driven by high end players.  This will probably change over time should slots ever take off and as the market grows.


For now, pay little attention when someone says "the casinos are packed" or "the casinos are empty". 


Business Week reported on McDonald’s expansion of its McCafés in Europe and like so many other reports regarding increased coffee competition in the U.S. that have come before it, implied that Starbucks will be the likely loser.  There are some definite differences in the way MCD is growing its McCafé business in Europe relative to in the U.S. and the outcomes are, therefore, likely to be different.  In both regions, I don’t recognize McCafé as a significant competitive threat to Starbucks.


We all know where I stand on the U.S. initiative; McCafé will not provide the added sales layer that so many are anticipating and it will not provide the necessary returns.  In the U.S, MCD did not build a separate café section, but rather, the bulk of the McCafé investment came from new equipment costs and the cost to remodel the drive-thru to accommodate this new equipment.


In Europe, MCD’s McCafé remodel includes adding a café area to existing restaurants with a separate counter and comfy furnishings.  Although the article correctly points out that because the café is located within a McDonald’s restaurant, it will still smell like a McDonald’s, the addition of the café does provide more of a coffee house environment than is present in the U.S. 


The more important difference, however, stems from franchisee support of the McCafé rollout.  In the U.S., there was a lot of “noise” in the system regarding MCD’s decision to nationally launch McCafé.  A lot of franchisees openly communicated their opinions that the test market performance did not warrant a national rollout.  The Business Week article points out that “European franchisees like McCafés because they encourage customers to stop in for breakfast and during off-peak hours. Store revenues jump 20% to 25% after adding a new McCafé, says Michael Heinritzi, McDonald's No. 1 European franchisee, with nearly 40 stores across Germany and Austria.”  Franchise support is often a strong indicator of future success because franchisees will typically only want to invest in something if they have seen proven results. The results appear to have convinced European operators where as the test markets in the U.S. left many franchisees concerned.


I don’t know enough about McCafé results thus far in Europe to know if it will prove to be a successful strategy for McDonald’s but it seems to be more promising than in the U.S., which I continue to think will be a failed strategy.  Relative to Starbucks, I continue to think that even with McDonald’s adding cafés in Europe that the two companies offer a completely different experience which will appeal to two different consumers.  McDonald’s will maintain its fast-food image first and foremost before that of a coffee destination.

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The Economic Data calendar for the week of the 28th of September through the 2nd of October is full of critical releases and events. The market will be impacted by several key non-economic factors as well next week: China will be celebrating the 60th Anniversary of the PBOC while the German National Election results will be digested on Monday. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  



Monday Sept. 28


North America

The Treasury will auction 4 week, 3 month and 6 month Bills at 1 PM.



In the UK, Nationwide house prices for September will be released on Monday morning, as will September Italian Consumer Confidence.



On Monday morning Taiwanese August Leading Economic Index levels will be released while in Japan August CPI as well as September Tokyo specific CPI, will be announced at 7:30 PM.  



Tuesday Sept. 29


North America

Case-Shiller Home prices for July will be released at 9 AM on Tuesday, followed by Conference Board Consumer Confidence levels for September at 10 AM and USDA September Agricultural prices at 3 PM. Weekly ICSC, Redbook and ABC Consumer Comfort index data will also be released at normal scheduled times. 



Tuesday brings a slew of critical economic data points for Europe. At 5 AM Bloomberg Eurozone PMI as well as Confidence Measures (Consumer, Economic, Retail and Construction) for September will be released.  Also on Tuesday morning German Import Prices for August, as well as Italian Business Confidence and Spanish CPI for September will be published. In the UK, third release GDP as well as second release Trade Data, Government Spending and Fixed capital Formation for Q2 are scheduled as are BOE Mortgage and M4 levels for August. The UK’s DMO will be Auctioning 3.75 billion GBP in Gilt due in 2022.



Hong Kong Retail Sales for August will be published on Tuesday morning while in the evening Japanese industrial production and Shipments for August and September PMI will be announced. Also in the evening, Retail Trade and Building Approval data for August will be released in Australia as will South Korean Current Account balance levels.



Wednesday Sept. 30


North America

Third Report Q2 GDP and Corporate Profits will be released at 8:30 AM on Wednesday while Chicago PMI readings for September will be issued at 9:45 AM. Weekly MBA Mortgage application data will be released at the normal time as will EIA oil gas and distillate stock levels. In Canada, August raw Material and Industrial Product Prices for August and July GDP by Industry and Average Earnings will be announced.



French and Italian PPI for August, as well as Italian CPI for September are scheduled for release on Wednesday morning as will September Eurozone Flash CPI. German Unemployment data for September will be published and the German government will be auctioning 2 year Schatz.



On Wednesday morning Japanese Housing Starts and Constructions as well as Thai Trade and Production data for August will be released. In the evening, South Korean Trade data for September and Japanese Retail Sales for August will be announced. Chinese PMI for September is scheduled for release at 10:30 PM.



Thursday Oct. 1


North America

At 8:30 AM on Thursday PCE and personal Income data for August will be released, while ISM Manufacturing levels for September as well as Construction Spending and pending Home sales for August will be published at 10AM. Domestic Car Sales will also be announced. Weekly Initial Claims, M2 and EIA Natural gas stocks data will be released at the normally scheduled times. The treasury will announce a reopen on 10 year notes, 10 year TIPS and 30 year Bonds at 11 AM. Finally, at 10 AM Chairman Bernanke will testify on regulation reform.



On Thursday Morning Reuters PMI-Manufacturing for September will be released for Germany, France, Italy and The Eurozone in aggregate, while in the UK CIPS PMI will be released. German Retail Sales for August will be announced at 2 AM. France and Spain will be auctioning Treasuries during the day while in the UK the DMO will be taking 2.25 billion in Gilts due in 2030 to market.



October First is the 60th anniversary of the People’s Republic and Chinese markets will be closed. September CPI for South Korea and August CPI for Thailand are scheduled for release on Thursday as will Indian Trade data for August (along with weekly WPI data). In the evening PCE, Income and Unemployment data for August will be released in Japan.



Friday Oct. 2


North America

The Labor Department will release September unemployment, Average hourly Wage, Non-Farm and Manufacturing Payroll at 8:30AM. August factory Orders will be released at 10 AM.



Eurozone PPI for August will be released on Friday morning as will UK CIPS Construction PMI.



The continuing celebration in China and the mid-autumn festival in Korea will leave markets closed in both nations on Friday. September PMI will be announced in Singapore.  



ELECTION PREVIEW: Merkel’s push to Build a NEW Coalition Government


Yesterday German Chancellor Angela Merkel arrived in Pittsburgh for the start of the G20. Unlike her global counterparts, Merkel has an election to win back home on Sunday. While it would appear disadvantageous for her to have left the campaign trail, we view her appearance at the G20 as a net positive for her campaign as it reinforces her creditability as a global leader working to solve the larger issues facing global economies. As we’ve hammered on in many posts this year, the task of returning growth to Europe’s largest economy has been no small feat, yet through Merkel’s leadership the country grew +0.3% in Q2 quarter on quarter—a gain not shared across most of Europe.


Below we’ve broken down the main parties and their platforms going into elections. Unlike in the US, German campaigning is carried out on a much smaller scale: not only can budgets not be compared to those in the US, but really only starting this month did candidates hold public (televised) debates.  With less than 48 hours before the vote, we like Merkel’s chances, yet her opposition Frank-Walter Steinmeier of the Social Democrats could stage a late comeback which would have serious implications for a governing coalition and impact the TAIL for economic and business development:



Chancellor Merkel and the Conservatives


Germany’s largest party, the Christian Democratic Union (CDU), together with their Bavarian Christian Social Union (CSU) allies, has held a steady lead in polls this year under the slogan, “We have the strength”, positioning the party as the only contender to make Germany stronger than it was before the crisis. On Merkel’s watch—in the last year alone—she has been responsible for issuing a measured stimulus package to promote growth (while not piling on excessive levels of public debt), crafting arguable the strongest auto rebate programs across the globe to incentivize growth in Germany’s all-important automobile industry, forming bad banks to remove toxic asset from bank balance sheets, leading negotiations to save Opel—a catalyst for demonstrating her focus on saving jobs—and has made tough decisions like the refusal of the government to bailout Arcandor AG, owner of one of the country’s largest retailers, Karstadt.  Despite a handsome spread over her challengers this year, the CDU has seen its support wane ever so slightly in September. The most recent polls suggest the CDU leads the SPD by a spread of ~10-11% (See Chart Below).




Platform: the CDU strongly rejects tax increases to finance measures to stimulate the markets and economic growth. Merkel’s plan for expansion includes boosting domestic consumption by 1.) Lowering income tax for the lowest income bracket to 12% from 14% and, 2.) Raising the threshold on the highest income tax rate (45%) to earners above 60,000 Euros from its current level of 52,552 Euros.  Additionally the party has stated that it will examine corporate taxes to ensure that they don’t over-burden firms.


The conservatives are against the introduction of nationwide minimum wage, promote stronger supervision of the banking sector, and support a strengthening of the EU’s Stability and Growth Pact, which underpins the Euro. Merkel holds that good ties with Russia are in Germany’s best interests and although the conservatives don’t want to build new nuclear plants, they argue that nuclear is an important part of the energy mix and want to extend legislation that would close existing plants in 2020.



Steinmeier and the Center-Left


The most significant challenger, Frank-Walter Steinmeier, is currently Merkel’s foreign minister, and is running under the Social Democrats’ slogan: the party of the people.  The SPD has been junior partners in the Grand Coalition since Merkel’s victory in 2005. Since 2005 popular support for the SPD in the Grand Coalition has waned, yet cannot be ruled out, especially considering their recent 2% gain in polling from 9/16 to 9/23, according to a Forsa/RTL poll.


Platform: Steinmeier’s most grabbing headline is a promise to create 4 Million jobs over the next decade. To help reduce the public debt burden, the SPD proposes raising income tax to 47% for top earners. To appeal to families the SPD offers to raise the tax break for each child per household by 200 Euros. The party hopes to cut the bottom income tax rate to 10% and calls for a nationwide minimum wage of 7.50 EUR/hour.


A big rallying cry for the SPD is energy policy, namely reducing the country’s dependence on oil and to get half of its power from renewable sources by 2030. On nuclear power the SPD stands with its policy (along with the Green party) to phase it out by 2020.  [At stake are stations run by Dusseldorf-based E.ON, RWE AG of Essen, Sweden’s Vattenfall AB and Karlsruhe-based EnBW Energie Baden-Wuerttemberg AG].


The SPD’s “Plan for Germany” entails programs to foster energy-saving and environmentally friendly industries that could employ two million people.  Further Steinmeier suggests that that healthcare system could employ an extra one million to cope with the country’s ageing population.



Forming Coalition Partners


Merkel’s preferred coalition partners remain the liberal, pro-business Free Democrats (FDP). Headed by Guido Westerwelle, the party has branded itself as representing the interests of small and medium-sized businesses, and has also been labeled the “party of the wealthy”.  Earlier this year the party saw its support surge to 18%, yet has settled down to 13% in the latest poll. The party has garnered support from the right as well as those dissatisfied with the efforts of the SPD in the Grand Coalition. While Westerwelle has voiced support for the CDU, it has not been ruled out that the FDP could join a coalition party with SPD and Green party depending on how the numbers shake out on Sunday.  The SPD, on the other hand, has voiced support of the Greens and Left party as coalition partners.  


Central to the FDP platform are tax cuts for families and middle income earners worth up to 35 Billion EUR and to simplify the tax system with three tiers: 10%, 25%, and 35%. The FDP wants to support small and medium-size businesses with 10-25% business tax, compared with the nearly 30% rate now. The party wants the state to sell its stake in the banks it has invested in. On foreign policy, the FDP calls for the withdrawal of troops in Afghanistan, a position not held by either the CDU or SPD, both of which see a continuation in near-term involvement.



By the Numbers


Undecided voters still remain aplenty. Due to the voting system there’s a potential to see a number of “overhang votes” in the Bundestag (Parliament), which could change the complexion of the winner and coalition formed.  Up until about two weeks ago, which coincides with the first dual and live televised debate (polls varied on the relative winner of the tv dual), Merkel and her preferred coalition partners (FDP) held a healthy majority of 50% support. Yet since then, the CDU has teetered slightly to the benefit of the SPD, putting into question the ability of the CDU and FDP to maintain a majority, which stands in and around 50% based on the voter tally.


Clearly the ruling coalition will have implications on the TAIL for Germany, the EU, and greater global landscape. Recent German sentiment indices, including the Gfk’s consumer confidence released today and Ifo’s business confidence released yesterday, both show steady improvement that should buoy Merkel’s credibility in strengthening the economy in these hard economic times (See Chart Below). Although the CDU looks to be in the driver’s seat, one cannot forget the sizable gap that Gerhard Schroeder (SPD) closed, despite losing, in the last elections of 2005.


We’re long Germany via the etf EWG in our model portfolio. We’ll have our sights on the election as it relates to our investment position.


Matthew Hedrick





Slouching Towards Wall Street… Notes for the Week Ending Friday, September 18, 2009

Streetballs – Obama Takes Wall Street To The Pavement


Settler Trouble – An Opinion On An Opinion


And: Dead To Rights – 6’, Granite Headstn, Rvr Vu




Speech Impediment

When all is said and done, much more is said than done.

                             - Anonymous


President Obama must be wishing he could trade places with Anonymous.  Anonymous is a world-renowned author of sayings ranging from the fiendishly witty, to the profoundly pithy.  Anonymous is quoted every bit as much as the Bible and Shakespeare, and with no less reverence.  Most important of all, while everyone knows Anonymous and know many of Anonymous’ sayings, no one can name a single thing that Anonymous actually did.  And yet, Anonymous is held in universal high esteem.  Our analysis indicates that Anonymous is universally revered, because he had the good sense to always speak wisely, and leave it at that.


President Obama shares certain characteristics with Anonymous.  Both are noted for saying profound things – which stir thought but in the end beget no action.  Both are known for their ability to get crowds nodding in warm agreement at their words, then walking away leaving their listeners to ask “but now what?”  And both are noted for their ability to eloquently support any point of view – so much so that one is often at a loss to know exactly where they stand on an issue.  So many similarities…


You notice that you never see the two of them together?  Coincidence…?


And so it was in the revered tradition of Anonymous that last week President Obama, true to form, saw a major problem – and said something about it.


Before we get into the story, here’s the punch line: the markets ticked up after Obama’s Wall Street speech, because the professionals realized the President is pandering to them.


The President has “sought ideas and input from industry leaders, policy experts, academics, consumer advocates, and the broader public. And we've worked closely with leaders in the Senate and House, including Senators Chris Dodd and Richard Shelby, and Congressman Barney Frank, who are now working to pass regulatory reform through Congress.”


Translation: The financial system has been assassinated and democratic society around the world is in mortal peril.  Round up the usual suspects.


For all the eloquent noise in the President’s talk – much of it worthy of Anonymous himself – there are moments when he managed to address what actually went wrong.  The “loopholes that were at the heart of the crisis. Where there were gaps in the rules, regulators lacked the authority to take action. Where there were overlaps, regulators often lacked accountability for inaction. These weaknesses in oversight engendered systematic, and systemic, abuse.  Under existing rules, some companies can actually shop for the regulator of their choice – and others, like hedge funds, can operate outside of the regulatory system altogether. We've seen the development of financial instruments, like derivatives and credit default swaps, without anyone examining the risks or regulating all of the players. And we've seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to someone else. Those who refuse to game the system are at a disadvantage.”


Many of the key problems of Wall Street are neatly summed up here.  But the conclusions drawn by the President are not unambiguous winners.


A Consumer Protection Commission.  Isn’t that fundamentally  every regulator’s brief: to protect the consumer?  Whether it be an individual trading her IRA, who is victimized by her broker – or a Fortune 100 corporation that can not ship its manufactured products across country without paying millions of dollars in bribes to the transport companies – the job of a government regulator is to establish standards and prevent abuses.  There is neither mystery not magic to any of this.  Nor is it sufficient to point fingers at the Great Stone Wall erected by former SEC Chairman Cox, nor to chastise the SEC staffers who prevented their junior reports from investigating Madoff.


The plain fact is that, in every aspect of its underlying mission of market integrity and consumer protection, the government of this nation has failed its citizens.  President Obama sailed into office on the mantra of Yes We Can.  Everything he has done since taking office seems to reveal that the real underlying message is – Well, We Might…  Significantly absent from the President’s speech was any hint of playing hardball. 


For example: Wall Street executives are forever admonishing their supervisory and compliance personnel “You can’t just impose compliance procedures on our salesmen and traders.  They’ll leave!”


In short: any time you throw up a roadblock in front of the wicked, they find a new route.  And Obama publicly caved in to this as well, acknowledging that regulation should not be so harsh as to drive business overseas.


So if we’re going to ask the very people who got us into this mess to give us the solutions, if we’re not going to make regulation “onerous” or “burdensome”, but instead reassure the powerful that we will keep their seats warm and cozy for them so they don’t have to go setting up shop in Andorra and Macedonia – then what exactly is it we are going to do, Mr. President?


As Peter Tosh sings, “Everybody want to go to Heaven, but nobody want die.”  The pathetic dithering in Washington makes it clear that this country has long since been sold to the highest bidder.  Can it really be that America can not take steps to prevent environmental disaster because it will cost money?  Can it really be that we will not provide medical insurance to 40,000,000 of our citizens unless the insurance companies and medical providers can be guaranteed they will make a profit on it?  The “Greatest Nation on Earth” (are we still allowed to call it that?) has been brought to its knees by its unquestioning embrace of the profit motive, to the exclusion of any notion of proper business practices.

It is our religion, and our fanaticism will be our undoing.


Wall Street was satisfied with Obama’s speech, because the biggest players will just continue to get bigger and bigger.  Washington – ably aided and abetted by the press – will go after the SEC, and not Goldman Sachs.  


A Consumer Protection Agency?  We love it!  Another layer of bureaucrats to tell the other bureaucrats what new forms need to be filled out.  A systemic risk regulator?  Bring it on!  We’ll keep moving the parts of the puzzle around so it always looks like someone else’s fault – and with senior Wall Street executives whispering in their ear, the Fed and Treasury are not likely to pull any surprises, especially when any adverse outcome will hinder repayment of the TARP Trillions.


Those who were terrified that Obama would socialize America were right after all.  Except his redistribution of wealth is going up the ladder, not down.  All because no one in Washington is willing to tell people “this will cost money”.


America was once the greatest country on earth.  Right now there is a Greatness vacuum, but America does not have the political will to make the tough economic policy choices that would propel us back to a position of prominence.  As our CEO, Keith McCullough says of many of the ill-advised programs being promulgated by our already-failed government, this is another thing that will end badly.


Or, as Peter Tosh sings, “You never miss your water ‘till your well run dry.”




I’ll Be The Judge Of That


When one reads of Settlement Expansion in the press, one is likely to think about tension between Israel and the Palestinian Authority.  But we have our own form of unbridled encroachment going on right here in the US, aided and abetted by everyone from the courts, to Congress, to the press.  Despite the widespread acknowledgement that it is contributing to disaster, there has been no sign of a settlement freeze.


And then along came Jed.


We welcome the recent article by Columbia Law School professor John Coffee (New York Law Journal, 17 September, “The End of Phony Deterrence?  SEC v. Bank of America” – available on the web at which asks, “With Southern District Judge Jed Rakoff’s blistering decision on Monday, rejecting the proposed settlement between the SEC and Bank of America Corporation, two key questions come to the fore: (1) Will this decision change SEC enforcement practices, which today invite corporate executives to purchase immunity for themselves with their shareholders’ money? and (2) Who is minding the store at the SEC so as to enable its litigators to shoot themselves in both feet?” 


Professor Coffee predicts that the SEC’s conduct in this matter “could haunt the SEC for years.”


Too right, we say.


This was the Commission that Chairman Schapiro vowed to turn around, bringing a number of cases right off the bat.  Now, it appears she has made such a feast out of low-hanging fruit that she is woozy with excess.  The B of A settlement represents the lowest of all: the shareholders’ cash.


Professor Coffee quotes Judge Rakoff’s decision as exposing a “cynical relationship between the parties.”  “The SEC gets to claim that it is exposing wrongdoing.”  Meanwhile, “the Bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators.”


When you look at it that way, it really is a win/win.


Professor Coffee is onto something deeper than just the BofA fiasco – and for our money, Chairman Schapiro should be bounced for signing off on this.  The fact that President Obama failed to pull her in for a good woodshedding only adds to his aura.  “Yes We Can!” is turning into “Awww – I Couldn’t…”  Next stop is – “Oh s**t!  Did I do that?!”


The culture of settlements is a time-honored one in the American practice of law.  Most lawyers, as the saying goes, don’t know how to find the courthouse steps – because their standing practice is always to settle cases.  Indeed, among tort practitioners, lawyers who refuse to settle are often seen as dogs in the manger, standing in the way of the proper flow of the legal give and take.  One of the ingrained characteristics of the American practice of law has been the one-third contingency fee.  We remember going through a number of arbitration and court cases before learning – naïve that we were – that the 33% figure is a convention.  Nothing in the canon of legal ethics or practices points to the figure of 1/3 of damages recovered as a fair – or “standard” – fee for legal representation.  For years, though, it was a given.  Thus did large segments of the legal profession evolve from advocates whose role was to win justice for their clients, to a cartel whose job was to ensure steady income from deep-pocketed corporate defendants.


Addressing the SEC’s practice of pushing for settlements, Professor Coffee calls this the “sale of indulgences” by the regulatory agencies, and urges the SEC Inspector General to follow up with a full inquiry into the SEC’s handling of the BofA matter.


Professor Coffee cites an SEC policy statement from 2006 that explicitly acknowledges that the Commission’s prior record in such high-profile matters had been weak.  Quoting from the Commission’s statement: “Where the shareholders have been victimized by the violative conduct, or the resulting negative effect on the entity following its discovery, the Commission is expected to seek penalties from culpable individual offenders acting for a corporation.”


Judge Rakoff was incredulous, among other aspects of this mess, that the SEC staff’s reason for not digging deeper was their understanding that BofA’s executives and board had relied on guidance of counsel.


We have previously observed this widespread lying down before the legal profession.  Congress, in their recent hearings on the BofA / Merrill transaction, accepted Fed Chairman Bernanke’s version of the events with an excess of restraint after Chairman Bernanke testified that he had acted in consultation with the Fed’s lawyers. 


Here’s a tip: as Professor Coffee points out, the SEC does not have to prove “scienter” – state of mind or malicious intent – to obtain a finding of negligence in a proxy matter.  The SEC staff were at a loss because BofA might have relied on opinions of counsel – but since they did not waive privilege, the SEC staff could not challenge the opinions (which they were not sure existed in the first place…)  but had they obtained access to the opinions, the SEC could have challenged them in court.  But they never even determined that these opinions existed…


We wondered at the time why the SEC did not simply find BofA negligent – thereby forcing them to cough up the opinions of their lawyers – if, indeed, they exist.  Hint to the SEC: you (of all people!) should know that, just because a lawyer says something is legal, doesn’t make it so.  And the regulatory agencies – and Congress – have the right to determine whether an opinion of counsel is valid, or at the very least to challenge it in court.  That the SEC failed to do so in this matter looks to us to be gross negligence.


One political problem is, if Chairman Schapiro forced BofA to cough up its legal opinions, would Congress not have to yank Chairman Bernanke back and make him do the same?  And former Secretary Paulson?  The Obama Justice Department hovered perilously close to challenging previous Department legal opinions, as a means to charge individuals with crimes regarding alleged torture of detainees during the Bush administration.  That they have not done so is likely not for fear they will lose, but some smart staffer probably looked out over the halls of Congress and whispered “Pandora’s box”.


Where will it end?  Apparently not here, and not today. 


As reported in Bloomberg (21 September, “SEC Bid to Speed Probes, Win Esteem Stumbles on Bank of America”) new Director of Enforcement Robert Khuzami exhorted the troops on his first day in his new position to adopt the “four S’s – for strategic, swift, smart, and successful.”  Khuzami says his objective is “to build strong cases, then compel defendants to settle quickly on the commission’s terms or face evidence in court.”  (Emphasis added)


Mary Schapiro, the New Broom, apparently is adept at the Old Trick of sweeping under the carpet, and plans to take it to a new level in her term as Chair of the Commission.


That bit about facing evidence in court is the only way there will ever be any transparency in the securities industry.  If people knew the real truth about what went on with Madoff, we suspect the outrage would reach to the Capitol building.  His guilty plea enabled him to avoid a trial, and robbed us of the explanation that we are rightfully entitled to.


The SEC’s BofA settlement is no less scandalous and should be seen as grounds for serious disciplining and censure of Chairman Schapiro, at the very least.


We suspect Chairman Schapiro was nervous about this matter.  Professor Coffee points out that, in a departure from standard SEC practice in such high-profile enforcement cases, the SEC office of the general counsel appears to run from this settlement like the plague.  Professor Coffee points out that, in keeping with standard SEC procedure, given the importance of the BofA case, high-ranking counsel should have signed the Commission’s briefs.  In the event, “the Commission’s two memoranda submitted to Judge Rakoff were signed only by the SEC’s associate regional director.”  Professor Coffee thinks this case might have been “orphaned because no senior official wanted to accept responsibility.”


We offer one observation in defense of the SEC’s approach: the days of the Trust Busters are behind us.  Gone is public sentiment for going after the Robber Barons, and the government is not about to slap cuffs onto the hands that feed them so sumptuously.  The world has fallen definitively under the sway of Gordon Gekko’s dictum that Greed Is Good.  Beyond being Good, the excesses of Wall Street have come to be viewed romantically, and greed is seen as being downright virtuous. The free-market capitalist democracy that was America is hurtling towards becoming the world’s leading piratocracy, where government – aided and abetted by a decidedly un-free press – continues to mount vast programs designed to steal from the poor, and give to the rich. 


The argument goes that, in a free market system, shareholders stand to reap the benefit of performance and thus, when performance goes negative, they deserve to be wiped out.  Alas, the SEC’s blatant theft of shareholder cash to shield those responsible for this fraud fits right into this Sheriff of Nottingham economy.  The Bush and Obama administrations have made not a single bean about bankrupting this nation to save the jobs – and personal wealth – of incompetent and corrupt senior managements, labor unions, and political cronies.  The American taxpayer – and in their wake, the rest of the world – have transmigrated to a new incarnation as Shareholder of Last Resort. 


Meanwhile, New York AG Andrew Cuomo is swinging his bat.  Love him or hate him, his office is bringing actual charges against real people in this miserable affair, and we have hopes that a head or two will roll.  At last, Robin Hood may be on the way. 


Professor Coffee’s full and dreary picture of the depths inhabited by this bottom-feeding Agency – the SEC – ends with the observation that the SEC Office of the Inspector General has not seen fit to look into the culture of settlements at the SEC and the way in which investigations are handled and settlements negotiated.


We wonder when they will get around to it.




Bid, Ask – Last Sale


Last week we wrote about Wall Street’s project to securitize life insurance policies (“And Now It’s Time To Play ‘You Bet Your Life’”).  In a related story, the Wall Street Journal (24 September, “Where Real Estate Is Still Hot”) reports on the burgeoning secondary market in grave sites – people down on their luck are selling their own intended final resting places, seeking to raise quick cash.


The Journal reports that many individuals have decided to “trade down”, from a full-out funeral to cremation.  A quick check on-line indicates that cremations go for as little as $1000 – far less than the cost of the traditional funeral, as several websites assure us.  Cremations are also pitched as environmentally friendly.  They use far less wood than caskets, no concrete is poured into the ground, and there are no embalming fluids to leach into the ground.


And of course, cremation has a smaller… er… footprint.


The Journal article helpfully gives tips on pitfalls to be aware of when buying or selling a gravesite.  Sellers should make sure the cemetery will permit transfer of title, while buyers should obtain verification of the actual owner of record.  (Wouldn’t it be embarrassing to bring Dad’s fancy coffin to your prize plot, only to see the Mahoney family shoveling dirt onto Aunt Sally?  Talk about bait and switch…!)


Companies mentioned in the article include such names as Grave Solutions and Caskets-N-More.


As this business heats up, will majors get into it?  Will Wal-Mart offer a range of affordable urns?  Will Home Depot produce a DIY casket kit?  Will Toys R Us offer a “Little Chiseler Do-It-Yourself Headstone”?


We would not be surprised if the Wall Street firms planning to securitize billions of dollars of viaticals also buy up large quantities of gravesites.  In B-School they call that Vertical Integration.


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.45%
  • SHORT SIGNALS 78.38%